HYBRID VIGOR: VOL 3 ISSUE 3 "Old and New"

What did yesterday’s NFL conference championships teach us? For one thing, it’s good to keep a balance of old-school know-how and new, energetic approaches.

That said, it’s often easy to give the old school more credit than it deserves. “If it ain’t broke, don’t fix it” is a refrain that’s led many companies—indeed, many industries—to ruins that could have been avoided with imagination and energy. One could say that Peyton Manning showed he still had it yesterday, leading the Broncos to victory. While the result might suggest that, those who actually watched the game know that a mix of Denver’s fantastic defense (which kept Tom Brady off balance most of the day), a missed extra point, and a dubious choice by Bill Belichick were the keys. Peyton is still an NFL quarterback, but just barely.

The new stuff, meanwhile, is more likely to mean business. Cam Newton is the man. You may not love some of his antics but you can’t ignore how this remarkable athlete can dominate a game. Is there anything he can’t do?

You know what’s coming next. Something to do with convertibles. For those of us who know convertibles, the old-school convention has to be to view them as derivatives. A former boss of mine once harrumphed, “convertibles are derivatives and will be treated as such,” as a defense for having option-based models override experienced traders’ judgment on valuation and risk management. You should have seen the look on his face when one of his subordinates said he used “feel” in determining how to hedge his positions. And no, it wasn’t me.

But here’s the thing. While there are clear legal and economic distinctions between traditional stocks and bonds, and convertibles (as the old school knows) have pieces
of both, there are entirely reasonable views that work a bit differently. What if, for instance, you viewed the convertible as the core security representing a business’ cash flows and risk—equity-like at the low and high ends, bond-like in the middle—and then called those equity and debt pieces derivatives of the core convertible? Give it some thought.

To that end, today’s issue of Hybrid Vigor includes a guest submission that dares to suggest that some stocks can actually be analyzed using a convertible-like approach. While there are limits and pitfalls to such a line of thought, there can also be some major benefits. Read on and see what you think—we leave plenty of room for you to fill in the blanks as you see fit. 

(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).