TIP381: High Yield Masterclass w/ David Sherman

Episode Summary

Executive Summary: David Sherman explains how high-yield credit is analyzed and why it can offer equity-like returns with less volatility. He walks through capital structure, pricing, duration, ratings, and callable features, then applies the same disciplined, principal-first mindset to responsible credit and pre-merger SPAC investing as cash-alternative, low-duration strategies.

Main Topics: Why Sherman specialized in high-yield credit (Priority: 5/5): Sherman traces his career from cold-calling and Drexel Burnham to Lucadia, explaining that curiosity, good mentors, and the intellectually interesting but underfollowed nature of high yield kept him in the space. How to mitigate risk in high-yield and distressed debt (Priority: 5/5): He distinguishes money-good high yield from stressed/distressed credit, emphasizing bottom-up analysis, principal protection, business-model quality, and selective use of hedges like CDS or ETF shorts. Capital structure and bond pricing basics (Priority: 5/5): He breaks down debt seniority, secured vs. unsecured, mezzanine, preferreds, ratings, spreads, and duration, showing how credit migration and rate changes drive bond performance. Short-duration and low-duration strategies (Priority: 4/5): Sherman defines short-duration as roughly one year or less and low-duration as more than one year but under three years, positioning these products as suitable cash-management tools for near-term liabilities. Responsible credit and ESG-minded investing (Priority: 4/5): He argues for a pragmatic, internally scored ESG framework that includes positive and negative attributes, avoiding greenwashing while preserving investable opportunity. MicroStrategy as an example of structured credit analysis (Priority: 4/5): He explains why MicroStrategy debt fits the strategy: the core software business supports the bonds, the bitcoin collateral adds optionality, and the issue was attractive because of its cushion and downside protection. SPACs as a low-duration, principal-protected opportunity set (Priority: 5/5): Sherman frames pre-merger SPACs like zero-coupon, cash-backed instruments with upside optionality, and describes launching an ETF to harvest yield by buying at or below trust value.

Key Arguments: High-yield debt can resemble a hybrid of debt and equity: it offers equity-like returns over long periods but with materially lower volatility than stocks. Risk in high-yield is best mitigated by bottom-up credit work focused on protecting principal, not by relying mainly on macro calls. Distressed investing is fundamentally about understanding business quality and bankruptcy rules; good businesses with too much debt are the best candidates. Bond returns are driven by spread, duration, credit migration, and callability; a downgrade or upgrade can create large price moves even without default. Responsible credit should be ESG-aware but not so rigid that it destroys opportunity; negative ESG attributes matter as much as positive ones. MicroStrategy’s debt was attractive because the operating software business supports the credit, while the bitcoin collateral created additional upside and coverage. Pre-merger SPACs can be treated as short-duration, trust-backed instruments: buy at or below collateral value, earn yield to liquidation, and redeem if the deal is unattractive. The SPAC market is large enough and inefficient enough to support a diversified strategy, especially for investors seeking cash alternatives with optionality. Warrants can create venture-like optionality, but Sherman’s firm prefers principal-protected exposure through shares/units rather than pure lottery-ticket upside. Transparency and liquidity are central: Sherman prefers markets where positions can be sold, redeemed, or monitored rather than opaque club deals.

Data Points: Assets under management: over $2.3 billion - Crossing Bridge Advisors AUM mentioned in the episode intro High-yield market returns: quite similar to the equity market over 10-year periods, slightly less with significantly less volatility - Sherman’s explanation of why high yield can offer attractive risk-adjusted returns Short-term security definition: 1 year or less - Sherman’s definition for the short-duration strategy Low-duration strategy: more than 1 year, less than 3 years - Sherman distinguishes low duration from short duration Low-duration focus window: about 9 months to 1.5 years - Crossing Bridge’s low-duration implementation SPAC liquidation yield median: almost 2.5% - Yield cited for the universe of SPACs near liquidation using trust-backed pricing SPAC universe size: approximately 550 SPACs - Sherman’s snapshot of the market at the time of recording Cash in trust: over $170 billion - Aggregate trust value backing the SPAC universe Announced deals: about 140 - Out of the roughly 550 SPACs, number that had announced acquisitions Typical SPAC deal size: about $2 billion - Used to estimate future enterprise value created by successful mergers ETF expense cap: 80 basis points - Proposed cap for the SPAC ETF covering management and operating expenses Expected returns for SPAC strategy: 1% to 3% net if conditions are low-rate and returns compress - Sherman notes fee pressure could require adjustments if returns are lower than expected Sponsor economics: about 20% or more of the upside - Describes the sponsor promote in SPACs Initial sponsor risk capital: about $8 million in a $200 million SPAC - Illustrates sponsor risk versus potential reward Bid-ask spread in high yield: quarter-point to half-point in many cases today - Sherman contrasts modern high-yield trading frictions with older, wider spreads Historical high-yield trading spread: 4 to 5 points - Sherman recalls the wide spreads common in the 1980s

Pivotal Quotes: "Our number one mantra here at our firm is to protect principal first. And the way to make money is not to lose it first." — David Sherman: Summarizing the firm’s investment philosophy across credit and SPAC strategies "High yield is the entire area is intellectually interesting and it's not well followed." — David Sherman: Explaining why he stayed in high-yield credit throughout his career "We're really focused on buying things at or below collateral value and then either letting them go to liquidity or redeeming them, right, as a yield product." — David Sherman: Describing the SPAC ETF’s principal-protected approach

Implications: Listeners should view high-yield credit and pre-merger SPACs as specialized, valuation-driven markets where downside protection matters most. Sherman’s framework favors disciplined underwriting, liquidity, and principal preservation over speculative upside chasing.