PTY, PFL, And PFN: Are We There Yet?
- We have had bearish ratings on all the popular PIMCO closed-end funds.
- The recent drop was in line with our expectations.
- We are about halfway through this decline, but we are upgrading a few names.
- I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
We generally give our readers the most direct and painful version of the truth. This is often interspersed with some basic math. Take for example the ViacomCBS Preferred Shares (VIACP). There was a zero percent chance that they would outperform the common shares in a decline. Yet, the madness of crowds prevailed and people chased it up believing they were getting a safe risk-free dividend. Lost in that chase was the simple fact that this was a mandatory convertible issue trading miles ahead of fair value. Unfortunately math and reality don't really care about your opinion.
Source: VIACP Chart From Seeking Alpha Dec 2, 2021
The three famous funds, PIMCO Income Strategy Fund (NYSE:PFL), PIMCO Corporate & Income Opportunity Fund (NYSE:PTY) & PIMCO Income Strategy Fund II (NYSE:PFN) were another setup that looked abysmal to us in June.
Unlike VIACP, where owners could have a positive return if the common shares appreciated a lot, PIMCO funds offered no remote chance of that over 1-3 years. Well that was our opinion any way. Let's see where that is going and whether we need to change the thought process.
Markets take a random walk at times and the feedback we get often resembles where that walk went. In this case, the crazy premiums on PTY got another boost as insanity hit new highs and that created the proverbial "boos".
But valuation is an anchor that ultimately overwhelms all optimism. The funds have gone pretty much where we thought they would. Now why did this happen?
Well there are two reasons for this. The first being that their NAV declined.
We had warned previously that the extreme risk taking behavior that was prevalent at the time would make it very hard to generate alpha in high yield land. The three funds have NAV declines exceeding that of SPDR Bloomberg High Yield Bond ETF (JNK) which is passively managed.
But of course the bigger story was what happened with the premiums to NAV.
When a stock or fund is going up, every logical argument falls on deaf ears. With these funds we heard the strangest counterarguments including that Treasury bonds were paying zilch and cash was losing value rapidly. Unfortunately, all three funds handily "beat" cash in losing value. But the good news here is that the premiums to NAV have compressed dramatically for two of them. PTY still stands at a lofty 27.36% while PFL and PFN have compressed to single digits.
This has improved the risk-reward a lot for those latter two. One can glean the same information by examining the Z-score which looks at a more recent reference point. Z Score = (current discount - average discount) / standard deviation of the discount. A negative Z-score indicates that the current discount is more than its average. A positive Z-score indicates that the current discount is less than average. PFN's Z-score is now negative 0.99.
Source: CEF Connect
PFL's 1 year Z-score is now at negative 1.73!
Source: CEF Connect
Compare this to what it was when we told you this was a bad entry point in July.
Source: CEF Connect, July 7 2021
The swing from positive 2.29 to negative 1.73 is pretty huge. The tables have certainly turned.
Pricing for PTY has improved and the Z-score looks respectable.
But the fund still remains extremely expensive when we look at a longer time line and it is our experience that extremes in one direction are followed by extremes in the other.
Outlook & Verdict
How you play this comes down to your risk preference and your outlook for where high yield bond spreads go. High Yield CCC or below spreads tend to blow up periodically and when they do, you can bet your bottom dollar the three funds will show further compression on their premium to NAVs.
PTY remains the riskiest of the three and we maintain a hard sell on that. For PFL and PFN, the declines have softened our tone and we are upgrading both to a neutral rating and see the possibility that you can get competitive returns from here. There is still a tall mountain to climb even for those two funds as we are in the middle of the most leveraged asset bubble that will likely blow up a lot of assets on the way down.
But at least you are not paying silly premiums at this point so you can rest easy on that front.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
Are you looking for Real Yields which reduce portfolio volatility?
Conservative Income Portfolio targets the best value stocks with the highest margins of safety. The volatility of these investments is further lowered using the best-priced options. Our Cash Secured Put and Covered Call Portfolios are designed to reduce volatility while generating 7-9% yields. We focus on being the house and take the opposite side of the gambler.
Learn more about our method & why it might be right for your portfolio.
This article was written by
Conservative Income Portfolio is designed for investors who want reliable income with the lowest volatility.
High Valuations have distorted the investing landscape and investors are poised for exceptionally low forward returns. Using cash secured puts and covered calls to harvest income off value income stocks is the best way forward. We "lock-in" high yields when volatility is high and capture multiple years of dividends in advance to reach the goal of producing 7-9% yields with the lowest volatility.
Preferred Stock Trader is Comanager of Conservative Income Portfolio and shares research and resources with author. He manages our fixed income side looking for opportunistic investments with 12% plus potential returns.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.