Differentials, from Vince Fulco

October 23, 2008 |

Institutional investors now have a decade of no return. With some detailed credit work they can get 15-20%+ annualized from more senior securities and meet long term liabilities. Why subject oneself to the vol of equities when all your peers are moving to liability management policies and many are way behind the curve? The word on the street is hedgefund managers ( those still in existence) are blowing out their equity teams under the banner, "debt is the place to be for the next decade." Granted equities are undervalued by many historical measure but can stay so for a lengthy amount of time and the recent moves can be lethal if not careful.

Victor Niederhoffer asks:

Given that it would be possible to make 10% on senior debt, what would the required return on equities be at this level? That's my point about VIX and the required a priori rate of return.

Tim Melvin replies:

I would humbly suggest two times the level of senior debt rates.

Phil McDonnell ventures:

One reasonable and quantifiable approach might be to assume the market demands comparable Sharpe ratios from various asset classes. Consequently the ratio of the observed or estimated standard deviations of stocks to bonds may be the same as the ratio of the required expected returns.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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