From the Bard to
Lessons in Fixed Income Investing
from Shakespeare
By Douglas Tengdin, CFA
S
hakespeare’s plays address
issues of life and death,
revenge and forgiveness, love and
hate, war and peace. The word
“genius” is overused today, but it is
the only term that does him justice.
He wrote for all times, all peoples, all
cultures. Shakespeare is performed
on stage, as ballet, as opera, in film, as
a cartoon, and there are over a dozen
Shakespeare apps. So it should be no
surprise that many of Shakespeare’s
insights can benefit investors. As we
examine what he has to say about
finance, borrowing, lending, and
markets it will be highly relevant to
investors.
william shakespeare
england’s national poet
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& the “bard of avon”
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“Neither a borrower nor a lender
be.” So spoke Polonius to his son
Laertes in Act I of Shakespeare’s
Hamlet. And that’s pretty much all
that people think Shakespeare has to
say on the subject of borrowing and
lending. After all, Shakespeare was
a dramatist. He wrote about life and
death, kings and courtiers, marriage
and love, and other life-issues. Some
say he was the greatest writer the
English-speaking world has ever
known. And it’s true that his works
have been continuously in production
since the day he penned them.
Shakespeare has a unique ability to
communicate something essential to
the human condition. That’s why films
based on his plays are almost always
enormous box-office winners.
the Bond Market
“To be, or not to be: that is the question.” (Hamlet III.i)
So it should be no surprise that his
insight regarding investment goes far
beyond prudential financial advice.
Polonius’s counsel is sound:
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
(Ham. I.iii)
Making loans to acquaintances is
hazardous: if they pay you back,
you may create hardship that will
be resented, and if they don’t pay
you back, you’ll feel awkward
collecting—and they’ll feel guilty. As
a general rule, avoiding leverage in
our personal financial affairs is a good
thing. Avoiding debt avoids interest
expense, and making loans to friends
and family is relationally risky.
But Shakespeare offers so much
more. His insights into human nature
often provide sound precepts for
all of life, which includes looking at
investments. And since there were
no organized stock exchanges at his
time, much of the investment advice
he offers is especially pertinent to the
bond market.
Security – The Law
Why do people buy bonds? Primarily
for security. Bonds are a senior claim
on the cash-flow of an enterprise.
Sometimes they are secured by
collateral. In The Merchant of Venice
the character Shylock makes a loan
to the businessman Antonio with an
unusual kind of security: a pound of
Antonio’s flesh. Typically, secured
bonds are tied to more economically
viable collateral—a plant, or a
home—that can be sold to recover
the principal. Nevertheless, Shylock
secures his loan of 3000 ducats with
a personal guarantee—one that will
cost Antonio his life if he defaults on
the loan.
When Antonio does default, he is
taken to jail, to secure his person
before the collection of the collateral.
And in a brief scene in the jail where
Antonio and Shylock speak, Shylock
repeats, “I will have my bond” five
times. Security of principal is of
prime importance to a fixed income
investor.
This is natural. Bonds are the ultimate
loser’s game. The upside is defined
from the beginning: principal plus
interest, and that interest is specified
in the bond indenture at the outset. A
10-year 3% bond will return a total of
30% to its owner over the course of its
tenor. No more.
But they can return less. If the
enterprise borrowing the cash
founders, bondholders have to
resort to the courts to recover what
they can. Sometimes a company in
financial straits can rearrange its
operations and make good on its
obligations. But more commonly
the financial structure needs to
be reorganized. That’s what the
bankruptcy courts are set up for. In
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such a situation, secured bondholders
get paid first; hence, Shylock’s
insistence on his collateral.
But the court is the final arbiter of
contracts. That’s why the play’s action
moves from the jail to the courtroom.
In the next Act, Shylock’s novel
security is reviewed. In reviewing the
law of contracts, Shakespeare has a
young judge declaim the importance
of precedent:
There is no power in Venice
Can alter a decree established.
‘Twill be recorded for a precedent,
And many an error by the same example
Will rush into the state.
(Merch. of Venice IV.i)
The priority of the rule of law is
critical to a well-functioning capital
market. If securities law and contract
law is not well-established, then
investment risk (and the cost of
capital) is higher. Later, when the
judge examines Shylock’s bond, he
finds no fault intrinsic to the contract
itself:
A pound of this same merchant’s flesh is thine,
The court awards it, and the law doth give it.
….
And you must cut this flesh from off his breast,
The law allows it and the court awards it.
(Merch. of Venice IV.i)
The law can seem harsh. But that’s
what the law is for: to enforce
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actions that would be unacceptable
if undertaken by a private individual.
In this case, however, the contract is
suspect. It would never pass muster
today, and as an audience, we don’t
want Antonio to suffer. Indeed, he
had offered to pay his creditor 18,000
ducats in recompense for the late
3,000 ducat loan, which Shylock
rejects, out of spite.
So we are not surprised when the
judge later finds a technicality which
spares Antonio’s life:
Tarry a little, there is something else.
This bond doth give thee here no jot of blood;
The words expressly are ‘a pound of flesh.’
But in the cutting, if thou does shed
One drop of Christian blood, they lands and
goods
Are by the law of Venice confiscate
Unto the state of Venice.
(Merch. of Venice IV.i)
It is significant that the law is not
set aside simply because it seems
unreasonable. Rather, the sanctity of
the bond is preserved, even as the
law is given a human face. This also
is important. Courts—while sworn
to uphold and faithfully interpret the
law—are also a human institution.
If they can uphold a law and reduce
human suffering that the law brings
about, they may well do that.
Security – Credit Analysis
When investors lend money, they
don’t need to just worry about the
legal structure of the indenture
agreements underlying their
bonds. They also need to look at
the enterprise’s credit. Good credit
follows five fundamentals: liquidity,
solvency, efficiency, credibility,
and growth. For years, bankers
have summarized these as the
“Three C’s: Character, Capital, and
Cashflow.” Character is a measure of
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management—how willing are they
to pay their debts; capital looks at
the balance sheet—how sturdy is the
asset base, and how much do they
owe; cashflow describes how strong
the business is—how able are they to
fulfill their obligations.
Indeed, the personal financial advice
of Polonius in Hamlet is sound
counsel for creditors:
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
(Ham. I.iii)
Polonius is urging a prudential limit
to leverage, and personal controls on
spending—husbandry. He goes on to
give other sound counsel:
Those friends thou hast, and their adoption
tried,
Grapple them unto thy soul with hoops of steel,
But do not dull they pal with entertainment
Of each new-hatch’d, unfledged courage.
Beware
Of entrance to a quarrel, but being in,
Bear’t that th’opposed may beware of thee.
(Ham. I.iii)
Laertes’ father is urging temperate,
self-controlled character. Credit often
comes down to whether the borrower
has a sound, growing business,
enough money to get by when
times get tough, and the integrity
to make sure his investors are paid
before feathering his own nest. In
other words, he doesn’t run off with
unclear, new-hatch’d plans. Polonius
tells his son to mind his character,
capital, and cashflow.
Of course, when we examine a
company’s credit, we look at their
audited financial statements, making
sure the auditors are also of good
character with sound businesses.
But we need also to look for the
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reality that underlies the financial
statements. Sometimes accounting
rules change, or the company adopts
novel interpretations to obscure
what is happening in its business.
But the truth always comes out.
Renaming something doesn’t change
its underlying reality. In the famous
“balcony scene” of Romeo and Juliet,
Juliet makes some remarks regarding
Romeo’s family:
‘Tis but thy name that is my enemy;
Thou art thyself, though not a Montague.
What’s Montague? It is nor hand nor foot,
Nor arm nor face, nor any other part
Belonging to a man. O, be some other name!
What’s in a name? That which we call a rose
By any other word would smell as sweet;
So Romeo would, were he not Romeo call’d,
Retain that dear perfection which he owes
Without that title.
(Rom. and Juliet II.ii)
Juliet wants to re-name her beloved,
to change the underlying reality that
the two lovers come from warring
clans. But tragically, they aren’t able
to escape the consequences of their
names. As Montegue’s and Capulet’s
they’re caught up in the feuds and
vendettas of their families. So watch
out for expenses that try to pass as
investments, for leases that are really
loans, for vendor-financed sales that
aren’t really sales. When it comes to
finance, new policies are sometimes
adopted to disguise reality. But the
truth eventually emerges.
Security – Diversification
Sometimes there are risks that come
from investing that are not related to
legal challenges or business credit.
If bad weather or bad economic
conditions or technological
innovations or competitive conditions
make it difficult for a company to pay
back its loan, investors may suffer
from losses—even if their claims are
legally sound, enforced by the courts,
and management wants to pay them.
There just may not be enough money
there.
It is situations like these that keep
some people out of the investment
world all together. They fear the lack
of control that comes with venturing
out into the investment world. They
don’t even want to consider the
possibility of loss. In the opening
scene of The Merchant of Venice,
Shakespeare portrays just such a
person. Antonio’s friend Salerio
describes what he would think about,
if he had invested in trading ships:
My wind cooling to my broth
Would blow me to an ague (sickness) when I
thought
What harm a wind too great might do at sea.
I should not see the sandy hour glass run
But I should think of shallows and flats.
… Should I go to church
And see the holy edifice of stone,
And not bethink me of dangerous rocks,
Which touching but my gentle vessel’s side
Would scatter all her spices on the stream.
(Merch. of Venice I.i)
Salerio would not be able to sleep at
night for worry. Everything would
remind him of some treacherous risk.
The investor, Antonio, explains why
these risks don’t worry him:
My ventures are not in one bottom (ship)
trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year.
(Merch. of Venice I.i)
Antonio lays out the fundamental
truth of diversification: by spreading
out our investments into diverse
enterprises, various countries, and
even into different time-frames, we
are far less likely to see our fortunes
compromised by one problem or
another. Diversification reduces risks
that we can’t control—that credit
analysis or other due diligence doesn’t
pick up ahead of time.
Investment Goals –
Diversification
Diversification reduces risk. But
it can also enhance returns. A
bond portfolio that is comprised of
many different types of bonds with
different maturities and different
credit characteristics will usually
have a higher return, for a given level
of risk, than a more concentrated
portfolio. That’s because when you
diversify, you don’t just reduce the
consequences if something goes
wrong. You also increase the chances
of something going right.
When Shakespeare writes about King
Henry V venturing to France to lay
claim some ancestral lands, one of
Henry’s counselors suggests a division
of labor to accomplish his ends:
That many things, having full reference
To one consent, may work contrariously,
As many arrows loosed several ways
Come to one mark; as many ways meet in one
town;
As many fresh streams meet in one salt sea;
As many lines close in the dial’s centre;
So may a thousand actions, once afoot,
End in one purpose, and be all well borne
Without defeat.
(Henry 5th I.ii)
Here is the positive side of
diversification: many arrows fly to
one mark; many streams meet in
one salt sea. Having a singular goal
is important. Using a collection of
different investment instruments to
reach this goal increases the investor’s
chances of reaching that goal.
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Investment Goals – Interest
Rate Risk
Of course, what concerns most
people who invest in bonds is the
risk that interest rates will rise. And
certainly, interest rate movements
are the most common source of bond
price volatility. Since the price of a
bond is determined by the present
value of its contractual payments,
their value rises and falls with
changes in the interest rate used to
discount those projected cashflows to
their present value.
Naturally, then, people worry that
changes in interest rates will affect
the value of their investments. They
shouldn’t. Prices may change. But
the value of an investment strategy
is determined by whether or not
it enables the investor to reach his
financial goals. No one ever bought
at the absolute bottom nor sold at
the very top. But many investors have
held back from investing from fear,
and so handicap themselves.
In Act I of Measure For Measure,
Isabella is urged to visit Lord Angelo
to sue for her brother’s release from
prison. Angelo is described as coldblooded and strict in upholding the
city’s laws, and Isabella doubts that
her suit will be successful. But her
friend tells her
Our doubts are traitors,
And makes us lose the good we oft might win,
By fearing to attempt.
(Meas. for Meas. I.iv)
Often the most difficult investment
action is to get started. Whether
it’s formulating a plan, or selecting
an advisor, or transferring cash,
doubts assail us all the time: “Is the
advisor honest? What am I leaving
out of the plan? Is this a good time?”
Human nature will always cause us to
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question our actions. This is healthy.
But once those questions have been
addressed, we need to act.
Investment Goals –
Predictions
Everyone has a forecast. That’s a good
thing. We should invest with a clear
view of what we expect to happen.
But our predictions shouldn’t be
the primary item that determines
our investment strategy. That
should be established based on our
return requirements, risk tolerance,
and other special limitations and
constraints. Bond investors need to
be aware of the current economic and
financial climate, but we mustn’t base
our policy on our predictions. In Act
V of Hamlet, the main character’s
friend urges him to avoid the
upcoming fencing dual with Laertes.
But Hamlet replies:
Not a whit, we defy augury. There is a special
providence in the fall of a sparrow. If it be now,
‘tis not to come; if it be not to come, it will be
now ; if it be not now, yet it will come—the
readiness is all.
(Ham. V.ii)
When we are investing, “the readiness
is all.” It’s critical that we be prepared
for adverse developments. But we
shouldn’t delay putting our plans into
effect because something unexpected
might happen. Something unexpected
will happen. It always does. We
need to plan on the basis of the
best information available, and then
execute that plan to the best of our
ability.
Innovation
Something new is always being
developed in the fixed income
markets. Because they are contracts,
there are always innovative kinds
of contracts to be had. Whether it
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was floating-rate notes in the ‘70s or
residential mortgage-backed bonds in
the ‘80s or asset-backed bonds in the
‘90s or collateralized debt obligations
in the ’00s, the types of bonds
seem to be limited only by people’s
imagination.
While most investors are naturally
conservative, these innovations
shouldn’t be rejected out-of-hand.
Of the examples I listed above, only
the last one—collateralized debt
obligations—turned out badly, for
the most part. And that was more
because of the conditions under
which they were issued, as much as
by the instruments themselves. The
other innovations were developed in
response to real market needs.
When I look at the pace of
innovation, I’m sometimes filled
with a sense of wonder. The capital
markets can be complex, but they
also have products to help investors
reach their goals. In the final Act of
one of his final plays, The Tempest,
Shakespeare has Miranda, the
sheltered daughter of the magician
Prospero, exclaim upon meeting a
crowd:
O wonder!
How many goodly creatures are there here!
How beauteous mankind is! O brave new
world That has such people in’t!
(Temp. V.i)
Ironically, some of those people are
kindly, and wish Miranda and her
father well. But some of them are
malevolent. In the same way, some
innovations are useful for investors.
But others seem designed primarily
to generate fees for the folks who sell
and manage them. Any investment
benefit is incidental.
Shakespeare urges us to be wise to
the ways of the world. Things are
not always as they seem. And yet,
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we should not reject an innovation
out-of-hand simply because it is new.
There are many ways the markets
can be made more efficient, and
more accessible, so that investors can
acheive their goals.
Conclusion
Part of what makes Shakespeare so
great is his vastness: he seems to
encompass so much of life. It has
been said that he doesn’t so much
imitate nature as his plays and poetry
are a force of nature. He doesn’t speak
about the world; rather, the world
seems to speak through him.
So it should be no surprise that we
can draw investment lessons from
his works. Investment is a reflection
on human nature, where the drama
is depicted in dollars and cents.
Shakespeare’s fictional characters—
whole and unique as they are—can
teach us how to be aware of our own
strengths and weaknesses, and how
to work with the resources that we
have. We can strive to follow the final
admonitions of old Polonius’s counsel:
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not be false to any man.
Farewell, my blessing season in thee!
(Ham. I.iii)
Douglas Tengdin, CFA
Chief Investment Officer
Charter Trust Company
Mr. Tengdin can be reached at 603-252-6509
or via email at: [email protected]