I noted in my book Finding Alpha that junk bonds have not outperformed investment grade bonds since data on junk bonds really became available, around 1987. This is the real corporate bond puzzle, in direct contrast to the corporate bond puzzle most academics address, which is the anomalously high return premium between BBB and AAA bonds (around 100 basis points annually).

Academics seem to consistently miss the big picture in corporate bonds, which to me is the lame returns on patently riskier junk bonds over the business cycle. For example, Steve Cecchetti’s textbook Money, Banking, and Financial Markets, immediately presents the seemingly straightforward example of how bonds with higher default rates have higher yields: Risk and return rise together. Yet, this is purely an anticipation of the default rates, and so is not risk in the sense of something priced. BBB bonds have, over time, about the same total return as B-rated bonds. One must subtract the expected defaults and the resulting losses from a stated yield regardless of one’s risk tolerance.

Preface

In my weekly CEF update of July the 2^nd, I mentioned PIMCO High Income Fund (PHK) as a focus stock for the reason I couldn’t understand its valuation relative to its high yield peer group(s). I queried whether anyone had any insight as to why it was trading as it was. I received some thoughtful replies regarding others' befuddlement. The following is a formal argument why its valuation appears faulty.

Summary

Based upon publicly available information, the shares of PIMCO High Income Fund (PHK) appear greatly overvalued relative to its closed end fund (CEF) peer group and ETFs specializing in high yield securities. (PHK is being removed from the Eqcome CEFBig10™ Portfolio and is being replaced with Western Asset High Income Fund II (HIX).)

The 13 closed end fund (CEF) types on average increased 3.3% the holiday shortened week ending 5/29/09. The S&P 500, as measured by the SPDR S&P 500 ETF (SPY), registered a slightly stronger performance of 3.9%. On an aggregate, unweighted basis, the weekly price increase for 641 CEFs was 3.1%. The Claymore CEF Index registered an increase of 3.9% for the week.

CEFs’ aggregate, unweighted current distribution yield is 8.5% and is trading at a 6.8% discount. The Eqcome CEF Fear Index continued to move lower: prices increased 1.2% greater than their related NAVs. This is consistent with an 11.4% plunge in the CBOE Volatility Index (VIX) which rises when the market declines. While in the stock market the past is never prologue, in the absence of surprisingly poor economic news, the equity markets appear to be poised to move higher.

Many income investors are looking for monthly dividend payments to support their income during retirement. Other pre-retirement investors want monthly dividend stocks for their IRAs for faster compounding.

This list is now up to 150 different stocks, CEFs, REITs, floating rate funds, and oil income funds [such as Canadian royalty trusts], all of which are traded on the New York Stock Exchange or the American Stock Exchange. I've added over twenty new securities since the year-end update, reposted the yields, kept the readers' recommendations of sorting by yield with the highest first, and identifying the Canadian companies [due to tax withholding issues].

Due to requests from readers, I have sorted the list by yield, from highest to lowest. In addition, I have identified the Canadian trusts due to the tax withholding issue which can significantly affect the yield, especially with regard to holding these Canadian Oil Income Trusts in retirement plans (they all trade in the U.S.). The list shows the name of the stock, the stock market symbol, the yield, and if the stock is Canadian.

1. Aberdeen Asia-Pacific Income Fund Inc. (FAX) 6.6%