On page 121, the author writes: “The purpose of sub debt can be because of ‘market discipline’ reasons enticed by bank regulators to disincentive moral hazard.”
Read that sentence. Then reread it. You think you might understand what it means, but you wonder whether the author is actually Google Translate. Then reflect: much of the book is written in prose, which is just as convoluted. What is more, author, Ben Emons should sue his proofreader because the text is peppered with infuriating typos that make his already complex arguments even more opaque.
That is a shame because the author is clearly a well-informed and smart guy with an important case. This is that stocks and bonds are not as different as you might think. Both can be seen as instruments representing claims on future cash flows, albeit those flows are delivered to owners either fixed (interest income) or variable (dividends).
This similarity has two important implications, which Mr Emons explores. First, the prices of both are influenced by interest rates, and this means there will be occasions when a corporate bond or its related equity will offer better value to an instrument-indifferent investor. And yet value is often left on the table because investors unnecessarily segregate themselves into one or the other asset camp.
Next, stock and corporate bond holders are exposed to the same company-specific risks. Any adverse development that threatens corporate bond interest payments is more than likely malign for ordinary dividends. There is a useful stock market law that states when equity holders of a company are optimistic, but its bondholders are pessimistic, you should always pay more attention to the bondholders. Candidly, this is because bondholders are more likely to do the necessary hard-nosed, detailed corporate analysis than their dilettante equity counterparts.
Will the book be useful to you? Try this quote on page 151 to see: “Then an investor should consider doing just the opposite: sell 2.5 per cent out of the money calls on the S&P Index and roll a short position in Eurodollar futures with a two-year maturity (as a proxy for seven-year Treasuries)”. Clear?
Nick Train is investment manager at Finsbury Growth & Income Trust
