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PKO: Allocation, Valuation And Earnings Tailwinds

Jun. 12, 2020 6:16 AM ETPIMCO Dynamic Income Fund (PDI)24 Comments


  • Thursday saw serious weakness across the CEF market both in underlying asset prices and especially in sharp discount widening.
  • The sector allocation profile of the PIMCO taxable suite matches well our sector stance of high-yield and external EM bonds as well as non-agency RMBS.
  • Within the taxable suite we highlight PKO - a fund that has been able to add assets through the drawdown and improve its earnings profile.
  • PKO has not yet been rewarded for this development and its discount valuation remains very attractive relative to other PIMCO CEFs.
  • Looking for a portfolio of ideas like this one? Members of Systematic Income get exclusive access to our model portfolio. Get started today »

Over the last few weeks we have discussed a number of dry powder options for investors to deploy if the market were to run into the wall of reality. On Thursday we may have met that wall - the S&P 500 fell nearly 6% and the Down nearly 7%.

In this article we take a look at the reaction of PIMCO taxable CEFs and the opportunities the sell-off presents for investors. The asset allocation profile of these funds across the high-yield, external EM debt and non-agency RMBS jives well with our sector stance. Thursday's weakness in premiums has also pushed these fund valuations to attractive levels. Together, this combination makes for a compelling investment opportunity.

Within the taxable suite we highlight the Income Opportunity Fund (PKO) as one deserving a closer look. The fund has been able to acquire assets through the drawdown and improve its earnings and coverage profile. The fund has not been rewarded for this by the market. We expect this to change as its coverage and earnings profile outperforms in the months ahead.

Action In PIMCO Funds

The chart below shows the composition of PIMCO CEF Thursday's returns.

Source: Systematic Income, Tiingo

The chart shows a couple of interesting things. First, we see a clear difference in NAV performance between muni (highlighted in purple) and taxable funds with munis registering a small NAV increase and taxable funds all showing negative NAV returns.

Secondly, we see a large discrepancy between NAV and discount moves, particularly in the taxable funds. For example, the average NAV return of the taxable funds was -1.4% while the average premium fell about 6%. In other words, the average price sharply underperformed the NAV.

Thirdly, the performance of the three RMBS-heavy funds (highlighted in orange) was particularly stark. These three funds registered the smallest NAV drops among

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This article was written by

ADS Analytics profile picture

At Systematic Income our aim is to build robust Income Portfolios with mid-to-high single digit yields and provide investors with unique Interactive Tools to cut through the wealth of different investment options across BDCs, CEFs, ETFs, mutual funds, preferred stocks and more. Join us on our Marketplace service Systematic Income.

Our background is in research and trading at several bulge-bracket global investment banks along with technical savvy which helps to round out our service. 

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PKO over the next 72 hours. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (24)

fabskxha profile picture
All that terrific highly taxed income, yet a simple ETF like LQD or GTO would have made you more money the last 3 years while allowing you to sleep at night. In a highly volatile market do you want to own leveraged investments with crap holdings that can drop 10% in a single session? That and the annoying discount/premium game that has ZERO relevancy as to the quality of the mangers. I buy managers not discounts.

After crippling losses 2 of the last 3 years and HUGE volitility, Im done with leveraged investments that no one understands. These are income vehicles, no biotech stocks...yet trade like them.
CashFlow13 profile picture
@fabskxha PKO has about double the CAGR of LQD, so I am not sure how you would have made more money with LQD.

Volatility is very high with closed end funds which is why they are not suited for everyone.
bobholt profile picture
@ADS Analytics

PKO is very high risk. Inv grade =12.5% and non-Inv Grade=47.6%. High default risk. 5.41% of holdings already in default (D). Another 21% grade C. Getting worried about holding it. This was not discussed much in the article. Any thoughts?
ADS Analytics profile picture
The holdings are definitely not for everyone. The PIMCO funds tend to hold pretty similar assets just in slightly different proportions. If you're not keen on holding below-IG rated assets you should consider funds other than PIMCO.
ksal55 profile picture
May UNII report posted today.
bobholt profile picture
@ADS Analytics

Thanks for the thorough information and analysis. Starting to nibble now - wish I had more cash.
I am new in PIMCO funds (since March). I enjoy reading on them as I plan to increase my position in the funds I already own (PCI, PDI, PFN, PKO, PTY). The thing I find the most interesting about these funds is that everyone writing about them on SA lately seem to have a different opinion about which one will outperform the others!
Better to own them all!
I had a huge position in multiple Pimco funds, but have since cut them back about 75%. I retained PKO and PFN. One problem I had with Pimco was their funds' performance during the crash - with prices dropping severely - in fact double that of so-called risky, or highly volatile - issues. You could have done much better with QQQ for example.

More significant was their action during the bounce - tepid at best. When they couldn't participate in the recovery, V-shape, dead-cat-bounce (whatever you want to call it), that was a big red flag for me. You can learn a lot by watching the price action on big Up or Down days. Stocks that don't participate are waving red flags.

So, we had yesterday. If Pimco couldn't participate with the big upside move, then there was, in my view, a lot of sub-surface weakness. A lot of Pimco funds fell much more severely yesterday than the Dow or S&P (as they also did during the March crash.) Call that Red Flag #2.

A lot of Pimco funds have big Premiums to NAV. I call that "label" premium, as in Stoly vs house brand vodka. In my opinion, Pimco's label premiums are getting worn off, perhaps on a long term basis. Securities that can't participate on the upside, but are over-enthusiastic on the downside are securities with structural problems. Some funds have had distro cuts; I think more are in Pimco's future.
ADS Analytics profile picture
I'm not sure the upside/downside comparison makes sense in the context of fixed-income funds. Maybe this is more relevant for equities. Generally speaking credit spreads don't tighten as quickly as they widen. So there's not as much that you can say about a given fund from this upside/downside dynamic.
PKO declined about 50% during the March crash, and has recovered approx 50%. QQQ declined about 26%, and has since recovered all of its loss (and then some.) If you held both in Feb and sold today, you'd be out over 20% with PKO and would be ahead with QQQ.

What's so hard to understand?

Fact is (for me, anyway), the goal of higher yields in the fixed-income space, with less volatility than equities - especially supposed low/no yield, volatile tech glamour girls - turned out to be 110% myth. The emperor had no clothes.

My expectation is for Pimco to continue to pare distro's pushing them back down to the 7-8% level most were in prior to the crash - meaning price appreciation is likely not going to happen back to the pre-crash levels. It also means that Pimco's "traditional" Premiums are going to narrow. Another lesson for me - as preached by some here on SA - paying a premium - especially a big one - for a CEF fund is an endeavor fraught with risk and eventually going to cost you.

I've winnowed all my Pimco funds with outsize premiums. There are better options out there with similar yields and a better record during and after the crash - ETJ is one example.
Pooh_Lover profile picture
@N93143 Come back and post after the tech bubble pops. See if your tune changes. I mean you're posting like growth will out shine value forever. If history has anything to say a lot of people, very arrogant people, will be a lot poorer soon.
A senior moment here. What is ARPS?
ADS Analytics profile picture
Auction-rate preferred securities. PIMCO uses them as a source of leverage.
SenBiden profile picture
Based on chart above it looks like PTY may be poised to outperform in addition to PKO, PCI underperform. Agree?
ADS Analytics profile picture
Agree - though not to the same extent as PKO as it did not add as much leverage. The expensive premium valuation of PTY gives me pause as well.
A newbie to CEFs, I've be buying PKO since last year. Looks like a real keeper. (Also long PTY.)

Thank you for sharing these PIMCO reports, ADS Analytics. Valuable information indeed.

Retired income investor
sc21 profile picture
thanks the interesting and helpful piece. But you might do well to consider more carefully the nature of the PKO holdings i.e. they have a lot of non agency mortgages which means that they are very open to default should things remain week. This is a major negative worthy of exploring.If it is not as serious a concern as I suspect, would value your take on it. tia sc
ADS Analytics profile picture
That sector allocation is part of the fund's attraction, at least to me.
Looking at your first graph, quick question. What is the time stamp and price source on the NAV as displayed? Are you calculating NAV or taking someone else's calculation? Looking, subsequently, at the current yield vs. distribution coverage chart, how much time delay is there between the yield and the distribution coverage? Is it one month backward-looking?
ADS Analytics profile picture
The funds provide NAVs a few hours after the close. No one except for the funds themselves calculate their NAVs. Distribution coverage for the PIMCO funds is currently as of April month end. The figure itself is the 6-month rolling average net investment income / April distribution.
most helpful, thank you
gimmeecoffee profile picture
Bought a small starter batch yesterday at 21.81. Of course, a few hours later it was down to about $21, and I was salivating at the prospect of a few more nasty market days to get some at about $20 or under, but it looks like today for some reason, we are going to bounce, so a little more patience will be needed. Still think the overall market has some selling to do, and I will be buying up as much of the good PIMCO funds as I can to add to my stash when it happens.
ADS Analytics profile picture
I reckon you're going to be in the money when the market opens. PKO closed less 2% below your fill. Drawdowns last for as long as it takes people to remember that the Fed's backstopping everything which is not very long.
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