TSI TCW Strategic Income Fund Inc

TCW Strategic Income Fund, Inc.

To the shareholders of the TCW Strategic Income Fund:

Executive Summary

TCW is pleased to present the 2022 semi-annual report for the TCW Strategic Income Fund (“TSI” or the “Fund”). TSI is a multi-asset class closed-end fund managed by TCW Investment Management Company and is listed on the New York Stock Exchange under the ticker TSI. For the first half of 2022, shares of TSI fell by 14.45%% while the Fund’s net asset value (i.e., returns of the underlying assets) fell by 7.42%. The Fund’s six-month price-based return was below the NAV-based return, as the share price moved from a premium to NAV of 1.4% at the start of the period to a 6.4% discount by June 30, 2022.

Over the past four quarters, the Fund paid dividends of 5.5 cents per share each quarter, as well as a short- and a long-term capital gains distribution of 4.02 cents per share and 7.77 cents per share, respectively, and a special cash payment of 2.90 cents per share. This represents an annualized rate of approximately 37 cents per share, contributing to a realized 12-month trailing yield of approximately 7.6%, as of 6/30/2022. As yield is a function of a number of parameters, the go-forward yield of TSI will likely differ from the trailing figure.

As a reminder, TSI’s original blended benchmark¹, which dated back to the inception of the Fund when it was envisioned to be a (predominantly) convertibles fund, was replaced with the income-oriented benchmark of Bloomberg 3-Month U.S. Treasury Bellwethers Index + 400bps effective March 1, 2022. The management team believes that since TSI is now run as a multi-sector, primarily fixed income fund, the original blended benchmark had lost its relevance, and the new benchmark is more appropriate.

Past performance is no guarantee of future results. Current performance may be lower or higher than that quoted. The market value and net asset value of the Fund’s shares will fluctuate with market conditions. Returns shown do not reflect the deduction of taxes that a shareholder would pay on the Fund’s distributions. You should not draw any conclusions about the Fund’s performance from the amount of the quarterly distribution or from the terms of the Fund’s distribution policy.

Management Commentary

For a Fed long in practice of reacting dovishly to quell asset market volatility rather than hawkishly to stem upward consumer prices, the past year-plus has been a dramatic turn. From calming proclamations last summer that inflationary pressures were transitory effects of an awakening economy, Chair Powell’s monetary authority finds itself in an aggressive

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tightening mode, with a fervor unnecessary since 1994, as persistently climbing prices have proven beyond “talking down”. While it’s not necessarily the three straight meetings that have ended with hikes that are indicative of alacrity, it’s that the latest two came with 50 and 75 basis point bumps, respectively, to the reference rate, the latter deemed a “surprise” by Fed watchers. Punctuating the circumstances, global central banks are synchronized in their tightening, leaving few, if any, havens. Examining the details, headline U.S. CPI (Consumer Price Index) came in at 8.6% year-over-year through May, as pre-pandemic price stability has given way to a fusion of supply chain disruption, stimulus-driven demand surges and structural shifts such as de-globalization. Treasury rates shot higher, led by shorter maturities as investors started to price a heavily front-loaded rate-hiking regime (the 1-Year Treasury yield was up 117 bps in the second quarter and 239 bps year-to-date). Out the curve, the 10-Year yield in mid-June neared 3.5%, its highest since 2011, before settling back to 3% on growth concerns over the Fed’s impact on the economy (more on that below). Across markets, unsurprisingly, prices reacted adversely with equities, as proxied by the S&P 500, tumbling 16% for the quarter en route to a decades-worst 20% first-half decline. Summing it up back to the end-investor, the combination of rising prices, negative headlines, increasingly unaffordable homes, mounting interest rates, and falling equities has made consumers the most pessimistic in some 40-plus years.

Higher Treasury yields translated to negative returns for fixed income, reflected in a 4.7% loss for the Bloomberg U.S. Aggregate Bond Index (the “Index”) in the second quarter and a 10.4% setback in 2022’s first six months. Underlying the second quarter result, corporates were down 7.3% in the face of the tightening Fed and margin compression due to higher costs, while the year-to-date loss amounted to 14.4%, the sector’s worst first half on record. Long corporates, owing to duration, endured a steeper decline of 22.8% year-to-date. Waning risk appetites took a toll on levered credits and high yield bonds fell 9.8% in the second quarter on widened yield spreads. Notably, however, the high yield market saw a shift in underperformance from higher-quality bonds, which had been tapped for liquidity earlier in the year, to the most levered borrowers as investors focused on impairment potential and default. CCC’s were down 13% in the latest quarter, versus an 8.4% decline for BB-bonds. Securitized issues were weighed down by agency mortgage-backed securities (MBS), which fell over 4% in the second quarter (98 bps of negative excess return) given pressure from higher rates, rising volatility and fears of outright Fed sales. Non-agency MBS prices weakened as well, particularly for tranches that sit lower in the capital structure, though strong home price appreciation in recent years and ongoing loan amortization provide an equity buffer for these securities, mitigating risks. Meanwhile, the commercial mortgage-backed securities market has become increasingly bifurcated, as non-agency collateral-backed CMBS fell 3.2% and trailed duration-matched Treasuries by 108 bps for the quarter, while agency CMBS fared better with a 2.4% loss and outperforming Treasuries. The year-to-date experience has been similar, with non-agency CMBS trailing Treasuries by 175 bps while agency MBS delivered 12 bps of positive excess return. Finally, asset-backed securities (ABS) was one of the better-performing fixed income sectors with a loss of 0.9% for the quarter and 3.8% for the first half of the year, though the potential for consumer stress has been recently reflected in wider spreads.

The Economy and Market Ahead

Challenging year-to-date performance aside, there is the appeal of nearly 200 basis points more yield to the Index at June month-end versus the start of 2022 and that bodes well for improved return prospects. Uncertainty over effects of tighter monetary policy, inflation and geopolitical tensions renders the market vulnerable to continued volatility and would-be opportunity. Eager to demonstrate its inflation-fighting willpower and achieve an easing in prices, expectations are that the Fed will continue lifting short rates aggressively until inflationary pressure subsides, suggesting that a recession is probable. However, because this will probably not be a recession caused by a financial crisis, but rather a more traditional type slowdown, it could look more like the 2001 experience – a longer, shallower event rather than a shorter, more extreme episode like those experienced more recently. Responsively, valuations have moved to increasingly attractive, i.e.,

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cheapened, levels for much of the fixed income market, while increased volatility and illiquidity are creating opportunities to buy defensive, high-quality bonds at levels commensurate with the spring of 2020. In particular, investment grade credit yields are near decade highs and, illustratively, near what high yield credit offered at the start of the year. However, given a high likelihood for further volatility and increased potential for a recessionary environment, the team’s investment approach remains disciplined, steeped in relative value across sectors.

Given repriced expectations of Fed hikes and climbing Treasury yields, the duration profile of the strategy was extended, moving from 5.3 years at the start of the period to approximately 5.5 years by June 30, 2022. While long-term rates at current levels are close, or even slightly above, fair value, the team will be slow to add further to duration as there is the potential for a sizable, but likely temporary, move in rates higher. Among corporates, buy interest has increased as valuations have improved to reflect more symmetric risk/reward profiles. Banking is a preferred sector as fundamentals remain solid (good liquidity, peak margins, improved credit metrics, stable leverage ratios), while yield spread levels – i.e., compensation – are the highest since 2009. Additions have been made in this sector, among others, at attractive levels, and are expected to benefit returns as yield spreads, in time, move more in line with fundamentals. Yield spreads are likely to continue widening should the economy slow, and in that environment additions will be made in a disciplined, incremental fashion. High yield positioning has also increased selectively, though at this point, high yield spreads appear not yet compensatory enough given the myriad risks facing issuers. Further dislocation and rising yield premiums will provide compelling opportunities to layer in additional exposure. Within the securitized space, high-quality residential MBS, both agency and non-agency, continue to look attractive as recent home price appreciation provides ample cushion for homeowners and investors, even if home prices start to level off or drop somewhat. Similarly, ABS at the top-of-the-capital structure provides fair compensation given robust structures, even with the possibility of recession. CMBS has the potential for significant future volatility – specific, high-quality properties should do well, while the broader market is likely to face challenges. As a result, allocations in CMBS heavily favor single asset, single borrower CMBS where exposures can be targeted, rather than more broadly diversified issues.

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Portfolio Positioning

Modest leverage can be utilized by the Fund through a Line of Credit facility, though the Fund did not use any of the available $70 million commitment during the semi-annual period that ended June 30, 2022. Leverage is used when market opportunity is abundant and management deems the use of leverage accretive to returns.

We greatly appreciate your investment in the Fund and your continuing support of TCW. If you have any additional questions or comments, we invite you to visit our website at www.tcw.com or contact our shareholder services department at 1-866-227-8179, or contact@tcw.com.

Sincerely,

David Lippman