Falling-Knife Cycle-Value Underwriting
Buy dislocated credit only after proving its value through the cycle
- Difficulty
- Advanced
- Time to result
- ~months to results
- Steps
- 5
- Confidence
- 96%
The framework treats a market collapse as a potential source of mispricing, not as sufficient reason to buy. First determine why holders are selling and whether the pressure comes from redemptions, structural leverage, or deterioration in the underlying business. Then conduct bottom-up analysis of cash flow, liabilities, asset value, and recovery prospects across a complete economic cycle. The purchase price must create an ownership valuation that remains acceptable if restructuring becomes necessary. Investors should assume the security may fall further immediately after purchase and size positions accordingly. The output is a defensible decision to buy, wait, or reject the opportunity based on business value rather than prevailing fear or short-term price direction.
Origin
Armen Panossian learned this discipline while Oaktree deployed hundreds of millions of dollars per day after Lehman Brothers failed, often while other market participants were forced sellers.
Core principles
- 01Price declines do not automatically imply permanent impairment
- 02Conviction must come from analysis rather than courage alone
- 03Underwrite ownership through an entire economic cycle
- 04Anchor decisions to creation value and recovery potential
- 05Expect further mark-to-market losses after buying
How to run it
- 1
Diagnose the dislocation
Determine whether the price decline reflects forced selling, disappearing liquidity, or a fundamental collapse in the borrower. Separate market mechanics from business impairment.
Pro tip Look for redemptions, bank balance-sheet pressure, or liability mismatches that can create price-insensitive sellers.
Watch out A low price is not evidence that a security is undervalued.
- 2
Underwrite the business through a cycle
Analyze normalized cash flow, leverage, liquidity, competitive durability, and refinancing needs under both base and stress cases.
Pro tip Model conditions that are worse than the current consensus forecast.
Watch out Do not rely on a quick market recovery to make the investment work.
- 3
Calculate creation value
Translate the debt purchase price and likely restructuring outcome into an implied valuation for the underlying company. Decide whether you would willingly own the business at that valuation.
Pro tip Compare the implied valuation with conservative asset and earnings measures.
Watch out Ignoring the post-restructuring ownership outcome can conceal substantial downside.
- 4
Size for continuing declines
Allocate enough to benefit from the opportunity without losing the ability to withstand or exploit further price falls.
Pro tip Reserve capital for subsequent purchases if the thesis remains intact.
Watch out Short-term marks may deteriorate even when the fundamental analysis is correct.
- 5
Hold to the analyzed outcome
Monitor whether business performance and recovery value remain consistent with the underwriting. Change course when facts change, not merely when fear intensifies.
Pro tip Document the original assumptions so later reviews distinguish thesis failure from volatility.
Watch out Conviction without ongoing verification becomes stubbornness.
In the wild
After Lehman Brothers failed, Oaktree bought hundreds of millions of dollars of publicly traded debt each day while banks, special investment vehicles, and hedge funds were forced sellers. Purchases frequently fell another five points within a week, but the team relied on cycle analysis and the valuation created by the purchase price rather than short-term marks.
→ The strategy produced strong performance and returned substantial capital to clients.
A lender facing redemptions offers the senior debt of a stable industrial company at 60 cents on the dollar. An investor stress-tests cash flow, estimates recovery at 80 cents, confirms manageable refinancing needs, and buys a modest position while reserving capital in case the price falls further.
→ The decision rests on recovery value and survivability rather than an attempted market-bottom call.
Common mistakes
Buying solely because the price collapsed
Distress can reflect permanent impairment rather than a temporary liquidity event. A purchase requires independent evidence that value exceeds price.
Treating volatility as thesis failure
A sound purchase can decline immediately in a panic. Investors should distinguish changing fundamentals from continued forced selling.
Using leverage that destroys patience
Excessive leverage can force an investor to sell before the analyzed recovery occurs, negating the framework's advantage.
Is it for you?
Best for
It is best for patient credit investors deploying capital during forced selling, panics, or liquidity shocks.
Not ideal for
It is not suitable for leveraged investors who cannot tolerate illiquidity, volatility, or additional price declines.
From the transcript
“we are paid to catch falling knives. That's our job.”
“We need to do our work and make sure that we've done a very good amount of analysis to be comfortable with owning a business…”
“everything we bought was down five points a week later”
From the episode
Armen Panossian on Credit in a Time of Rising Rates
Armen Panossian