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Although this CEF's distribution rate is high, Morningstar's Steve Pikelny says the numbers are misleading and that the fund ...
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Tags:This PIMCO Fund is Worth the Hype,closed end fund analysts,jeremy glaser,morningstar,morningstar business news,pimco closed end fund,steve pikelny,what are closed end funds
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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Investors seeking income have increasingly been turning to PIMCO High Income, a closed-end fund. I am here today with Steve Pikelny, a closed end fund analyst at Morningstar, to take a closer look and see if it’s a good place for investors to place their bets. Steve thanks for joining me. Steve Pikelny: Thanks for having me. Glaser: So let's take a look at this PIMCO fund. I know it's always on lot of people's minds at conferences and elsewhere. Can you tell us a little bit about it? Pikelny: Well, this is a very weird fund for I think two main reasons. One is the fact that it most notably trades at 73% premium which is enormous even in the closed-end world. It's one of those things when you're a conference, and two closed-end fund analysts are talking to each other, it's kind of something that you can bring up to break the awkward silence because you are aware of the fact that the other analyst knows of it. I mean it is odd that it trades at such a high premium and one thing that you have to ask yourself, is why is that? The first reason I think is because it's managed by Bill Gross. So a lot of people see the name Bill Gross, who was Morningstar's Fund Manager of the Decade [for fixed income], and they think they are getting a good deal. The second reason is if you just look at the posted distribution rate of 18.8%, that looks enormous, and like you said for investors looking for high income that can be very attractive. Glaser: That distribution certainly sounds attractive, but is it deceiving? Pikelny: Yes, in fact it is very deceiving for a few reasons. One is that when you actually include the high premium, you can knock that rate down to somewhere around 10.8%. Another thing is the fact that the fund distributes a lot of shareholders' money back to them; it’s a lot of return of capital. So once you take that into account, it gets kind of knocked down to 7.9%. If you want to peel one more layer back, the fact that investors have to reinvest this return of capital at such a large premium, the rate that they actually realize is probably closer to around 6.3%, and this is mainly because since it's trading at a 73% premium, for every dollar that investors reinvest into the fund, they are essentially getting something like $0.55 back. Glaser: So given that's still a reasonable yield, what does this fund hold? How does it kind of even get to that relatively high level? Pikelny: Well, the fund holds a lot of corporate bonds, it holds a few municipal-bonds, and for a while it is holding large derivatives stake. I don’t think that in the last quarterly reportings it had as big of a stake, but it still makes up a major part of its strategy. But the second thing that’s really strange about this fund is the fact that there is a nearly identical PIMCO closed-end fund out there, ticker PFN, PIMCO Income Strategy II. What makes this fund interesting is the fact that it's also managed by Bill Gross, but it's trading at somewhere close to a 6% premium, which is weird because that means that the distribution rate that investors actually realize is closer to 9.2%. So not only is the distribution rate realized by investors higher, but also this fund holds fewer corporate bonds and more municipal bonds. So it's actually less risky. Glaser: So given that less risk, is there a lot of leverage in the second fund that kind of helps produce that higher yield. Pikelny: Surprisingly enough both funds use about the same amount of leverage, about 28% of net assets are leveraged in both funds. Glaser: So it sounds like for investors looking for a Bill Gross-managed high-income fund, they should definitely look towards PIMCO Income Strategy II and less so at PIMCO High Income. Pikelny: Right. I guess one more strange thing about it is the fact that PFN has a much larger portion of undistributed net investment income. So that distribution is also safer as opposed to just being higher. Glaser: Well, Steve, appreciate your thoughts on this today. Thanks for talking with me. Pikelny: Thank you. Glaser: For Morningstar, I am Jeremy Glaser.