PIMCO High Income Fund: Look to Swap Out

For a Valuation Pro, PHK Was a Bad Call Then, and a Short Now: Look to Swap Out

Bill Gross is not naïve to securities valuation, he is one of the best in the world. In fact, most would take his advice on various non-fixed income asset valuation over professionals in their respective specialty, and rightfully so. However, the recent article in Barron's titled Rocky Road (the full link is pasted below), where he talks up (PHK) PIMCO High Income Fund, I would strongly disagree with. In this recent article, Mr. Gross makes his case why:

“Treasuries don't make sense at these levels”

and states where he finds risks priced at both attractive and unattractive levels. He further justifies why.

“Pimco is not a fan of the high-yield market. It is a little early to be buying high-yield bonds.”

Two additional comments I found troubling were:

“Yet, while junk-bond funds in general yield 14%, the Pimco High Income Fund yields 23%."

“It's about as good a deal as any in the bond market today.”

Here’s why I strongly disagree with that call. On the Friday the 16th, the fund closed at a 22.6% premium! By no means a “value” in today's beat up closed-end fund market. Is anything worth paying a premium for in todays market? Furthermore, it is in no way still a value after this article ran up the share price to a 55.6% premium over its net asset value (NAV) as of yesterday's close (1/22/09) since the article was released.

An additional note: The NAV was down $.35 since Fridays $5.35 NAV close, 6.54%. Despite its positive strategy changes over the past few months, this is still a leveraged high yield fund and will act as such over time.

This fund is not yielding 23%, it is distributing. For those who don’t know the difference, here is the math.

Based on the funds earnings report ending 9/30/08 for 3 months (calculated monthly):

Net Income +$.1267 per month
Leverage Costs* -$0.02 per month
Monthly Distribution -$.1219
Earning/-Not earning -$0.0152 per month

Its earning rate is ~ $0.1067 per month.- anything paid beyond that is from cash, or returning principal (aka selling securities to pay the dividend).

*Pimco does not include leverage costs in Net Investment Income, see the semi-annual report for the assumed leverage costs.

Investors buying the fund today are losing ~1000 basis points or ~10% in distribution simply because the premium is so absurd. Here’s the math:

Share Price NAV

Distribution $1.46 $1.46
Value $7.78 $5.00
Distribution Rate 18.77% 29.20%

Without making this rant too long, it would be my advice to 1) short PHK if you can get a borrow (it may take another week or so before this crazyness stops- the same thing happened with AVK in November- it took about 2 weeks after the barrons article-but it worked! 2) If you own PHK, swap into the equivalent open-end fund or 3) replace it with another similar Closed-end fund: EVV, EAD or ERC.

I look forward to feedback.

I do not have a position in any of the securities mentioned above.

• Article
• Earnings Report [pdf]
• Semi Annual Report

Comments

[BDHPlayer:]

I think that you can forget about trying to short PHK. Tried to borrow shares on Wednesday and none were available.

Jan 23 08:16 AM

[notsosmart:]

be careful of selfserving advice no matter how smart or good record the advisor.think for yourself in these uncharted waters.

Jan 23 10:47 AM

[Alan Young:]

While the fund is absurdly overbought now, at the time of the interview (Jan 2) it was trading around 6.00, and had paid 1.463 in dividends, for a yield of 24%. The delay in publication made Gross's advice untimely. He may be a scoundrel, but he's not a liar.

Of course, anyone who owns the fund now would do well to sell it for the premium. There are, amazingly, safer ways to get 24% yields!

Jan 23 11:26 AM

[Income Inve...:]

I've been following PHK's NAV saga. A clear case of irrationality. The market, for the time being, apears to have set a level for both NAV discounts and distribution amounts. EAD, for example, is riding comfortably at it's historical 10% discount, and elevated 20% distribution. Expect this to continue until the market further increases its appetite for high yields.

PHK, a former core holding and favorite of mine, fails any such sanity/value testing.

Jan 23 11:34 AM

[ETFdesk.com:]

Great Stuff Johnny.

Jan 23 01:43 PM

[amorgano:]

You are not just buying a fund...you are buying the expertise and overwhelming knowledge of an expert in bonds ...in today's market this is worth a great deal....

Jan 23 02:15 PM

[spope33:]

I surmise that PHK and PTY are trading at a premium because that is where some hedge funds, or hedge-fund investors, are parking their money while they are waiting to return to the market. The thinking is the premium will not evaporate in the near term and meanwhile the yields are good. I am just guessing however.

Jan 23 02:53 PM

[notsosmart:]

guessing is the name of the game.

Jan 23 04:54 PM

[Income:]

The author is missing a key point. These are income oriented funds investing in bonds. The NAV would be a valuable input in the case of capital appreciation as the fund would be in essence an overvalued conglomerate (more than the sum of its parts). However, as Gross points out, they are buying undervalued assets (due to fear or market anomalies) where the resulting income yield is high - AIG is one example given. Gross has a 5 plus year track record with this fund in delivering and overall his record spans more than 3 decades. The premium means the market believes in his ability to continue to deliver that income stream - this is divorced from the NAV of the underlying asset. Again, the comment would be relevant in the case of a capital appreciation fund, like most, but not here.

Jan 23 05:14 PM

[discount dave:]

As of the 1/23 close, I now calculate the premium at 72.8%! Paying $173 for $100 in assets is simply not rational. This CEF has been around since 2003, and never closed a month with a premium above 13%, so this is unsustainable.

This article even oversates the value of PHK net income because it is historcal. The $0.127 per share income eaned in Q3, could not be duplicated in the following months. This fund can no longer earn $0.127 per share monthly, since the assets and the leverage were cut; and so must the earnings.

We all know how this will end, but between now and then, it remains interesting. While I geneally believe in efficient markets, this fund today, proves that we are not always efficient.

Jan 23 08:36 PM

[Steve Ess:]

Agree, PHK is way out of line. Worse now with the runup, of course. I was very surprised to hear Gross suggest this one.

In addition to your points, the dividend almost definitely will be cut. The coverage numbers you refer to were before almost half of the preferreds were redeemed.

The current 17% yield (as of 1/23) is fantasy.

Jan 24 08:27 AM

[klarsolo:]

Anybody that kept track of PHK last year knows that this fund was badly mismanaged. It was overlevered on the way down and had to realize huge losses when the bottom fell out the high yield market in Q4 2008. They had to sell assets at probably the bottom of the market just to meet debt covenant requirements. How Gross in good conscience can recommend a levered high yield fund even if it was trading at NAV is beyind me. People should stick with Vanguard High Yield if they want to go that route.

Jan 24 12:47 PM

[Florida Frank:]

PHK was around $3.75 when PIMCO was appointed 1 of 4 advisors to the Treasury for purchasing toxic assets. Since that date, PHK has unloaded it's "Toxic Crap" to the taxpayers and continues to sing the praises of Bill Gross and Pimco as "The Authority on Bonds". What a joke.

Jan 24 02:15 PM

[Gruber:]

I don't get the math. If I had a fund that has $1 billion in assets at a yield of 14% and leveraged it 33% at cost of 6%, my equity yield would be 16.6% excluding fees. If investors were to bid up the stock to a 50% premium of the original equity value (NAV), my equity yield would drop to 9.3%--not go up.

Isn't a significant premium anticipatory; thereby implying significantly higher positive future events? While the fund could certainly buy higher yielding assets than the market rate because of market expertise, this type of premium is hard to justify.

What am I missing? I would appreciate some insight.

Jan 24 11:31 PM

[CEFsteve:]

My opinion is that this is a pure short squeeze and has decoupled from any typical analyis. It could still move higher if the squeeze continues. One question : i am not as familiar with U.S. closed end funds, can they issue shares in the secondary market ? If yes, it would seem that they will do so at these premiums.

Jan 25 01:46 PM

[raysay:]

Until someone can tell me the last date NAV was calculated it is impossible to make an informed decision re PHK and the premium being thrown around. Just try to get a quote on the bonds held in the portfolio. I tried and could not, so I can only assume those of you who are chattering about the relative value of PHK have a way of doing this on a current basis, and if so, I would appreciate your sharing that information with the rest of us. Cheers


On Jan 23 05:14 PM Income wrote:

> The author is missing a key point. These are income oriented funds
> investing in bonds. The NAV would be a valuable input in the case
> of capital appreciation as the fund would be in essence an overvalued
> conglomerate (more than the sum of its parts). However, as Gross
> points out, they are buying undervalued assets (due to fear or market
> anomalies) where the resulting income yield is high - AIG is one
> example given. Gross has a 5 plus year track record with this fund
> in delivering and overall his record spans more than 3 decades. The
> premium means the market believes in his ability to continue to deliver
> that income stream - this is divorced from the NAV of the underlying
> asset. Again, the comment would be relevant in the case of a capital
> appreciation fund, like most, but not here.

Jan 29 07:00 PM

[Estimated P...:]

Calculated Daily

www.etfconnect.com/sel...


On Jan 29 07:00 PM raysay wrote:

> Until someone can tell me the last date NAV was calculated it is
> impossible to make an informed decision re PHK and the premium being
> thrown around. Just try to get a quote on the bonds held in the portfolio.
> I tried and could not, so I can only assume those of you who are
> chattering about the relative value of PHK have a way of doing this
> on a current basis, and if so, I would appreciate your sharing that
> information with the rest of us. Cheers
>
>
> On Jan 23 05:14 PM Income wrote:

Jan 29 10:45 PM

[Cynical Con...:]

The single most revealing comment is that Bill Gross pushed PHK by reporting the 23% December annual distribution as a true yield. Does he really expect to earn that much in the future? If not, he'll be simply giving new investors other investor's money (possibly with taxes due). That's called a Ponzi scheme.

Of course he knows better. One can only conclude he is, first and foremost, a salesmen pumping his own funds, even when they are poor investments.

Feb 04 03:59 PM

[raytayzmd:]

...here's a website that updates NAV daily:

www.etfconnect.com/sel...


On Jan 29 07:00 PM raysay wrote:

> Until someone can tell me the last date NAV was calculated it is
> impossible to make an informed decision re PHK and the premium being
> thrown around. Just try to get a quote on the bonds held in the portfolio.
> I tried and could not, so I can only assume those of you who are
> chattering about the relative value of PHK have a way of doing this
> on a current basis, and if so, I would appreciate your sharing that
> information with the rest of us. Cheers

Feb 10 07:43 AM

[Ranjit Thomas:]

All the similar Pimco closed end funds (e.g. PTY and PCN) have been distributing dividends in excess of investment income available to shareholders. The yield is misleading - it can be anything the fund manager wants it to be. Bill Gross thy name is Bond Ponzi!

Feb 11 11:13 PM

[macsmart:]

If anyone of you actually believes that Bill Gross would not pump a fund then I have a bridge I would like to sell you. With all the good funds that are paying good yields and are still selling at a discount, why would anyone buy a fund that is selling at such a premium? I don't get it.

Feb 18 03:44 PM

[Artiecab:]

On Jan 23 11:26 AM Aalan wrote:

> While the fund is absurdly overbought now, at the time of the interview
> (Jan 2) it was trading around 6.00, and had paid 1.463 in dividends,
> for a yield of 24%. The delay in publication made Gross's advice
> untimely. He may be a scoundrel, but he's not a liar.
>
> Of course, anyone who owns the fund now would do well to sell it
> for the premium. There are, amazingly, safer ways to get 24% yields!

Would you mind telling me where????

Feb 27 03:54 PM

[biomedlives:]

Today's announcement about the postponement of dividends underscores the danger that declining asset values may put a leveraged fund in violation of agreements on its preferred.

Mar 02 03:16 PM

[User 371202:]

Every one of the blog comments on PTY, PCN and PHK has merit. What is missing is factual comment and explanation from Bill Gross, Mohamed El-Erian et al and to why these slightly bombastic individuals, always around to pontificate on markets in general, are in hiding when their own performances tank. Or, do they think their reputation is no longer at risk, seeing their contracts with Allianz may be soon up for renewal?
I feel they need to come out of their bunkers - now.

Mar 06 01:03 PM

[Artiecab:]

Cramer says that companies should pay dividends or decrease their dividends, rather than buy their stock back. Sounds good to me.

Mar 09 10:58 AM

[Boogins_00:]

I was under the impression that the NAV's had been marked down as a result of the 'mark to market' rule, valuing distressed assets or assets with no bids at liquidation value. Thus the NAV here could be falsely low, and when the mark to market rule changes, the NAV could go back up to something more normal. I'm not a bond expert, but folks who are have explained PHK this way to me.

Mar 18 03:58 PM

[Pecos Jack:]

I was able to short PHK just before the Fed announced their liquidity bomb late last week, and although it had a 50% preimum at the time, it has one up significantly to now trade at 66% premium to NAV. Although I am seriously upside down now, I think I will hang with this to see how long it takes to unwind.

Mar 25 10:54 AM

[Mafeking:]

As someone else has posted please tell me about the amazingly safe 24% yield you mentioned. Are you putting together another Ponzi scheme?


On Jan 23 11:26 AM Aalan wrote:

> While the fund is absurdly overbought now, at the time of the interview
> (Jan 2) it was trading around 6.00, and had paid 1.463 in dividends,
> for a yield of 24%. The delay in publication made Gross's advice
> untimely. He may be a scoundrel, but he's not a liar.
>
> Of course, anyone who owns the fund now would do well to sell it
> for the premium. There are, amazingly, safer ways to get 24% yields!

Mar 26 12:48 PM