Are High Premiums To Net Asset Value Sustainable?

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Includes: PDI, PGP, PHK, PKO
by: David Wedeking

Summary

2 closed-end funds now trade at a 50%+ premium to net asset value.

One fund’s premium to net asset value exceeds 100%.

Since inception, neither fund has generated average annual returns in excess of the current net asset value distribution level.

One great feature of closed-end fund (CEF) investing is the frequent opportunity to purchase shares of well managed CEFs, with great long-term total return performance, at a discount to net asset value (NAV). At other times, closed-end funds garner so much enthusiasm that they trade above net asset value for extended periods of time. This article presents the two funds currently trading at +50% premiums to NAV and suggests suitable alternatives that sport much smaller premiums in the same fund family.

PIMCO Global StocksPLUS&Income Fund (NYSE:PGP) - This fund was started on 5/31/2005 and has provided annual average returns of 10.92% (at NAV). Impressive, but the fund's current distribution rate at market price is 10.99% and it trades at a 103.46% premium to net asset value. Against net asset value the fund's distribution rate is a staggering 22.36%. Even with Dan Ivascyn, Morningstar's Fixed-Income Fund Manager of the Year (U.S.) for 2013, at the helm consistently generating 20%+ per year is a tall order. As shown in the chart below, PGP has traded at a premium to NAV for quite a while. But, the chart also shows occasions where the premium has been cut by at least half.

Data Source: Pimco

Click to enlarge

Chart Source: CEFconnect.com

As an alternative, the PIMCO Dynamic Income Fund (NYSE:PDI), also managed by Ivascyn, yields 9.8% at the current market price (9.99% to NAV). Since its 5/30/2012 inception PDI has provided average annual market returns of 16.15% (17.07% at NAV). The fund trades at a relatively small 1.93% premium to NAV. A small sacrifice in yield to gain a huge reduction in premium seems worthwhile, especially since the total return of PDI has handily outperformed PGP since inception.

Data Source: Pimco

Click to enlarge

Chart Source: Dividendchannel.com

PIMCO High Income Fund (NYSE:PHK) - PHK lists its inception date as 4/30/2003 and has provided annual average returns of 11.13% (at NAV). An even more impressive annual return than PGP, but PHK's current distribution rate at market price is 12.66% and it trades at a 51.62% premium to net asset value. Against net asset value the fund's distribution rate is 19.19%. Incredibly talented managers Alfred T. Murata and Mohit Mittal guide the fund, but generating 19.19% per year on the net asset value will be a difficult task. As with PGP, PHK has traded at a premium to NAV for quite a while. But there have been several periods of large premium contraction.

Data Source: Pimco

Click to enlarge

Chart Source: CEFconnect.com

In addition to PDI, Dan Ivascyn also runs the PIMCO Income Opportunity Fund (NYSE:PKO). At the current market price PKO yields 9.97% (10.13% to NAV) and since its 11/30/2007 inception has an annual average return of 11.08% (11.43% at NAV). PKO trades at a 1.64% premium to net asset value. It has not quite matched the total return of PHK since inception, but annual average return has more than covered its current distribution rate.

Data Source: Pimco

Click to enlarge

Chart source: Dividendchannel.com

PGP and PHK are great funds that have rewarded investors handsomely. But I believe that paying a huge premium to net asset value significantly increases downside risk, with little chance of enhanced returns. Why pay $2.03 for $1.00 worth of assets, or $1.52 for $1.00, when a proven management team has other options that have produced similar total returns?

Disclosure: I am/we are long PDI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.