Introduction and Company Overview

Market Cap: $1.3b

Enterprise Value (EV): $2.77b

Net Asset Value (NAV): $1.48b

Oaktree Specialty Lending Corporation (OSCL) is a business development company focused on debt financing, expansions, sponsor-led acquisitions, preferred equity, and management buyouts in small and mid-sized businesses. The company aims to invest across more than 15 sectors, diversifying its exposure to high-yield debt.Investments typically range from $5 million to $75 million, primarily in the form of first-lien and second-lien debt, with potential equity co-investment components.The company targets businesses with an enterprise value between $20 million and $150 million and EBITDA ranging from $3 million to $50 million.The fund has a maximum hold size of $75 million and may underwrite transactions up to $100 million, focusing on investments in North America. It aims to be the lead investor in its portfolio companies.As of September 31, 2024, the portfolio had a total fair value of $2.8 billion, consisting of 136 portfolio companies.

Why Invest in Oaktree Specialty Lending?

• Conservative Investment Approach: The company's adviser maintains a disciplined, conservative strategy focused on fundamental credit analysis and downside protection. It targets investments with strong credit safeguards, including default penalties, information rights, and financial covenants.
• Medium-Term Bond Issuances: Bonds are typically issued with maturities of 3 to 4 years, providing investors the opportunity to lock in current rates for the medium term.
• Oaktree's Investment Expertise: As the investment manager and advisor, Oaktree offers significant advantages to the business, benefiting shareholders through its expertise and extensive market knowledge.
• Long-Term Management Focus: Oaktree's management has a proven track record of delivering above-average returns to shareholders over the long term.
• Access to Exclusive Deals: Oaktree's strong reputation and long-term investment strategy provide it with access to proprietary deals and "first looks" at investment opportunities.
• Waiver of Incentive Fees: In 2024, Oaktree waived an incentive fee of $6.4 million, further demonstrating its commitment to shareholder value.
• Strong Insider Ownership: Insider ownership is currently at 22%, the highest level in years, aligning management's interests with those of shareholderscritical for long-term value creation.
• Institutional Ownership: Institutional ownership stands at 33%, which, while still relatively high, was over 50% in the past. If institutional ownership returns to these levels, it could drive increased demand for the stock, potentially raising its price.
• Insider Activity: Over the past three years, there has been insider buying activity, though the amounts have been modest. There have been no insider sells during this period.
• Recent Share Purchase by Oaktree Capital: In February 2025, Oaktree Capital I, L.P., an affiliate of the company's investment adviser, acquired $100 million in shares, paying a 10% premium to the market price at the time.
• Attractive Dividend Yield: The company offers a current dividend yield of approximately 14%, with debt yields around 10.7%. As long as interest rates remain stable, these dividend returns should continue.
• Trading at a Discount: The company is currently trading at a 0.9x book value, meaning the market cap may eventually converge with the book value, with the potential for the fund to trade at NAV in the future.
• Attractive Relative Valuation: Compared to similar organisations with parent company support, Oaktreespecialising in debt financingis trading at the most attractive valuation based on P/BV.
• Low Default Rate: Oaktree has maintained a default rate of 1-2%, significantly better than the sector average. In contrast, speculative-grade debt typically experiences a 2-4% default rate in normal conditions.
• Trump Presidency: Under a potential Trump presidency, the country could experience significant economic growth, which would likely reduce defaults as underlying companies perform better. As these companies expand, they may seek additional funding to support their growth.
• Investing in the Undervalued Small-Cap Market: As of February 2025, U.S. small-cap stocks are trading below historical averages. The Russell 2000 Index is at a 31% discount to the S&P 500 based on trailing P/E ratios, compared to the historical average of 4%. This presents an opportunity for Oaktree Specialty Lending Corporation (NASDAQ:OCSL), which lends privately and sometimes takes equity stakes in small-cap stocks, potentially benefiting from these attractive valuations.
• Regulatory Protections: OCSL is restricted from issuing shares below its Net Asset Value (NAV), a safeguard that protects shareholders from dilution and poor capital allocation practices. While this limits expansion opportunities, it serves as a more cautious and prudent approach, shielding shareholders from the risks associated with overly ambitious expansion plans.

Additionally, OCSL imposes restrictions on the types of investments that can be placed within its corporate structure. While some of these restrictions may seem unnecessary and could potentially exclude profitable opportunities, they reflect a more conservative approach that prioritises safety and stability for shareholders.

Catalysts for Growth

• Market Recognition of Strong Dividend Payouts: Investors may increasingly value the company's robust dividend yield, enhancing its market appeal.
• Continued Solid Performance: Oaktree's consistent ability to keep defaults low and generate steady cash flows positions the company for ongoing success.

Competitive Landscape and OCSL's Advantages

The specialty lending sector is competitive, with numerous firms competing to provide financing to middle-market companies. Despite this crowded space, Oaktree Specialty Lending Corporation (NASDAQ:OCSL) distinguishes itself through several key advantages that enhance its ability to source, evaluate, and manage lending opportunities effectively:

1. Deep Network of Industry Contacts

One of OCSL's most significant advantages lies in its extensive network of relationships built over decades through Oaktree Capital Management. This network spans private equity sponsors, investment banks, business intermediaries, and corporate advisors.

• Deal Flow Access: These long-standing relationships provide OCSL with access to off-market or proprietary dealsopportunities that may not be available to the broader market. This exclusivity reduces competition and allows OCSL to negotiate more favourable terms.
• Repeat Borrowers: Oaktree's reputation and prior successful lending arrangements lead to repeat business from borrowers, reducing acquisition costs and improving portfolio quality over time.

2. Rigorous Business Evaluation Process

OCSL employs a disciplined and comprehensive due diligence process to assess potential borrowers. Their evaluation is designed to minimise risk while identifying companies with strong fundamentals and sustainable cash flows. Key aspects of their methodology include:

• Qualitative and Quantitative Analysis: OCSL combines in-depth financial modelling (including cash flow, leverage, and enterprise value analysis) with qualitative assessments of management quality, industry position, and competitive advantage.
• Sector Expertise: Oaktree's team includes specialists across multiple industries, allowing them to evaluate niche sectors with precision. This expertise gives them an edge in understanding the unique risks and growth drivers of each borrower's business.
• Proactive Risk Management: By maintaining close oversight of their borrowers, OCSL can anticipate problems early and work with management teams to address potential challenges before they become significant issues.

3. Identifying the Right Borrowers

OCSL focuses on middle-market companiestypically firms with EBITDA ranging from $10 million to $250 millionthat may not have access to traditional bank financing. Their ideal borrowers often share the following characteristics:

• Resilient Business Models: Companies operating in industries with stable cash flows, recurring revenue, and defensible market positions.
• Underbanked Niches: Businesses in sectors where traditional lenders may be reluctant to engage, such as healthcare, technology, and industrials.
• Sponsor-Backed Companies: A significant portion of OCSL's portfolio consists of private equity-sponsored businesses, which are often better capitalised and more professionally managed.

OCSL's rigorous credit selection process emphasises lending to companies where they can exert influence or provide strategic value beyond capital. This approach allows them to maintain portfolio quality even during economic downturns.

4. Competitive Edge in Structuring Loans

OCSL differentiates itself by offering customised, highly structured financing solutions that meet the specific needs of borrowers. This flexibility gives them a competitive advantage over lenders that only provide standardised loans.

• Creative Loan Structures: They provide tailored financial instruments such as uni-tranche loans, second-lien debt, and mezzanine financing, enabling them to meet complex borrower needs while achieving attractive returns.
• Relationship-Oriented Approach: Their collaborative approach with borrowers means they are often a preferred partner for businesses seeking flexible and patient capital.

5. Barriers to Entry and Competitive Moat

New entrants face significant challenges in replicating OCSL's model due to the following:

• Reputation and Trust: Oaktree's established track record of responsible lending fosters trust with both borrowers and co-investors.
• Operational Scale: OCSL's size allows it to participate in larger, more complex deals and to spread risks across a diverse portfolio.
• Specialised Talent: Their team's deep expertise in credit analysis and distressed situations is difficult to replicate quickly.

While competitors may attempt to lure borrowers with better terms, OCSL's reputation for reliability, its bespoke solutions, and its ability to navigate complex financial environments give it a sustainable advantage in the specialty lending landscape.

Why Is the Fund Trading Below Net Asset Value (NAV)?

OCSL currently trades at 0.9x NAV, despite its strong track record and highly regarded advisors. Ideally, it should trade at NAV, given the quality of its management and performance history. However, the discount exists primarily due to its fee structure.

Fee Structure and Market Perception

The fund charges a 1% fixed management fee and a performance fee, which is structured as follows:

• A 6% annual hurdle rateif performance is below this threshold, no performance fees are charged.
• Returns between 6% and 7.2% per annum are fully taken as performance fees.
• Above 7.2% per annum, a 17.5% fee is applied to the excess returns.

While these fees may seem high, they compensate external advisors who manage the fund, as OCSL itself has no employees. Importantly, the performance fee structure aligns the interests of both the investors and the advisors, ensuring a focus on superior returns.

Market Mispricing and the Efficiency Assumption

The discount to NAV stems from traditional financial theory, which assumes that markets are efficient and that no one can consistently outperform the market. Under this belief, investors see the fund's fees as a long-term drag on returns, rather than a cost justified by skilled active management.However, this assumption is flawed. OCSL's advisors have consistently delivered strong results, demonstrating that expertise can add value over time. The market's inefficiency in recognising this creates an opportunity for investors willing to look beyond conventional wisdom.

Risks

Market Volatility in Economic Downturns

During the 2020 pandemic, OCSL's share price fell to $7, trading at a significant 62% discount to NAV (P/B ratio of 0.38). If another recession or financial crisis occurs, a similar decline could happen again.

Unlike traditional bonds, which tend to remain relatively stable during downturns, OCSL's share price is more volatile. If your goal is to hold bonds to balance your portfolio and maintain flexibilitymeaning the ability to sell bonds and reallocate to equities when markets are undervaluedthen this investment might not be ideal. Should prices drop as they did in 2020, I'd be more likely to hold my position rather than sell at depressed prices to raise cash for equities.

Default Rate Surge During an Economic Crisis

Defaults shoot up during times of economic crisis. This is a risk to consider when investing in OCSL.

Leverage and Restrictive Structure

OSCL operates with a 1.1x leverage ratio. And while this boosts returnssince they borrow at 6.7% and earn an average return of 10.7% on what they lendit also adds significant risk. Major asset devaluations could result in write-downs, potentially breaching the 1.3x leverage ratio required under the laws governing its RIC structure. This could lead to financial distress or even a forced restructuring at an inopportune time (although assistance from parent company could be a mitigating factor).

Exposure to High-Risk Debt

OCSL primarily issues loans classified as "junk" bonds, which carry a higher risk than investment-grade bonds. While these loans offer higher returns, they also come with increased default risk.

Lending to Smaller Companies

• Smaller businesses are generally less established in their markets.
• They have weaker government protection due to limited lobbying power.
• They often lack the experienced management teams found in larger corporations.

These factors make them more vulnerable to economic downturns.

Vulnerability in a Capitalist System

In a recession or financial crisis, the US government may not step in to rescue struggling businesses. Without state support, smaller firms could face severe financial distress, increasing the risk of loan defaults. If banks begin to default and credit markets freezesimilar to the 2008 financial crisisOSCL could suffer significant losses.

Also, any deposits exceeding the insured limit would not be government-backed, adding another layer of risk.

First Lien Loans and Collateral Risk

While 82% of OCSL's loans are first lien, meaning they have a primary claim on assets, the underlying collateral is often highly specialised. In a market downturn, demand for such assets may be low, potentially leading to significant write-downs and losses upon liquidation.

Interest Coverage and Business Resilience

The companies OCSL lends to have an average interest coverage ratio of 2.3x, which may appear adequate. However, financial stability depends on the businesses' cost structure and financial leverage. Companies with high fixed costs are particularly vulnerable in an economic downturn, as even a slight revenue decline could quickly turn profits into losses.

Interest Rate Risk

With 94.4% of OCSL's portfolio in debt and 87.6% of loans on floating rates, a decline in interest rates would reduce interest income from these loans. However, it would also lower OCSL's borrowing costs, largely offsetting the impact. The company also has hedging strategies in place to help manage and balance this risk.

Additionally, the value of fixed-rate debt would increase if interest rates decline, strengthening the balance sheet as asset values rise.

From current levels, interest rates are more likely to decline than rise if Trump implements policies such as:

• Expanding oil and gas supply, which could lower energy prices.
• Ending the war in Ukraine, potentially removing sanctions on Russia and further reducing energy costs.
• Cutting government spending, which could ease inflationary pressures, reduce the need for money printing, and improve the USA's credit rating.

To conclude, if inflation falls, interest rates are likely to follow. However, the overall impact on OCSL's profitability would be limited, as the key factor is the spreadthe difference between the borrowing rate and the lending raterather than absolute interest rate levels.

Outsourced Advisors

• The advisor can resign with 60 days' notice.
• They may seek to renegotiate fees, potentially demanding higher fixed and performance-based compensation.
• Key personnel could be poached by competitors through headhunting efforts.

Restrictive Mandate

OCSL is primarily limited to investing in debt issued by privately held and thinly traded public companies. Additionally, it cannot hold more than 3% of a company's equity. This rigid mandate restricts the asset manager's ability to pivot into more attractive asset classes as market conditions change, potentially limiting opportunities for enhanced returns.

Concentration Risk

The entire portfolio is currently invested in U.S.-based companies, making it vulnerable to domestic political and macroeconomic risks. While OCSL has the ability to allocate up to 30% of its portfolio internationally, it has opted to keep 100% of its investments within the U.S. Despite holding a diversified portfolio of 136 companies, it remains exposed to country-specific risks.

Stronger Competition

Although OSCL benefits from strong barriers to entry, competition in this niche market could intensify. Higher returns may attract new entrants, some of whom could have a lower weighted average cost of capital (WACC), stronger marketing strategies, greater risk tolerance, or more sophisticated risk assessment models.

Herd Mentality Risk

There is a potential risk that OCSL may lower its lending standards to stay competitive with the broader market. In periods of excessive optimism, many lenders ease their terms, which could pressure OCSL to do the same to maintain deal flow.

However, the fund's annual statements emphasise that it prioritises risk management over returns. Additionally, its advisors have a reputation for taking a contrarian approach, often avoiding market trends rather than following them. This disciplined strategy reduces the likelihood of reckless lending, though it remains a factor to monitor.

Conclusion

In conclusion, this investment does not offer significant growth potential. While it is unlikely to trade at its NAV, share repurchases below NAV can contribute to ongoing value. However, it is well-suited for retirees or individuals seeking additional income beyond what typical bonds provide, particularly through dividends. I estimate a long-term dividend yield of around 10% per year, with the potential for higher returns. While the portfolio carries more risk than a single high-quality corporate bond, it offers a higher return, is well-diversified, and benefits from strong management and experienced advisors.

I believe this investment is a sensible addition for those looking to enhance returns and generate a reliable income stream. However, it is important to be comfortable with volatility, as the stock behaves more like equity than a bondevidenced by its sharp drop to $7 in 2020 during the pandemic and lockdowns.

Disclaimer: This is not investment advice and is for educational purposes only. I do not hold a position in the stock described in this write up. Please do your own due diligence.

Appendix - Important Questions to Answer

Market and Company Sentiment The best opportunities often arise when sentiment is overwhelmingly negative. Ideally, you want to buy when Mr. Market is deeply pessimisticalmost irrationally so. As Warren Buffett (Trades, Portfolio) advises, Be fearful when others are greedy and greedy when others are fearful. Going against the crowd can be highly rewarding.

The market in the USA is currently high, as indicated by the Buffett Indicator, the Shiller P/E ratio, and the Inverted Yield Curve. While the company is trading below its NAV, it is doing so to a lesser extent than the median over the past decade.

Min:0.38

Med:0.83

Max: 1.13

Current: 0.91

Bad Narrative, Good Fundamentals Is the company's story unappealing, yet the financials and valuation metrics strong? Would it be a tough sell to the average investor? If so, that's actually a positive sign. The harder a stock is to market, the more likely it is to be undervalued.

The company's story is neither overly hyped nor unappealing. It provides a solid dividend yield, which is particularly attractive to income-seeking investors, especially retirees. This is easy to identify through screeners.

I believe I could convince the average middle-class person, even without much financial knowledge, to buy this stock by highlighting its diversified portfolio, its partnership with Oaktree, and its strong yield.

Has the company been the subject of negative media coverage? The market frequently overreacts to bad press, which can lead to overdone price declines, presenting potential buying opportunities.

OCSL has received limited media coverage recently. While there have been a few articles on Seeking Alpha highlighting concerns about its financial performance, mainstream media attention has been sparse.

Has there been a temporary dip in earnings? Analysts often make the mistake of blindly extrapolating trends, meaning a small downturn in earnings can lead to significant downward pressure on valuations. This is especially true when valuations are based on discounted cash flows, and where growth assumptions have a major impact on net present value.

Earnings are still positive but have declined. The large portfolio causes fluctuations in estimated values, resulting in both realised and unrealised gains and losses. Unrealised gains are recorded in OCI and do not affect net income or EPS, whereas realised losses do. Historically, write-downs have been sporadic, sometimes making earnings appear more volatile than they truly are.

Is the company stable but the stock price volatile? Remember, Mr. Market is there to serve you, not dictate to you. Volatility presents an opportunity rather than a risk. It allows a savvy investor to buy low and sell high. Therefore, it can be more beneficial to invest in volatile stocks.

No, the stock's price range has been relatively stable over the past ten years. The highest recorded price was $23, while the lowest was $7 during the pandemic. While this may suggest high volatility, the drop was an exceptional event. Note, if another pandemic were to occur, the share price could potentially reach similar lows again. Overall, volatility has been low, primarily because the company distributes 90% of its income as dividends, limiting price appreciation. Additionally, its straightforward business model and lack of involvement in the high-tech industry contribute to its stability.

Has there been forced selling or insider activity? Understanding the motivations behind who is selling and why is essential. Forced selling can create opportunities, while sales by seasoned investors or gurus may signal caution.

There has only been buying activity over the past three years, though the amounts have not been significant. In 2021, Leonard M. Tannenbaum made substantial sales at $22 per share (notably higher than the current trading price of $16). His reasons for disinvesting remain unknown at this time.

Are short-term prospects weak, but long-term fundamentals strong? Many funds focus on short-term results due to redemption pressures, leaving companies with short-term struggles but robust long-term potential as hidden gems for value seekers.

No, this fund isn't going through a short-term crisis. The long-term prospects are quite good.

Does the company exhibit high uncertainty but low risk? As Mohnish Pabrai (Trades, Portfolio) suggests, such situations may offer opportunities for outsized returns. Look for companies with uncertain outlooks but limited downside risk.

No. This company has relatively stable cash flows, but the primary risk is debt collectability, which impacts potential write-downs. This risk is heightened by the company's use of leverage to boost returns. While it borrows at a lower interest rate than it lends, failure to collect the debt magnifies the downside risk

Is the company involved in a lawsuit or legal challenges? The market often overreacts to legal issues, creating potential opportunities for investors to acquire shares at a discounted price.

There is nothing significant here that should deter investorslarge companies often face legal challenges.

Currently, the two most notable cases are:

Shareholder Lawsuit (Donoghue v. Oaktree Specialty Lending Corp.)

As of February 2025, Oaktree Specialty Lending Corporation (NASDAQ:OCSL) is involved in a derivative lawsuit initiated by shareholders. The case focuses on allegations that company insider Leonard M. Tannenbaum engaged in short-swing trading in violation of Section 16(b) of the Securities Exchange Act of 1934. Plaintiffs claim he profited by supporting the merger between Oaktree Strategic Income Corporation (OCSI) and OCSL, acquiring OCSL shares, and selling them at a profit within six months. The case has gone through various legal stages and was remanded for further proceedings as of June 2024.

Banca Progetto Investigation

In October 2024, Banca Progetto, an Italian bank backed by Oaktree Capital Management, was placed under judicial administration amid allegations of issuing state-guaranteed loans to businesses linked to organized crime. While this involves an entity associated with Oaktree Capital Management, it is not directly related to OCSL.

Neither of these cases appears to pose a material threat to OCSL's business operations.

Does the company have an unusual or quirky name? As Peter Lynch pointed out, companies with odd names can attract less attention, making them ripe for value investors looking for overlooked opportunities.

No, it capitalises on the well-established Oaktree name, which has been recognised and trusted for decades.

How many analysts cover the stock? Fewer analysts often means a stock is undervalued, as it may deviate more from intrinsic value due to neglect or limited coverage.

The stock has some analyst coverage, with the company listing seven analysts on its website (as shown in the image below). There are likely additional analysts covering it as well. This level of professional oversight reduces the chances of the stock deviating significantly from its intrinsic value.

Is the company too small for institutional investors? Many large funds have mandates that restrict small-cap investments, but small companies historically outperform large-cap ones (as shown in the Fama-French small-cap premium). As small-cap companies grow, they can draw institutional interest, driving up stock prices.

The company has a market capitalisation exceeding $1.3 billion and already attracts institutional investors, indicating that it is not too small.

Do investment gurus own shares in the company?

• • What percentage of their portfolio does the stock represent?
  • At what price did they buy?
  • What is their investment track record?
  • Have they shared their reasons for investing?

Guru ownership is often a positive signal, especially if their track record suggests a successful approach to investing.

No well-known investment gurus currently hold shares in the company. This is a drawback, as having investors with a strong track record invested alongside you is generally preferable.

• How does the current market cap compare to historical levels? Stocks that have seen significant price declines might present value opportunities, as they could be on sale. Investors should be cautious of speculative behaviour, where others chase stocks that are rising without consideration for their intrinsic value. A contrarian strategy can often lead to profitable outcomes.

The share price is currently $16, although it has been higher in the past. The decline since 2008 is largely due to the company being required to distribute at least 90% of its income as dividends to maintain its tax-exempt status. While it may appear to have been a poor investment for shareholders, this is not the case when you take the dividend yield into account.

• Warning! GuruFocus has detected 4 Warning Sign with OCSL.

Proximity & Access

• • Is the company close enough to attend AGMs?

The company's AGM is held in California, which makes it difficult for me to attend due to the significant expenses involved (flights, hotels, etc.). As a result, I won't have the opportunity to engage with other shareholders or access valuable non-public information. I will remain an outsider and won't be able to ask questions directly, which is a clear disadvantage.

• • Do I have an insider at the business whom I can speak to? Can I conduct a scuttlebutt and/or speak to management?

I do not know any insiders at OCSL or its affiliates. While it may be possible to establish connections, most of them are based in the USA, which presents a challenge. Additionally, all portfolio companies are located in the USA, making a scuttlebutt approach both costly and difficult to carry out effectively. This is a notable disadvantage.

• Has the company received a clean audit? Is the auditor reputable (Big Four) or relatively unknown? Have there been restatements in prior years?

The current auditors are Ernst & Young, a well-regarded Big Four accounting firm. They have held this role since 2018, indicating a long-standing relationship, which is a positive sign. At present, there are no disputes with the audit firm. However, during periods of financial distress, disagreements could arise, particularly over valuation methods and the growth assumptions applied to individual companies.

Share Issuance & Buybacks

• • When has the company issued shares, and at what price?
  • When has the company bought back shares, and at what price?
  • Did they issue shares during a market boom or when the stock was overvalued?
  • Did they repurchase shares when the stock was undervalued?
  • How aggressively did they act in these situations?
  • In hindsight, how are these transactions to be evaluated?

A significant portion of the share repurchases is carried out by associated third parties, so they don't appear in the accounts as buybacks. This makes analysis more challenging, but I trust that the advisors, who manage over $200 billion in assets, have a solid grasp of intrinsic value. They are likely to repurchase shares opportunistically when the fund trades at a notable discount to its NAV. If executed effectively in the future, this capital allocation could potentially add around one percent per year to the investment's return.

• Are there easy price comparisons (e.g., free comparison websites)? Transparent pricing often reduces margins.

Structuring a complex loan package involves more than just setting the interest rate; it also includes many other factors, making it a time-consuming and ongoing negotiation process. This is more intricate than a simple comparison of interest rates, meaning the market is differentiated and not solely driven by price competition. The borrowing firm will consider a range of variables, both qualitative and quantitative, to identify the best provider to meet their needs.

• Does the company have regulatory protections?

Yes, but the regulations in place are primarily designed to protect investors. OSCL's licensing requirements are not particularly difficult to obtain or highly exclusive, meaning these regulations do not provide them with a competitive advantage.

• How important is the brand?
  • Has it been strengthened or weakened over time?

Oaktree's brand has only grown stronger over time. Back in 2010, the firm managed$84 billion in assets under management (AUM)a figure that has more than doubled, surpassing $200 billion today. This expansion reflects Oaktree's ability to consistently attract capital, execute its investment strategies effectively, and reinforce its reputation as a leader in alternative asset management.

• How will technological changes impact this business?
  • Specifically, how will AI affect it?

AI may streamline the numerical and procedural aspects of credit analysis, making data processing and risk assessment more efficient. However, the relationship-driven nature of lendingbuilding trust, negotiating terms, and understanding nuanced borrower needswill remain fundamentally human.

Additionally, AI will undoubtedly impact the businesses within OCSL's portfolio, though in varying ways. Some companies may leverage AI for operational efficiencies, while others might face industry disruptions.

• What do the Buffett Indicator, Shiller PE, and Inverted Yield Curve suggest about the general market?

All three indicators suggest that the market is overvalued; however, larger companies appear significantly more overvalued compared to smaller-cap stocks. OSCL falls into the small-cap category, with a market capitalization of under $2 billion.

U.S. small-cap stocks are currently trading below their historical averages. The Russell 2000 Index, which represents small-cap stocks, is currently trading at a 31% discount to the S&P 500 based on trailing price-to-earnings (P/E) ratios. Historically, this discount has averaged around 4%, indicating that small-cap stocks are undervalued relative to large-cap stocks.

• Is the market fairly valued, overvalued, or undervalued? What is the expected return for the market?

The market's expected return being close to 0% suggests a notable overvaluation overall. Furthermore, prominent investors like Warren Buffett (Trades, Portfolio) have built up substantial cash reserves, indicating that he and his team are struggling to find attractive investments in this pricey market. Additionally, the decision not to repurchase Berkshire shares at current levels further signals caution regarding valuations.

That said, the potential of the AI revolution to stimulate greater prosperity could lead to higher market returns in the future, providing a glimmer of hope for growth despite present concerns.

• It is better to buy during recessions and when the public mood is depressed. The best time to buy is when "there's blood on the streets

Understanding the Business

• • Is this a business I understand?

I understand this business model. They have a competitive advantage in lending and fostering effective collaboration with small companies. Additionally, they successfully capitalise on the arbitrage between the rate at which they lend and the rate at which they issue notes or borrow from investors.

• • Have I worked in this industry before?

No, but I have experience working at Asset Managers. My background gives me a solid understanding of both the product and the industry.

• • Is it a simple industry to understand?

Yes, it's quite straightforward. Technology is unlikely to disrupt this industry significantlylending has stood the test of time and has existed for as long as civilization itself.

• • Have I personally bought or used the company's goods or services?

No, I haven't. This is quite challenging, as it would require running a company of the right size. Additionally, this is a highly niche market.

• • What misconceptions have led others to a different conclusion about this business?

Many so-called "investors" are actually short-term speculators. Their mandates force them to focus on the next year or two, preventing them from taking a longer-term view. As a result, some analysts may be buying or selling the stock based on short-term projections. In contrast, I am a long-term investor and do not face the pressure of redemptions.

The fund's fee structureparticularly the performance feehas deterred some investors. However, I believe the fee is justified because: (1) OSCL has no employees and outsources all its work to associated companies, and (2) the fee is reasonable given the value it adds.

What is the tax treatment for this investment? What structures can be utilised to minimise taxes, and which allowances can be applied to offset gains? Does the investment qualify for any exemptions from inheritance tax?

This investment is not accessible through an ISA or SIPP, only in a trading account, meaning the dividend gains are subject to tax. In the UK, dividend tax can be relatively high, depending on an individual's circumstances. Recent changes to the laws have reduced the annual allowance to just 500. However, the tax rate for the basic bracket is still only 8.5% (on income up to 50,270). Beyond that, the dividend tax rate rises to 32.5%, which is high and could significantly reduce the returns. I advise clients to consider this investment only if their dividend gains will remain within the basic tax bracket. Otherwise, the yield may not justify the associated risk.

For other jurisdictions, I suggest investors contact their financial advisor to understand tax considerations.

This article first appeared on GuruFocus.