No. of Recommendations: 1
Jack,

In another thread, you write: Picking corporate debt is easier than picking corporate equity, because there are far fewer moving parts.

How can there be “fewer moving parts”? In either case, it’s the same, underlying issuer that has to be understood, from the same information sources. Stock due-diligence or bond due-diligence, it don’t make no difference. Both had better be done thoroughly and competently, or else money is going to be lost. The number of moving parts is the same for either analyst. What is different, as you point out, is that for a stock-holder to do well, the company has to do well. But a bond-holder can do well if the company merely doesn’t go belly up. But to that upside, there is a downside. No matter how well the company does, the bond-holder doesn’t benefit any more than if the company does poorly, whereas if the company prosperous, the stock-holder can hit the jackpot.

In general, the difference I’ve observed between owning the debt and owning the common is about 3.5x in favor of equity. In other words, buy the bonds and buy the common. Sell the common when the bonds mature and compare the results. In general, with the past ten years being a weird anomaly, equity out-performs debt, because equity is riskier. To say that in another way, a bond is a put, and the premium is paid for with greatly-reduced returns. That said, I’m more than willing to pay the put-premium, because I value the reduced volatility that bonds offer compared to equity.

< I>Picking bonds is easier and safer, while buying them is still more cumbersome.

Again, I’d quibble. These days, if the issue is liquid, bond orders are easy to write, and fills are fast. So there isn’t much difference between executing a stock-order and executing a bond-order. What does deserve complaint is the abusive spreads and commissions that bond-buyers have to tolerate. Things are better than they used to be, but nowhere as good as the stock-jocks have it. OTOH, if the issue is long-dated and if the intention is to hold to maturity, then execution costs drop to reasonable levels. But the bottom line is that bonds are an institutionally-dominated market in which retail investors are unwelcome and, therefore, poorly-served. That’s slowly changing, but it won’t ever go away.

Of the potential risks floating around in the current markets, the two we ought to worry about most are inflation-risk and reinvestment-risk. The fear of bankruptcy and realized capital losses within individual corporate bonds is highly overblown.

Nope, that just ain’t so. There’s nothing overblown about BK and capital-loss, or have you already forgotten what happened to anyone holding Lehman’s double-AA rated debt and whose court case is still dragging on, and on, and on? Or WAMU, Tribune, Sea Containers, Abitibi, TXU, Wolverine, to name just a few more? BK is real, and companies are all too quick to file Chapter 11 when it is to their advantage to do so. Also, recently, workouts have sucked majorly, coming in far below historical norms. That said, credit-risk is tolerable if it is properly managed, and the gains won by not avoiding credit-risk generally far-outweigh the losses, as well as offer the benefit of diversification. In other words, the fixed-income portion of a portfolio is far more robust if the bets aren’t focused on just the level/direction of interest-rates but include a judicious exposure to credit-risk as well.

You are correct. In your prior reply you said that these are puzzling times.

Puzzling? What’s puzzling? Prices go up, and prices go down. Have you done any bond-shopping lately? There’s still stuff to buy, just as there always. Not as easy or obvious as when we were coming off the March, 2009 lows. But I’m not having trouble putting new money to work in bonds, at tolerable prices and yields.

Charlie
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