PHT - PHT: A Very Solid Bond Fund Selling At An Attractive Discount

2023-05-15 15:41:09 ET

Summary

• Investors are desperate for income as rising prices have devastated most household budgets.
• Pioneer High Income Fund, Inc. invests in a portfolio of junk bonds in order to provide its investors with a very high level of income.
• The PHT closed-end fund should be reasonably safe from default risk, despite investing in speculative-grade securities.
• The 10.00% yield is almost completely covered by NII and should be reasonably safe.
• The fund is currently trading at a very attractive discount to the net asset value.

Without a doubt, the biggest problem facing the average American household today is the incredibly high inflation rate that has permeated the economy. Over the past eighteen months or so, inflation has been at the highest level that we have seen in more than forty years, as the consumer price index has risen at least 6% year-over-year in ten of the past twelve months:

A healthy inflation rate is generally considered to be about 2% per year, and this is the rate that policymakers usually aim to achieve and maintain. We can see that inflation is slowly trending toward this rate, but that is primarily driven by falling energy prices. I discussed this in a blog post recently. This inflation has been devastating for many people because it is centered on food and energy, which are necessities. Thus, people cannot simply avoid buying the products that are being affected, as they can with smartphones and automobiles that have also skyrocketed in price over the past few years. This has forced people to take on second jobs or go into debt simply to maintain their standard of living. As I pointed out in a recent article , revolving credit card debt balances just set a new record due to rising prices for everything. In short, people need new sources of income, and they are not getting it from their jobs as real wage growth has been negative for more than two years.

As investors, we are certainly not immune to the effects of rising prices. After all, we have bills to pay and need food for sustenance, just like everyone else. We do have more options to obtain the extra income that we need to maintain our lifestyles, however. After all, we have the ability to put our money to work earning an income. One of the best ways to accomplish this is to purchase shares of a closed-end fund, or CEF, that specializes in the generation of income. These funds are unfortunately not very well-followed by the investment media and most financial planners are unfamiliar with them, so it can be difficult to get the information that we would really like to have to make an informed decision. This is a shame because these funds offer a number of advantages over familiar open-ended and exchange-traded funds. One of these advantages is that a closed-end fund can use certain strategies that boost its effective yields beyond that of any of the underlying assets or, indeed, just about anything in the market.

In this article, we will discuss the Pioneer High Income Fund, Inc. ( PHT ), which currently yields an impressive 10.00%. This is certainly a yield that will appeal to anyone that is looking for a source of income. I have discussed this fund before, but it has been several months, so naturally several things have changed. This article will, therefore, focus specifically on these changes, as well as provide an updated analysis of the fund's finances.

About The Fund

Unlike most closed-end funds, the Pioneer High Income Fund does not have a dedicated webpage. The closest thing that it has to one is this site , which allows investors to download various documents from the fund sponsor about the fund. For our purposes, we will reference the fund's most recent fact sheet, which is dated March 31, 2023. According to the fact sheet, the Pioneer High Income Fund has the objective of providing its investors with a high level of current income. This fits well with its name, and it is unsurprising because it is a bond fund. As we can see here, currently 93.43% of the fund's portfolio consists of bonds, although it does have a small amount of cash and preferred stock:

The reason that the objective makes sense considering this is that bonds and other fixed-income securities deliver their returns primarily through direct payments to investors. After all, a bond is purchased at face value when it is issued, makes a regular payment to its investors, and then pays back the face value at maturity. Thus, any investor that purchases the bond at issuance and holds it until maturity will not realize any capital gains. The only return will be the fixed payments that the bond makes over time. This differs from common equity, which can actually appreciate in value as the issuing company grows and prospers.

This is not to say that bonds cannot deliver capital gains, but it is necessary to trade them to benefit from such gains. This is because bond prices vary with interest rates in the economy. It is an inverse relationship, so when interest rates rise, bond prices decline and vice versa. As everyone reading this is certainly well aware, the Federal Reserve has been aggressively raising interest rates over the past year as part of its fight against inflation. A year ago, the effective federal funds rate was 0.33% but today it is 4.83%:

This has pushed down bond prices generally. This is because newly issued bonds will have a yield that corresponds with the federal funds rate at the time of issuance, while older bonds will have a lower yield. As such, nobody will buy an existing bond when they could buy a new one with identical characteristics but a higher yield. Thus, the price of the existing bonds will need to decline until they deliver a similar yield to maturity as an identical brand-new bond. As might be expected, this has pushed down the price of this fund's shares:

This is because the fund's shares correlate at least somewhat with the value of the assets in its portfolio. However, as I have pointed out in various previous articles, it is possible for shares of a closed-end fund to deliver different performance than the portfolio itself. However, the two are at least somewhat correlated, so shares of a bond fund will decline when bond prices go down. We can see that relationship here:

As we can see, the fund's portfolio frequently underperformed its market price, although the divergence between the two has gotten much closer in recent times. This can sometimes make it possible to essentially obtain the fund's assets for less than they are actually worth. We will discuss this in more detail later in this article.

It is important to keep in mind that fluctuations in the fund's market price are not the only way through which investors earn a return in closed-end funds. This is because these funds typically pay out most to all of their net investment income and net capital gains to their investors through distributions. It is also not uncommon for investors to reinvest the distributions into new shares of the fund, which will then increase the distributions as the newly obtained shares will pay out distributions. As such, we want to look at the fund's total return, which includes distribution income. Here are the figures for this fund as of March 31, 2023:

The figures will naturally be a bit better now. As we can see above, the fund's share price bottomed out right around the end of March but has since rebounded. The point though is that the actual return that an investor realized is going to be much better than would be assumed by its market price performance due to the distributions paid by the fund.

In the fund's description given on the fact sheet, it specifically states that the Pioneer High Income Fund focuses its investments on speculative-grade securities:

"Pioneer High Income Fund, Inc. is a closed-end fund that invests for a high level of current income by investing in a portfolio of below-investment-grade bonds and convertible securities."

Thus, this is essentially a junk bond fund. This is something that might be concerned to some investors, particularly risk-averse ones that are highly concerned with principal preservation. After all, we have all heard about how junk bonds have a significant risk of losses due to defaults. It may be possible to reduce our concerns by looking at the credit ratings assigned to the securities that comprise the fund's portfolio. Here is a summary:

An investment-grade security is anything rated BBB or higher. As we can see, that is only 7.38% of the portfolio, although cash equivalents are almost certainly very high-quality securities, such as U.S. Treasuries and agency securities. Thus, it appears that roughly 90.68% of the portfolio is invested in junk-grade bonds. Please note that I am considering the 9.61% of the portfolio that is not rated to be junk bonds. This is by no means certain, but it is likely that any company with a sufficiently strong balance sheet to get an investment-grade rating will opt to have its securities rated as such to save money on interest expenses. Thus, the overwhelming majority of the bonds held by this fund are junk bonds.

However, we can see that 63.45% of the bonds in the fund's portfolio are rated either BB or B by the major rating agencies. These are the two highest possible ratings for junk bonds, and according to the official bond ratings scale , bonds with these ratings are issued by companies that have the financial capacity to afford their current debt obligations as well as weather a short-term economic shock. Thus, these bonds should be reasonably safe, although they will not be quite as safe as investment-grade bonds. This category accounts for the majority of the portfolio, so that should be some comfort to those investors that are worried about default risk. In addition, the fund has 327 current positions and no individual position accounts for more than 1.28% (with the exception of U.S. Treasury securities) of the portfolio so any individual default will have a negligible impact on the fund as a whole. This is not something that we need to concern ourselves with.

Leverage

In the introduction to this article, I stated that closed-end funds like the Pioneer High Income Fund are capable of using certain strategies that boost their effective yields beyond that of any of the underlying assets. One of these strategies is the use of leverage. In short, the fund is borrowing money and using that borrowed money to purchase junk bonds and similar assets. As long as the purchased assets have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. As this fund is capable of borrowing at institutional rates, which are considerably lower than retail rates, this will usually be the case.

However, the use of debt in this fashion is a double-edged sword. This is because leverage boosts both gains and losses. As such, we want to ensure that the fund is not using too much leverage because that would expose us to too much risk. I generally do not like to see a fund's leverage exceed a third as a percentage of its assets for this reason. The Pioneer High Income Fund, fortunately, satisfies this requirement as its levered assets comprise 32.58% of the fund's assets as of the time of writing. Thus, it appears that this fund is striking a reasonable balance between risk and reward, although it is admittedly pretty close to the threshold. For the most part, though, the fund's leverage does not appear to be posing an outsized level of risk.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the Pioneer High Income Trust is to provide its investors with a high level of current income. In order to achieve this, the fund invests in junk bonds and similar high-yielding securities. It then applies a layer of leverage to boost its yield beyond that of the underlying assets. As such, we can probably assume that the fund will have a remarkably high yield itself. This is certainly the case as the fund pays a monthly distribution of $0.055 per share ($0.66 per share annually), which gives it a 10.00% yield at the current price. The fund has, unfortunately, not been very consistent with its distribution over the years. In fact, it has steadily declined over the past several years:

The fund has cut its distribution twice in the past twelve months, which is somewhat annoying. Overall, though, this distribution history is likely to be a bit of a turn-off for those investors that are seeking a relatively consistent source of income with which to finance their lifestyles or just pay their bills. It is not entirely unusual for a bond fund though as the low interest rates that have existed over the past fifteen years have made it very difficult for funds to generate any sort of income from bonds. As I have pointed out numerous times in the past, the fund's history is not really the most important thing for anyone buying shares today. This is because new money will receive the current distribution at the current yield. As such, the most important thing is the fund's ability to maintain its current distribution. So let us investigate that.

Unfortunately, we do not have an especially recent document that can be consulted for that purpose. As of the time of writing, the fund's most recent financial report corresponds to the six-month period that corresponds to the six-month period that ended on September 30, 2022. This is quite disappointing since it will provide no insight into the fund's performance over the past several months. However, the Federal Reserve began its monetary tightening regime in March of 2022 and the following few months were much more challenging for the bond market than the last six or seven months were. This financial report covers that period, so it could still be useful in helping us see how capable the fund's management is at navigating challenging conditions. During the six-month period, the Pioneer High Income Fund received $12,940,018 in interest and $215,511 in dividends from the assets in its portfolio. This gives it a total investment income of $13,155,529 over the period. The fund paid its expenses out of this amount, which left it with $10,556,556 available for shareholders. That was, unfortunately, not enough to cover the $11,003,113 that the fund paid out in distributions. It did get very close to covering the distribution solely out of net investment income though, which is nice to see.

The fund does have other methods through which it can obtain the money that it needs to cover the distribution, however. For example, this fund can engage in bond trading, so it might have some capital gains that can be paid out. As might be expected from the disappointing performance delivered by many other bond funds over this period though, this one failed to accomplish a solid performance here. It reported net realized losses of $4,966,773 and had another $40,784,842 net unrealized losses during the period. Overall, the fund saw its assets decline by $46,198,172 after accounting for all inflows and outflows during the period. That is disappointing, but it does appear that this fund is trying to use its net investment income to cover the distributions as it got pretty close during both the six-month period in question as well as in the immediately preceding full-year period:

We can clearly see that net investment income in both periods is very close to the amount needed to cover the distribution. This is comforting to those that want secure distribution. One of the nice things about the rate hikes over the past year is that bonds are now providing a much higher level of income than they once did. This will benefit the fund in the form of rising income as it adds new bonds to the portfolio.

The only real problem is the losses that it booked from the bonds that were already in its portfolio prior to each rate hike that occurred over the past year. These losses are almost certainly the reason why it has cut the distribution twice. As analysts now widely believe that the Federal Reserve is done raising rates, it seems likely that the current distribution is probably going to prove sustainable.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the Pioneer High Income Fund, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current market value of all the fund's assets minus any outstanding debt. This is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are acquiring the fund's assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of May 12, 2023 (the most recent date for which data is currently available as of the time of writing), the Pioneer High Income Fund had a net asset value of $7.58 per share but the shares only traded for $6.62 each. This gives the fund's shares a 12.66% discount to the net asset value at the current price. That is a very reasonable discount that is much better than the 11.45% discount that the shares have had on average over the past month. Thus, the price is quite reasonable today.

Conclusion

In conclusion, the Pioneer High Income Fund offers a way for investors to obtain a significant amount of income that can be used to help maintain their standard of living in the face of the highest inflation that we have seen in decades. The fund invests mostly in junk bonds, but it is sufficiently diversified that default risk should not really be a concern. In addition, the Federal Reserve is probably done with rate hikes, so the worst should be behind us as far as the fund's losses are concerned. The fact that this fund appears to be paying its distributions almost entirely out of net investment income is also quite nice to see.

The Pioneer High Income Fund has a very attractive valuation right now. My only real concern here is that the most recent financial report is almost eight months old at this point, and I would hold off on any investment until an updated report is released. However, this does overall look like a pretty decent bond fund.

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