The Good and the Bad of Closed End Funds

| About: PIMCO High (PHK)

Karl Denninger has a couple of posts up about some peculiar trading with the Pimco High Income Fund (NYSE:PHK). This is his first post from last week, followed by this one from Monday. In the first article, Karl notes volume about ten times the average, saying that he believes someone said "get me out right now irrespective of price."

Apparently, there was a tweet that Karl found that attributed the action to fat fingers, a.k.a. a trade error. This is possible, but then in the second post Karl notes that the following two days had huge volume too as all the while the price was falling a lot. The fund looks like it trades about 700,000-800,000 shares per day. On December 30th it traded 8.2 million shares, then on December 31 it traded 2.1 million shares and then yesterday it traded 5.1 million shares.

Karl thinks the fat finger excuse is bogus and that the action is a warning for would be risk takers. There is a way that the fat finger excuse could be true. There are a couple of ways to fix an error. One is to cancel the trade and the other is to trade out of the error, so if the error was over-selling 6 million shares then that 6 million shares would need to be bought back and it is possible that this was the case. I certainly do not know if that was the case and the fact that the price of the fund kept falling suggests it probably wasn't.

There is a bigger point here than whether or not the fund really is malfunctioning, and that is that occasionally closed end funds behave in ways that are not expected or desired. They are capable of puking down in a shocking fashion. Whatever the story is with PHK, it is down 17% since last Monday's close and at one point last week it printed $8.81. Karl notes some changes in the ground that the fund can cover. Assuming someone really said 'get me out no matter what,' then perhaps the new mandate is the explanation or maybe not. As is often the case, the details may be different but the reaction in the market is the same; a fairly large closed end fund has dropped in a manner that was not easily foreseen.

People tend to love CEFs and I usually give the same warning about it being OK to own a couple of them in modest weightings, but occasionally one-off events like this happen and occasionally many of them implode at the same time. In a 60/40 portfolio someone with a 10% weight in PHK wouldn't have even taken a 1% hit to the portfolio, so at this point it would not be the end of the world, but all 40% in a series of CEFs at the wrong time could have a serious impact on the portfolio.

All products have benefits and drawbacks. Nothing is immune from this. If you think otherwise then you probably don't know the product as well as you should.