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RiverPark Cohanzick 2Q17 Commentary – High Yield Market, Blucora, Spanish Broadcasting, Mueller Industries, Whole Foods

RiverPark Short Term High Yield & Strategic Income Fund 2Q 2017 Commentary

“I have no special talents. I am only passionately curious.” – Albert Einstein

  • SocGen argues that the absolute yield of US investment grade and high yield credit is “extremely rich” because they are low on a historical basis, approximately the 10th and 2nd percentile, respectively
    • Calculations are correct but lack context and require further analysis – the observation is meaningless in isolation
  • Inquisitive investor would likely pursue further analysis:
    • How do these yields compare to a US Treasury bond of similar maturity?
    • Am I being paid enough to take on the additional risk inherent in a corporate bond?
  • Yields for corporate bonds are low because Treasury rates are particularly low relative to history
    • US Treasury yields are at the 10th percentile, exactly the same as investment grade yields
    • Using the credit spread as a measure of compensation for taking on greater risk than a US treasury, one observes that investment grade credit spreads are near the historic average, at the 45th percentile, and high yield credit spreads, although at the 27th percentile, are still about 140 bps above the historic low
    • Thus, in historical context, corporate credit is not as expensive as SocGen’s headline numbers suggest
  • Credit spreads alone do not provide a complete measure of compensation. Another way to look at it is to divide the credit spread by the US Treasury yield for bonds of equivalent maturity
    • For IG bonds the spread is about 60% of the Treasury rate – on this basis, credit spreads are above average, at the 72nd percentile for high yield and the 65th percentile for IG, countering SocGen’s conclusion
  • Believe that successful investing requires an inquisitive and intellectual approach to reach well-founded, reasoned decisions

Blucora

  • Conventional view: Redeemed US corporate bonds should not trade at negative yields; Our view: Not always true
  • In early April, announced that it was pursuing a new credit facility that would partly be used to refinance the company’s only outstanding bond – the 4.25% convertible notes due 2019
  • Began purchasing the bonds later that month as the process of issuing the new credit facility neared conclusion
  • Two features made these notes unique compared to the typical called bond
    • Conversion feature of the bonds presented us with the potential to earn returns beyond the typical yield for called paper if the price of equity rose
    • In contrast to most indentures, these bonds required at least 45 days’ notice, allowing us to hold the position longer, thereby increasing the time during which we earned interest as well as the period during which the stock price might rise
  • Stock surpassed the conversion price, drawing the bond price up with it and allowing us to sell a portion of our position at negative yields

Spanish Broadcasting

  • Conventional view: Not paying off a bond at maturity is a bad thing; Our view: Not always true
  • 5% first lien notes matured in April; although the company paid the accrued interest, it did not pay off the bonds and went into default
    • Despite this, the bonds continued to trade at or above par
  • We have been confident that the value of the company’s radio stations fully covered the bonds – leverage was a reasonable 4.4x; any additional value attributable to the company’s money-losing TV stations and prospective spectrum sales would only provide extra coverage
  • Company balked on the repayment of the bonds at maturity solely because company’s preferred shareholders were arguing that their accumulated accrued dividends should be paid concurrently with the refinancing
    • Company disagreed and was willing to go into default to avoid paying the preferred dividends at that time
  • Bond investors saw the opportunity to continue to collect the 12.5% bond coupon while company resolved its issues with the preferred, bearing little concern about the eventual repayment of principal
    • Thus, the bonds traded up above par following the payment default

Mueller Industries

  • Conventional view: A bond needs a credit rating, an underwriter and investors happy to own it; Our view: Not always true
  • Issued its 6% subordinated notes, due 2027, directly to shareholders without an underwriter in March as a form of dividend; notes are unrated, have no underwriter to support trading, and were primarily held by equity funds who needed to sell them as they were not natural holders
  • Despite this, company’s credit statistics indicated investment grade quality, or, worst case, a BB level due to the subordination
  • Purchased notes in April at an initial price of 98 3/8, at yields ranging from 6 to 6.25% which was substantially cheap to the BB index yielding 4.2% at the time
  • Bonds were priced at 102.25 at quarter-end and we expect more appreciation if the bonds become rated

Whole Foods

  • Conventional view: Investing in high grade bonds is boring, generating “coupon clipper returns” while waiting for something to go wrong; Our view: Not always true
  • Initiated our position in BBB- bonds in October 2016 when bonds traded down on fear of a private equity firm buying the company and increasing leverage
  • Were of the view that high brand value would attract a strategic buyer that would outbid private equity investors, preserving, if not improving, credit quality
  • Change of control in bond terms provided protection against a sale that caused the credit rating to fall below investment grade
  • When the company announced that it would be acquired by Amazon, bonds traded up 7 points, yield narrowing toward that of Amazon’s bonds

 

  • For many years we have tracked the risk-adjusted after-tax yield of high yield bonds relative to the 10-year US Treasury rate as an indicator of whether the market is rich, cheap, or fairly valued
  • At present, this indicator shows that the high yield market is on the low end of fairly-valued
  • In keeping this observation, we remain defensively positioned with a low duration and cash holdings available to take advantage of specific investment opportunities as we identify them
  • Equity and fixed income market continue to exhibit a low degree of volatility with significant identifiable exogenous risks
Image Source: BAML Bond Indices, RiverPark Cohanzick 2Q17 Letter
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