Gross Fund at 66% Premium Shows Pimco Allure in Quest for Yield
Call it the Pimco premium.
Six of the 10 most expensive bond closed-end funds are managed by Bill Gross or his colleagues at Pacific Investment Management Co., according to data compiled by Bloomberg, as investors starved for yield are bidding up prices of funds with high payouts run by brand name managers.
Gross’s $1.55 billion Pimco High Income Fund, which is trading at a 66 percent premium, above its three-year average of 49 percent, offers investors distributions of 11.5 percent. The Pimco Global StocksPlus & Income Fund, which is run by Pimco manager Dan Ivascyn and has a 10 percent payout, trades 76 percent above its net asset value as of Feb. 14.
“When investors see a nearly 12 percent yield and Bill Gross is the manager, the premium doesn’t come into question,” Patrick Galley, chief investment officer at Chicago-based RiverNorth Capital Management LLC, said in an interview. “The catalyst is low rates and the fact that they’re going to be staying there until 2014,” said Galley, whose firm manages about $1.5 billion in investments, including closed-end funds.
Closed-end funds, which sell a fixed amount of shares to raise money for investments and then trade on an exchange like stocks, on average pay out 6.7 percent, beating dividend yields offered by open-end mutual funds, stocks in the Standard & Poor’s 500 Index and bonds, in part because they can use debt to boost returns for investors. While a premium signals confidence in the manager, buying the funds for more than its underlying holdings are worth can increase the risk of losses if the share price declines.
Gross Takes Over
Gross, who started managing Pimco High Income in May 2009, is better known as manager of the Pimco Total Return Fund, the world’s biggest mutual fund. The $250 billion fund lagged behind 69 percent of peers last year after Gross missed a rally in U.S. Treasuries and put money into riskier assets. The fund returned 2.7 percent since the start of this year through Feb. 14, beating 97 percent of peers. It has outperformed 98 percent of similarly managed funds over the past five years and became the world’s biggest mutual fund in 2009.
Gross, whose firm is based in Newport Beach, California, owned 206,600 shares of Pimco High Income, valued at about $2.5 million based on a $12.09 per-share price, according to a Dec. 14, 2010, regulatory filing. Gross in late 2009 recommended buying the fund, which prompted a surge in the premium in a “self-fulfilling prophecy,” said RiverNorth’s Galley.
Highest Since 2009
The Pimco High Income Fund (PHK) reached a 72 percent premium on Jan. 11, according to data compiled by Bloomberg, the highest since May 2009, when Gross took over management of the fund. Pimco’s payout, calculated as the latest distribution, annualized and as a percentage of the fund’s market price, is almost twice as much as the 6.5 percent average distribution rate for competing bond closed-end funds, data compiled by Chicago-based Morningstar Inc. show.
Other closed-end bond funds trading at high premiums as of Feb. 14 include the Pioneer High Income Trust, whose share price is 33 percent more than the value of its underlying holdings, and the Western Asset Premier Bond Fund, at a 24 percent premium, according to data compiled by Bloomberg. Among U.S. equity funds, the Gabelli Utility Trust has the highest premium, at 41 percent, data compiled by Bloomberg show. The data includes closed-end funds in the U.S. with more than $100 million in assets.
Jeffrey Gundlach, manager of last year’s top performing mortgage fund, last month opened a closed-end fund to invest in bonds including mortgage-backed securities, emerging-market debt and developed-market credit. The fund, DoubleLine Opportunistic Credit Fund, raised $327 million in a Jan. 27 offering and is trading at a 9.8 percent premium.
Gross, the co-chief investment officer of Newport Beach, California-based Pimco, has said that the unprecedented period of low interest rates has squeezed investors, who are being subjected to “financial repression” because of the Fed’s policies.
Fed Chairman Ben Bernanke said last month the central bank is considering additional asset purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014. The 10-year U.S. Treasury yield fell to a four-month low of 1.797 percent Jan. 31. The average yield for taxable money funds was 0.03 percent as of Feb. 7, according to IMoneyNet Inc., a research firm based in Westborough, Massachusetts.
The biggest allure of closed-end funds for investors is the distribution, mostly generated from income and gains from investments, that they pay out to investors in such an environment, said Cecilia Gondor, executive vice president at Miami-based Thomas J. Herzfeld Advisors Inc.
There are more than 615 closed-end funds in the U.S., with a market capitalization of about $220 billion, according to the firm.
Closed-end funds that invest in bonds are commanding higher prices as investors have fled riskier asset classes such as stocks. Bond closed-end funds are trading at an average premium of 1.3 percent, compared with a 6.2 percent discount on stock closed-end funds, according to data from Morningstar.
The four other most expensive Pimco fixed-income funds include the Pimco Strategic Global Government Fund, which is trading at a 31 percent premium and offers an 8.1 percent distribution; the Pimco Corporate & Income Opportunity Fund, also managed by Gross, which is at a 25 percent premium and offers a 7.3 percent payout; the Pimco California Municipal Income Fund II, at a 22 percent premium and paying 7.4 percent; and the Pimco Corporate & Income Strategy Fund, managed by Gross, which is at a 20 percent premium and pays 7.6 percent.
“Investors are being attracted to that very high distribution rate because they can’t get that many other places,” said Cara Esser, a closed-end fund analyst at Morningstar. “The Pimco brand probably has something to do with it too -- people like Pimco, so many Pimco funds sell at very large premiums.”
Investors like bond closed-end funds because they tend to have less risk than equity funds and their payouts are less likely to include returns of capital, said John Cole Scott, portfolio manager of Richmond, Virginia-based Closed-End Fund Advisors, an investment advisory firm registered with the Securities and Exchange Commission that oversees $70 million in assets. Distribution rates for equity closed-end funds are higher because they tend to reflect return of capital, he said.
Closed-end funds that have a policy of distributing a fixed yield may also return investors’ own capital in the form of a distribution, said Gondor. Although the practice has gotten a “bad rap” because it can reduce the net assets of the fund, the return of capital can be good for investors in some instances, such as when the funds distribute capital from unrealized gains, she said.
About 16 percent of Pimco’s High Income Fund payout in December was estimated to be return of capital, according to a statement from Munich-based insurer Allianz SE (ALV), Pimco’s parent.
Gross’s fund is able to generate such a high distribution through leverage and derivatives trading, although there is the risk that it won’t be able to meet future payouts without including more return of investor’s capital, according to Esser. The net asset value of the fund has declined about 19 percent in the past 12 months, data compiled by Bloomberg show. Adjusting for distributions paid out to investors, the net asset value fell 3.1 percent during the same period.
Mark Porterfield, a spokesman for Pimco, declined to comment on the closed-end funds.
Many closed-end funds use leverage, or borrowed money, to boost payouts. Leverage allows the funds to take advantage of low interest rates and borrow relatively cheaply while investing at long-term rates that are higher.
Closed-end funds tumbled during the 2008 financial crisis as markets declined and borrowing dried up. They were also squeezed by the collapse in February 2008 of the auction-rate market, which historically helped managers raise money to boost returns. Many, including the Pimco High Income Fund, suspended dividend payments as assets plunged and they couldn’t use leverage. Pimco restored dividends on its closed-end funds when the markets rebounded in 2009.
Premiums and discounts are less important than the net asset values and share prices of the closed-end funds themselves, said Morningstar’s Esser. Funds trading at high premiums such as Pimco’s could deflate, like overvalued stocks, if investors think the fund is too expensive and will sell to take profits while they can, according to Esser.
“It’s a big risk when you have these funds trading at high premiums,” said Esser.
The fluctuations of a closed-end fund’s market price also lead to higher volatility, as does the use of leverage. That might surprise investors who are looking for stability with a fixed-income fund, said Esser. Pimco’s High Income Fund has a risk rating of “high” from Morningstar, in part because of its volatility, Esser said.
Volatility could also be exacerbated if a closed-end fund uses derivatives, which are contracts whose value is derived from stocks, bonds, currencies and commodities, said Sangeeta Marfatia, a closed-end fund analyst in the New York office of UBS AG.
She recommended funds that are trading at cheaper premiums, such as Legg Mason Inc. (LM)’s Western Asset Managed High Income Fund (MHY), which is at a 4.8 percent premium and doesn’t include return of capital in its payouts.
“Smart investors should really take advantage of these premiums and lock in their gains by selling,” Marfatia said, referring to funds with the highest premiums.
The Pimco High Income Fund invests at least 50 percent of its assets in U.S. dollar-denominated high-yield debt, according to information posted on the firm’s website. The fund had 29 percent of its assets in high-yield debt; 25 percent in investment-grade corporate bonds; 16 percent in government securities and 14 percent in municipal debt as of Dec. 31.
The fund’s return to investors, including dividends, was 6.7 percent in the year ended Feb. 14, according to data compiled by Bloomberg.
The Pimco Global StocksPlus Fund, with a market capitalization of $218 million, invests in stock index derivatives and futures backed by a portfolio of low-duration debt. The fund returned 1.9 percent to investors over the past year, including dividends. The net asset value fell 21 percent during the same period and adjusting for distributions, the net asset value declined 6.4 percent.
For some investors, the stable yield still balances out these risks. Closed-end funds are able to maintain stable levels of payouts better than regular mutual funds because they have fixed pools of capital since investors can only buy or sell shares on the secondary market rather than from the fund itself, said Alan Goodson, head of product U.S. for London-based Aberdeen Asset Management Plc (ADN), which has North American closed- end fund assets of more than $5.6 billion.
“Given the interest rate environment, investors are looking for yield and that’s clearly where closed-end funds tend to have an advantage over open-end funds,” Goodson said.
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