Why certain equities can be lower a risk proposition than certain bonds

Seth Klarman: “A common mistake institutional investors make is to allocate their assets into overly narrow categories. The portion of a portfolio that is targeted for equity investments, for example, cannot typically own bonds of bankrupt companies. Money assigned to junk-bond managers will be invested in junk bonds and nothing else, even when attractive opportunities are lacking. A municipal-bond portfolio will not usually be allowed to own taxable debt instruments.

Such emphasis on rigidly defined categories does not make sense. For example, a bond of a bankrupt company at the right price may have the risk and return characteristics of an equity investment. Equities such as utility stocks may demonstrate the stable cash- flow characteristics of highquality bonds. Equity “stubs” -low-priced, highly leveraged stocks- may closely resemble warrants, offering high potential return but with considerable risk. ”

source: Margin of Safety book by Seth Klarman

Especially the second half of the above paragraph cannot be stressed enough. Sometimes equities of certain companies have risk characteristics, when looked at over a time period as opposed to a point in time, that is a very favorable risk return situation. And other equities can be as risky as an option, think of biotech companies that meet or fail to meet their phase III clinical study targets.

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