YH CEF Report April | Distribution Cuts Finally Plague PIMCO

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April distributions announcements came out yesterday and the big headline has to do with PIMCOs widespread and in some cases significant chops to payouts.  Allianz, the parent company of PIMCO, also cut the distribution on their two flagship convertible income funds.  

For April, we saw a total of 15 changes to the distribution.  Of those, 4 were distribution increases and 11 were decreases.  That compares with 47 changes in March: 17 increases and 30 declines.  

Discounts in the CEF space continue to tighten though the rate of change has slowed dramatically.  The average discount today, according to CEFA, is 5.82% in bond funds, compared to 9.08% on January 4th.  Average discounts on equity funds are 5.84% today, compared to 8.77% at the start of the year.  

The VIX continues to be a solid driver for discounts- as the market calms, investors flock into closed-end funds reducing the spread between price and the NAV.  

Distribution Changes For The Month 

All of these funds pay monthly.  We omitted some of the smaller distribution changes that were less than 2% including MFS funds and TEI.  

Distribution Increase (>2%)

EV Senior Income (EVF):  +3% to $0.034 from $0.033.

EV Floating Rate Income (EFT):  +2.7% to $0.076 from $0.074.

EV Sr Floating Rate (EFR):  +2.7% to $0.077 from $0.075.

EV Floating Rate Income+ (EFF):  +1.2% to $0.084 from $0.083.

Distribution Decrease (>2%)

PIMCO High Income (PHK):  -24% to $0.061331 from $0.080699.

PIMCO GlobalStkPLUS and Income (PGP):  -23% to $0.09394 from $0.122.

Allianz Convertible and Income (NCZ):  -21.7% to $0.045 from $0.0575.

PIMCO NY Muni Income (PNI):  -21% to $0.040045 from $0.05069.

AllianzGlobal Convert and Income (NCV):  -19.2% to $0.0525 from $0.065.

Templeton Global Income (GIM):  -18.1% to 0.0336 from $0.041.

PIMCO NY Muni Income III (PYN):  -16% to $0.03549 from $0.04225.

PIMCO Strategic Income (RCS):  -15% to $0.0612 from $0.072.

PIMCO Muni Income III (PMX):  -9% to $0.050733 from $0.05575.

PIMCO CA Muni Income III (PZC):  -7% to $0.04185 from $0.045.

PIMCO NY Muni Income (NYSE:PNF):  -7% to $0.05301 from $0.0703

Commentary

The big news on the day was PIMCO cutting the distribution for 8 of their 20 funds. PIMCO is one of the few sponsors that takes cutting the distribution very seriously and will stave off doing so at all costs. However, by doing that it sometimes means the cuts have to be deeper. They also tend to cut more significantly in order to prevent future cuts as well.

PIMCO High Income (PHK), PIMCO Strategic Income (RCS) and PIMCO Global StocksPLUS & Income (PGP) are both high yielding and high premium funds.  The draw to these funds is no surprise.  They both yield significantly more than anything else you can find in the marketplace.  Below is an image from CEFConnect that sorts PIMCO CEFs by highest premium as of the close of day April 1.  

PGP is a unique fund in the industry that plays off their StocksPLUS brand of funds.  These are funds that are exposed to various specific equity indices via futures contracts, placing only the minimum margin down which is usually 20%, and investing the remainder of the capital into their high yield bond strategy.  It also has a "defensive" options strategy which involves writing calls and purchasing puts on the S&P 500.  That high yield bond strategy is what you would find in PHK.  

The big news on the day was PIMCO cutting the distribution for 8 of their 20 funds. PIMCO is one of the few sponsors that takes cutting the distribution very seriously and will stave off doing so at all costs. However, by doing that it sometimes means the cuts have to be deeper. They also tend to cut more significantly in order to prevent future cuts as well.

PIMCO High Income (PHK), PIMCO Strategic Income (RCS) and PIMCO Global StocksPLUS & Income (PGP) are both high yielding and high premium funds.  The draw to these funds is no surprise.  They both yield significantly more than anything else you can find in the marketplace.  Below is an image from CEFConnect that sorts PIMCO CEFs by highest premium as of the close of day April 1.  

PGP is a unique fund in the industry that plays off their StocksPLUS brand of funds.  These are funds that are exposed to various specific equity indices via futures contracts, placing only the minimum margin down which is usually 20%, and investing the remainder of the capital into their high yield bond strategy.  It also has a "defensive" options strategy which involves writing calls and purchasing puts on the S&P 500.  That high yield bond strategy is what you would find in PHK.  


PIMCO Strategic Income (RCS) is a bit of an odd animal.  We highlighted last year in our PIMCO updates that they were petitioning the IRS to change the way they account for mortgage rolls.  

We think the IRS will approve the change as most other mortgage funds already account for income in this manner. RCS is an outlier due to the long history of the fund. Essentially, the change will show up on the 19a form showing the distribution as short or long-term gains rather than interest income. Since the fund has a large amount of loss carryforwards, much of the next few years' income would actually be classified as ROC. However, we do think that there is at least a 50% shot that they cut back the distribution as well. At such a high premium, that could result in a significant fall.

Below is the most recent 19a.  You can clearly see the difference in the level of net investment income under the two different accounting methodologies.  It may appear that they believe they will win the IRS approval for the change and are thus including the distribution cut for RCS with the other cuts this year.  

In summation on those funds, we still wouldn't consider them despite the clobbering they are receiving today.  The premium for PGP was over 100% back in the fourth quarter of 2016 when they chopped the distribution.  The premium went from 105% to 39% in approximately 4 months time.  

The last couple of times PHK cut their distribution, the premium was cut by 25% and by 12%, in 2016 and 2017.  

The duration of these cuts can last anywhere from 1 to 6 months.  Thus, we believe it is way too early to think about entering them.  While the price is not going to fall enough for the current yield to get back to where it was prior to the cut, they will likely fall enough for the yield to rise back to competitive levels with other higher risk offerings.  PHK, being down over 11% currently, has seen its yield already rise back to 9.2%.

There was a great discussion on our chat about PIMCO funds and forewarning about potential cuts.  @acamus discussed watching the 19a notices since none of the funds have a managed distribution policy - the only funds that should have persistent ROC.  

Also, as he noted, if the CEF market was efficient, prices wouldn't get clobbered from a distribution cut.  What he is referring to is an investor should be indifferent between a fund that pays 10% with 4% being return of capital and a fund that pays 6%, all of which is net investment income.  However, most investors in CEFs are income-oriented and the payout yield is their primary driver.  

On the muni side, there wasn't much in the way of surprises.  PIMCO muni CEFs have been the best performing but one thing I wanted to cover here was to note that they are also likely the junkiest of any muni CEF.  They are mostly high yield munis even though their name doesn't consist of the words "high yield."  This may mean that many of the investors are simply unaware that they are fairly junky.  

The PIMCO name carries a lot of weight and investors pile in to them based on reputation and trust.  That means that PIMCO will inevitably carry a higher valuation.  In our modeling, we figure that the PIMCO name is worth about 12 points.  That means that if a PIMCO muni fund and a Nuveen fund were identical except name, and the PIMCO traded at par, the Nuveen fund would be at a -12% discount.  That is massive and demonstrates just how valuable that name is to investors.

Part of that name was the fact that their distributions have been so stable.  The funds are mostly low and unrated bonds that are high yielding.  This also helps insulate them from some calls as well.  

What's interesting in the muni cuts is that they hit PNF and PZC, both of which still had some UNII left.  It is plausible that they saw the writing on the wall and had modeled out what they expected to be called and what the replacement coupon of those lost would be and knew that a cut was going to be needed.  This begs the question of how much time the large UNII funds have left (PML and PZQ both have large UNII bucket).  Perhaps its not as long as previously thought.

Update on Special Opportunities Fund (SPE):

The fund adopted a managed distribution plan where they will shift the payout to a monthly payment at an annual rate of 6% (or 0.5% per month) of NAV for the remainder of this year.  Starting in January of 2020, the fund is proposing to make monthly distributions at an annual rate of 6% based on the NAV on the close of business on the last business day of the previous year.  

Our team wrote on this just a few weeks ago anticipating the change.  

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