I’ve been reviewing the eleven taxable-income closed-end funds from PIMCO. With this article I’ll summarize the current status of the funds. I’ll be going through them over my next few articles, so consider this current background for reference.
- PIMCO Dynamic Credit Income (PCI)
- PIMCO Dynamic Income Fund (PDI)
- PCM Fund (PCM)
- PIMCO Corporate & Income Opps (PTY)
- PIMCO High Income Fund (PHK)
- PIMCO Income Opportunity (NYSE:PKO)
- PIMCO Global StocksPLUS & Inc (PGP)
- PIMCO Income Strategy Fund II (PFN)
- PIMCO Corporate & Income Strgy (PCN)
- PIMCO Strategic Income Fund (RCS)
- PIMCO Income Strategy Fund (PFL)
Closed-end funds (CEFs) differ from open-end funds(OEFs) and exchange-traded funds (ETFs) in important ways. First, the share count is fixed. Although funds can expand or contract in various ways, they do so in a regulated manner that includes notices to shareholders, SEC filings and well documented dates for effecting such changes. Between those expansions or contractions, the share count is fixed. The shares trade like stocks which means they are worth what the market decides they are worth. The funds do report actual net asset values regularly, typically daily but there are exceptions, so market values can be, and nearly always are, at a discount or premium to the funds’ net asset values. Compare this to open-end funds which are bought and sold at their daily NAVs, or ETFs where managers strive to maintain the market prices at NAV as shares outstanding change.
With that in mind I’ll start with the market valuation status of the eleven funds.
As we see only one of the eleven funds (NYSE:PCI) trades at a discount, even over the last 52 weeks on average. (Note these data are from July 16. As of today PCI is trading at a small premium, so all eleven have premium status). The premiums range as high as 46% (NYSE:PGP) with three of the funds over 30%. Furthermore, ten of the eleven are trading at valuations above their 52-week averages. The one exception is PCM which is less than a half percentage point below its average.
In evaluating the significance of these valuations, it is important to have an appreciation for how typical they are. Some CEFs trade at extreme valuations but do so with remarkable stability. For example a fund may have a -10% discount, but it holds that discount within a few percentage points over years. Others will trade with a lot of volatility in their valuations, sometimes going from deep discounts to moderate premiums and back in months. In the first case, current valuation may not be a significant consideration in a decision to buy or sell a fund; in the second it can make the difference between a successful investment and a disastrous one. So, we need some measure of how much the current premium or discount varies from the fund’s recent valuations. That measure is the Z-score.
Z-scores compare the current premium or discount to a fund’s average premium or discount for a given period, typically 3-, 6- or 12-months. It’s useful to think of the Z-scores as having a dimension of standard deviations, such that a Z-score of 1.0 means the current premium or discount is one standard deviation from the average for the period under consideration. Z-scores also have a sign. If the Z-score is positive the valuation is greater than the average. In our example that 1.0 Z-score means the current premium or discount is one standard deviation higher (i.e. greater premium or less discounted) than the average. If it’s negative the discount is deeper or the premium less than the average.
With that preamble, let’s look at the PIMCO Z-scores.
Nearly all the Z-scores are positive. Of 33 scores here, only four are negative and three of those are for the last three months. Note the slightly negative value for PCM’s 1-year Z-score and recall that it is the only fund trading below its 52-week average premium/discount. Note as well that many of these are above 1.0 and the scores go as high as 2.1.
In a normally distributed population, Z-scores of 2.0 or above would only be expected to occur about 2.5% of the time. But, CEF valuations are rarely normally distributed so this is not a valid inference despite what one might read in other sources Morningstar, for example, tell us that a Z-score of 2.0 “would be expected to occur less than 2.25% of the time.” This is decidedly not the case. I discuss this in detail in (Do Z-Scores Matter? A Case Study).
But Z-scores do give us a quantitative handle on where a fund’s valuation is relative to its recent past. To the extent that there is a tendency for valuations to revert to their means, negative Z-scores, particularly deeply negative Z-score can signal buying opportunities.
In thinking about Z-scores, realize that the standard deviation may be large or it may be small, so the Z-score only tells us part of the picture. In a fund with little change in its valuation, a Z-score will not be as meaningful as in a fund where the standard deviation is high. The only site I know that provides that information is cefanalylzer.
The next significant quality of CEFs is their yields. Most investors consider CEFs as income investments, so yield is of primary significance. Investors are concerned about yields on market prices, which, is after all, the yield they receive. But yield on NAV is critical because that is what the fund must pay out. PIMCO’s CEFs are built on portfolios of bonds and credit investments, so the income from those investments are the primary sources for distribution payments. One of the eleven, PGP, includes equity in its mix but it too is largely invested in various debt and credit instruments with a portion of its portfolio dedicated to equity option positions. I’ll be discussing the nature of the funds individually, so I’ll not go beyond that point here.
Here, then, are the current yields for the funds.
The yields are high as we see. The market yields range from 8.33% for PCI to 11.35% for PHK. But, with the premiums to NAV, the funds are paying out well above those rates. PCI is the only fund whose NAV payment is below 9%. Four are paying in the double-digits, and the highest payout comes from PHK whose NAV yield is 15%. It should be clear that these kinds of yields are not coming from conventional bonds and credit investment strategies.
Recall that PCI is trading near par, i.e. at a small discount or premium. PHK, PGP and RCS are trading at premiums over 30%. Then notice that PCI has the lowest yield at NAV, while PHK, PGP and RSC have the highest yields at NAV. This illustrates an important market force driving those discounts or premiums. The income investors who make up the largest group of the CEF marketplace place a high value on yield and tend to be willing to pay for it. There is a recurring relationship among similar funds between they NAV yields and their premium/discount valuations. Here is the current relationship for these eleven.
Clearly, other factors go into the market’s determination of a fund’s premium or discount, but there’s no denying that there is a strong positive correlation between these two metrics. The r2 of 0.76 tells us that the relationship is strong enough that NAV yield explains 76% of the variation among funds’ premiums/discounts. So, when one asks “why does PCI consistently carry a discount while the other PIMCO funds are at a premium?” one has to look no further than PCI’s yield which is the lowest of the set.
When the relationship is this highly correlated, there can be a tendency for funds to regress to the regression line. This means funds that are below the line are more likely to gain value in their discounts or premiums than those above the line. Ignoring the high-premium funds, this single observation suggests that PCI, PFN and PFL are attractively valued relative to the other funds, and PCN is less attractively valued.
PCI and PDI (and to a somewhat lesser extent, PKO) have similar strategies and portfolios. On the basis of their positions on this chart, PCI would look to be a better buy than the other two if one were concerned about potential for losses or gains to discount/premium moves. It is of course only a single metric, and one without a solid body of research that I’m aware of, so it would not be wise to make decisions on this point alone. It does however add information on how one might consider choosing among similar funds.
Let’s turn our attention to past returns from the funds. The values that follow are total return. For market price, it means with all distributions reinvested. For NAV, it means with the distributions added back. I’ve not included price returns because I consider total return to me a more meaningful way to compare funds with distribution yields this high and this variable.
Here are the data on market price returns for YTD (through July 16, so six months plus two week), 1- and 3-years.
To put this in perspective, I’ve compared the top three performers to the S&P500 index ETF (NYSEARCA:SPY). It doesn’t make sense to compare these funds to equity, of course, but most investors have a pretty good sense of what US equity has been doing, so it’s a pretty good mental comparison.
For three years, the top market performance comes from PDI, PTY and PCN.
For one year, the top funds are PTY, PDI and PCI.
Market returns are, of course, what an investor earns, but a better reflection of fund performance comes from NAV returns. This tells us what management is earning without the changes in market valuations that affect market returns.
In this next table I rank the eleven funds for each of the metrics I’ve discussed. One is best for each column and I’ve highlighted the top (green) and bottom (red) three funds.
For one last data set, I went to cefconnect and selected the top 50 taxable fixed-income CEF for three-year NAV performance. All eleven of these funds were in the top 50 (N=143). I rank them for their positions in the top 50.
I’ve highlighted the funds in the top quintile of the 50 selected funds. As you can see the PIMCO CEFs do extremely well on return metrics. Several rank high for yield. But, as a set they also rank among the funds with the highest premiums. It should be clear that these premiums are earned by the yields, as we noted above, but, more importantly for this set of funds, but the exceptional return performance at market and NAV.
Earlier this week I discussed another aspect of these funds: Distribution sustainability as indicated by coverage and net investment income (here). In the coming days I plan to look at several of the funds separately or in groups of similar funds. One of the key things I’ll be looking at is trends in NAV.
Today’s message is something close followers of PIMCO CEFs are likely aware of: These are excellent funds, among the very best CEFs on the market. But their valuations at this time, based on premiums and Z-scores, make most of them difficult to consider for purchase. I continue to like PCI at its current valuation and consider it as something every income portfolio should own or plan to own at some point.
Disclosure: I am/we are long PCI, PDI, PFN,, PHK.
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.
Additional disclosure: I am not an investment professional and nothing I write here should be taken as professional advice. Everyone's personal situation is unique. It is the role of finance professionals to provide advice in the contexts of an individual's personal situation. What may be right for my investment goals and risk tolerances may well be quite wrong for someone else. Do your own due diligence. Consult with professionals on your own needs, objectives and tax circumstances before you invest. I do not give advice and ask that readers refrain from asking for it.