Podcast Summary
A Career in High Yield Debt Investing with David Sherman: David Sherman shares his journey in high yield debt investing, from college to becoming a junk bond analyst, and provides insights on strategies for short and long duration investing, responsible credit, and SPACs.
That David Sherman, the founder and portfolio manager of Crossing Bridge Advisors, shares his long and successful career story in investing in high yield corporate debt. He was drawn to this asset class during his college years when interest rates were coming down and people were seeking yield. Despite the risks involved, he was determined to minimize them by learning from his experiences and seeking out great mentors. His journey led him to work at Drexel Burnham and eventually join an insurance company as a junk bond analyst. Throughout his career, he has developed clear and concise strategies for investing in high yield debt, covering topics such as short and long duration investing, responsible credit strategies, and the unique risk-reward profile of SPACs. If you're looking for alternative assets in today's economy, this masterclass on high yield debt with David Sherman is a must-listen.
High yield investing: Understanding business models and mitigating risks: High yield investing offers lower volatility and potentially similar returns to the equity market, but requires thorough financial analysis and a focus on protecting principal. Find strong business models with damage for best opportunities, and consider derivatives for risk management.
The high yield market, which includes distressed and stressed securities, has historically produced returns similar to the equity market with less volatility. This makes it an intellectually interesting and less crowded space for investors who are good at gathering information and doing research. To mitigate the risks involved in high yield investments, financial analysis is key, and focusing on protecting the principal is essential. This requires being a bottom-up investor who understands the business model and does thorough analysis. The best opportunities often come from finding companies with strong business models that have experienced damage. Derivatives like CDS and CDX, or even buying puts on high yield ETFs, can also be used to hedge market risks. Overall, high yield investing is about understanding the business model, doing thorough analysis, and having some protection while giving up unlimited upside potential.
Understanding Distressed Investing and its Complexities: Distressed investing involves profiting from distressed companies by mastering bankruptcy laws, business models, and debt structures. Investors aim to buy distressed assets at a discount and benefit from their recovery.
Distressed investing is a specialized area of investing where investors use their understanding of bankruptcy laws and business models to profit from distressed companies. Distressed investors often act as equity investors in bankruptcy proceedings, but they must master the rules of engagement and conduct thorough analysis of the business model. Debt is the top of the capital structure in a company, and within debt, there are different tiers of seniority. In a distressed situation, understanding these tiers is crucial. Corporate debt comes in various forms, including private loans, syndicated loans, and structured products like collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs). These investors aim to buy distressed assets at a discount and benefit from their recovery. The evolution of distressed investing led many firms to become private equity firms, such as Oaktree, Cerberus, and Apollo. In summary, distressed investing requires a deep understanding of bankruptcy laws, business models, and debt structures.
Analyzing a company's debt involves understanding various types and risks: Secured and unsecured debt, mezzanine financing, and preferred stock each have unique risks. Equity investors and bondholders have different priorities. Rating agencies provide insights on credit quality, and companies can move between investment grade and high yield.
Understanding the different types of debt and their risks is crucial when analyzing a company. Secured debt, like a mortgage, may seem safer, but it's not immune to potential losses. Unsecured debt, mezzanine financing, and preferred stock all have unique characteristics and risks. Equity investors and bondholders have different perspectives, with equity investors focusing more on management and potential upside, while bondholders prioritize competence and minimizing risk. Hidden assets can impact both parties, and rating agencies provide valuable information on credit quality. Companies can move between investment grade and high yield, offering opportunities for higher returns when credit quality improves. It's essential to consider a company's total worth, potential risks, and the impact of external factors when evaluating its debt structure.
Impact of credit rating downgrade on bond price: A downgrade in credit rating can lead to a substantial loss in bond price, potentially impacting total return significantly.
The credit quality of a company, as represented by its bond rating, can significantly impact the return an investor receives. A downgrade in credit rating can lead to a substantial loss in bond price, potentially resulting in a significant decrease in total return. For instance, if a single A rated company is downgraded to single B, the spread over treasury could widen by 400 basis points, leading to a potential loss of 30-40 points in bond price. Additionally, investment grade bonds are generally not callable, meaning the company cannot refinance them easily, while high yield bonds have more flexibility in this regard. Understanding these concepts and the nuances of bonds is crucial for investors looking to navigate the bond market.
Support and resources bring ideas to life: Reliable support and resources can help bring innovative business ideas to life. Stay informed about market trends with Yahoo Finance, and consider short-term or low-duration investment strategies based on investment horizon.
Having reliable support and resources can help bring innovative business ideas to life. Raine Wilson's talking pillow, Sleep with Rain, became a success with the backing of AT&T Business. Similarly, staying informed about market trends and news is crucial for making informed investment decisions. Yahoo Finance is a valuable tool for keeping up with the latest financial news and analysis. Another key point discussed was the difference between short-term and low-duration investment strategies. Short-term bonds, with a maturity of one year or less, are ideal for those looking to invest for a shorter period, such as for college tuition payments. Low-duration strategies, with a maturity between one and three years, offer higher returns for a longer investment horizon. The Responsible Credit Fund was also mentioned, emphasizing the importance of responsible investing. While the alternative to responsible investing may not be explicitly stated, it implies investing without regard for social or environmental impact. The Responsible Credit Fund, on the other hand, focuses on investing in companies with strong ESG (Environmental, Social, and Governance) practices.
ESG ranking system concern: While promoting ESG-minded investing, it's important to consider the potential limitations and unintended consequences of an ESG ranking system. A holistic view of ESG, considering both positive and negative attributes, is essential, and being ESG-mindful is key.
The Responsible Credit Strategy is an ESG-minded investing approach that emphasizes a mindful and transparent approach to Environmental, Social, and Governance (ESG) factors. However, there is currently no standardization or agreement on what constitutes ESG or how to measure its impact. The speaker expresses concern that an ESG ranking system may be developed, which could limit investment opportunities and potentially lead to unintended consequences. The speaker advocates for a holistic view of ESG, considering both positive and negative attributes, and emphasizes the importance of being ESG-mindful rather than solely focused on meeting a certain ESG requirement. The speaker also acknowledges the potential for negative attribution in companies, such as Tesla, that may have governance issues or rely on government subsidies, and emphasizes the importance of considering the whole picture when evaluating ESG companies. The speaker's system for evaluating ESG is internal and constantly evolving, and they welcome the development of external systems while maintaining a commitment to being an ESG fund, but are also prepared to be ESG-minded if the requirements become too restrictive.
Crossbridge's ESG strategy: 80% completion threshold, 20% carve out: Crossbridge invests in companies with strong underlying businesses and good debt, even if they don't meet their ESG policy, improving their credit profile and attracting investors
Crossbridge's responsible investing strategy involves an 80% completion threshold for ESG attributes, while a 20% carve out includes companies with some ESG benefits but not meeting the threshold. An example given was MicroStrategy, which is owned by Crossbridge in multiple strategies but doesn't meet their ESG policy. The company's lack of a satisfactory ESG policy prevented it from qualifying for the 80% bucket. However, the investment was made due to the strong underlying business, the debt being secured by that business, and the potential for refinancing if Bitcoin's value increases. The investment in MicroStrategy also includes Bitcoin as collateral, which improves Crossbridge's credit profile. The minimum qualification for purchasing such assets is likely a reason why investors seek out firms like Crossbridge, which are FINRA sponsored and well-accredited.
Trading corporate debt less efficient for individual investors: Due to large transaction costs, market structure, and low liquidity, trading corporate debt is not yet efficient or accessible for individual investors. Consider passive ETFs or actively managed funds instead.
Trading corporate debt, unlike stocks, is not yet as efficient or accessible to individual investors due to large transaction costs and a market structure that resembles the old stock market with bid-ask spreads and market makers. The debt market is fragmented, with some debt remaining in the hands of a few large investors in "club deals," leading to less transparency and volatility. The debt market also has wider bid-ask spreads for lower credit quality debt, making it less attractive for individual investors. High yield debt, while interesting, can be challenging for individual traders due to its complexities and the low liquidity of the market. The debt market is evolving, and as technology advances, it may become more accessible and efficient for individual investors. However, for now, the most efficient ways to participate in the debt market are through passive ETFs or actively managed funds.
Public Investing's High Yield Cash Account and SPAC Expertise: Public Investing's high yield cash account offers a 5.1% APY, while their SPAC ETF showcases their expertise in this investment area
Public Investing offers a high yield cash account with an APY of 5.1%, which is significantly higher than many other financial institutions. This account is a secondary brokerage account with Public Investing, and the funds are automatically deposited into partner banks where they earn interest and are eligible for FDIC insurance. Public Investing is not a bank, but rather a broker-dealer registered with FINRA and SIPC. Another topic discussed was SPACs (Special Purpose Acquisition Companies), which have been a focus of investment for Public Investing since the mid-2010s. The recent launch of a SPAC ETF by Public Investing is aimed at capitalizing on the opportunities within the SPAC product cycle. A SPAC is a company that goes public but does not have an existing business. Instead, it raises funds from investors, who receive shares in the SPAC. The cash given by investors is held in a trust account, earning interest in the form of short-term Treasury bills. The sponsors of the SPAC are then tasked with finding a business to acquire, and investors hope that they will find a good deal at a good price in a timely manner. The success of a SPAC depends on the sponsors' ability to identify a promising acquisition target. In summary, Public Investing's high yield cash account offers a competitive APY, and the launch of a SPAC ETF highlights the firm's expertise and experience in this investment area.
Buying into potential deals with SPACs: SPACs offer investors protection and potential deal participation, but sponsors take significant risk and high fees. Investors can vote on deals and redeem shares for trust proceeds.
SPACs, or Special Purpose Acquisition Companies, offer investors an opportunity to participate in potential deals while being protected by the collateral trust. However, sponsors of SPACs take on significant risk and only benefit if a deal is successfully completed. The sponsors' potential reward is a significant portion of the upside in the deal. While investors may feel there's a misalignment due to the high fees, they also have the power to vote for or against a deal and can redeem their shares for the trust's proceeds if they choose not to be part of the merged company. Essentially, investors are buying a convertible bond with a 2-year maturity and no coupon, where they can either receive equity upside if a good deal is announced or make a return in yield if no deal is announced. Despite the high fees, the attractive nature of this asset class is highlighted in today's market where many convertible bonds have zero coupons and trade at premiums over current stock prices.
Investing in SPACs through an ETF: Focusing on collateral value and low duration yields: David's team invests in SPACs via an ETF, aiming for collateral value and low duration yields, avoiding principal risk, and disposing of shares post-merger.
The speaker, David, and his team have been investing in Special Purpose Acquisition Companies (SPACs) through an ETF, focusing on buying units and shares at collateral value or discounted collateral. They are not taking principal risk and will get their money back if the SPACs liquidate. If the SPACs find deals and the combined entity's enterprise value exceeds $200 billion, 550 new companies will enter the small and mid-cap market. The median yield for SPACs that have announced deals but not yet closed is almost 2.5%. The team's strategy is to provide low duration yields and only buy things at or below collateral value. They also plan to dispose of shares or units within 10 business days post a successful combination merger. The strategy shares similarities with a venture capital firm, as they expect some losses but only need a few outliers to make the portfolio successful in aggregate. The SPAC market is significant, with over $170 billion in cash in trust, and the team believes it's big enough to provide low duration yields if investors are disciplined.
Investing in SPACs: Understanding the Risks and Potential Rewards: SPACs offer the potential for high returns, but also come with risks like unsuccessful acquisitions, complex warrant structures, and uncertain sponsor selection. Thorough research and a focus on not losing money first are key.
Investing in Special Purpose Acquisition Companies (SPACs) involves packaging together various SPACs, some of which may not find a company and get liquidated, while others might find a unicorn. The key to making money is to not lose it first. This strategy, known as not losing money first, is the focus for some investors. SPACs typically issue a unit consisting of a stock and a warrant. Selling the warrant and using the cash to reduce the cost basis of the stock purchase is a common strategy. Warrants offer the potential for future upside, but they come with risks such as European-style warrants that cannot be exercised within the first 12 months of a deal announcement and the company's right to force redemption or conversion when the stock price reaches a certain level. Investors need to understand these risks before diving into this investment strategy. When it comes to selecting SPAC sponsors for investment, due diligence is crucial, but the experience has not always been positive. There are a few successful sponsors, but identifying them requires thorough research. Overall, investing in SPACs and their warrants involves understanding the risks and potential rewards, as well as the importance of not losing money first.
SPAC success depends on sector and sponsor's record: Through due diligence and sector selection, investors can make informed decisions on SPAC investments, potentially outperforming despite proposed expense ratios.
The success of investing in Special Purpose Acquisition Companies (SPACs) depends not only on the sector but also on the sponsor's track record. Due diligence is crucial, and it can be done through "testing the waters" by talking to management and getting information about the deal. However, with over 50 stacks focused on Fintech and potentially fewer good deals at reasonable prices, sector selection is important. Our hope is to provide a free, basic database of SPAC information to help investors make informed decisions. The proposed ETF's expense ratio, estimated at 80 basis points, covers various costs, including management fees. Despite the proposed expense ratio, individual investors can still potentially outperform by doing it themselves with the right information. Transparency is key, and investors must decide whether they want to pay for the convenience of an ETF or do the work themselves.
Managing a SPAC ETF comes with unique challenges: Unique challenges include low yields, capacity constraints, and regulatory issues related to ownership control. To provide competitive returns, fees may be reduced or lower yields accepted.
Managing a SPAC ETF comes with unique challenges, such as low yields, capacity constraints, and regulatory issues related to ownership control. David Sherman of Crossing Bridge Capital emphasized that they aim to provide competitive returns, but if interest rates remain low and the net returns are below 2.5% to 8%, they may need to reduce fees or accept lower yields to make the product more reasonable for investors. The number of SPACs in the ETF will depend on market conditions and liquidity. Additionally, owning more than 9.9% of a SPAC comes with regulatory issues. The SPAC market is big enough today, but capacity constraints are a concern. Crossing Bridge is being mindful of growing assets for the sake of broad revenue. To learn more about Crossing Bridge and David Sherman, visit their website at www.crossingbridge.com or email him directly at [dsherman@crossingbridge.com](mailto:dsherman@crossingbridge.com).
