DHF: High Yield Fund Under Pressure Amid Rising Rates and Dovish Fed Outlook

The BNY Mellon High Yield Strategies Fund (DHF) has long navigated the volatile terrain of high-yield credit markets with a blend of leverage, active management, and strategic diversification. Yet, as the Federal Reserve's tightening cycle reaches a critical juncture and market participants speculate on potential rate cuts, the fund's risk-reward profile is under renewed scrutiny. For income-focused investors, the question is whether DHF's current valuation—a 13.83% discount to NAV—offers a compelling entry point, or if the combination of rising rates and uncertain Fed policy amplifies its vulnerabilities.

Leverage as a Double-Edged Sword

DHF's leverage ratio of 28.6% as of 2025 is modest by closed-end fund standards but remains a key driver of its risk profile. The fund employs $79 million in borrowed capital to amplify returns, a strategy that has historically supported its 7.04% average portfolio coupon. However, leverage magnifies sensitivity to interest rate fluctuations. With the Fed's benchmark rate hovering near a multi-year high, the fund's fixed-income holdings face downward price pressure, while its floating-rate exposure (9.8% in bank loans) offers partial insulation.

The fund's leverage cost—2.25% in interest expense—adds to its total expense ratio of 3.52%, which must be offset by strong net investment income. Fortunately, DHF's conservative credit selection (weighted average rating of B+) and active management by Alcentra NY have historically kept defaults low. Still, rising rates could strain weaker issuers in its high-yield portfolio, potentially eroding credit quality and increasing the risk of capital losses.

A Persistent Discount and Its Implications

DHF's shares trade at a -13.83% discount to NAV as of July 2025, a spread that has widened from the 52-week average of -12.59%. This discount reflects broader market skepticism toward high-yield CEFs in a rising rate environment, where the appeal of fixed income has waned. The discount also highlights the fund's structural challenges: its reliance on borrowed capital and its exposure to lower-rated credits make it less attractive to risk-averse investors.

However, discounts can also create opportunities. A wider gap between NAV and share price often indicates undervaluation, particularly when the fund's fundamentals remain strong. DHF's NAV of $2.53 versus its $2.18 share price suggests a potential upside if market sentiment improves or the Fed signals dovishness. Yet, the discount could widen further during periods of liquidity stress or if the fund's credit quality deteriorates.

Yield Sustainability in a Tightening World

DHF's 8.26% annualized distribution yield is a draw for income seekers, but sustainability is paramount. The fund's distribution is fully sourced from net investment income, with a distribution coverage ratio of 1.24x (based on $0.1061 average EPS and $0.0175 monthly payouts). This strong coverage, coupled with a 7.17% average portfolio coupon, suggests the yield is well-supported.

Yet, rising rates could test this resilience. While the fund's floating-rate loans reset quarterly, its fixed-income holdings are vulnerable to valuation declines. A 100-basis-point rate hike could reduce the NAV of these securities by 5–7%, depending on duration. The fund's average effective duration—though not explicitly stated—is likely moderate given its focus on short- to intermediate-term high-yield bonds and bank loans. Still, a prolonged rate hike cycle would pressure returns.

The Fed's Dilemma and DHF's Outlook

The Federal Reserve's next move will be pivotal. If inflationary pressures ease and the economy shows signs of slowing, rate cuts could bolster DHF's risk-reward dynamics. Floating-rate loans would benefit from higher yields, while a dovish pivot could narrow the fund's discount as demand for high-yield income rebounds. Conversely, a hawkish stance would exacerbate its challenges, particularly for fixed-income holdings.

Investors must also weigh the fund's liquidity. DHF's current ratio of 0.68 as of May 2025 is manageable but leaves little room for error. A sharp rise in defaults or a liquidity crunch in the high-yield market could force asset sales at a discount, further eroding NAV.

A Calculated Entry Point?

DHF's valuation presents a nuanced case. The -13.83% discount suggests a margin of safety, especially if the Fed pivots to cut rates. However, the fund's leverage, credit risk, and duration profile make it unsuitable for risk-averse investors. For those with a higher risk tolerance and a focus on income, DHF could offer attractive returns if the Fed's policy shifts align with a dovish outlook.

Investment Thesis:
- Buy if the Fed signals rate cuts by mid-2026, with a target entry at a 15% discount to NAV.
- Hold if rates stabilize but remain elevated, with a focus on the fund's credit quality and distribution sustainability.
- Avoid if the Fed tightens further and defaults in the high-yield sector rise.

In conclusion, DHF's current valuation reflects a balance of opportunity and risk. While its yield and leverage strategy are compelling, the fund's performance will hinge on the Fed's trajectory and its ability to navigate a fragile high-yield landscape. For income-focused investors, the key is to align with the broader macroeconomic outlook and monitor the fund's credit metrics closely.