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The following post is as good a reason as any as to why I buy bonds.

Yes, on an absolute-returns basis, stocks --on average-- can be expected to offer greater reward, because they carry far, far, far, far greater risks. And even when you do a genuine, heads-to-heads, apples-to-apples comparison --such as buying both the debt and the common of the same issuer, and then enter and exit on the same dates-- stocks will offer larger money, because bonds are puts, and that insurance function has to be paid for. Anecdotally, I’ve found that the absolute-returns advantage (the “spread”, if you will) of owing the common versus the debt of the same issuer was about 3.5x. But, also, that was during conditions of rising stock prices. These days, with a broad-market correction --if not a crash-- quite immanent, the spread has probably lessened. So I decided to run the numbers.

Back during what is mistaken called “The Great Recession”, but which was merely a cyclical correction, asset prices fell almost across the board. No one could have known that prices wouldn’t fall further, and they should have been let fall further instead of the Treasury’s Plunge Protection Team stepping in and the Fed/Treasury cartel bailing out their Wall Street buddies. But falling prices were creating what a value-investor might have considered to be Ben Graham’s “a sufficient discount to intrinsic-value to create a margin of safety”, and he or she should have done some buying. Not a lot, but some, or else they couldn’t in good conscience have called themselves a ‘value-investor’.

In those conditions, and in that frame of mind, I got my butt back into the value game in early 2009, and I began buying. Not big, but widely, and one of the positions I put on was E*Trade’s 7-7/8’s of ’15 at 48 (all-in). Yesterday, the bond was called at par, meaning, I made decent money. But would I have done better if I had bought the common instead? The Motley Fool’s stock touts would reflexively say “Yes”, that stocks are what those who want to appreciate their capital should be buying. But if you want to appreciate capital, you buy ‘risk’, and it don’t make no difference where that risk is found, as long as, (1) you can price it properly and, (2) buy it advantageously.

E*Trade’s common pays no dividend. So setting up a head-to-heads, apples-to-apples comparison between the gains/losses to be made by owning the common versus the debt is very straight-forward. I put on my bond position on April 21, 2009 at 48. On that same day, ETFC closed at $2.43. My position was called yesterday, Dec 3, 2012, at par. Yesterday, ETFC closed at $8.34. I’ll leave it as an exercise to you to run the numbers. But it should be pretty obvious, no matter how you run them, that the stock/bond spread has narrowed substantially. (Note: when I do my comparisons, I don't do the cheat of reinvesting dividends or coupons. Total gains --any source-- are divided by the entry-price, meaning, for me, owing the bond offered about three-quarters of what the stock did, but with far less worry. Or, to say that another way, the stock/bond spread has narrowed to about 1.3x from its previous 3.5x.)

Now comes the important stuff. Were the returns for owing E*Trade's bond versus its stock merely an isolated, ignorable instance, or it is representative of a larger pattern? Again, I’ll leave that one for you to figure out by examining your own portfolio and running “what-ifs”. I just know from my own experience that a bond investor can hold his or her own in terms of decent-enough gains, and not because bonds or stocks pay better than each other, but because risk is risk, no matter where it is found. When the times are good, even idiots throwing darts make fabulous money in stocks. But when stock-investing get tough, those gains disappear like snow falling on the desert’s dusty face. And the same is no less true for bond-investing. There are easy times. There are tough times. But when bond-investing gets tough, a competent investor has a full storehouse that should carry him through the hard times until the buying can resume. But a stock-investor hasn’t the comfort of the promise of maturity for his purchases, nor as fat an income-stream from his dividends.

Do you want to eat well, or sleep well? Do you want the certainty of a bird in the hand, or the allure of two in the brush? Or is it a binary choice at all? Doesn’t Ben Graham-style, value bond-investing, when done “across the yield-curve and across the credit-spectrum” as a value-investor would be doing it, offer a lot of the advantages of the two, customarily-separated disciplines? In other words, by pricing and buying 'risk' properly, cannot close to stock-like returns be achieved with not much more than bond-like risks?

Years ago, “middle-path", Graham-style bond-investing is the way I chose to to go. I buy debt at enough of a discount to create some cap-gains for the account. (Hence, capital appreciation). But I pay up for what I'm buying enough to create some protection for the income-stream. (Hence, capital preservation.) Should I have bought the common in favor of the debt? The debt and the common? Or just the bonds, as I did? Who knows? This time, a decent-enough choice was to buy the put (aka, the bond). Which choice to make next time will depend on the circumstances, my willingness to accept ‘risk’, and --most importantly-- my ability to price those risks.


PS Excel's YIELD function suggests my YTM on the trade was 33.9%, which is good enough for the girls I go dancing with.
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