RiverPark Short Term High Yield Fund (RPHYX) – July 2011

By Editor

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/riverpark-short-term-high-yield-fund-rphyx-july-2011-updated-october-2012/

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds. They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisers. Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009. RiverPark oversees the five RiverPark funds, though other firms manage three of the five. Until recently, they also advised two actively-managed ETFs under the Grail RP banner. A legally separate entity, RiverPark Capital Management, runs separate accounts and partnerships. Collectively, they have $90 million in assets under management, as of May 2011.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY. Cohanzick manages separate accounts and partnerships. The firm has more than $320 million in assets under management. Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts. Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries. From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios. All told, he has over 23 years of experience investing in high yield and distressed securities. He’s assisted by three other investment professionals.

Management’s Stake in the Fund

30% of the fund’s investments come from RiverPark or Cohanzick. However, if you include friends and family in the equation, the percentage climbs to about 50%.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $20.5 million in assets. The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%. Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point. Update – 1.25%, after waivers, on $53.7 million in assets (as of 12/31/2011.)

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds. The case for seeking an alternative is compelling. Money market funds have negative real returns, and will continue to have them for years ahead. As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%. Fidelity Money Market Fund (SPRXX) yields 0.01%. TIAA-CREF Money Market (TIRXX) yields 0.00%. If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes. You might be tempted to say “that’s better than nothing,” but it isn’t. The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power. The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero. Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking. The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments. In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt. In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly. In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain. On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund. Cohanzick generally does not buy conventional short term, high yield bonds. They do something far more interesting. They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds. A firm or government might have issued a high yielding ten-year bond. Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make. That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds. Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%. You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy. The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them. According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.” The buyers are a handful of hedge funds and this fund. If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another. The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund. The others include

Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet. If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities. By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011. The public announcements gave the manager enough comfort to purchase the bonds, which were subsequently called less than 2 weeks later. Buying before call means that the fund has to post the original maturities (five years) despite knowing the bond will cash out in (say) 90 days. This means that the portfolio will show some intermediate duration bonds.
Cushion bonds (14%), refers to a bond whose yield to maturity is greater than its current yield to call. So as more time goes by (and the bond isn’t called), the yield grows. Because I have enormous trouble in understanding exactly what that means, Michael Dekler of Cohanzick offered this example:

A good example is the recent purchase of the Qwest (Centurylink) 7.5% bonds due 2014. If the bonds had been called on the day we bought them (which would have resulted in them being redeemed 30 days from that day), our yield would only have been just over 1%. But since no immediate refinancing event seemed to be in the works, we suspected the bonds would remain outstanding for longer. If the bonds were called today (6/30) for a 7/30 redemption date, our yield on the original purchase would be 5.25%. And because we are very comfortable with the near-term credit quality, we’re happy to hold them until the future redemption or maturity.

Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

It’s currently yielding 100-400 times more than a money market. While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
It features low share price volatility. The NAV is $10.01 (as of 6/29/11). It’s never been higher than $10.03 or lower than $9.97. Almost all of the share price fluctuation is due to their monthly dividend distributions. A $0.04 cent distribution at the end of June will cause the NAV will go back down to about $9.97. Their five separately managed accounts have almost never shown a monthly decline in value. The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade. Do you really want to bet on Eastman Kodak’s ability to survive to 2021? With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month. If he’s not sure, he doesn’t bite. And the odds are in his favor. In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985.
It offers protection against rising interest rates. Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
It offers experienced, shareholder-friendly management. The Cohanzick folks are deeply invested in the fund. They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers. We … know how to negotiate purchase terms.” They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund. It is, in the mutual fund world, utterly unique. It has competitive advantages (including “first mover” status) that later entrants won’t easily match. And it makes sense. That’s a rare and wonderful combination. Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure: I intend to shift $1000 from the TIAA-CREF money market to RPHYX about one week after this profile is posted (July 1 2011) and establish an automatic investment in the fund. That commitment, made after I read an awful lot and interviewed the manager, might well color my assessment. Caveat emptor.

Note to financial advisers: Messrs Sherman and Schaja seem committed to being singularly accessible and transparent. They update the portfolio monthly, are willing to speak individually with major investors and plan – assuming the number of investors grows substantially – to offer monthly conference calls to allow folks to hear from, and interact with, management.

Fund website

RiverPark Short Term High Yield

Update: 3Q2011 Fact Sheet

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