NYer1's  Instablog

Since PHK zoomed to unrealistic (as well as un-sustainable premiums) some 3 years ago , the choir on the Yahoo Message Board, as well as a few members here on Seeking Alpha, has insisted PHK is a great investment.
This has been a MYTH over the past 3 years and can clearly be shown by looking at comparable total returns of alternative funds across several different asset classes (not just within the HY arena).
Below are a few data points of total return performance - I even included JNK which is not using ANY leverage to drive the point home.
The after tax performance of ALL CEF's mentioned below is even BETTER vs. PHK's because a big part of their total return has been by capital appreciation which is subject to a MUCH LOWER tax rate than the ordinary income the PHK distributions are subject to (no capital appreciation for PHK over the past 3 years - again, it's the PREMIUM to NAV!).
To add insult to injury take a look at the total returns of TAX FREE muni bond CEF's over the same time frames.
We are talkig TAX FREE INCOME here (worth perhaps 65% to 70% more than taxable income to people at high tax brackets) - with some capital appreciation as well.
Drum roll please....:

1 YEAR :
PHK + 4.67%
JNK + 15.60 % - UN-LEVERAGED HY ETF!
FHY + 24.17% - Leveraged HY fund that pays what it earns and was at a nice discount 3 years ago.
JQC +35.16% - MUCH more conservative portfolio with hardly any duration risk vs. PHK!
ERC + 18.79% - Diversified bond fund with about HALF the volatility of PHK!
NAD +21.31% - National TAX FREE CEF, yes TAX FREEINCOME + capital appreciation.
NXK +17.51% - NY RAX FREE CEF, yes, TRIPLE TAX FREE INCOME for NY residents!

18 months:
PHK +8.12%
JNK +15.68%
FHY +24.60%
JQC +24.29%
ERC +16.71%
NAD +36.30%
NXK +29.75%

2 YEARS:
PHK +13.54%
JNK +20.77%
FHY +46.15%
JQC +35.57%
ERC +24.15%
NAD +42.58%
NXK +37%

30 months:
PHK +32.63%
JNK +34.51% (no leverage here, remember?)
FHY +61.32%
JQC +58.11%
ERC +35.51%
NAD +37.36%
NXK +31.68% (seems like in line with PHK right? Now try and figure out what was the AFTER TAX return on both funds!)

3 YEARS:
PHK 40.96%
JNK +37.60%
FHY +68.98%
JQC +75.22%
ERC +42.67%
NAD +48.83% (TAX FREE INCOME)
NXK _43.05% (TAX FREE INCOME)

Now, why would a fund that pays such a high distribution LAG so badly other CEF's from all different sectors, all the while being managed by such a hot shot manager?
Drum roll again please.......:
IT"S THE PREMIUM!!!

Disclosure: I am short PHK.

In the published three and six months results by PHK -http://www.businesswire.com/news/home/20121130005608/en/PIMCO-High-Income-Fund-Reports-Results-Fiscal - we can see that the fund has under - earned its distribution rate by 0.0931 for the 3 months ending Sept30th.
That means that about 25% of the funds distributions must have come from other sources.
What is even more disturbing is the fact that when compared to the same quarter a year ago, PHK has earned about 21.5% LESS in Net Investment Income on a portfolio that was LARGER by about 9.25% !!
So look at it this way, the fund earns much less on more assets ..makes me smile ;)

What we see is that the fund earned income of roughly 7.2% on an ANNUALIZED basis in the 3rd Qtr 2012 vs. about 10% ANNUALIZED in the 3rd QTR. of 2011.

The fund pays $1.4625 a year in distributions (or roughly $179Miil based on the Sept. 30 share count.
When I annualize the net investment Income figure from the 3rd Qtr. I get about $94.7 mil - that means that on that basis the fund MUST make up a difference of about $84.3mil from derivative bets - that is a HUGE number.
Now the fund has been doing GREAT on an NAV basis this year which probably enabled it to use capital gains (realized or not) to fill the gap of its Net Investment Income shortfall.
BUT, as we saw in 2011, derivative bets can be and are very risky and if/when the fund will be on the losing end (like it was during 2011) - those earnings will evaporate and turn to steep losses which would make a dividend cut all the more urgent.
For now, with the premium back to 35%+, I have been HAPPY to short again (prices of 11.20-11.60) 25% of the quantity I covered BELOW $10 just some 2 weeks ago.
I am long several other closed end funds that are trading at discounts and ARE earning their full distribution rates, as a mean to lessen the carry trade and hedge this short.

Over the past 12-18-24-30 months this pair trading has proven itself quite nicely and while the slam-dunk is still in the future (when PHK WILL crash to below its NAV) .

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On another note, the Wall Street journal just featured PHK as an example for a bad trade in the high premium closed end fund arena.

In an article published today after the markets closed (for the weekend edition, probably), "The Great Yield Gamble",

http://online.wsj.com/article/SB10001424127887324020804578149444248625794.html?mod=googlenews_wsj#articleTabs%3Darticle

The WSJ reviews how small investors have been chasing yield into all the wrong places and gives better alternatives to those mistakes.

here is what WSJ writes about High-Premium Closed End Funds with PHK serving (as usual) as a poster boy for that crowd:

"

Risky move: buying closed-end funds that trade at a premium.

Better idea: buying ones that trade at a discount.

Yield-starved investors are flocking to closed-end mutual funds, which have a fixed number of shares and trade on exchanges like stocks. That is because most of them use borrowed money, or leverage, to juice their yields as high as 20%, according to Morningstar.

Closed-end funds rarely trade at the value of their assets. Usually, they change hands at a discount-but these days, 250 of 381 fixed-income funds command a premium, says Cara Esser, a closed-end fund analyst at Morningstar. When a fund trades at a premium, the risk of losses rises.

For example, the Pimco High Income Fund has suffered losses of 14% during the past three months, even though its "net asset value," or the value of the assets in its portfolio, rose by 8.3% during the period, according to Morningstar. The reason: Its premium had shot up to about 70%, then plunged to 39% as investors concluded the fund was overvalued and bolted.

A safer strategy: Look for funds with lower yields that trade at a discount, Ms. Esser says. In general, stock funds are trading at lower premiums than bond funds, but still are throwing off decent yields. "

Disclosure: I am short PHK.

In a recent interview for US News & World Report : money.usnews.com/money/personal-finance/...

Bill Gross was asked where does he see opportunities for individual investors.
He mentions Muni CEF but does not mention his corporate bond funds.

So where are the investment opportunities for individuals?

"Both from the standpoint of stocks and bonds, an investor wants to go where the growth is. There are countries that should grow faster than Euroland countries, and countries that should grow faster than the United States. They would be the big obvious ones: China and Brazil, and even Mexico.

In terms of the bond market, there are opportunities in what are known as closed-end funds, [which issue a fixed number of shares and] trade like stocks. The magic to them is that many of them are slightly levered: They borrow basically at zero percent or close, and then reinvest back into their asset class. Municipal closed-end funds with bonds that yield typically 4 to 4½ percent can be turned into a 6 to 7 percent tax-free investment on the basis of this borrowing and the mild leverage. Many PIMCO funds, many BlackRock funds, many Vanguard-they're all over the place-you can buy them at 6 percent yield, tax-free, and they provide the opportunity for investors to get those historic 6, 7, 8 percent returns that I said at the beginning were not available through generic types of investments. So I say buy these closed-end funds, because they yield 6 to 7 percent and there's basically the same risk as in the generic universe."

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But what I found more interesting in this interview is Bill Gross' take on the "new normal" in bonds.
He said that if he is able to deliver 1%-2% a year above the universe of the Total Return fund it would be acceptable - hence returns of 3-4% a year should be the norm under such conditions.
For the HY universe, maybe 10% could be achieved but the risks are too high there now and thus he is NOT concentrating on this sector now.

I imagine that's on a lot of investors' minds. What should they expect?

"You start with the obvious: The Federal Reserve has lowered short rates to close to zero. The investment-grade bond market, which includes treasuries and corporates and mortgages, all in one big pot, yields 1¾ percent. It's hard to manufacture near double-digit returns from that. It's the metaphorical concept of squeezing juice out of an orange; almost all of the juice has been extracted, so to speak.

So investors looking for a repeat of historical performance are bound to be disappointed, and that's why I wrote several months ago-which caused a ruckus in the market-about the [dying] cult of equity. It was the same thing with the cult of bonds, the "cult" meaning that there was a belief that historical returns could be projected into the future. They can't. They can't for bonds and they can't for stocks either, in my opinion.

The PIMCO Total Return Fund starts with a universe that yields 1¾ percent. If we can outperform the market by 1 to 2 points a year and things stay the same, then investors can get a 3 to 4 percent type of return. But they shouldn't expect a 6 or an 8. A 10 percent return, it's nearly impossible, at least from a generic [investment-grade] type of universe. We can speak to high-yield and we can speak to opportunities elsewhere, but they, of course, involve risk-taking. [Now we are concentrating on] more short- and intermediate-term bonds, mainly mortgages and, in some small percentages, bonds in Italy and Spain."

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This re-enforces my notion that at current market conditions the PHK portfolio will be lucky to produce a rate of 8%-10% a year on the positions it holds and thus we see the great reliance on derivative trading to compensate for the "hole" between the earned income and the inflated distribution rate.

2012 has worked well for PHK in that regard based on NAV performance but they cannot and will not be right all the time with derivatives and when the mistakes occur (see 2011 fiascoes), both NAV as well as the distribution rates will be cut badly.

In the meantime, I am very happy to be short PHK while being long alternatives like FHY and FSD (and others too) who trade at discounts to NAV and actually EARN their distributions in pure income from their portfolio without the risk of derivative trading.

Happy Thanksgiving to all!!

Disclosure: I am short PHK.