Gentlemen Prefer Blondes... Investors Prefer Bonds

Our strategy focused on trades like these—legitimate companies with stratospheric stocks, buying reality and selling hype. It served us well throughout the 2001–2002 unwind of the dot-com boom. Our success came in part from what we did not buy—convertible preferred stocks issued by the most speculative telecommunications companies. Many hedge funds liked these trades because premiums on convertible preferreds are generally much lower than on convertible bonds. Lower premiums meant less capital at risk if you were buying the convertible and selling short all the underlying stock. However, the person who coined the phrase “you get what you pay for” might have had preferred shares in mind. Unlike bonds, preferreds typically have no set maturity—and even when they do, the maturity has no real bite. Companies that don’t pay bondholders can be forced into bankruptcy, while preferred shareholders can be forced to wait indefinitely. We received the spoils of at least one convertible arbitrageur who had gotten too big in convertible preferred shares. Such shares can be acceptable alternatives to the common stock at the right price, but only for investors fully cognizant that they will likely fare as badly, or worse, than common shareholders in down markets. For this r....