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I know nobody is a fan of fixed income here, but what if a fixed income asset is selling at a significant discount to its NAV? Closed End Funds (CEFs) are trading at a higher than average discount these days. Take for example, the Doubleline Income Solutions (DSL).

NAV: 22.60
Price: 19.95
Discount: 11.73%
Duration: 7.41
Distribution: 0.15/month
Leverage: 31.74%

Sector Breakdown:
Mortgage-Backed Securities 22.40%
Emerging Markets 45.01%
High Yield Corporates 17.54%
Bank Loans 10.10%
CLOs 4.95%

So if an investor bought today, they would get an annual yield of (0.15*12)/19.95 = 9.02%. The portfolio is managed by Doubleline which I think is a top notch fixed income shop.

This looks very tempting. I see limited downside risk. Even if interest rates rose 100 bps over the next 1 year, the price would decline by 7.41% (same as the duration of the fund), but the total return would still be positive because of the 9% yield. Of course, the price would decline even more if the discount expanded, but how much more can the discount increase? It's already 11.73%. Can a CEF trade at a 20% discount? I honestly don't now. From what I understand, the price of a CEF is determined solely by supply and demand for that CEF by individual investors. The big boys don't bother with CEFs because the universe of CEFs is too small. They can't buy without affecting the price.

On the other hand, if the discount compressed and interest rates went down or even stayed flat over the next 1 year, that translates to a nice total return of more than 10% (9% yield + a few points for discount compression). It's not out of the question that interest rates might revisit their all time low that was hit last year (10 yr bottomed at around 1.39). With the Fed continuing to buy bonds, high quality collateral is disappearing from the market at a rapid pace. This may increase demand and lower yields.

I am looking for a sanity check. What can go wrong with an investment like DSL bought at this price or CEFs in general?

Thank you.
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