Today 9/12/2011 , Moody's cut ratings on 5 Pimco funds' Preferred Shares due to a higher risk and leverage positioning and net asset value deteriorations
PHK's Preferred shares were downgraded to Aa3 from Aaa.
While this is far from posing default risk, the trend is clear:
Morningstar has floated the risk behind PHK's portfolio late July, news.morningstar.com/articlenet/article...., and Moody's is following suit today.
This is a marginal issue,as the cost of borrowing for PHK is currently fixed due to the auctions of its Preferred Shares failing and thus the interest rate has been fixed at the maximum rate alloable under the terms of the issues , which is still very low (thanks for Dave from the Yahoo finance board who corrected me on this issue).
I have tried to point out the rather obvous rise in risks PHK (and other Bill Gross managed funds) has been piling into its portfolio over the past few months.
Those risks have been translating to obvious and consistent declines in the fund's NAV which reached today a low of $7.78/share (low point since Dec. 2009).
As discussed in my previous posts here, PHK has not been earning its stable managed distribution for the past few months and this could easily be seen by looking at the NAV deterioration which went well above and beyond the distributions paid out by the fund.
The fund DOES NOT carry any excess Undistributed Net Investment Income ( UNII ) reserves on its books and thus must pay the stable managed distributions from either realized gains or return of capital (NYSE:ROC).
During the last period of distribution 08/09/11 to 09/08/11 the funds NAV lost 0.34/share while the distribution was only 0.12187/share.
That dismal month comes on the heels of a much more horrid month between 7/7/11 and 8/9/11 when the fund lost a whopping $1.26/share of NAV (or more than 13% of its holdings values) while posting a shortfall of about $1.14/share after accounting for its distribution.
While it may be possible the fund has some unrealized capital gains at its disposal to manage its distributions, the NAV chart of the past few months tells us they probably won't last for long.
The recent NAV weakness has not deterred retail investors from jumping on the wagon and "addicting" themselves to the stable, very high, distribution rate.
At current NAV level, the funds must earn a fantastical 18.8% a year on its holdings.
The Premium of PHK's market price to it's diminishing NAV stands today at a very high 57% !
Even after accounting for the fund's leverage (say 30% currently), the fund should be in a "hole" of about 8-9% a year which it must generate in excess of normal High yield peers just to break even with its oversized distribution rate.
THIS IS UNSUSTAINABLE - to say the least!
Making up 8%-9% a year in today's low rate (and shaky) environment is very hard without taking very risky bets and this is what Gross is facing.
To achieve this task, Mr. Gross and his team at Pimco would have to generate income or capital gains from taking HUGE macro bets (not unlike the soured bet on treasury bonds taken a few months ago).
One quick look at the fund's NAV over the past few months would tell you those bets ARE NOT working for them.
That means that in a few months, the fund would likely have to include return of capital with its distributions just to keep that 12 cents going every month.
That, in turn would would further erode assets, further limiting the income earned.
If NAV erosion continues (due to general market weakness and return of capital) a playback to the nightmare of 2008 where dividends were disrupted can not be ruled out at all.
Now think about it, once return of capital starts, you'd be getting back capital valued at 100% for every share you currently hold with a value of 157%+ (due to the premium) - not a very enchanting prospect , is it?
This has become a macro hedge fund more than the High Yield income fund people believe they own, and one or two soured bets could drive it to its knees.
A window into the way Gross and his team manage their funds has been opened and some details of their bets have been emerging as of late.
See below a link to the article in Bloomberg, discussing the Pimco Total Return fund's elevated credit risk exposure using deriivatives - not unlike what Gross has been doing in PHK (and with similar, more pronounced results).
I urge you to do your due diligence, not on the past, but on the present - and the future would seem less rosy in my opinion..
I use PHK's very high volatilty to increase/decrease my core position from time to time.
My intermediate to long term objective (6-12 months) would be to cover if/when the premium erodes to a more normal level (e.g. discount to NAV).
Catalysts for a strong move lower in PHK's price can be:
1) Higher percieved risk by market participants (see today's Moddy's downgrade)
2) Monthly distributions that indicate a start of return of capital to shareholders
3) Reductions and/or disruption of monthly distributions
As always, sensible, fact based comments are always appreciated.