Bill Gross Picks 3 Levered Closed-End Funds

Includes: PML, UTG, VMO
by: George Spritzer, CFA

Bill Gross just announced his picks for the 2012 Barron's Roundtable. As is customary, he selected several closed-end funds. Last year, I published some articles describing significant personal purchases by Mr. Gross of Pimco fixed income closed-end funds. I did not see any additional purchases by Mr. Gross this year in the SEC filings, but he still holds large positions in these funds.

Bill Gross believes there are two primary forces affecting the global markets:

  • De-levering: Countries, companies and households are trying to reduce debt which is negatively affecting economic growth. This force will be with us for 5, 10, 15 years.
  • Reflation efforts by central banks: Some countries can't issue debt at attractive yields (e.g. Italy, Greece), and in many cases households and companies are shut out of the credit market. Central banks respond with policies to prevent credit destruction. Central banks push interest rates far below the rate of inflation resulting in short term interest rates that punish savers ("Savers are getting robbed of the 2%, 3% or 4% yields they used to think [were] destined for their pockets").

In order to survive in this environment, Gross believes that "investors should borrow at 25 basis points (0.25%) and lend safely at 4%, 5% or 6%." For most retail investors, closed-end funds provide the best vehicle for doing this. They also provide the only legal way to borrow and invest in municipal bonds without being taxed.

Here are his three closed-end fund selections for this year:

1) Reaves Utility Income Fund (NYSEMKT:UTG)

  • Pays monthly
  • Total Assets= 739 MM Total Common Assets= 554 MM
  • Annual Distribution (Market) Rate= 5.91%
  • Latest monthly distribution= 0.125 (annual= $1.50 + 0.332 year-end)
  • Fund Expense ratio= 1.27%
  • Premium over NAV= +5.40%
  • Average One Year Premium= +3.8%
  • Portfolio Turnover rate= 34%
  • Top 5 Holdings: BCE, VZ, PPL, PGN, SO
  • Effective Leverage: 25%
  • Average Daily Volume: 70,000 Average $ Volume: 1.67MM

Bill Gross comments: "… the sector might be a little overbought now. But utility stocks could continue to provide 4% to 5% dividend yields…UTG borrows up to 40% of assets. It invests in stocks such as AT&T, Verizon, Southern Co., Century Link and PPL. I don't know the management. I know the concept." (Note: Leverage was reduced by UTG management in October to around 25% because of uncertainty in Europe.)

2) Pimco Municipal Income II Fund (NYSE:PML)

  • Pays monthly
  • Total Assets= 1045 MM Total Common Assets= 679 MM
  • Annual Distribution (Market) Rate= 6.59%
  • Latest monthly distribution= 0.065 (annual= $0.78)
  • Fund Expense ratio= 1.24%
  • Premium over NAV= +3.86%
  • Average One Year Premium= +3.26%
  • Portfolio Turnover rate= 21%
  • Effective Leverage: 40.3%
  • Average Daily Volume: 120,000 Average $ Volume: 1.27MM

Bill Gross comments: "A number of levered funds own relatively safe A-rated double-A rated municipal bonds and yield 7%, plus or minus….It is a $700 million fund and trades at a 5% premium to net asset value. It provides a 7% tax-free yield by investing in 5% municipal bonds and borrowing at 25 basis points".

For more information on PML, read my Seeking Alpha article published in August 2011, when PML traded at a discount to net asset value for a few weeks.

3) INVESCO VK Municipal Opportunity Fund (NYSE:VMO)

  • Pays monthly
  • Total Assets= 694 MM Total Common Assets= 473 MM
  • Annual Distribution (Market) Rate= 7.10%
  • Latest monthly distribution= 0.086 (annual= $1.032)
  • Fund Expense ratio= 1.08%
  • Premium over NAV= +3.86%
  • Average One Year Premium= +3.03%
  • Portfolio Turnover rate= 2%
  • Effective Leverage: 40.5%
  • Average Daily Volume: 57,000 Average $ Volume: 0.76MM

Bill Gross comments: "VMO is also 40% levered. It buys A-rated and double-A rated municipal bonds and levers a 4% to 5% return up to 6% or 7%. Munis have done well in the past few months. But 7% tax-free sounds pretty good, and I'll take it for 2012."

I expect these three closed-end funds may experience a "Barron's pop" on Monday morning. But it may be worthwhile to monitor them and wait for a better buying opportunity when they trade closer to net asset value once the dust clears.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.