I just bought a second tranche in PIMCO Dynamic Income Opportunities Fund (NYSE:PDO) for my Seeking Alpha Marketplace Service's Quality High-Yield Income portfolio.
PDO is my highest conviction TOP CEF IDEA for 2023. The highly diversified fixed income fund meets my father's diversification requirements on all accounts. What's more, when including the recent special dividend, we are talking about an extraordinary 16% annual return. Be advised, this is not guaranteed every year of course. I was watching PDO for a majority of 2022.
I have had PDO on my watchlist since the beginning of 2022. I was made aware of the 2021 yearend special dividend distributed from the undistributed net investment income, UNII, on the books.
The 2021's special dividend was about two thirds the amount of the $0.96 most recent special dividend. Be aware the special dividend will vary based on the amount of undistributed net investment income available.
I waited for the 2022 special dividend announcement to buy a 1/2 position knowing that after the ex-div date the shares would most likely sell off. I have now purchased my second tranche and have a full position at only a 3% capital loss versus the 20% the fund is down to date.
This brings me to my second reason for waiting. The shares were in a well-defined downtrend for the entirety of 2022. This is emblematic of my father's abiding investing principle, "Patience equals profits." Moreover, I see the 2023 macro outlook unfolding in an extremely favorable way for PDO. Nevertheless, it appears I am not alone. The fund has just broken out of its long-term downtrend.
Technical analysis is nothing more than a graphic representation of the bulls and bears at battle. It appears as though the bulls have taken charge as of late. When performing my due diligence, I start by screening for securities I posit will flourish in the current macro environment. With the Fed on an unrivaled rate hike warpath and inflation out of control, it was not conducive for PDO's capital appreciation prospects in 2022. Nonetheless, now with inflation seemingly rolling over and the Fed nearing the end of their torrid rate hike cycle, the odds of an economic recovery ensuing in 2023 have increased greatly. This should provide the ideal atmosphere for PDO to recover a substantial amount of ground it lost in 2022. I know many of you are hardened income investors with thick skins and can handle the ups and downs of the stock price as you collect the income distributions. I am right there with you! Even so, if I had my druthers, I'd rather be in the black than the red. That's just me. Now, let's take a deep dive into the fund and see what exactly we are working with.
This is the fund description from PIMCO.
PDO is a highly diversified fixed income CEF focused on income first and capital appreciation second. That is the exact description of my service. We strive to achieve a 20% total annual return with 10% coming from dividends and 10% from capital appreciation. PIMCO is famously known for their expertise in fixed income investing. PDO has five managers overseeing various subsets of the fund's assets.
PDO is a relatively new fund, barely two years old. This is a risk factor to consider.
Now let's touch on the dividend details since that's why we are all here. Below is the dividend summary info from Seeking Alpha.
PDO is a monthly payer distributing approximately $0.13 per share each month for a 10.63% annual yield.
For the past two years PDO has declared a special dividend at the end of each calendar year. They use the special dividend to distribute the undistributed net investment income of the fund. For 2022, it was $0.96. This is not guaranteed.
Now let's take a deeper dive into the holdings.
Total managed assets are $2.8 billion. This includes a variety of financial instruments. According to PIMCO:
"Total Managed Assets include Net Assets Applicable to Common Shareholders ("Common Net Assets") + Preferred Shares + Reverse Repurchase Agreements + Credit Default Swaps + Floating Rate Notes Issued in Tender Option Bond ("TOB") transactions, as applicable. In TOB transactions, a fund sells a fixed rate municipal bond to a broker who places that bond in a Special Purpose Trust from which Floating Rate Notes and Inverse Floaters are issued."
You can see the entire list of instruments by clicking here. Below is a list of the top holdings.
This is where the diversification comes into play. PDO is an excellent vehicle for investors to capture a wide swath of highly diversified assets in one fell swoop. The fund is not only highly diversified by financial instrument, but by industry, sector, and country.
The highest weighting by industry is healthcare. Although the funds are spread out fairly evenly.
The US government, the mortgage industry, and high-yield credit are the highest weighted sectors.
The fund is heavily weighted to the United States as far as geographic diversification. I have saved the best for last, the maturity percentages.
With 45% of PDO's bonds maturing in the 0-3 year range, PDO managers should be able to capitalize on the increased yields of today's bonds. PDO is in a great position to take advantage of current higher yields by rolling the funds received from maturing securities into new higher yielding instruments. The next characteristic you should be aware of is the fact the CEF is highly leveraged.
if you didn't figure it out already by the exotic list of financial instruments in play, the fund is highly leveraged at about 50%. This is another risk factor to consider. The inordinate use of leverage plays a big part in the overall cost of fees and expenses.
The 2.79% total for fees and expenses is at the upper range of expenses for CEFs. Yet, the potential for a 16% yield more than makes up for it. Let's now turn our attention to where the shares are currently trading in comparison with the net assets value, or NAV, of the fund.
As you can see, for the entirety of 2022 the shares were trading at a steep discount to NAV. Then popped up bigtime when the special dividend was announced, as all the dividend hunters piled in. Afterwards, the shares nosedived as everyone has their fill and ran for the exits. This is why I held back a second tranche. I knew a post ex-div date selloff was bound to ensue. This allowed me to dollar cost average in and taking advantage of the highly telegraphed share price drop. My 30 years in the market has taught me to always layer into positions overtime to reduce risk no matter how highly convicted I am. Just recently the shares have begun trading at a slight premium to NAV. I surmise this is due to the fact that I'm not alone in recognizing 2023 may turn out to be the mirror image of 2022. If the macro picture develops as I expect it will, this portends well for PDO. Now let's wrap this piece up, shall we.
PDO has paid a steady monthly dividend like clockwork for the past two years. The yield is presently over 10% with the shares trading in the $14 range. On top of this, PDO has declared a hefty special dividend in each of the past two years. Last year's special dividend of $0.96 increased the effective yield to approximately 16%. That is extraordinary. What's more, 2023 could be the year PDO finally makes good on its second objective of capital appreciation. With inflation waning and the Fed on the brink of hitting its terminal rate, I see blue skies ahead for the CEF. I predict we will break out of the current bear market before the end of 2023. This should provide the ideal environment for PDO to flourish. In spite of this, it would be regrettable of me not to mention that all investments come with inherent risk. PDO is no different. I suggest you read the lengthy risk disclosure section provided by PIMCO prior to initiating a position. Those are my thoughts on the matter. I look forward to reading yours. Thank you for your time.
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Disclosure: I/we have a beneficial long position in the shares of PDO either through stock ownership, options, or other derivatives. 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.