Closed-End Fund PGP And PHK - 11% Yields Worth It?

Summary

• PGP and PHK continue to trade at premiums that are unjustified.
• Both funds have had distribution cuts and more should be in the future.
• PCI is the only Pimco fund I would want to take a chance on at this time.

Pimco funds are popular funds to hold in the CEFs space but I think you're better off in other holdings at this time. I know I will get a lot of criticism for not wanting to hold these funds at this time.

Pimco High Income Fund (NYSE:PHK) is a fund that utilizes a strategy of multiple fixed income sectors to achieve it's stated objective of seeking high current income, with capital appreciation as a secondary objective. PHK has $1,139 million in assets and has an inception date of 4/30/2003. PHK is using 25.05% leverage.

Pimco Global StocksPLUS & Income Fund (NYSE:PGP) has an objective of seeking total return comprised of current income, current gains, and long-term capital appreciation. While "Stocks" in it's name is misleading, because this fund holds no equities from what the funds website shows as of February 28, 2018 and also picture below. PGP currently utilizes 25.80% leverage.

Source - PHK Fund Website

One of the major risks with these funds is the Fed raising interest rates when they hold virtually all interest rate sensitive investments, which will just increase the NAV yield more on these funds that are already paying out too much at this time, more on distributions below. I don't believe bonds are going to perform well until we are out of an interest rate hike cycle and with the economy on track to continue to keep momentum through 2018 I don't foresee these two funds performing well going forward.

Premiums

Both funds are trading at significant premiums, PGP currently has a 26.04% premium and PHK is showing 18.50% premium. These two funds have long traded at premiums, however, with distribution cuts recently that premium has begun to erode. I expect it will continue this trend.

Source - CEFconnect

PGP's premium and discount over time shows that it indeed has traditionally sold way above it's NAV.Source - CEFconnect

Likewise, PHK's chart has shown that it has traditionally traded at a large premium over the NAV as well. PGP actually has a z-score of -1.10 for the 1 year period and PHK is showing -0.10 1 year z-score, however, I do not think this is the time to get into these names even being undervalued.

Distributions

Both funds have had stable dividends since their inception until September 2015 for PHK and PGP ended up cutting the distribution starting in November 2016.

Source - Morningstar

Source - Morningstar

Both funds have been using return of capital in their distributions for years, this is destructive ROC that has been eating away at the NAV with every distribution. Even with the distribution cuts recently PGP is paying 10.73% market yield and a NAV yield of 13.52% which, in my opinion, is not likely to be sustained without more destructive ROC.

PHK is yielding 12.29% on market price and an unbelievable 14.56% of NAV, and again I believe that is not a sustainable distribution without ROC being used and NAV declining. I think more distribution cuts are needed in the future to better align this fund with realistic yields and when these cuts happen I believe we will continue to see the premium fall. I would consider owning shares if the NAV yield dropped below 10% and the premium disappeared.

CEFconnect is showing UNII as of 12/31/2017 for PGP at -$0.5002 and PHK UNII is at -$0.2775, for funds that use bonds and other fixed income strategies UNII should be positive. There are other types of CEFs like equity or option writing funds that UNII and NII are not all that significant but with PHK they should be earning the whole distribution with income that is produced from the holdings. When a bond CEF is earning all of the income it is paying out that would reduce or even eliminate the destructive ROC that these two have been utilizing. PGP does employ writing equity index call options.

Potential Pimco Fund to Hold

I do own shares of Pimco Dynamic Credit Income (PCI), while I criticized owning bonds above, this is a relatively small position in my overall portfolio (less than 1%.) PCI trades at a slight discount to NAV, actually one of the only Pimco funds that does trade at a discount and has since shortly after it's inception. I also like PCI because of it's market yield of 8.39% and a reasonable NAV yield of 8.21%.

PCI does utilize a huge 45.13% of leverage, like I said, this is just a small position in my portfolio. PCI has an inception date of 01/31/2013 with $6,149 million in managed assets. There are significant risks with PCI but I believe as far as the distribution is concerned there should not be any cuts in the near future.

Conclusion

PGP and PHK both trade at significant premiums making them unattractive. While the yields are tempting at 10.73% PGP and 12.29% PHK and even higher yields on the NAV that they actually have to earn to pay out to holders of their funds, these are just too high to continue to pay. I believe we will continue to see more distribution cuts from here, which will lead to more loss of premium as the market price will be sure to fall. I may like these funds after they reduce a couple more times. The problem is they are trying to "pull the band-aid off gently," when they need to just make significant cuts before eroding more of the NAV.

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Analyst’s Disclosure: I am/we are long PCI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.