Kenneth Jeffrey Marshall is an author, professor, and value investor. He is the author of the McGraw-Hill book Good Stocks Cheap: Value Investing with Confidence for a Lifetime of Stock Market Outperformance, which was also published in Chinese and Small Steps to Rich: Personal Finance Made Simple. He teaches value investing and personal finance at Stanford University; industry analysis in the masters in engineering program at the University of California, Berkeley; and investing in the masters in finance program at the Stockholm School of Economics in Sweden. He holds a BA in Economics, International Area Studies from the University of California, Los Angeles; and an MBA from Harvard University.
He is also the author of the recently published Good Debt Cheap: Value Investing in Bonds, Preferreds, and Other Fixed Income Securities and we took the value opportunitty to talk with about it.
Roque: Your first book was about selecting equities using a value investing framework. Your second book was about personal finance management. And on your third book you are focusing on selecting bonds. Are you slowly getting rid of stocks?
Marshall: Oh, goodness no. The order of the books just reflects what I was focused on at particular times.
Listed stocks is where high returns come easiest—anybody can see that—so that was naturally my first subject. Plus, that's where most of my teaching experience was. I'd been teaching equity value investing at Stanford since 2014. So “Good Stocks Cheap” came out first, in 2017.
Personal finance was next, for two reasons. First, I added a personal finance course to my Stanford schedule. So I got experience wrestling with the issues that students face with that topic. They're big, those issues. It's amazing how perfectly smart people become wedded to destructive money habits. Second, there were some people in my life that routinely botched money choices. Basic things: credit cards, leasing, spending, and so forth. I was sad about that. Sad—that's not too strong a word. So I wrote “Small Steps to Rich.”
This newest book, Good Debt Cheap, grew out of a course I started teaching in fixed income value investing. The timing turned out to be good. I wrote it just as bond yields were rising. But that's by chance.
Roque: Why did you write Good Debt Cheap?
Marshall: Over the years I saw some freak cases where certain investors made money—significant money—in junk bonds. Berkshire, for example. A couple decades ago it bought a junk bond issued by Tyco, the old industrial conglomerate. Tyco was going through a rough patch. Very rough. But what Berkshire seems to have focused on was the bond's put provision. It gave holders the right to force Tyco to buy the bonds back. And soon; the put date was in only a year or so.
Berkshire apparently saw that even though Tyco was in a pickle, it was likely to have enough cash to honor the put. And that's exactly what happened. I think Berkshire made about 29% on the deal. Twenty-nine percent, on a bond!
That's a lot. Any sensible investor would want to be able to identify such opportunities. So I poked around for a book, or a journal article, or anything, really, that described such cases. I was looking for a framework for uncovering big bond opportunities, and one that didn't misidentify likely defaults as promising.
I found a few good books on bonds. But they focused on investment-grade stuff. Treasurys, blue-chip corporates - securities with yields to maturity of three, four, or five percent. Those are useful to pension funds, and to some other pooled vehicles. They have their place. But to a stock picker - to an investor with a hurdle rate of 15% or so - they're narcoleptic.
So in 2015 I started writing the manuscript. It began as notes for a fixed income value investing course I was teaching. By 2022 I had about 30,000 words. But it wasn't until last year, 2024, that I busted out the final draft.
Roque: Could you briefly explain the value investing framework for select bonds that you propose in your book?
Marshall: Sure. It's similar to the framework for stocks - the one in Good Stocks Cheap - but with different particulars.
The overarching process has three steps: know what to do, do it, and don't do anything else. That sequence has really stood the test of time. It works.
The detail is under the “know what to do” step. It's three questions to ask about a security: do I understand it? Is it good? And, is it inexpensive?
“Do I understand it” is about defining the security along eleven parameters: issuer, currency, par value, issue date, maturity, payments, security, seniority, provisions, covenants, and liquidity. Those terms are just broad enough to accommodate both bonds and preferreds. Take payments. With bonds it means interest, and with preferreds it means dividends.
Next, “is it good?” This breaks into two parts: issuer and issue. If an issuer is good, it's likely to be able to service the security. That's mostly about solvency. The debt to equity ratio, for example, and the interest coverage ratio. But it's also about things like credit rating, ownership, and—with sovereign debt—the power to coin.
As for issuer goodness, that's mostly about performance. Is the security paying interest or dividends as promised? It's also about credit rating, and sometimes duration and convexity. But candidly, duration and convexity are often canards in the hunt for good junk. They matter with something like investment-grade bond ladders for pension funds. But in the junk game they're noise.
Lastly, “is it inexpensive?” That's usually about yield. If the security has a fixed coupon rate, the popular metric is yield to maturity. And that's often the best metric to use. But the book focuses a lot on embedded option exercises, situations where the key metric becomes yield to call or yield to put.
With floaters, my favorite metric is required margin. And with preferreds it's dividend yield. The framework accommodates all of that.
Roque: How would you filter the bonds arena to look for the kind of opportunities that you talk about?
Marshall: Well, as you know, I'm not a big fan of online screeners with stocks. But with fixed income, they're useful. I'll often screen for a high yield to put, and then do fundamental analysis to see if the issuer is likely to have enough cash to honor the put. Other times I'll screen for a high yield to call, and then see if the issuer's creditworthiness has increased enough for it to refinance at a lower rate.
The key, I think, is focusing on the right inexpensiveness metric. Take some fixed-rate coupon bond with a call provision. If yield to maturity is 7% and yield to call is 30%, and every other analyst focuses on yield to maturity while you see that the issuer's solvency has skyrocketed, you're going to zoom in on the 30%. And you should. The bond is likely to get called, because the issuer can refinance at a lower rate. It's simple.
Roque: Do you think that the returns on these types of opportunities have a low or high correlation with the markets?
Marshall: Short–term market correlations have never been interesting to me. I suspect that a concentrated portfolio of well-picked junk bonds would have low correlation to the Blomberg Agg, or to the S&P 500, or to much else. That's because they're about specific actions: exchange offers, recapitalizations, calls, puts, and so forth. Of course some of those actions correlate with macroeconomic circumstances, circumstances that register in market indexes. Calls are less likely when interest rates rise, for example.
But short-term noncorrelation has never been a goal of mine. The goal has always been long-term outperformance over the right benchmark. With junk, that benchmark probably isn't the Agg. That's because the Agg's bonds are investment grade. Instead, the benchmark is probably an equity index. And many of the cases in “Good Debt Cheap” blew past that kind of benchmark. Such cases will crop up again. They're findable. One just needs a good framework and the right temperament. I can't help with the latter.
Roque: What was the hardest part about writing the book?
Marshall: Well, piecing the cases together took some doing. The Tyco case, for example. I stitched it together from a bunch of SEC filings. Some were filed by Berkshire, and some were filed by Tyco. There wasn't some tidy summary that I could access.
Writing the glossary was also challenging. That's because I wanted to keep each definition short and digestible. Most of them are under 20 words. When you impose an economy of style like that, you have to know precisely what each term means. There's no wiggle room.
But none of the book was really hard, per se, to write. I like writing, and I like the subject.
Roque: Now that Good Debt Cheap has been out for a few months, would you have written anything differently?
Marshall:Not too differently. But there is something that I might have changed. The last case is an activist short. It's a great story. The investor thinks that the bond is going to crash. But it's hard to know exactly what the trade was. I treated it like an actual short, with the investor borrowing securities and then selling them, hoping to buy them back in the market at a reduced price. And indeed, that might have been the mechanism that the investor used.
But the investor might also have done it through credit default swaps. That would be a different mechanism. I could have added something about that.
That said, the book was already too long. The original limit was 60,000 words. But it came out at 67,000. So if there's a second edition I'd prefer that it be shorter, not longer. The bond world has enough tomes.
Roque: Couldn't you have just dropped the section on preferreds?
Marshall: I thought about that. But the line between bonds and preferreds is blurry. Take a preferred that's nonperpetual and cumulative. Nonperpetual means it ends, like a maturity date. Cumulative means that any missed dividend payments are still owed to the investor, like a missed coupon payment. That sounds a lot like a bond, doesn't it? I think so. So the preferred bit should stay, I think.
Roque: Your last book, Small Steps to Rich, was just for Americans. Is this one as well?
No, not at all. Small Steps to Rich is about personal finance. Personal finance specifics vary by country. For example in the U.S. we have 401Ks, IRAs, HSAs, and other things that are irrelevant elsewhere.
But bond investing is more like stock investing in that sense. It's international. Its specifics - - terms, solvency, guarantors, maturity, credit ratings - apply to fixed income securities all over the world. The words can vary, but the ideas are the same. It's not by chance that the book's examples come from Germany, Japan, Colombia - all over.
Roque: Have you used the framework in Good Debt Cheap since it was published?
Marshall: Oh, sure. There's one deal that matures in a few weeks, actually. It's crazy. Someone showed it to me in September, four months ago. It was trading at 80 something - - 85% percent of par or so - - and the coupon was four or five percent or something. But it matured in just a few months. So the yield to maturity was over 40 percent. I've never seen anything like it.
To be fair, there were solvency issues. The quick ratio was less than one, as was the interest coverage ratio. But the management team had decades of experience managing through tough situations. They had never defaulted on anything. True to form, they quickly got some of the bondholders to accept an exchange offer. And the other bondholders didn't get forced into the exchange. There was no collective action clause. So one could hold to maturity.
Such situations aren't common. But they happen. And that's the point. These 20 percent, 30 percent, 40 percent return opportunities, they pop up occasionally. So you want to have a way, a structured way, to assess them. My hope is that that's what Good Debt Cheap delivers.
