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Upon searching for interesting situations in the closed-end fund space, I came across several funds trading at substantial premiums to NAV. Now, that by itself doesn't mean much as there can be some underlying reason (though rare). But everything changes when you can find funds that not only trade at a substantial premium to NAV, but whose underlying NAV performance can simultaneously be gotten mostly without the premium.

That's the case with PIMCO Global StocksPLUS & Income Fund (NYSE:PGP). PGP is trading as of June 29 with a premium to NAV of 74.9% (PGP price $20.27, NAV $11.59). This is extraordinary. Even more extraordinary is how this premium came about, taking into account the chart below, from PIMCO:

(click to enlarge)

As we can see, the fund mostly traded along with its NAV until March 2009. It would seem that the subsequent quest for yield, more than any change the fund suffered, made for the disconnect. The fund consistently making monthly $0.18335 distributions certainly played a part it this fatal attraction. These distributions mean PGP is trading with a present yield of 10.86%.

Where it gets real curious, however, is that you can get almost the same exposure as PIMCO Global StocksPLUS & Income Fund offers, but using an open-ended fund … with no premium! This fund would be the PIMCO StocksPLUS Total Return (PTOAX, PTOBX, PSOCX, PSTDX). The fund has a slight difference in not having international exposure, but for the most part follows a similar strategy as PGP, getting its exposure through derivatives, keeping an investment in income producing assets and writing options on its derivative equity exposure. As we can see below, PTOAX has tracked PGP close enough to be a good substitute (indeed, has beaten PGP's return). Also, by including the SPDR S&P 500 ETF (NYSEARCA:SPY) I show that PGP never had an extraordinary performance worth of a giant premium, either.

(click to enlarge)

Possible trades

Since we've already established that PGP has no incredible performance advantage, several trades can now be set up with it. The most basic would be to short PGP and go long PTOAX (or any of the other classes of PIMCO StocksPLUS Total Return).

Alternatively, one could go short PGP and go long SPY, for as we've seen over time PGP has shown no great inclination to outperform it in terms of NAV.

Finally, one could use PGP as a short hedge to other long positions, as a substitute for shorting the market, since over time it is likely that PGP will underperform as it will lose its premium at some point.

Main problem

Although there is available stock to borrow, and thus PGP is shortable, it does carry an high cost to borrow, at around 10.5% per year. Still, the premium is so large and so likely to go away, that this cost seems bearable.

Catalyst

The main catalyst for the premium to go away is the likelihood of the distributions being cut. This likelihood is high because presently the distribution as a percentage of NAV is already at an unsustainable level (19% per year).

Conclusion

PGP is an obvious short, which can either be used as a portfolio hedge or as a leg in an arbitrage trade.

Source: Arbitrage Opportunity In The Closed-End Fund Space