DHY - DHY: High Yield But High Return Variability

Summary

• The DHY fund aims to provide high current income from junk bonds and loan investments.
• It has an attractive 9.9% current yield on market price.
• Like many CEFs I have recently analyzed, the DHY fund suffers from a 'return of principal' problem as it does not earn its distribution.
• However, DHY's shortfall appears less than peers, as it has a higher long-term average return.
• DHY also has higher return variability than peers, which has led to higher average returns but worse risk metrics.

The Credit Suisse High Yield Bond Fund ( DHY ) aims to provide high current income from investing in non-investment grade bonds and loans. It has an attractive 9.9% current yield on market price that is arguably sustainable, if we compare the distribution to average annual returns excluding 2022.

Comparing the DHY to other junk bond closed-end funds I have analyzed recently, my sense is the fund is managed on a 'swing for the fences' approach which produces high average annual returns, but at the expense of higher volatility and variability.

The DHY may appeal to risk-seeking investors, as it has been able to deliver 5 years of 10%+ annual total returns in the past decade.

Fund Overview

The Credit Suisse High Yield Bond Fund is a closed-end fund ("CEF") that seeks to deliver high current income to investors. The fund primarily invests in non-investment grade bonds and senior loans, and may use leverage to enhance returns.

According to the fund's marketing materials, the DHY fund seeks to capitalize on Credit Suisse's team of credit professionals, including sector analysts covering over 1,000 corporate issuers. The DHY fund utilizes Credit Suisse's proprietary credit ratings, trend outlooks, and spread evaluations to construct an outperforming portfolio in the high yield bond asset class.

Portfolio Holdings

Figure 1 shows a snapshot of the fund's allocation by asset class and geography. True to its strategy, the fund is mostly invested in high yield bonds and senior loans (93% of the portfolio). The DHY fund is also U.S./Canada-centric, with 93% of assets belonging to issuers from North America.

Figure 2 shows the fund's allocation by industry and credit rating. Basic Industries, Technology, and Leisure are the three largest industries at 16.6%, 13.5%, and 10.9% respectively. The fund is 97% invested in non-investment grade credits.

Returns

DHY's average annual total returns to October 31, 2022 have been mediocre. As can be seen in Figure 3, 2022 has been tough for DHY, with YTD returns of -14.6%. This has impacted the short-term return figures, with 3 and 5Yr average annual returns of 0.8% and 2.3% respectively. However, the long term 10Yr average annual return remains respectable at 5.7%.

Ignoring the poor 2022 result, the DHY fund has actually generated pretty strong average annual total returns of 9.5% from 2012 to 2021.

Distribution & Yield

One of DHY's main selling point is its high distribution yield. The fund pays a monthly distribution of 0.0155 / share which has been maintained since early 2021. This implies a 9.9% forward yield on market price and 9.1% yield on NAV.

However, investors should note that DHY's distribution has been in long-term decline, from $0.80 / share in 2002 to $0.186 / share today (Figure 5).

Judging from the high year-end yields in figure 5 above, it appears DHY was not earning its distributions historically, as the distribution rate far exceeded the fund's average annual total returns. This caused NAV to decline as NAV was used to fund part of the distribution as 'return of principal' (Figure 6). (Note, 'return of principal' is an economic returns concept different from the 'return of capital' tax concept) The decline in NAV reduced the amount of income earning assets, which over time caused the distribution rate to also decline in a negative spiral.

However, if we look at DHY's current distribution rate of 9.1% of NAV vs. the 10-yr average annual return of 5.7%, we can see the income shortfall has decreased, which should slow down the pace of NAV declines.

An argument can also be made that the current distribution rate is sustainable, if we compare it to the 9.5% 10-Yr average annual total return from 2012-2021.

Fees

The DHY fund charges a 1.74% gross expense ratio and a 1.58% net expense ratio after waivers.

DHY vs. peers

I recently reviewed several junk bond CEFs, so this article would be an ideal opportunity to compare the funds side-by-side to see the pros and cons of each (Figure 7).

By and large, the funds' returns ebb and flow in unison, as they all primarily invest in the junk bond / senior loan asset class. However, we can see individual annual returns can vary a great deal and reflects the managers' skill in security selection.

First, with respect to DHY specifically, we can see that the DHY fund has the worst short-term returns, but best long-term returns. Looking at annual returns, the DHY fund has the highest annual return variability, as it has delivered 5 years of 10%+ returns in the past decade, but also two significant annual declines. I would characterize DHY's approach as 'swing for the fences'.

DHY's 'swing for the fences' approach manifests in weaker sharpe ratios and elevated volatility.

DHY also has one of the higher current distribution yields, but the caveat is that DHY's distribution had been shrinking at a 7% CAGR for the past 5 years.

Although all 4 funds have an average total return vs. distribution shortfall (i.e. part of the distribution is return of principal), DHY's shortfall is smaller than most peers. Comparing the current distribution to the average annual return from 2012-2021, one can argue that the current distribution rate of 9.1% of NAV is actually sustainable, whereas the peer funds do not earn their distributions, even if we ignore poor 2022 returns.

Overall, my composite score penalizes the DHY fund for its 'swing for the fences' approach, as it receives a low score on short-term returns and risk metrics (Figure 8).

Conclusion

The DHY fund aims to provide high current income from investing in non-investment grade bonds and loans. It has an attractive 9.9% current yield on market price that is arguably sustainable, if we compare the distribution yield to average annual returns excluding 2022.

Comparing the DHY to other junk bond funds I have analyzed recently, my sense is the DHY fund is managed on a 'swing for the fences' approach which has produced high average annual returns, but at the expense of higher volatility and variability. In my opinion, this leads to a low composite score. However, the high return potential may appeal to some investors.

Consistent with my prior recommendation, investors may want to consider the PGIM High Yield Bond Fund ( ISD ) for their high yield bond fund exposure, as it has modest long-term returns with lower return variability, which leads to better risk measures. However, ISD does suffer from having a distribution yield higher than its average annual total returns.

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