RiverPark Short Term High Yield Fund (RPHYX), July 2011, updated October 2012

By David Snowball 

This profile has been updated. Find the new profile here.

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 Advisors, LLC. Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the six RiverPark funds, though other firms manage three of them.  RiverPark Capital Management runs separate accounts and partnerships.  Collectively, they have $567 million in assets under management, as of July 31, 2012.

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

Mr. Sherman has over $1 million invested in the fund.  At the time of our first profile (September 2011), folks associated with RiverPark or Cohanzick had nearly $10 million in the fund.  In addition, 75% of Cohanzick is owned by its employees.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $197 million in assets (as of September 2012).  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.

There’s also a 2% redemption fee on shares held under one month.

Update

Our original analysis, posted September, 2011, appears just below this update.  Depending on your familiarity with the fund’s strategy and its relationship to other cash management vehicles, you might choose to read or review that analysis first.

October, 2012
2011 returns: 3.86%2012 returns, through 9/28: 3.34%  
Asset growth: about $180 million in 12 months, from $20 million  
People are starting to catch on to RPHYX’s discrete and substantial charms.  Both the fund’s name and Morningstar’s assignment of it to the “high yield” peer group threw off some potential investors.  To be clear: this is nota high yield bond fund in any sense that you’d recognize.  As I explain below in our original commentary, this is a conservative cash-management fund which is able to exploit pieces of the high yield market to generate substantial returns with minimal volatility.In a September 2012 conference call with Observer readers, Mr. Sherman made it clear that it’s “absolutely possible” for the fund to lose money in the very short term, but for folks with an investment time horizon of more than three months, the risks are very small.Beyond that, it’s worth noting that:

  1. they expect to be able to return 300 – 400 basis points more than a money market fund – there are times when that might drop to 250 basis points for a short period, but 300-400 is, they believe, a sustainable advantage.  And that’s almost exactly what they’re doing.  Through 9/28/2012, Vanguard Prime Money Market (VMMXX) returned 3 basis points while RPHYX earned 334 basis points.
  2. they manage to minimize risk, not maximize return – if market conditions are sufficiently iffy, Mr. Sherman would rather move entirely to short-term Treasuries than expose his investors to permanent loss of capital.  This also explains why Mr. Sherman strictly limits position sizes and refuses to buy securities which would expose his investors to the substantial short-term gyrations of the financial sector.
  3. they’ve done a pretty good job at risk minimization – neither the fund nor the strategy operated in 2008, so we don’t have a direct measure of their performance in a market freeze. Since the majority of the portfolio rolls to cash every 30 days or so, even there the impairment would be limited. The best stress test to date was the third quarter of 2011, one of the worst ever for the high-yield market. In 3Q2011, the high yield market dropped 600 basis points. RPHYX dropped 7 basis points.  In its worst single month, August 2011, the fund dropped 24 basis points (that is, less than one-quarter of one percent) while the average high yield fund dropped 438 basis points.
  4. they do not anticipate significant competition for these assets – at least not from another mutual fund. There are three reasons. (1) The niche is too small to interest a major player like PIMCO (I actually asked PIMCO about this) or Fidelity. (2) The work is incredibly labor-intense. Over the past 12 months, the portfolio averaged something like $120 million in assets. Because their issues are redeemed so often, they had to make $442 million in purchases and involved the services of 46 brokers. (3) There’s a significant “first mover” advantage. As they’ve grown in size, they can now handle larger purchases which make them much more attractive as partners in deals. A year ago, they had to beat the bushes to find potential purchases; now, brokers seek them out.
  5. expenses are unlikely to move much – the caps are 1.0% (RPHIX) and 1.25% (RPHYX). As the fund grows, they move closer to the point where the waivers won’t be necessary but (1) it’s an expensive strategy to execute and (2) they’re likely to close the fund when it’s still small ($600M – $1B, depending on market conditions) which will limit their ability to capture and share huge efficiencies of scale. In any case, RiverPark intends to maintain the caps indefinitely.
  6. NAV volatility is more apparent than real – by any measure other than a money market, it’s a very steady NAV. Because the fund’s share price movement is typically no more than $0.01/share people notice changes that would be essentially invisible in a normal fund. Three sources of the movement are (1) monthly income distributions, which are responsible for the majority of all change, (2) rounding effects – they price to three decimal points, and changes of well below $0.01 often trigger a rounding up or down, and (3) bad pricing on late trades. Because their portfolio is “marked to market,” other people’s poor end-of-day trading can create pricing goofs that last until the market reopens the following morning.  President Morty Schaja and the folks at RiverPark are working with accountants and such to see how “artificial” pricing errors can be eliminated.

Bottom Line

This continues to strike me as a compelling opportunity for conservative investors or those with short time horizons to earn returns well in excess of the rate of inflation with, so far as we can determine, minimal downside.  I bought shares of RPHYX two weeks after publishing my original review of them in September 2011 and continue adding to that account.

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.  Buying before call means that the fund has to post the original maturities (7 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%), a type of callable bond that sells at a premium because the issued coupon payments are above market interest rates.
  • 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 high than $10.03 or lower than $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 and even then the bondholders are secured creditors in the bankruptcy proceedings.
  • 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

Several of us own shares in RPHYX, though the Observer has no financial stake in the fund or relationship with RiverPark.  My investment in the fund, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Fund website

RiverPark Short Term High Yield

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.
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About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.