Just the other week I wrote an article, which you can read here, comparing the valuation gap of the Allianz/PIMCO fixed-income closed-end funds (CEFs) with their equity funds. As one might expect, the PIMCO fixed-income CEFs tend to get a premium boost because of PIMCO's reputation and stature as one of, if not the best fixed-income manager in the world. So it's a bit of a surprise to see the Allianz/PIMCO equity CEFs, which are usually held in high regard as well, suffer at the other end of the valuation spectrum even though virtually none of them are pure stock funds, i.e. most include some fixed income component even if that is convertible securities.
It's this valuation gap between the fixed-income funds, all of which use leverage, and the equity funds, none of which use leverage, that first caught my attention, particularly at this stage of a bond and stock market rally. Two funds represent the poster children of extreme valuation differences and I would like to expand a bit more on both. One fund gets a lot of attention in the media because of its huge premium valuation while the other goes largely unnoticed by investors even though the fund is three times as large as the other.
The first fund I'm referring to is the Allianz/PIMCO Equity & Convertible fund (NIE) and the second is the Allianz/PIMCO Global StocksPlus & Income fund (PGP). Let me first describe the two funds since they do have a big difference in their portfolios and income strategy resulting in a much different risk/reward profile.
PGP is essentially a heavily leveraged multi-sector bond fund (mortgage backed, corporate bond, Govt. agency, etc.) that goes out and buys large positions in S&P 500 mini-futures, hence where the StocksPlus part of the title comes from. PGP does not in fact, own individual stocks and, in addition, I don't see where the fund has much exposure to non-US securities despite having global in its name. Nevertheless, what's important to understand about PGP is that it's a high leverage, high risk fund that can have a very volatile Net Asset Value ((NAV)) because of its use of leverage and derivatives. To see PGP's entire portfolio as of 12/31/2012, click PGP Holdings.
NIE, on the other hand, is essentially a large cap US stock based fund that includes about 27% of its portfolio in convertible securities. NIE can also sell options against up to 70% of it stock portfolio though currently the sell call option strategy is not being heavily utilized based on the fund's holdings as of 1/31/2013, shown here NIE Holdings. NIE's top 10 holdings are also shown below.
Now NIE is a more defensive fund because instead of using leverage and long derivatives to generate the income and growth needed to cover its high distribution and yield, NIE instead uses a combination of yield oriented convertible securities, option premium and even appreciation. However, this does not mean that NIE doesn't have high NAV growth capability and in fact, the fund's NAV can generally keep up with the S&P 500 over varying market cycles, i.e. NIE's NAV tends to hold up better than the S&P 500 index during difficult market periods though it may underperform during strong up market periods.
The bottom line is that NIE is a much lower risk/reward fund than PGP but does that mean the fund should trade at a valuation discount that borders on the absurd compared to PGP? Let's first take a look at the vital statistics of the two funds as of February 22, 2013.
The first thing to notice is that both funds went public with the same $25 market price (not shown) and the same $23.83 inception NAV and yet its NIE that currently has the much higher NAV at $20.11 compared to $14.24 for PGP. Then consider that NIE went public much closer to the start of the bear market later in 2007 and really should have been expected to lose more NAV. So for a fund that has an NAV 41% higher than the other currently, one would think NIE's market price would at least receive some measure of respect since not too many equity CEFs have NAVs that are close to their inception NAV's, certainly not PGP. But in this case, respect and popularity have a fickle finger, even for an Allianz/PIMCO fund.
So despite NIE's significantly higher NAV, the fund trades at a market price going on $4 lower than PGP. I don't think I have ever seen such a valuation disparity from one fund family especially since both funds are really hybrid equity/fixed-income funds. Yes, PGP has a more aggressive income strategy, a higher risk/reward profile and a significantly higher yield paid monthly, but there are significant advantages to NIE that investors should take into consideration.
The first of which is both fund's longer term NAV total return performances. Yes, PGP's NAV will far outperform just about any CEF during a strong bull market cycle but throw in a bear market and look what happens. Here is NIE's and PGP's total return NAV performances on a quarterly basis starting from around the market high at the end of the 3rd quarter of 2007. All distributions and capital gains are included to give you a running total return performance quarter by quarter. Red represents down quarters and green represents up quarters.
So over a 5-year+ period, which includes the bear market of 2008, NIE's NAV has slightly outperformed PGP's and essentially matched the S&P 500 as reflected by the SPDR S&P 500 Trust (SPY), which includes dividends. Something to think about if we ever go back into a more difficult market environment.
Do you want another example of how insane the valuations of these two funds are? Go to this link, CEFConnect, which sorts all of the 600+ CEFs, bond and stock, by their discount and premium levels. There you'll see at the bottom of page 1 of all 341 funds at a discount currently, that NIE checks in with one of the widest discounts of all CEFs at -12.2%. This means that investors value the fund at a market price over 12% below its liquidation value as represented by its NAV. This for a fund that has one of the best NAV total return performances of any non-leveraged US equity based CEF. Note: This sorting will change day-to-day based on funds' closing valuations.
Next, put in "Premium" in the drop down menu under Sort Funds By: and you'll see that PGP has the highest premium valuation of all 600 or so CEFs, bond or equity. In other words, investors are willing to pay a 49.6% market price premium over PGP's NAV just for the right to own this fund, still a far cry from the 82.6% premium that PGP had when I panned the fund back in July of 2012. You can read that article here.
Now I believe PGP is a terrific fund and certainly worthy of a premium pricing based on its NAV growth potential (over 54% since the beginning of 2012) and how difficult it would be for anyone to replicate PIMCO's strategy. However, I also believe that investors would be far better served to invest in a fund like NIE from Allianz/PIMCO at this point.
The reason is because not only do I believe both the stock and bond markets will be running into more resistance at this point in the market cycle, which will favor the more defensive funds, but the real reason is that I believe NIE may be on the verge of raising its distribution.
Back when both funds went public, both NIE and PGP had roughly 9% NAV yields. In other words, that was the yield that both funds were expected to be able to support. Today, PGP's NAV yield has ballooned to 15.5% which is a huge red flag for the fund going forward, despite its NAV growth potential. PGP has never adjusted its distribution since inception and pays the same $2.20/share annually now at a $14.24 NAV as it did when it went public at a $23.83. That is a big reason why PGP's NAV has dropped to $14.24 while trying to support that huge distribution and NAV yield. If that doesn't cause you to take notice, I don't know what will.
NAI's NAV yield, on the other hand, has dropped to an exceptionally low 5.6%, much lower than its 9% inception NAV yield. Part of the reason is because of a hefty distribution cut in early 2009 after the financial crisis bear market, but the other reason is because NAI's NAV has recovered nicely since then. From a low of about $13 back on 3/31/2009 (refer to table above), NIE's NAV is back over $20, not too far from its inception NAV.
Though Allianz/PIMCO probably won't restore NIE's distribution back to its original $2.25/share annual distribution ($0.5625/quarterly), I wouldn't be surprised if they restored it partially, perhaps up to a $0.35 to $0.40/share quarterly distribution. This would put it more in line with its other equity funds though it would still be the lowest yielding fund of any of the Allianz/PIMCO equity CEFs.
Even if Allianz/PIMCO does not raise the distribution this go around, we can expect to see this step taken at some point in the future. This would not be unlike what happened to another Allianz/PIMCO fund, the NFJ Dividend, Interest & Premium Strategy fund (NFJ), which also cut its distribution in early 2009, rebuilt its NAV back to around $20 and then largely restored its distribution in late 2010. And how did NFJ's market price react when the distribution was restored? It cut its discount in half from around -15% to around -7% and even went to a premium for a short while in 2011.
Allianz/PIMCO should declare 1st quarter 2013 distributions for its CEFs around the first week in March.
Disclosure: I am long NIE.