The purpose of this article is to highlight the most highly leveraged closed end fund in the closed end fund universe and a potential buying opportunity in PIMCO Strategic Global Government Common Fund (RCS). Highlighted on Morningstar's website, PIMCO's Strategic Global Government Common Fund seeks high current income with capital appreciation through investment in global sovereign debt securities.
Unlike most PIMCO closed end funds, RCS trades at a relatively conservative premium (compared to the rest of the PIMCO closed end funds) and by conservative I mean 8.62% above net asset value. Other PIMCO closed end funds, like PIMCO's High Income Fund (PHK) and PIMCO's Global StockPLUS & Income Common Fund (PGP), which both trade at premiums of over 50% and yield about 12% and 9.5%, respectively, are considered to be priced at a significantly higher level over net asset value than the standard closed end fund (mostly to do with investor/market demand and the financing cost structure of their closed end funds). RCS, on the other hand, is priced fairly close to its net asset value (about 10% away), and presents a great buying opportunity.
Market Cap: $408.6mil
Distribution Rate: 9.57%
Total Leverage Ratio: 56.44%
52 Week Range: $9.52 - 12.15
Current Market Price: $10.06
Expense Ratio: 1.55%
Here's why one should consider buying RCS:
Strategic Market Opportunity - The current fund premium is 8.62%, which to some investors is considered overpriced, however, the three year average premium is 18.44% and the 6-month average premium is 10.72%, meaning this fund has strayed away from its typical market price levels (from a premium to net asset value perspective). There is a 10% price appreciation opportunity with RCS if performance remains consistent in the coming few months. Not only will the price appreciation be advantageous, but the fund is also yielding a pretty attractive 9.57%, paid out monthly, which means that price appreciation paired with that payout could mean a pretty good return on investment in a couple of months.
Credit Quality - 60% of RCS's bonds are rated AAA, 19% are rated BBB and higher, and only 14% of the bonds are BBB, BB, or B. Note, 7% of the bonds are Not Rated, but that only means the institution issuing the bonds did not get the bonds rated and does not necessarily mean more risk for the bonds. The biggest kicker, RCS's portfolio is largely made up of sovereign debt, which means, the chances of default are slim to zero (however, invest with caution and always assume it is a possibility).
CEF Diversification (mainly away from Equity heavy portfolios) - RCS invests in a couple of investment instruments consisting of mainly Agency MBS Pass-Throughs, Agency MBS CMOs, and Non-Agency Residential MBS securities (which explain the high yield).
Reasonable Expense Ratio - 1.55% is about the average across the high yielding closed end fund industry and it makes sense relative to the market capitalization of the fund. I will note that this may actually be too high for a fund that is leveraged over 50% and investing in AAA government backed securities. Generally speaking, when it comes to leveraged funds, I like to see a 1.10% to 1.30% expense ratio.
Distribution Rate and Frequency - With a distribution rate of almost 10%, every investor's portfolio could find this fund useful from a monthly distribution perspective. When doing the math, and even leveraging RCS in a personal portfolio, that 10% distribution rate could turn into 13% (or more, depending on the amount of leverage taken) as your dividends reinvest in the fund to yield higher returns every month (note: only leverage your personal account if you understand the fees/costs associated with leveraging a closed end fund in your brokerage account).
Distribution Composition - RCS's dividend distributions are solely made up of Fund Income, which follow the objective the fund markets to investors. When it comes to distributions, the first thing an investor should always scrutinize is the composition of the dividends to determine how sustainable certain investments may or can be for a long-term income portfolio. For funds like RCS, any Return of Capital (ROC) would bucket RCS into the "do not invest" bucket, since funds like RCS are not supposed to be distributing the funds they are supposed to be using to grow and distribute income distributions with. There are some funds that are solely ROC funds, however, RCS and other funds with similar strategies are not to be mistaken for those types of funds (a good example of an ROC distributing fund is ETV, where the ROC distributions are explained. Read that article here).
Morningstar 4 Star Rating - The average Seeking Alpha investor generally does not assign Morningstar's rating system that much value when it comes to investment ratings, but when you do see a four or five star rated closed end fund and compare the funds you currently have in your portfolio (that may have lower or no ratings), wouldn't it be interesting to look into why that specific fund is rated four or five stars? I've always treated Morningstar ratings as additional information to give me perspective on what other investors, or rating agencies, think of that given closed end fund. I actually find the Morningstar rating system fairly credible and will definitely use it to influence my investment decisions.
Considerations before buying RCS:
High Leverage Ratio - RCS's leverage ratio is 56.44%, which is the highest in the entire closed end fund universe, but not necessarily the riskiest. The bonds that RCS holds are considered fairly safe and the ratings, Morningstar risk consideration, and brand name (PIMCO) are a testament to the security of the fund for the long-term.
Betalyst View: The first time I came across RCS was about two years ago and at the time I didn't find the fund that attractive for two reasons: 1) the yield was under 8% (automatically was factored out of my investment considerations) and 2) the investment strategy didn't exactly excite me (AAA bonds are pretty easy to understand, and I like the complicated stuff… doesn't exactly take a sophisticated investor to understand the complexities of ratings and their lack of accuracy. So, naturally, lower rated bonds are much more attractive for an investor like myself). To this day, the second point holds true, but the first point has changed course, presenting the fund at a more attractive yield and buying opportunity (with a 10% upside mentioned earlier). Overall, I'm proactively looking to take a position in RCS in the near future (next two months), and would consider allocating about 5% of my portfolio(s) to the fund to capture the opportunity. However, I will note that once the premium to net asset value climbs to 3 year average levels, this fund would lose its holding opportunity, in which case I would sell it for alternative opportunities.