A Junk Bond Fund That Delivers High-Quality Returns

As the portfolio manager of the $642 million
CrossingBridge Low Duration High Yield
fund, he takes a value investor’s cautious, patient approach to the seemingly speculative high-yield bond market. The fund’s mission is to preserve capital first, then seek yield and capital appreciation. Sherman, who also manages four other CrossingBridge funds, says junk bonds are the perfect place to implement value investing principles.

“You start with ‘How am I getting my money back, and is my money secure?’ And that’s value investing 101,” he says.

It adds up to a laser focus on mitigating downside risk, including a willingness to sacrifice upside opportunities. The fund has one of Morningstar’s highest risk-adjusted returns relative to its multisector bond fund peers across various time frames. In 2022’s bond rout, for example, when the Bloomberg U.S. Aggregate Bond Index suffered a 15% loss, Low Duration gained 1%. It was one of the few bond funds of any type with a positive return that year.

Morningstar gives Low Duration five stars and puts the fund in the top 11% of its multisector bond category over five years. While the firm considers the fund’s expense ratio of 0.91% high, it beats its peers’ returns handily across one-, three-, and five-year periods, with a five-year return of 4.5% compared with 2.8% for other multisector bond funds.

The Pleasantville, N.Y.–based Sherman has managed Low Duration since its 2018 inception. Kirk Whitney joined as assistant portfolio manager in 2021. The fund targets an average portfolio duration—a measure of interest-rate risk tied to a bond’s maturity, yield, and other factors—between 0.75 and two years. Such a low duration may make some investors think it’s an enhanced cash alternative, but Sherman stresses it’s a bond fund, with its attendant ups and downs, not a money-market fund.

Still, he seeks “money good” securities, those where the issuer is likely to continue making interest and principal payments, either at maturity or soon thereafter.

When considering a potential holding, Sherman, Whitney, and their team of nine analysts first look at how the market is pricing the security and if the risk-adjusted return is higher than that of an equivalent Treasury. While the team mostly fishes in the high-yield market, they may select some investment-grade bonds they think are misunderstood.

The team reviews a company’s cash flow from operations, working capital, and underappreciated assets it can use to generate capital if needed. Sherman closely reads covenants to know the bondholders’ rights, something he says credit investors often overlook.

He’s seeing opportunities lately in event-driven debt—securities he thinks will be repaid early, often based on his engagement with management, or other potential changes that might raise the fund’s yield to maturity.

One recent score came when
Alaska Air
Group said in early December it would buy
Hawaiian Holdings,
the parent company of Hawaiian Airlines. In April 2020, the fund started buying discounted Hawaiian Holdings January 2026 3.9% equipment trust bonds, backed by a lien on its aircraft and guarantees from the operating and holding company.

Sherman sensed that the premier airline serving a popular tourist destination would attract a buyer. The fund added to its position when prices dropped after the Maui fires and yields ran as high as 15%, boosting it to a No. 8 holding.

The fund took advantage of a price dip in September to pick up privately held Chobani 7.50% bonds due in 2025, now a No. 10 holding, when the yogurt maker said it would call the bonds before the debt becomes a current liability in April 2024. By purchasing under par, Sherman expects a yield to maturity above 8%. That could rise if the firm redeems the debt early.

Icahn Enterprises
bonds are a mainstay position in CrossingBridge funds, as Sherman believes the asset value of Carl Icahn’s company greatly exceeds its total unsecured debt and its balance sheet has liquidity. Following a report by well-known short seller Hindenburg Research in May, Low Duration bought beaten-up Ichan 2024 4.75% and 2025 6.38% bonds. Icahn recently issued five-year bonds to redeem the 2024 unsecured bonds.

Sherman considers broker-dealer
StoneX Group’s
foreign-currency and commercial-processing business a hidden asset worth much more than the company’s total debt if it ever sold the platform. Since its issuance in May 2020, Low Duration has owned StoneX 8.625% June 2026 secured debt, which has become the No. 7 holding. He expects it will be refinanced in June 2024 when the call price drops. If the bonds aren’t called, Sherman says the high coupon will compensate for extension to maturity.

The bond market’s reaction to a more-dovish Federal Reserve and the potential for rate cuts later in 2024 underscored how volatile and unpredictable markets can be. Low Duration’s performance versus peers dipped slightly during last month’s bond rally, although it remains up 7.3% year to date during a very volatile year for fixed income.

Rate volatility may be a hallmark for 2024, though Sherman expects the yield curve to normalize to an upward slope. With that in mind, 28% of Low Duration is allocated to cash, cash equivalents, and securities of 90 days or less, highly liquid assets it can tap as it sees opportunities next year.

Rate cuts usually benefit longer-duration plays, but as a bottom-up investor, he doesn’t manage to macro landscape events or make bets on duration or the direction of rates. He’ll look for opportunities amid the volatility.

“Bottom-up credit selection will remain attractive whether we have a soft landing or enter a recession,” Sherman says.

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