PIMCO High Income Fund: A Swan Song

Preface: I believe I have clearly stated my case with supporting data for the overvaluation of PHK. Furthermore, I feel there is nothing I can add beyond what’s been written.

So, this will be the last comment I have on PHK until there is a major corporate event that proves me either right or wrong. As one commenter put it, it now sounds like I’m “ragging” on it. That was never my intent. I was seeking evidence to the contrary.

The following article is a response to a comment made by Jim Walsh, a portfolio manager of equity income monies, to an article I wrote on PHK PIMCO High Income Fund Cannot Support Its Share Price. Rather than it being buried 23 comments down, I thought it was worth repeating. Particularly, since this is my “Swan Song” on the topic.

To Jim Walsh: I want to address your specific contention that PHK’s valuation is subject of a dysfunctional high yield market. This is the basis of your reasoning that NAV is not a valid measurement during this period of time.

Swimming in the Same Pool? If that were true, the valuation risk should be systematic. All high yield CEFs, as PHK is classified both by the WSJ and ETFConnect, would be subject to this phenomenon. Therefore, all such funds should be bias toward a premium. I believe this is not the case.

High Yield CEF Valuations: There are 66 high yield funds in my data base. The average discount is 2.4%. Additionally, the standard deviation (SD) is 9.6%. For the purpose of this example, let’s say it’s 10.0%. All but two of the 66 fall within the 2 SD’s which should constitute 95% of the population.

Outliers: One of the two falling beyond 2 SD’s is Pioneer High Income Trust (PHT). Its premium is 18.3%. This places it just a little above the 2 SD’s of 17.9%.

Is PHK Out of Sight? Therefore, with PHK trading at a 47.8% premium, it is almost 5 standard deviations from the mean. This would mean that PHK has a 0.3% chance of being part of this peer group.

Several Explanations: There are several explanations for this. The first and most popular is that Bill Gross has a “secret sauce” that he will apply to PHK. The second is that PHK is really something other than its classification. The third is Pimco has either a faulty or a superior valuation mechanism relative to its peer group. Or, my personal favorite, that it is just plain overpriced.

Orbiting a Different Planet? Let me deal with the possibility that PHK is something else. Recently, PHK announced that it would change its investment policy to reduce it’s 80% holding in high yield securities to 50%. As a result it would be able to own more rated bonds. (Is this an indication of problems in the high yield markets?)

The fact that it has recently changed its investment policy towards higher credits mitigates the contention that PHK’s valuation is a function of a dysfunctional high yield market. Rated paper is more efficiently priced as the markets are more liquid.

Another Comparison: Additionally, if you were to now compare it to the CEF fund type “Other Funds” which include high yield funds you wouldn’t be in any better position. Statistically this group’s mean is 1.4% and the SD is 13.7%.

Lonely No More: However, PHK would no longer be lonely in the “Other Funds” Group. This is because its sister CEF, PIMCO Global StocksPLUS&Income (PGP), is classified as such. PGP is currently trading at a 63.6% premium. Ouch! Now, if you just focus on the high yield CEFs in “Other Funds” you’d really get depressed.

The Pimco Effect: So, let’s cut through this. The superior valuations are not a function of a dysfunctional high yield market: it’s the “Pimco Effect”. To the extent they can justify these valuation with future performance will be played out in the marketplace. I hope it has a happy ending—although history doesn’t support that conclusion.

I have nothing against Bill Gross or Pimco. I’m just looking for the numbers to support the valuation and not finding them. I’ve appealed to PHK to provide supplemental numbers for that purpose.

To the extent Pimco can beat these statistical odds it should make them odds on favorites for the Noble Prize in Economics.

Disclosure: Author is short PHK

Comments

[DrBenway:]

Some closed-end funds (PHK, CFP, TRF) along with bankrupt financial (AIG, C, FNM, FRE) are just new dot.coms. The standard fundamental valuation no longer applies because they trade up on pure technical analysis. Every trader hopes that someone else down the road will hold the bag. Some of us old enough to remember how it ended in 2000...

Sep 14 12:06 PM

[Terikub:]

You wrote: " this is my “Swan Song” on the topic". All I can say is Thank the Good Lord for small favors.

Sep 14 12:49 PM

[HighTower:]

I agree with your conclusion that this is more about Pimco's status as a bond manager than the specific valuation of PHK. As we've seen before, market's are subject to periods of "irrational exuberance". However, this exuberance can last longer that you'll be able to remain solvent. Probably a good idea to check back in 6 months.

Sep 14 01:15 PM

[GlobalTrekker:]

Of course PHK is wildly overpriced. There's nothing magical about PIMCo or Bill Gross. Both have done disastrously in many areas of debt over this recession. And Gross's justifiable but stubborn position on CEF ARPs blew up badly in his face, not to mention his investors. The reason is actually unmentioned. Saying that it's overpriced because its overpriced is tautologic. The price is simply supported by lots of small holders, most not in margin accounts, and no short stock borrow. Pure and simple.

Sep 14 01:27 PM

[frogmatic:]

I thought the prevailing argument was that mark-to-market undervalues junk assets, which is why we needed to allow mark-to-model again. And now Jim Walsh argues that mark-to-model undervalues the junk too? Please, give me a break.

Joe is spot-on here: PHK's premium to NAV is a virtual guarantee of future underperformance. (And PGP, which doesn't have the benefits of leverage nor the genius of Bill Gross, is even more of a basket case).

Sep 15 07:38 AM

[YoYoMama:]

Yes, please, can we move on? PHK overvalued. PIMCO bad. Yes, yes, already. Geez....

There are 10's of thousands of CEFs. Let's focus on the ones that are GOOD investments. At the end of the day, that's the only information that is useful.

On Sep 14 12:49 PM Terikub wrote:

> You wrote: " this is my “Swan Song” on the topic". All I can say
> is Thank the Good Lord for small favors.

Sep 15 10:35 AM

[perclae:]

What seems lost in this discussion is the distribution yield on these other CEF's. AFAIK very few CEF's beat the distribution yield on the PHK even with it's overvaluation. That is why dip buyers keep buying it, even with the overvaluation the yield still beats the competition.

Sep 15 12:24 PM

[All Smiles:]

I have watched these over valued comments and agree with them but, if your were short the stock every time one of these comments/articles came out, you have lost your shorts.

These articles have had short term decline in the price each time they were written but then up and away as the shorts have to cover.

Remember they are short the monthly dividend as well and the monthly distribution of 0.121875 per share is still 14.77% annualized.

What a blood bath for these poor shorts.

I bought this at a discount to NAV on 9/29/2008, 10/8/2008, 11/3/2008 and have an 111.3% total return and am not selling.

Talk about pain being short PHK and more to come.

Buy on any decline in price that is caused by these pleas.

These short are looking to cover to get out before their family looses their shorts as well.

Another short squeeze will result.

Up Up and Away ......with my beautiful ..........PHK !!!!!

Sep 15 01:28 PM

[DrBenway:]

As I mentioned before, some of the PHK buyers were apparently born in this century...


On Sep 15 01:28 PM All Smiles wrote:

> I have watched these over valued comments and agree with them but,
> if your were short the stock every time one of these comments/articles
> came out, you have lost your shorts.
>
> These articles have had short term decline in the price each time
> they were written but then up and away as the shorts have to cover.
>
>
> Remember they are short the monthly dividend as well and the monthly
> distribution of 0.121875 per share is still 14.77% annualized.<br/>
>
> What a blood bath for these poor shorts.
>
> I bought this at a discount to NAV on 9/29/2008, 10/8/2008, 11/3/2008
> and have an 111.3% total return and am not selling.
>
> Talk about pain being short PHK and more to come.
>
> Buy on any decline in price that is caused by these pleas.
>
> These short are looking to cover to get out before their family looses
> their shorts as well.
>
> Another short squeeze will result.
>
> Up Up and Away ......with my beautiful ..........PHK !!!!!
>

Sep 15 05:40 PM

[All Smiles:]

OOOPs.

PHK closed up +4.6% ($10.20) today on volume 52% above the average daily volume for the last 3 months.

Sure looks a lot like a short squeeze to me.

When you may have been born doesn't have anything to do with making or losing money.

Back when I was sailing with Christopher Columbus I learned not to go to the bathroom over the windward rail of the Santa Maria.

Windward is the direction from which the wind is blowing at the time in question. The side of a ship that is towards the windward is the weather side. If the vessel is heeling under the pressure of the wind, this will be the "higher side".

I have also learned not to fight the Fed or the Tape.

Being short anything in Corporate Debt or Preferred Stock since the panic lows in October and March is like going to the bathroom over the windward rail.

Yes everyone is crazy to pay such a premium for PHK, but the NAV is still rising and so is the Market Price. You just can't ignore the momentum in this market sector.

Once again, I bought PHK at below NAV

10% of current position on 9/29/2008 @ 8.61
27% of current position on 10/8/2008 @ 5.95
60% of current position on 11/3/2008 @ 5.29

I now have a 117% total return on this position but it was not looking pretty when the final lows were being put in during March.

PHK has traded at a 23% premium ($3.40) on 3/9/2009 to a 75% premium ($6.31) on 4/8/2009. I hindsight, I wish I hadn't worried so much about the premium and paid a 75% premium on 4/8/2009 @ $6.31.

PHK is one of the few CEFs that has not cut their monthly distribution rate. PHT is another that has not cut the distribution rate. Both are trading at a higher premium to the net asset value than their peers because of management and the stability in the distribution rate.

Our annualized distribution yield on PHK at cost is +31%.

I was almost certain that this distribution rate would have been cut when Bill Gross took over this CEF in 2009. I am pleased, and surprised, that he has maintained the monthly distribution.

The only shock that could possible have PHK trade at or near NAV would be a cut in the monthly distribution rate which would be a buying opportunity for those that missed this boat.

I also wasn't willing to pay the premium for PHK and was worried about a distribution cut so began buying NCZ at a discount to NAV as follow

9% of current position on 10/14/2009 @ 5.75
6% of current position on 11/5/2009 @ 5.20
30% of current position on 3/24/2009 @ 3.65
51% of current position on 3/24/2009 @ 4.07

I have a 107% total return on this position.

More importantly the annual distribution yield at cost is +27%.

I expected as much as a 40% cut in the monthly distribution rate
and NCZ did cut the distribution rate from .119 in October 2008 to .085 in Feb 2009 (-29%).

I expect that NCZ could be one of the first CEFs to raise their distribution rate over the next year as the convertible and preferred markets continue their recovery from the panic lows caused by Dr. Doom (Phd Rubini) in March when he was all over the TV saying that all the banks were technically insolvent and should be nationalized. Thanks Dr Doom for a panic low so that I could buy these cheap in March.

I also bought HWN on 5/20/2009 at $14.30. I have a +30% total return on this one at today's close while the S&P is up +16% over the same period.

HNW has cut the monthly distribution rate in March, 2009 from .22 to .19 (-14%) and again in August from .19 to .16 (-16%) and it has still outperformed the S&P.

There is a sunami of money still stuck in T bills , money market funds, and CD at less than 2% annual yields that are finally realizing that the "world has not ended" and they wish they had payed a 23% premium for PHK in March or a 75% premium in April.

When I sailed with Chris on the Santa Maria I also learned to sail with the wind and that most ships rose in the harbor when the tide came in and declined in the harbor when the tide went out.

The full moon low tide was reached in March, 2009.The tide is coming in and who knows how high the NAV for these Corporate Bond and Preferred Stock Funds CEFs will rise as the sunami of low yielders jump on board the Corporate Debt and Preferred Stock ship which has set sail.

I an not smart enough to call a top but I am riding this incoming tide.

Sep 16 06:20 PM

[Joe Eqcome:]

All Smiles

I find you’re your reference to your mythical service on the Santa Maria with Columbus an accurate analogy for your investment philosophy—particularly with regards to PHK for two very specific reasons:

1) The Santa Maria was the slowest of Columbus’ vessels;
2) The ship later ran aground and was lost off present-day Haiti.

Here’s wishing you safe passage to your ultimate destination.

Joe Eqcome

On Sep 16 06:20 PM All Smiles wrote:

> OOOPs.
>
> PHK closed up +4.6% ($10.20) today on volume 52% above the average
> daily volume for the last 3 months.
>
> Sure looks a lot like a short squeeze to me.
>
> When you may have been born doesn't have anything to do with making
> or losing money.
>
> Back when I was sailing with Christopher Columbus I learned not to
> go to the bathroom over the windward rail of the Santa Maria.
>
> Windward is the direction from which the wind is blowing at the time
> in question. The side of a ship that is towards the windward is the
> weather side. If the vessel is heeling under the pressure of the
> wind, this will be the "higher side".
>
> I have also learned not to fight the Fed or the Tape.
>
> Being short anything in Corporate Debt or Preferred Stock since the
> panic lows in October and March is like going to the bathroom over
> the windward rail.
>
> Yes everyone is crazy to pay such a premium for PHK, but the NAV
> is still rising and so is the Market Price. You just can't ignore
> the momentum in this market sector.
>
> Once again, I bought PHK at below NAV
>
> 10% of current position on 9/29/2008 @ 8.61
> 27% of current position on 10/8/2008 @ 5.95
> 60% of current position on 11/3/2008 @ 5.29
>
> I now have a 117% total return on this position but it was not looking
> pretty when the final lows were being put in during March.
>
> PHK has traded at a 23% premium ($3.40) on 3/9/2009 to a 75% premium
> ($6.31) on 4/8/2009. I hindsight, I wish I hadn't worried so much
> about the premium and paid a 75% premium on 4/8/2009 @ $6.31.
>
> PHK is one of the few CEFs that has not cut their monthly distribution
> rate. PHT is another that has not cut the distribution rate. Both
> are trading at a higher premium to the net asset value than their
> peers because of management and the stability in the distribution
> rate.
>
> Our annualized distribution yield on PHK at cost is +31%.
>
> I was almost certain that this distribution rate would have been
> cut when Bill Gross took over this CEF in 2009. I am pleased, and
> surprised, that he has maintained the monthly distribution.
>
> The only shock that could possible have PHK trade at or near NAV
> would be a cut in the monthly distribution rate which would be a
> buying opportunity for those that missed this boat.
>
> I also wasn't willing to pay the premium for PHK and was worried
> about a distribution cut so began buying NCZ at a discount to NAV
> as follow
>
> 9% of current position on 10/14/2009 @ 5.75
> 6% of current position on 11/5/2009 @ 5.20
> 30% of current position on 3/24/2009 @ 3.65
> 51% of current position on 3/24/2009 @ 4.07
>
> I have a 107% total return on this position.
>
> More importantly the annual distribution yield at cost is +27%.<br/>
>
> I expected as much as a 40% cut in the monthly distribution rate
>
> and NCZ did cut the distribution rate from .119 in October 2008 to
> .085 in Feb 2009 (-29%).
>
> I expect that NCZ could be one of the first CEFs to raise their distribution
> rate over the next year as the convertible and preferred markets
> continue their recovery from the panic lows caused by Dr. Doom (Phd
> Rubini) in March when he was all over the TV saying that all the
> banks were technically insolvent and should be nationalized. Thanks
> Dr Doom for a panic low so that I could buy these cheap in March.
>
>
> I also bought HWN on 5/20/2009 at $14.30. I have a +30% total return
> on this one at today's close while the S&amp;P is up +16% over the
> same period.
>
> HNW has cut the monthly distribution rate in March, 2009 from .22
> to .19 (-14%) and again in August from .19 to .16 (-16%) and it has
> still outperformed the S&amp;P.
>
> There is a sunami of money still stuck in T bills , money market
> funds, and CD at less than 2% annual yields that are finally realizing
> that the "world has not ended" and they wish they had payed a 23%
> premium for PHK in March or a 75% premium in April.
>
> When I sailed with Chris on the Santa Maria I also learned to sail
> with the wind and that most ships rose in the harbor when the tide
> came in and declined in the harbor when the tide went out.
>
> The full moon low tide was reached in March, 2009.The tide is coming
> in and who knows how high the NAV for these Corporate Bond and Preferred
> Stock Funds CEFs will rise as the sunami of low yielders jump on
> board the Corporate Debt and Preferred Stock ship which has set sail.
>
>
> I an not smart enough to call a top but I am riding this incoming
> tide.

Sep 17 10:13 PM

[Maven12:]

Swan song or not... Joe Eqcome has done an effective job of helping to illuminate (with our comments, too) the topic.

I've been attempting to FULLY understand the PIMCO leveraged ARPS model since I first purchased the California II leveraged muni bond fund.

Joe complains about the missing information that helps to understand the earnings vs the distributions. When you add leverage and its changing cost, you create more variables than our two-dimensional reporting system can sustain.

Best wishes in your quest, Joe, whether you write about it or not.

Sep 20 12:05 PM