Credit Suisse DHY: Fixed Income CEF Overweight HY Bonds

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Thesis

The Credit Suisse High Yield Bond Fund (DHY) is a closed-end fund focused on fixed income securities. The vehicle has a high current income as its main investment objective. DHY’s portfolio consists mainly of bonds, senior loans and occasionally convertible bonds. CEF is your typical HY fixed income fund that uses leverage (27.6% in the case of DHY) to derive higher investment income from a portfolio of fixed income securities. The fund has an average long-term performance, which stands at 4.4% and 6.7% respectively on a 5 and 10 year basis. The results are obtained with a low standard deviation of 11 but also with a fairly low Sharpe of 0.49 (based on 5 years). The fund is currently overweight HY bonds, which has resulted in a very poor year-to-date performance (down almost -9% on a price basis) due to the rate hikes the market has embedded in the yield curve amid a hawkish Fed and higher inflation. The fund has a low duration of 2.91 years but was nevertheless affected by the rise in short-term rates. Most of the risk for the fund now lies in its low credit quality (single B average rating, but with a large CCC tranche). The fund has an annual NAV drop of around -1.7% which has seen quite a significant erosion in NAV over the past decade. We are not a proponent of NAV dropouts greater than 1% as, in our mind, they are just a marketing gimmick and ultimately put the fund on a measurable downward NAV slope. The fund is currently trading near the bottom of its historical range, but we think there is a little more weakness to come from a price perspective in the coming months as the Fed provides more clarity on its timing of rise and the situation in Ukraine is coming to an end. For long-term holders, we rate this fund at Holdmost of the negative price action having already occurred, while retail investors looking to deploy new capital would be well served to revisit the name in 3 months when we expect better clarity on market risk term of the fund.

Assets

Since January 2022, the fund is overweight in HY bonds:

facts

Holdings (Fund Fact Sheet)

This setup has resulted in a very poor year-to-date performance, with the fund losing almost -9% on a price basis due to the Fed’s hawkish policy.

The fund takes on significant credit risk, with a weighted average rating that we estimate to be in the simple B tranche:

rating

Asset rating (fund fact sheet)

The fund is overweight single-B assets, but also has a large CCC tranche. The main risk of this fund is credit spread risk or the propensity of the portfolio to lose value as more assets than normal go into default and credit spreads widen due to adverse scenarios. ‘aversion to risk.

The fund is well-diversified across industries, with only one representing exposure above 15%, but still fairly well contained below 17%:

industry

Main sectors of activity (fund fact sheet)

On an industrial concentration basis, we don’t like to see two or three industries at 17% or more.

Based on an individual name, we also see good granularity:

transmitters

Top Issuers (Fund Fact Sheet)

Although it is overweighted in HY bonds, the fund has a fairly low duration, less than 3 years:

duration

Fund Duration (Fund Fact Sheet)

Depending on where the 3-year treasuries end up yield-wise, we’ve already seen perhaps the biggest impact of rates/duration on the price of the fund.

Performance

The fund is down almost 9% since the start of the year, mainly due to the rise in short rates:

rates

Year-to-date returns (seeking alpha)

On a 10-year basis, the fund exhibits the characteristics of a buy-and-hold vehicle, but with steep declines:

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10-year total return (seeking alpha)

The fund is currently exposed to significant credit risk, as mentioned above, such that any significant widening of credit spreads may result in a further significant decline in the fund’s total return. We are not yet close to a recession, but CCC credits are one of the most volatile tranches in the HY space.

Abandonment of NAV

The fund has a dropped NAV of around -1.7% per year, which means it pays out more than it earns:

ANV

Performance DHY NAV (CEFConnect)

One can see the historical downward trajectory of NAV due to the marketing tool of repaying the principal to enhance the visuals for a yield figure. An even better visualization of the manager’s NAV drop and trading performance is the fund’s price performance over the past decade:

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10-year price return (seeking alpha)

Please keep in mind that this is a price return chart (i.e. dividends are not taken into account).

Premium / Discount

The fund tends to trade at a slight discount to net asset value:

delivery

Premium / Discount (Morningstar)

Currently, the fund is close to its widest-ever deviation from net asset value, as highlighted by its deeply negative z-statistic of -1.77. We believe the reason for this is the current Fed tightening environment, with fixed income being an asset class bearing the brunt of rate moves. Once the cycle kicks off and the market gets more clarity on the number of upsides, we expect the discount to NAV to narrow. Further weakness is possible here, however, given the high proportion of fixed income instruments in the fund.

Conclusion

DHY is a CEF focused on the fixed income asset class. Unlike some of its peers who prefer to overweight leveraged loans to achieve low duration and exposure primarily to floating rates, DHY is overweight HY bonds. The fund has suffered from a rising interest rate environment this year, falling almost -9% from a price perspective. Although sporting an impressive return of 8.27%, the fund is showing an annual drop of -1.7%, which is destructive for the net asset value. DHY takes significant credit risk with a large CCC tranche and an average rating of B in the portfolio. We believe there is some more price weakness ahead until a clear picture of the Fed’s rate calendar is presented, but that will be mostly covered by the dividend yield. For long-term holders, we rate this fund a Holdwhile retail investors looking to deploy new capital would be well served to revisit the name in 3 months when we expect better clarity on the fund’s futures market risk.

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