Capital-Structure Opportunity Allocation
Choose the security offering the best protected return across the capital stack
- Difficulty
- Expert
- Time to result
- ~ongoing to results
- Steps
- 6
- Confidence
- 95%
Instead of beginning with a fixed stock-versus-bond allocation, map the investable claims across a company's capital structure. For each security, estimate expected return, contractual protection, recovery value, liquidity, and the conditions under which capital could be impaired. Debt can be preferable when it offers equity-like return with priority in a downside scenario; equity can be preferable when business quality and upside sufficiently compensate for weaker protection. Preferred shares, stressed bonds, and private credit can fill narrower opportunity sets. Portfolio cash is not a tactical macro forecast but the residual left when no available security meets the return and safety hurdle. Because liquidity differs across instruments, position sizes must also reflect the fund's obligation to return capital to investors.
Origin
Extracted from Masters in Business, where Steve Romick described building an unconstrained public-markets portfolio after finding equity-like returns in post-Drexel junk bonds.
Core principles
- 01Allocate by opportunity rather than asset-class quotas
- 02Compare downside protection and upside across securities
- 03Demand equity-like returns when accepting credit risk
- 04Let cash remain when no qualifying opportunity exists
- 05Respect liquidity obligations when using private assets
How to run it
- 1
Map the claims
List the company's common equity, preferred shares, secured and unsecured debt, and any accessible private credit. Record each claim's seniority, maturity, covenants, and liquidity.
Pro tip Include securities that are temporarily stressed or overlooked.
Watch out Do not compare yields without accounting for differences in seniority and loss severity.
- 2
Underwrite the enterprise
Estimate business value, cash generation, leverage, and asset coverage under several operating outcomes. Determine how much value reaches each layer of the capital structure.
Pro tip Stress the variables that affect both enterprise value and refinancing ability.
Watch out A senior claim is not safe when the enterprise itself cannot support the debt.
- 3
Compare protected returns
Calculate the prospective return and absolute downside for each security. Favor the claim that offers the best combination of return, protection, and realizable recovery.
Pro tip Ask whether debt can deliver an equity-like return with better downside protection.
Watch out High stated yield can conceal weak covenants or a poor recovery position.
- 4
Account for liquidity
Limit private or thinly traded positions according to the portfolio's redemption obligations and expected holding period. Treat illiquidity as a real cost requiring additional compensation.
Pro tip Reserve peripheral sizing for opportunities that cannot be exited readily.
Watch out Do not fund liquid investor liabilities with an excessive concentration of illiquid assets.
- 5
Allocate only when qualified
Buy securities that clear the portfolio's return and safety threshold. If none qualify, allow cash to remain as the residual rather than forcing exposure.
Pro tip Document why the selected claim dominates its alternatives.
Watch out Do not turn residual cash into an unsupported market-timing forecast.
- 6
Recompare continuously
Reassess securities as prices, fundamentals, covenants, and capital structures change. Shift toward another claim when its risk-adjusted proposition becomes superior.
Pro tip Review the whole capital stack after refinancing, asset sales, or major price dislocations.
Watch out Avoid holding the original security solely because it was the best choice when purchased.
In the wild
Coming out of recession and the Drexel Burnham collapse, Romick found debt securities capable of producing returns comparable to equities while offering greater downside protection. That experience established cross-capital-structure investing as a portfolio tool rather than treating fixed income as a passive allocation.
→ The fund gained a broader opportunity set for pursuing attractive risk-adjusted returns.
The portfolio periodically used secured first-lien asset-based loans when their contractual protection and return justified the illiquidity. Because Crescent is a public fund with redemption obligations, these investments remained peripheral rather than becoming the portfolio's main engine.
→ The fund accessed differentiated credit returns while containing liquidity risk.
Common mistakes
Forcing a fixed asset mix
A rigid allocation can require buying unattractive bonds or equities even when another part of the capital structure offers a superior claim.
Chasing yield without covenants
Low-quality contractual protection can transfer leverage from the lender to the borrower and undermine apparent downside safety.
Ignoring redemption liquidity
Excessive private exposure can conflict with the obligation to return capital promptly to public-fund investors.
Is it for you?
Best for
It is best for experienced investors able to analyze equities, stressed debt, preferred stock, and secured credit on comparable terms.
Not ideal for
It is not ideal for investors constrained to a single asset class or lacking the expertise to assess credit documents, covenants, and recovery values.
From the transcript
“we invest across the capital structure with this goal of delivering attractive risk of just returns”
“I learned that I could get a way to return in the debt markets that was as good as the equity markets with with with…”
“If we find an investment we like, we buy it. If not, cash ens up as a residual.”
From the episode
Steven Romick on Portfolio Investments (Podcast)
Steven Romick