PIMCO Global StocksPLUS & Income Fund Looks Overvalued

There are quite a few over-priced closed-end funds trading now which pay out high distribution rates, usually produced by gimmicks. I reported on several funds that used dividend capture a few weeks ago. Another closed-end fund selling at a large premium over NAV is the PIMCO Global StocksPLUS & Income Fund (PGP).

This fund takes an “innovative” approach to generate artificially high dividend payouts that has attracted strong support from retail investors. They do not invest directly in equities. They invest in futures contracts (50% S&P 500, 50% MSCI EAFE) using a short-term bond portfolio as collateral for the derivatives exposure. The bond portfolio has an average duration of about two years and includes emerging market bonds. They then write call options on the US equity portion to generate additional income from option premiums. They use about 33% leverage to increase the dividends generated.

Recently PGP has generated good market performance mainly because the shares have traded from a discount to a large premium over NAV.

11/28/2008 Discount to NAV of= -18.34%

11/11/2009 Premium over NAV= +65.14%

This is an 83% swing. Closed-end fund discounts and premiums over NAV usually revert to the mean, so PGP looks dangerously over-valued here. The shares are difficult to short, so I would not necessarily recommend a short sale, since the shares could be subject to a forced buy-in.

Pimco Global StocksPLUS&Inc pays monthly

• Common Assets= 107 MM
• Total Net Assets= 162 MM (uses 33.6% effective leverage)
• Annual Distribution (Market) Rate= 12.22%
• Income Only Yield= 3.43%
• Baseline Expense ratio= 1.88%
• Premium over NAV= +65.14%
• Portfolio Turnover rate= 214%

Full Disclosure: No position in PGP

Comments

[prairiedog555:]

I can't believe anybody would buy a CEF with premium higher than 0,
let alone a 65% Premium.
Would you buy anything that is priced at 65% over the components it owns?
Must be the God-like wisdom of Pimco management.

Nov 13 08:51 AM

[mavericks:]

Hmm, seems I missed that last article on overpriced dividend capture CEF's. Wondering what your thoughts on AOD are now that it has reversed its 20%+ discount into a 20%+ premium one year after you first wrote about it.

Nov 13 09:26 AM

[suburban blues:]

Good point, Mavericks

Nov 13 09:36 AM

[Joe Eqcome:]

The historically unsupportable CEF premiums you note are illustrative of the pricing bubble being built by a continuation of the Fed’s zero interest rate policy. I understand and support their policy but note the aftershocks it could produce.

The Fed's zero funds rate policy has driven down these CEFs' cost of capital to tenths of a percent. As a result it has allowed for unprecedented spreads between the asset yield and the cost of capital.

This spread translates into attractive, but unsustainable, distribution yields accessible by retail buyers in a low yield environment. This retail buying of these high yields is driving the share price up and unmooring it from NAV. So, there is a disconnection between the two and the creation of a valuation bubble.

As I argued here before, unsuccessfully, in the case of the Pimco CEFs, Pimco’s managements are the ones valuing the NAV on level I & II assets in their CEFs. They’re presumably the best in the business and they’re telling you that the stocks are overvalued! Nature speaks; it is we who fail to listen.

However, investors have been emboldened by the Fed's declaration of a continuation of this policy. Nonetheless, once rates begin to rise, these CEF stock prices will plunge like Kamikaze pilots on to the decks of the retail investor.

Remember, financial suicide is not illegal.

Nov 13 12:32 PM

[Joe Eqcome:]

In the comment above, I intended to say: "level II & III assets". I apologize for the error.

Nov 13 12:33 PM

[GlobalTrekker:]

Good, straightforward article. PGP is, indeed, over-valued but is not that hard to short. It's just not for the faint-hearted. Pimco is not all-knowing, the fund just has a perhaps overly loyal following that is seduced by the high distribution (I wouldn't call it a dividend) and the current mania for commodities/natural resources.

Were I long, I'd sell. Otherwise, I'd look at the recent (one year or so) discount/premium profile and see where it is now. If it's particularly high by *that* measure, and you have the stomach for it, it could be a good short. I am short it now.

Nov 13 01:02 PM

[George Spri...:]

Mavericks- I owned AOD for awhile when it sold at a discount to NAV in 2008, but I almost always sell a closed-end fund once it goes to a premium. Some closed-end funds with low expense ratio and low turnover ratio can be good buy and hold investments, but I view the dividend capture funds with high turnover ratios as trading vehicles, and I would only purchase them at above average discounts to NAV.


On Nov 13 09:26 AM mavericks wrote:

> Hmm, seems I missed that last article on overpriced dividend capture
> CEF's. Wondering what your thoughts on AOD are now that it has reversed
> its 20%+ discount into a 20%+ premium one year after you first wrote
> about it.

Nov 13 02:51 PM

[George Spri...:]

GlobalTrekker-
At Interactive Brokers, you would have to pay 20% interest for the privilege of selling short PGP. That is too high for me to consider it.
It may be available for shorting at other brokers without paying interest, but you would have to be careful about forced buy-ins at an inopportune time.


On Nov 13 01:02 PM GlobalTrekker wrote:

> Good, straightforward article. PGP is, indeed, over-valued but is
> not that hard to short. It's just not for the faint-hearted. Pimco
> is not all-knowing, the fund just has a perhaps overly loyal following
> that is seduced by the high distribution (I wouldn't call it a dividend)
> and the current mania for commodities/natural resources.
>
> Were I long, I'd sell. Otherwise, I'd look at the recent (one year
> or so) discount/premium profile and see where it is now. If it's
> particularly high by *that* measure, and you have the stomach for
> it, it could be a good short. I am short it now.

Nov 13 02:59 PM

[suburban blues:]

And a stopped clock is right twice a day.. This reminds me a great deal of all the naysayers against the present rally...eventually they will be right. but they sure passed up a lot of profits.


On Nov 13 12:32 PM Joe Eqcome wrote:

> The historically unsupportable CEF premiums you note are illustrative
> of the pricing bubble being built by a continuation of the Fed’s
> zero interest rate policy. I understand and support their policy
> but note the aftershocks it could produce.
>
> The Fed's zero funds rate policy has driven down these CEFs' cost
> of capital to tenths of a percent. As a result it has allowed for
> unprecedented spreads between the asset yield and the cost of capital.
>
>
> This spread translates into attractive, but unsustainable, distribution
> yields accessible by retail buyers in a low yield environment. This
> retail buying of these high yields is driving the share price up
> and unmooring it from NAV. So, there is a disconnection between the
> two and the creation of a valuation bubble.
>
> As I argued here before, unsuccessfully, in the case of the Pimco
> CEFs, Pimco’s managements are the ones valuing the NAV on level I
> & II assets in their CEFs. They’re presumably the best in the
> business and they’re telling you that the stocks are overvalued!
> Nature speaks; it is we who fail to listen.
>
> However, investors have been emboldened by the Fed's declaration
> of a continuation of this policy. Nonetheless, once rates begin to
> rise, these CEF stock prices will plunge like Kamikaze pilots on
> to the decks of the retail investor.
>
> Remember, financial suicide is not illegal.

Nov 13 05:14 PM

[HighTower:]

Your logic is the same as the one that produced the current financial crisis. You ignore the fact and let the bubble build until it explodes. This is the greater fool theory supported by fools, traders and government supported financial institutions. The little guys are usually the victims--twice.


On Nov 13 05:14 PM suburban blues wrote:

> And a stopped clock is right twice a day.. This reminds me a great
> deal of all the naysayers against the present rally...eventually
> they will be right. but they sure passed up a lot of profits.

Nov 15 07:50 AM