PDI - PDI: Buyer Beware

• PDI has a 12% yield, well covered by investment income YTD.
• PDI has impressively never cut distributions.
• However, analysis of holdings suggest caution as investment income is generated from holding leveraged long positions on high yield 'junk' debt.

Recently, I wrote a cautious article on the PIMCO Dynamic Income Fund ( PDI ), explaining why I am staying away from that particular closed end fund ("CEF") despite its attractive high current yield.

The comments I got from the article were quite eye-opening. Many commentators left hostile comments after I pointed out unflattering facts about the PIMCO fund, such as its unrestricted 'black box' investment strategy, volatile performance (ranging from first to third quartile), higher risk (on a 3, 5, and 10-year basis as defined by Morningstar), and higher expenses (total expense ratio of 2.78%). Some commentators even went as far claiming the PIMCO managers are 'out of this world' and the author was an inexperienced amateur in comparison.

While I read the comments with a slight chuckle, I must admit I had not expected this behavior from an unbiased discussion of a fixed-income fund. In this article, I will provide a few comments on PDI's holdings report, to see whether the manager is really 'out of this world' or is it simply a leveraged 'high yield' bond fund. The holdings report can be found PDI)%20Portfolio%20Holdings.xlsx&id=lQj7KqKuFrPk1QQH76fx2vsK8eoj2l9y%2bWX7JRZwd5SKPm8NNgiCat5kRg6Vhqx%2bRZaNpy3tXt9r%2bjqeAcnTLjc99lVUgpmM55rccODjyqdPX5zAFitnGP%2blWO%2b372nVNsISADPqFabg%2bkjq07pm91YtAuGUIcxlez%2fdyH%2f3FGgSfHwyJg0QcvMOox4KI0e93lJZsIV57l08AM1ZNSyXMSOmudR0VkmOPh95Okv1djkyiEvDXT3XoFMmva%2bsz7KsWlyQchpvnbiVc0vUTDwhtU6KlOdWyT2FbwPT2pKRjkFvLzs1jT%2f0ERfzCeoS66U%2fjMKwujPKKNfwmF2yiq8I70XDe3KxYHklIA00k4Kw%2fJ4ZQ%2b9fSqa0r8%2b7MnqPb64wFd6OpSiLC4tRv2fY%2b6lrx%2bl7BCYU%2feUhNOwIy7KXwTg%3d" > here .

UNII Report Shows YTD distributions well covered

First, a house-keeping item. Many commentators claimed I cherry-picked things to look at and did not mention PDI's Undistributed Net Investment Income ("UNII") report . So let me spend a few minutes to fawn over the UNII.

The UNII report, excerpted below in Figure 1, shows that the PDI fund has generated $2.97 per unit in net investment income and has a 3 month rolling coverage ratio of 161%. On a fiscal YTD basis, the coverage is 118%.

These are impressive figures for sure. Kudos to the PIMCO management team for generating such high investment income.

Holdings Analysis

Now let's take a look at the 'out of this world' investments generating that income.

Analysts who opened the holdings report will be immediately struck by the sheer size of the PIMCO Dynamic Income Fund. The portfolio holdings report contained over 1,900 lines (Figure 2). While many positions were FX and repo transactions, the core longs still totaled over 1,300 lines.

As someone from an equity fund background, I never understood why bond funds had to have so many securities, and PDI is no exception. Figure 3 shows PDI has 101 long positions with 0.001% weight. Are the dozens of securities at 0.001% weight really going to move the needle? I would love to hear thoughts from bond fund managers on this.

Top 10 Holdings

Figure 4 shows the top ten individual positions. Notice the average yield on these are very high, at 8.85%, excluding the 1.45% Fixed Income Clearing Corp. ("FICC") position. FICC is the clearinghouse subsidiary that facilitates processing of government and mortgage-backed securities ("MBS"), so I think that position is most likely cash tied to PDI's MBS portfolio.

Also, note there is a position in "Neiman Marcus Group Ltd. LLC" that has no yield. It is in fact common stock of the retailer Neiman Marcus. Neiman Marcus filed for Chapter 11 bankruptcy in 2020 , so this position is likely from a debt restructuring that PIMCO was a part of.

In my prior article, I commented:

For example, if PDI can buy $2 of a 6% corporate bond while borrowing $1 at 3% themselves, then PDI can earn 9% yield on its $1 in equity.

This is precisely the strategy PDI is employing. Investing in high yield 'junk' bonds with 2:1 leverage.

Let's go through the rest of the top-10 names quickly to see if there's any information we can glean.

Amsurg is a hospital chain that was merged with KKR-backed Envision Healthcare. As of 2020, Envision was rumored to be on the verge of bankruptcy , hence the 13% yield on the Amsurg loans. PDI has an additional 1.36% weight in Envision Healthcare loans yielding 8.875%.

Gateway Casinos is a company operating casinos in Canada. It's owned by the Catalyst Capital Group, a Private Equity ("PE") firm. On a slight tangent, casino loans and bonds (MGM, Melco, Wynn, LVS, etc.) show up frequently in PDI's portfolio, with a combined 3.9% weight.

Voyager Aviation Holdings is an aircraft leasing firm. It had a corporate restructuring in 2021.

Intelsat Jackson Holdings is a subsidiary of Intelsat, a satellite operator that filed for Chapter 11 bankruptcy in 2020 .

Wesco Aircraft Holdings is an aerospace parts and supplies distributor that was acquired by PE firm , Platinum Equity, in 2020.

Orient Point CDO is a Cayman Island registered Collateralized Debt Obligation ("CDO"). Unfortunately, I couldn't find much information on this CDO.

Stichting AK Rabobank Certificaten are preferred shares issued by Rabobank, a Dutch banking group.

Sequa Corp. is an aerospace aftermarket company owned by the PE-firm , Carlyle Group.

Additional Interesting Names That Come Up In The PDI Portfolio

In addition to the top 10 positions above, there are also many interesting exposures in the PDI portfolio that investors should be aware of.

For example, PDI has a combined 2.9% weight to Banca Monte dei Paschi di Siena, the oldest bank in the world in continuous operation that has been mired in controversy and was bailed out by the Italian government in 2017 (Figure 5).

PDI has a 10.2% combined weight in mortgage backed securities from Bear Stearns, Countrywide, Merrill, Lehman and Washington Mutual, names I have not heard of since the Great Financial Crisis (Figure 6). Were these carried over from 2008 (perhaps through the fund merger with PKO and PCI) or did PDI buy these securities in later years?

PDI has a 2.7% combined weight in Pacific Gas & Electric Co. (PCG), the Californian utility that went bankrupt in 2019 from wildfire liabilities.

PDI has a 0.8% weight to the Softbank Vision Fund that recently announced a $21.6 billion quarterly loss on poor investments.

PDI has nominal exposures to Chinese property companies Country Garden Holdings, Huarong Finance, and Sunac China (Figure 8).

PDI also has 1.2% weight in Argentinian sovereign bonds, 0.8% in Puerto Rico bonds, and a smattering of bonds from Russia, Ukraine, Venezuela, Turkey, Peru, Ghana, Ecuador, Ivory Coast, and Nigeria.

Holdings Analysis Further Supports Thesis That PDI Is High Risk

To be clear, I have a lot of respect for the PIMCO portfolio managers. I'm sure they are top notch professionals, and they must have good investment thesis for each of the investments listed above. The fact that they have been able to continuously pay distributions without a cut speaks to their abilities, especially as we've seen many credit events occur (like the Neiman Marcus bankruptcy).

I'm merely pointing out that the PDI portfolio is comprised of mostly high yielding 'junk' bonds and loans of companies that are in or near bankruptcy, or are highly indebted PE companies. There is no free lunch - to get 12% yield, investors must be willing to accept risk. In this case, it is heightened credit risk. For me, I don't think the risk is worth it. Readers may decide otherwise. But at least now they are aware.

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