INTEQ - PDO: Enterprising Fixed Income Fund At A 3.46% Discount To NAV

Summary

• I like to add closed-end funds trading at a discount to NAV to my portfolio.
• PIMCO is one of the premier fixed-income institutions with presumably great insights into interest rate developments.
• The Dynamic Income Opportunities Funds looks like an interesting fund with high leverage and a creative portfolio.
• The fund trades at a 3.46% discount to net-asset value which is attractive vs its historical discount.
• Within the universe of closed-end funds a 3.46% discount isn't that special, however.

PIMCO Dynamic Income Opportunities Fund (PDO) is an interesting closed-end fund ("CEF") managed by what's perhaps the premier institution when it comes to active fixed-income investing. The fund pursues high-conviction income-generating ideas across credit markets to generate yield and capital returns.

Sometimes, fund descriptions seem generated by the marketing department. But when I looked under the hood of this fund, I saw something that surprised me. Fixed income funds tend to diversify very aggressively. Their top position often constitutes only a few percent of the assets under management. This makes a lot of sense because of the payoff profile of fixed-income investments. You can lose a lot of money on a bond if its issuer gets into trouble, but you can rarely make a lot of money on a bond even if you hold it to maturity and you get your money back (a pretty good outcome usually). In other words, fixed income managers need to spend a lot of time watching the downside, and the upside tends to be capped and fairly reliable. I don't count major allocations to the U.S. treasuries or IRS receivables as large positions. But the fund holds a 4.41% position in Wesco Aircraft bonds yielding 10.5%.

PIMCO is well known for its macroeconomic analysis (think Bill Gross and Mohammed El-Erian), and these views form the basis for top-down investment decisions. But after distilling that information, this is an opportunities fund, and these can get fairly creative and adventurous. That's exactly why I love looking at closed-end funds that are "opportunistic" or "unconstrained" or suggest a high degree of freedom. The professionals at these funds have a lot of leeway to pursue the best stuff and don't have to pass up opportunities because of restrictive mandates.

To be clear, I prefer holding CEFs when trading at a deep discount to net asset value. It is common for these vehicles to trade at a sizeable discount. This vehicle currently trades at a 3.46% discount to the net asset value. Usually, that's not enough to entice me. The 6-month average discount has been more than 6%. This suggests that this may not be the best time to buy in here. Then again, if I look back to 2020 onwards, it even traded at a premium.

After acquiring units, I tend to hold until: 1) the discount to NAV comes in; or 2) I find something that I like a lot better. In many cases, there are sizeable distributions while waiting for the discount to NAV to revert to the mean.

The distribution of around ~10% (based on Morningstar figures) is likely another thing that attracts shareholders here and keeps the fund's size in the sweet spot.

I always look at the portfolio of CEFs that seem interesting. There are nearly always interesting investment ideas in its portfolio. The positioning may also reflect some of PIMCO's ideas about the macroeconomic backdrop.

Just like some other strong fund I've recently reviewed , the portfolio appears tilted towards lower credit qualities:

This may be a function of institutions with strong macro departments foreseeing a mild or no immediate recession. Alternatively, they may agree a recession will be forced upon us by Mr. Powell (which is a widely held view), but the prices are simply too attractive in the B-segments.

Looking at the sector allocations, you'll immediately notice these don't add up to 100%. The fund uses quite a bit of leverage. Morningstar has its leverage ratio in the mid-'40s. That's a lot even for fixed-income closed-end funds, but mortgage-backed, government, and government-related categories are a bit more forgiving in this respect.

Looking at the specific holdings, it is clear this fund isn't hugging any benchmarks, which is always a concern. Issued that jumped out to me were 1) Intelsat Jackson Holdings, Ltd. 6.5% bonds. Intelsat ( INTEQ ) is a distressed company if I'm not mistaken. I like to see these distressed situations in funds. Provided they didn't buy it and held it down, it shows real entrepreneurship in finding brilliant opportunities. It is not a token position either, but Morningstar pegs it at 2.6% of AUM.

Another one that jumped out to me, as I rarely see these in U.S.-based funds, was the Stichting AK Rabobank Certificaten 6.5%. These are preferred in one of the larger Dutch consumer-oriented banks. A large institution but somewhat peculiar insofar as it doesn't have any equity holders. Without the equity buffer, these "preferreds" are riskier and more interesting than the usual bank preferreds. You don't have the same dividend outflows here, which is good, but if there's a major downturn, you're not cushioned by the equity.

Taking everything together, I currently view PIMCO Dynamic Income Opportunities Fund as another to put on the watchlist. The fund seems to be managed creatively enough to look at its portfolio from time to time to see if there are interesting fixed-income investments to learn about. It uses a lot of leverage, which can be dangerous in the wrong environment but juice returns in the meantime. The management fee of 1.15% isn't out-of-the-ordinary for a fixed-income CEF. The total expense ratio is 2.61%, including interest expenses which is high. You do get a lot of leverage for these expenses.

At the end of the day, I want a much deeper discount to venture in here. At 10%-15% below net-asset value, I'll be very interested. For now, it is a pass.

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