PIMCO Update | September 2024 | Muni Coverage Jumps (Maybe), Taxables see Significant ATM Benefit
This is our monthly update on the PIMCO suite of closed-end funds ("CEFs"), primarily focusing on their taxable CEFs. However, this month we do spend a bit more time on the muni side given some structural changes that have occurred.
It is quite detailed and technical so I wouldn't gripe if you just read this summary!
Summary:
1. The best taxables at the moment are: PHK, PFN and at slightly cheaper valuations PDI, PCN.
2. The best munis at the moment are: PMF, NY funds (PNI)(PYN)(PNF), and PCK in CA.
3. The distributions are safe thanks to the funds monetizing their premiums through the at-the-market offering. This is where they issue new shares when the funds are at a premium to NAV. This supplements the net investment income which is the traditional measure for the coverage ratio.
4. The Muni CEF coverage ratios are suspect as they retired the ARPs which has boosted the ratios but we don't see how they are paying the new leverage costs yet. Further UNII reports will confirm this for us.
5. Leverage has come down, likely due to NAV appreciation which is starting to ramp. The NAV is likely reacting to a bullish call on rates.
6. I added to PDI a few weeks ago (detailed in the Daily Notes) and am looking to get add to PCN (small position at the moment). I have been steadily buying PHK and have a large position in PFN.
7. PMF is one of my larger muni CEF positions overall (top 10) and I now own a decent-sized position in PNI. I am steadily adding to many PIMCO muni CEFs as I am bullish on them all.
-----------------------------------------------------
Coverage Remains Depressed For Taxables, But....
Let's start with the taxables where the average coverage fell 7% to 70.2% from 77% last month. We saw five funds increase coverage (PTY, PCN, PHK, PFL, PGP) and six fall in coverage (PCM, PDI, PFN, RCS, PDO, PAXS).
PDOs coverage, which has been exceptionally high and a clear standout, saw the April month roll off the 3-month number and fall back below 100%. To me that looks like a one-off sale of an appreciated asset that is calculated as additive to net investment income.
Below is coverage for the last five months:
The lower dollar is helping to suppress coverage on the funds as their currency hedges tend to pull down those coverage numbers. July was a down month for the dollar versus the euro and pound which likely reduced coverage, all else equal.
The numbers in an absolute sense remain low and unimpressive. However, I don't see much of any risk to their distributions. I think that is important to emphasize as we received their annual reports on the 20th. The one exception would be PIMCO Access Income (PAXS) though even there I would say the risk is low for a cut.
Here is our calculations on their total "income" for covering the distribution.
How to read the above chart.
We start with net investment income, which is the aggregate interest earned by the underlying bonds in the portfolio. The traditional measure of coverage of the distribution would simply be this number divided by the distribution.
Realized and unrealized gains/losses affect the NAV only which only ancillary affects the distribution. If the NAV falls enough (more losses than gains), then the fund will be forced to de-lever which would reduce net investment income and lower coverage.
Next we have the distributions. Here you can compare the net investment income and the distributions to see that coverage is not 100%. But then we get the at-the-money offering.
At-the-money offering. This is where the fund, through its trading partner Jones, issue new shares to the market. This brings in new assets into the fund that can be used to supplement net investment income and cover the distributions.
The catch is that the funds can only do so when they trade at a premium to NAV. Currently, all taxable PIMCO funds trade at a premium except PDX.
The column in the above table which is titled ATM offering + Div reinvested is the new assets coming into the fund. In some cases, it is substantial. A high premium PLUS good liquidity is the best combination for this and can allow the fund to issue a lot of new shares.
In the case of PIMCO Dynamic Income (PDI), the ATM offering alone is enough to cover the distributions ($925m vs $764m). Add in the $512m of net investment income and you have "true coverage" of about 188% (the last column in the table above).
Only PAXS doesn't cover the distribution with the ATM offering since that fund has only been training at a premium for a limited time.
PIMCO Corp & Income Opp (PTY) and PIMCO Corp & Inc Strategy (PCN) both trade at large premiums and have good liquidity with average daily volume at 5.6m and 2.2m shares traded. That allows them to issue a lot of new shares relative to their sizes and puts their 'true coverage' at a very high level.
All else equal, focus on that last column in conjunction with their valuation for assessing which PIMCO taxables to allocate capital.
PFN, PFL, PAXS, PDO, and PHK, all of which I like, are in the low-to-mid single-digits for premium. They bear monitoring in the rare case that they move to a discount to NAV.
I don't have much of any concerns for PFN, PFL, and PHK for that risk since they have rarely traded at a discount historically.
PIMCO Muni's Retire Their ARPs Boosting Coverage
Back in April, the PIMCO muni CEFs retired their auction rate preferred securities ("ARPs"). Not to get too technical but these are a historical security (pre-financial crisis) that were used for the leverage of the muni CEFs.
Here is a short primer on them (if you care):
An ARS is a type of variable-rate bond or adjustable-rate preferred stock with an interest rate that can change in response to financial market conditions. The underwriting broker-dealer structures these instruments with longer-term maturities of 20 to 30 years.
The rate paid to investors is reset at specific intervals throughout the life of the bond by a process known as a Dutch auction. This can occur at seven-, 14-, 28-, or 35-day intervals. At each interval, the broker-dealer submits bids to an auction agent. These bids are the lowest rate the issuer is willing to accept. Once the broker-dealer receives the bids, it then determines the clearing bid, or the rate at which the bonds are reset for the upcoming interval.
The main thing to know is that they provide the borrowing for the PIMCO muni CEFs. Liquidity evaporated after the financial crisis and the auction for the securities resulted in few bids and higher yields (all else equal lower liquidity equals higher yields).
From the last annual report:
Since mid-February 2008, holders of ARPS issued by the Funds have been directly impacted by a lack of liquidity, which has similarly affected ARPS holders in many of the nation’s closed-end funds. Since then, regularly scheduled auctions for ARPS issued by the Funds have consistently “failed” because of insufficient demand (bids to buy shares) to meet the supply (shares offered for sale) at each auction. In a failed auction, ARPS holders cannot sell all, and may not be able to sell any, of their shares tendered for sale. While repeated auction failures have affected the liquidity for ARPS, they do not constitute a default or automatically alter the credit quality of the ARPS, and ARPS holders have continued to receive dividends at the defined “maximum rate,” as defined for the Funds in the table below.
The maximum rate is a function of short-term interest rates and is typically, but not necessarily, higher than the rate that would have otherwise been set through a successful auction. If the Funds’ ARPS auctions continue to fail and the “maximum rate” payable on the ARPS rises as a result of changes in short-term interest rates, returns for each Fund’s common shareholders could be adversely affected.
On August 14, 2023, each Fund commenced a voluntary tender offer for up to 100% of its outstanding auction rate preferred shares (“ARPS”) at a price equal to 94.5% of the ARPS’ per share liquidation preference of $25,000 per share (or $23,625 per share) and any unpaid but accrued dividends (each, a “Tender Offer”).
The coverage report that PIMCO releases shows coverage after paying all expenses including the preferred shareholders. Through the retirement of those ARPs, those payments went to zero, increasing coverage.
They then issued Remarketable Variable Rate MuniFund Term Preferred ("RVMTP") shares on April 17, 2024. These are 30-year securities with a call on every 5th anniversary. The borrowing rate will be SIFMA Muni Swap Index plus 1.30%.
In the table below, you can see the muni CEF coverage steadily increases after March as those older months roll off and the new net investment income levels after the redemption of the preferreds takes hold.
The question is why aren't the new RVMTP shares interest being taken out of the net investment income of the muni CEFs at this point? Or are they? There is a line item for interest expense and a separate line item for the old auction rate preferreds. One would suspect that the interest expense figure is the interest on the new preferreds.
The SIFMA muni swap index yield is now 2.84% so the interest on the new RVMTPs would be approximately 4.14%.
To make a long story, still long, the increase in the coverage ratios may be overstated as I find it hard to believe that size of the increase in coverage is not the retirement of the old ARPs and not adding back in the new RVMTPs. If I had to guess, I would guess it was a timing issue and that future UNII reports will start to show the RVMTPs reducing coverage in the near future.
Leverage Remains in their Target Range
Overall, leverage was reduced marginally in the last month for most funds except for a few (PFN, PFL, and PHK). PDI has lowered total borrowing by about 5% over the last three months while PDO has increased by 2.7%.
Total effective leverage is above 40% (something I watched regularly) for three funds, PDO (40.7%), PCM (40.4%), and PAXS (42.6%).
It would appear that PIMCO reduced some leverage through the realization of some gains ahead of the volatility in early August.
Short-Term NAV Performance Looks Great
The NAVs have started to move upward, likely due to a bullish call on rates. In their 6/30 quarterly commentary for PDI, they had the following contributors and detractors:
As of that time, long interest rate positioning was a detractor which is why the NAV likely declined in the second quarter. However, since then, rates are down and the NAV is up so that appears to be the largest correlation for the NAV at the moment.
Certainly cMBS and corporate credit have been up as well since 6/30 which may have helped.
Most NAVs are up nicely over the last year and supportive of lower leverage (reducing risk) and distributions. PTY is the leader at +24% vs PAXS the lowest at +20%. A 4% variance between the best and worst over a one year time period is actually very tight potentially indicating that the funds are largely positioned the same way.
Valuation | Fairly Reasonable When You Compare To The Entirety of the Taxable CEF Space
Keeping everything in mind above about the coverage WITH THE ATM offering, you want to balance a few things. The higher the premium the better in terms of covering the distribution since it would allow the fund to issue new shares to cover the distributions.
That said, that is offset by premium risks as the higher the premium, the greater the premium risks. This is the risk of a steep fall in the price relative to the NAV (premium shrink).
For instance, PIMCO Strategic Income (RCS) at a 56% is great for covering the distribution but that 56% premium could be a 25% premium a few months from now for no good reason. Thats a 21% loss and nearly 3 years of distributions evaporated.
So you want to balance higher premium valuations with premium risk. This is why I like PIMCO Income Strategy II (PFN) [I prefer PFN over PFL generally because of greater liquidity], and PIMCO High Income (PHK). I also like PIMCO Dynamic Income (PDI) below a 11% premium.
Concluding Thoughts
There's a lot of data above but right now, I would be comfortable buying:
And would watch for (and buy opportunistically):
In munis, we continue to like the national funds (PMF), CA with (PCK) and NY (PNI). For the first time in a long time the PIMCO munis look compelling both on NAV potential and on valuation.
This report included buys, sells, and other recommendations to Premium Members along with other guidance on where we see the markets heading…
---------------
Try Yield Hunting Premium for 7 Days On Us!
What Makes Yield Hunting so unique?
Our Core Portfolio has a standard deviation of just 4.94%. That is about 40% of the S&P's volatility over the last three years. And remember, the S&P had historically low volatility during that period of time. The Sharpe ratio is over 2X that of the S&P 500. That ratio tells us how much return per unit of risk we are taking.
That is an astounding figure given that the risk measure of the Core Portfolio is based on the PRICE volatility, not the NAV volatility. If we could assess the NAV volatility, it would likely be at least one point lower if not more.
In other words, you are taking two-thirds LESS RISK by NAV than the S&P and only giving up a quarter of the gains!
Time to go Yield Hunting!
Our member community is fairly uniquely focused primarily on constructing portfolios geared towards income. The Core Income Portfolio currently yields over 8% comprised of closed-end funds. If you are interested in learning about closed-end funds and want guidance on generating income, check out our service today.
We also have expert guidance on:
Fixed Income closed-end Funds, Muni's, Preferred stocks, Baby bonds, ETFs, and Mutual funds.... among others.
Yield Hunting Premium Subscription
Our strategy, simply put, is to create a portfolio of fixed income closed-end funds and alternative asset classes (such as REITs, Preferred Stock, and Baby Bonds) to create a risk managed approach to retirement income.
This approach can either be a standalone strategy (i.e- for most or all of your portfolio) or as a replacement for the failed 'fixed income' portion of your equity/ bond mix.
Either way, the goal is to create a safe income stream that meets as much of your monthly retirement expense needs as possible- thereby leaving the principle (as well as any equity positions) alone to grow unmolested. If selling is not necessary, we have effectively removed any or all sequence of returns risk from the portfolio.
We urge you to not miss this opportunity to take advantage of this really great offer. You really have nothing to lose with the one-week free trial which locks you in at the lower rate.
This is a unique opportunity to create a fixed income closed end fund portfolio utilizing extremely rare discounts and high yielding securities. Yield Hunting can be utilized in various ways- to be the 'bond side' of your 60/40 diversified portfolio, your paycheck replacement strategy for retirement, or as a way to de-risk away from lofty equities and risky dividend stocks.
Invest alongside a real portfolio manager and financial advisor with over 25 years experience managing assets- along with his dynamic team. Yield Hunting’s easy-to-follow low-maintenance models are aimed to generate a high single-digit yield for retirement income planning or fixed income allocations.
With a subscription to Yield Hunting, you get access to:
Our Three Portfolios that help create a safer and consistent 9% income stream:
Core Income Portfolio This is our main model. It has about a dozen securities (almost all CEFs) with almost no equity exposure. The risk profile by NAV is less than half that of the S&P 500. It is a bit more passive than most portfolios, with only a handful of trades a month- making it very easy to follow even for the novice investor. Current yield is over 10% .
Active Income Portfolio - The active income portfolio is your total asset allocation solution. It is built with an income focus in mind but has total exposure across all asset classes. We base our sector/asset allocation based on our Macro Ratings tab and put our money where our mouth is!
Model of Models - This is our conservative model, appropriate for the largest percentage of members of our service. It is an allocation blueprint for members to align based on their risk tolerances.
Database Lists - We also have lists of individual Munis, Preferreds, Corporate Bonds, Term Funds, and Mutual Funds to compliment your portfolio.
Our premium service is organized in the following manner:
Monthly Newsletter - Details the current investing environment, portfolio construction techniques and advice, and a review of our model portfolios. We do offer past issues for free. Simply message us that you would like to receive a past newsletter and provide an email address to send it to.
Weekly Commentary - Goes through the events of the week and things to watch for in the upcoming week. This also includes performance for our holdings and the effects the current market situation will have on them.
Daily Note- A brief synopsis of the day, including what to look for and specific actionable advice.
Spotlight - Several write-ups each month, with specific analysis on securities we want to bring to our members attention where we see specific opportunities.
Alerts - Buy/ sell alerts on securities within the portfolio as conditions warrant
And finally....
Access - You are not on your own! We are available weekdays during market hours via email at admin@yieldhunting.com for any and all questions or concerns. We also offer a complimentary cursory review of your portfolio, so you know you are not going it alone and always have a professional's ear whenever you need it.
Why Yield Hunting?
While our service is aimed primarily at late stage career and retired investors, the strategy can also be used to lower risk by augmenting traditional equity investing via open-end mutual funds or ETFs. This includes those who have spent many hours researching and selecting the equity side of their portfolio, but don't have the knowledge or time to do the same for the fixed income side. We use high quality institutional research to avoid distribution cuts, opportunity risk, and other pitfalls which can derail your strategy.
Our Team
Three For The Price Of One! Being one of the larger services means we have a larger budget. We believe we've assembled some of the best talent on Seeking Alpha analyzing closed-end funds.
Our stacked team includes:
1) Alpha Gen Capital (Yield Hunting) - I am a career financial advisor (non-practicing) and investor. Not someone from another career doing this on the side. The AGC team and I use detailed analysis to provide safe and actionable insight without the fluff or risky ideas of most other letters. Our goal is to provide a relatively safer income stream with CEFs and mutual funds. Maybe more importantly, we also help investors learn about investing and how to properly construct a portfolio.
2) George Spritzer - Another career financial guru who runs a registered investment advisor with a specialization in closed-end funds for individuals. George uses the following investment strategies: 1) Opportunistic Closed-end fund investing: Buy CEFs at larger than normal discounts to NAV and sell them when the discounts narrow. 2) Exploit special situations: tender offers, fund terminations, fund activism, rights offerings etc.
3) Landlord Investor- Spent his career as a management consultant for public sector clients at a multinational consulting firm in the DC area. He has transitioned to a new career as a full time landlord. His investment portfolio is comprised of two parts -- broad-based index funds and income plays such as preferred stock, CEFs, and REITs. He also owns individual/baby bonds which he buys on margin to boost total return. Landlord is our 'individual preferred stock' expert analyst.