Income

DoubleLine Income Solutions: Time to Buy Gundlach Fund, 9.9% Yield (DSL)

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Thesis

DoubleLine Income Solutions Fund (NYSE: DSL) is a multi-sector bond fund with a very broad mandate. The fund has the ability to invest in bonds”worldwide, including in emerging markets“. The fund is currently overweight emerging market debt and US high yield. With emerging market spreads at historic highs due to the Ukraine conflict and speculative US yields hitting decade-high levels, DSL has been badly compromised. from a performance perspective The fund is now down more than -15% from a total return perspective in 2022 and is at price levels not seen since the March 2020 Covid selloff.

2022 has seen considerable duration avoidance by market participants spooked by inflationary pressures and a very hawkish Fed that is behind the curve in bringing inflation down. This resulted in significant outflows from high yield. With a duration of 4.15 years, DSL has seen its NAV decrease due to the yield curve shifting by more than 200 basis points since the start of the year for the 4-year tenor point. However, we believe the bulk of the move is behind us. We also like the opposite view of starting to overlay HY when all market players exit, as this could be a sign of capitulation. For us, the HY positioning in terms of duration avoidance should have been done at the beginning of 2022 when the tightening cycle started, and not towards the end of the move.

DSL is now yielding over 9.9%, trading at a historic high discount to net asset value of -10.5% and approaching a net price level not seen since the Covid pandemic. We believe that corporate balance sheets and outlook are much better defined today than in 2020 and while higher yields may prove a headwind, rate developments are heading towards its tail. For a long-term holder, this is an ideal point to start layering exposure, with a time frame of over 3 years to retain the name. We therefore give it a rating To buy.

FEC Metrics

This section details some CEF metrics and overall fund analysis:

Leverage ratio: 28%

  • Average for the CEF space.

Expense ratio: 1.83%

  • A bit high for this type of leverage.

Manager: Double Line

Yield: 9.96%

  • Compared to its peers, the yield is rather high.

Discount / Z Stat: -10.50% / -2.1

  • The fund is trading at a discount.
  • The discount is high compared to historical levels

Assets

The fund is overweight emerging market credits, followed by US high yield bonds:

DSL Sectors

Sectors (Fund Fact Sheet)

The fund tends to invest in the riskiest part of the capital structure:

DSL Credit Quality Breakdown

Ratings (Fund Fact Sheet)

We can see that the allocation favors BB and B buckets with a high allocation to CCC credits as well. Credit spreads are extremely volatile at the bottom of the capital structure given the sensitivity to higher rates and the economic cycle.

The fund has a duration of 4.15 years, typically sporting a short bond maturity profile:

DSL Duration Breakdown

Duration (Fund Fact Sheet)

Holdings are very granular, and we have no issuers above a 2% threshold in the fund:

DSL's Top 10 Holdings

top 10 holdings (Fund Fact Sheet)

Performance

The fund is down more than -15% year-to-date due to rising rates and widening credit spreads:

Year-to-date DSL performance

Cumulative performance since the beginning of the year (Looking for Alpha)

When we look at the all-in yield levels of US high yield bonds, we can see that we are at all-time highs outside of recessionary times:

U.S. High Yield Index Effective Return

US HY all-inclusive returns (The Fed)

Currently, the effective return of the ICE BofA US High Yield Index is above 7%, which in the context of the past decade has signaled all-time highs outside of true recessionary periods (i.e. say much higher credit spreads to compensate for default risk).

Emerging market dollar spreads are also at historically high levels due to the conflict in Ukraine:

Effective return of the US Emerging Markets Liquid Corporate Plus Index

Emerging market spreads (The Fed)

The fund is USD based and although DSL has the ability to invest in foreign currency denominated securities, it is primarily a USD fund, therefore subject to interest rate movements and risks of the curve in USD.

The fund is now close to its all-time low reached during the Covid sell-off in March-April 2020:

DSL Stock Price Action

DSL Price Action (Looking for Alpha)

The current sell-off driver is not credit spread widening / default issues, but higher yields, driven by higher rates. We believe in mean reversion and believe that buying at the bottom of a historical range while the balance sheets of the underlying companies are still in excellent shape is a good way to add risk to HY.

Premium / Discount

The fund now trades at a historic discount to net asset value:

Premium/discount DSL

Discount to NAV (The morning star)

Currently, the fund is trading at a -10.5% discount to NAV, which is one of the highest levels ever. We can see from the chart above that DSL generally trades flat at -4% against its NAV. The current sell-off has driven the discount to historic levels. We consider this to be a good entry point from a revaluation point of view.

Conclusion

From a leading asset manager, DSL is a closed-end fund focused on emerging market debt and US high yield. The fund was severely hampered in 2022 by rising risk-free rates in the US and widening credit spreads in the emerging market space following the conflict in Ukraine. DSL is now at a historic broad net asset value discount of -10.5% and is approaching, price-wise, lows not seen since the Covid-induced sell-off. With a general market eschewing duration and fixed income, but healthy corporate balance sheets, we believe the time is right to start scaling risk in DSL. We believe most of the rate move is behind us and while we may still see some volatility in the coming months due to cash outflows, a long-term holder would be in the best position to start increasing their exposure. We therefore give it a rating To buy.