Is Your Capital Structure a Porsche or a Saab?

Erik Carlsson on the roof and Gunnar Häggbom at full speed in the 1962 Monte Carlo Rally. Source

David Dredge of Convex Strategies describes how downside risk control improves the long-term compounding of portfolio returns through the same dynamics of risk, braking, acceleration, and survival that determine who wins a Formula One race.

I find it applies to capital structures as well.

As Dredge puts it: “The most important thing on the car is THE BRAKES! The better the braking ability, the faster you can go between the sharp turns.”

“If you make a critical mistake at one of the sharp turns, the negative compounding effect means you aren’t winning the race (possibly not even finishing it).”

Races are won or lost in the curves, even if it’s the speed on the straightaways that sells the tickets or wins the underwriting mandate.

In capital structure terms, resilience changes the long-term compounding profile of the entire business. How many successful businesses damage their own long-term compounding because leverage forces management to slam on the brakes when they hit an unexpected curve?

Formula One takes place on a controlled circuit.

The Monte Carlo Rally, like capital structures, takes place in the wild.

In 1962, 313 cars started the Monte Carlo Rally. The race was five days and nights of endurance through snow, ice, fog, and narrow mountain roads under winter conditions in the Alps. Only 247 finished.

Saab entered a three-cylinder two-stroke that beat far more powerful and prestigious competitors through better traction, light weight, reliability, fewer moving parts, and engineering built for difficult terrain.

Every detail favored grip and agility over brute force. While rivals struggled, Saab’s unconventional front-wheel drive plowed through the snow and ice.

The best Porsche placed sixty-sixth. Saab took first.

After another upset victory in 1963, Saab began using the Monte Carlo name on a special-edition production car.

Its victories forced the rally world to rethink what mattered most. Not horsepower or prestige, but how every part of the car worked together in real-world conditions.

We have been enjoying a long hot summer on a capital markets straightaway.

Is it time to check what you’re driving?

Read the full Convex Strategies article here.

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