This unique actively managed portfolio was the first of its kind to debut from DoubleLine back in 2012 and has developed a cult following among CEF investors.
DBL primarily invests in a mixed basket of mortgage backed securities, collateralized loan obligations and other asset backed securities. The fund has just over $325 million in total assets with a relatively tame 16% leverage ratio to boost its net exposure. It currently yields over 8% annually and income is paid monthly to shareholders.
We don’t currently own any exposure to DBL for clients of our firm and have been wary of its fundamental analytics for some time now. This stems primarily from the above-average premium over the last 52-weeks in addition to the underperformance of its underlying portfolio relative to the category this year.
Although we have seen the premium in DBL recently collapse to some of the narrowest levels in the last nine months, there are other concerning factors that are beginning to crop up on our radar as well. The squeeze in credit spreads, alongside the relatively low interest rate environment, has created an inability of the fund to meet its existing distribution rate. Furthermore, without a firm buffer of undistributed net investment income (UNII), it’s relying on return of capital (ROC) in the short-term to meet its distribution policies.
According to Morningstar, DBL has identified a portion of its dividend as return of capital in the last four consecutive months. All income prior to August had been driven entirely by the bonds in the underlying portfolio. Situations like these are often a precursor to a dividend cut to re-align the income stream with realistic expectations and create a healthier long-term sustainability plan.
A similar fund that experienced a dividend cut earlier this year is the PIMCO Strategic Income Fund (RCS), which we recently added to our portfolio. RCS has shaken out a significant portion of its abundant premium and now trades at one of its tightest spreads to NAV in years. Furthermore, the fund has already taken the important step of reducing its dividend payout to forestall a dip into principal.
With spread compression and rising leverage costs due to the changes in short-term interest rates, investors need to be as vigilant as possible to avoid allocating to funds that are not earning enough from underlying portfolio assets, less expenses, to meet their distribution policies.
If DBL did eventually cut its dividend, it would likely move to a discount almost immediately as skittish and yield hungry CEF investors jump ship. That type of event would ultimately create a very attractive opportunity for new capital and is one of the reasons we are closely watching this fund’s fundamental progress over the next several months for any dislocations that may occur. These types of binary and unheralded events are often very interesting entry points for those who are paying attention and have capital on the sidelines to put to work.
This article is brought to you courtesy of FMD Capital.