Capital-Structure Relative Value
Choose the best-priced claim on a company, not a default asset class
- Difficulty
- Expert
- Time to result
- ~ongoing to results
- Steps
- 6
- Confidence
- 97%
Capital-Structure Relative Value begins with one fundamental view of a company, then evaluates the distinct claims issued against that business. Bonds, convertibles, preferred securities, structured equity, and common shares can offer sharply different income, downside protection, duration, and upside at different points in the rate cycle. The manager models those claims under common business scenarios and buys the security—or combination of securities—with the best risk-adjusted payoff. A strong company does not automatically make every claim attractive: low-rate bonds may offer poor compensation while the equity is reasonably valued, and a rate shock can later reverse that preference. The framework therefore joins company analysis with continual cross-security repricing rather than assigning a permanent favorite place in the capital structure.
Origin
Perks developed the approach through experience in equities, credit, and convertibles; Franklin's income portfolio often owns multiple parts of the same company's capital structure.
Core principles
- 01Analyze the company before choosing the security
- 02Compare every accessible layer of the capital structure
- 03Let valuation determine whether to own debt, equity, or a hybrid
- 04Seek income without surrendering attractive upside
- 05Reallocate when rates or prices change relative value
How to run it
- 1
Build the Company View
Assess the company's earnings, margins, cash generation, leverage, capital needs, and management's allocation priorities.
Pro tip Have equity and credit analysts examine management together to expose differences in the story told to each investor group.
- 2
Map Every Claim
List the accessible bonds, secured debt, preferred securities, convertibles, structured instruments, and common equity. Record their contractual rights and maturities.
Watch out Do not compare securities without accounting for seniority and embedded options.
- 3
Model Common Scenarios
Estimate the income, downside, and upside of each claim under the same company and rate scenarios.
Pro tip Include refinancing, credit-rating, and common-stock scenarios when evaluating hybrids.
- 4
Compare Relative Compensation
Evaluate whether each claim adequately compensates for duration, credit, liquidity, and equity risk. Reject securities whose yield or upside does not justify their exposure.
Watch out Investment-grade status does not remove interest-rate risk.
- 5
Select the Best Layer
Choose the security with the strongest expected risk-adjusted return. Hold multiple layers only where their different payoff profiles strengthen the portfolio.
Pro tip Use convertibles when they can blend income with meaningful upside participation.
- 6
Reprice Continuously
Repeat the comparison when rates, spreads, equity valuations, or company fundamentals change. Be prepared to migrate across the capital structure without changing the company thesis.
Pro tip Previously unattractive new issues may become compelling after a market repricing.
In the wild
A company's stock trades at a mid-teens multiple with a 3% dividend yield while its long-term debt yields only 1.5% to 2%. Under comparable company scenarios, the equity supplies more current income and retains upside, so the portfolio favors the stock.
→ The investor avoids accepting weak bond compensation merely for seniority.
Two years later, the company's stock remains near the same valuation while its bonds have fallen enough to yield 5% to 5.5%. The manager reruns the analysis and shifts toward the now better-compensated debt.
→ The portfolio captures changing relative value without requiring a new view of the underlying company.
A utility or industrial company offers an attractive long-term equity profile and a modest common dividend. The portfolio accesses a convertible whose coupon lifts portfolio income while preserving participation in equity upside.
→ The security improves current yield without fully surrendering appreciation potential.
Common mistakes
Buying Every Security From a Good Company
A favorable company thesis does not make every part of its capital structure attractively priced.
Comparing Yield Alone
Yield comparisons that ignore duration, seniority, optionality, liquidity, and upside produce false relative-value conclusions.
Keeping a Permanent Layer Preference
Rate and price changes can reverse which claim offers the strongest compensation even when company fundamentals are stable.
Is it for you?
Best for
Research teams with mandates that permit investment across corporate debt, convertibles, structured equity, and common stock.
Not ideal for
Single-asset-class mandates or investors without the expertise to compare claims with materially different payoff structures.
From the transcript
“looking across a capital structure”
“between a third or forty percent of the portfolio will be invested in companies where we own multiple parts of a company's capitals.”
“Absolutely, and that's something that we've really seen over the last five years”
From the episode
Franklin Templeton's Ed Perks on Fixed Income Investing
Ed Perks