PDI - PIMCO Dynamic Income Fund: You Can Now Get A 15.6% Yield On This Closed-End Fund

2023-10-12 12:11:39 ET

Summary

• PIMCO Dynamic Income Fund is still valuable for passive income investors despite losing value in 2023.
• The fund focuses on interest rate-sensitive fixed income instruments, which have long-term potential for price and value gains.
• The recent decrease in the fund's net asset value premium is likely due to inflation, but the long-term inflation trend supports an investment in PDI.

Despite losing value in 2023, PIMCO Dynamic Income Fund (PDI) has a role to play in the investment portfolios of passive income investors, in my view.

The PIMCO Dynamic Income Fund is focused on interest rate-sensitive fixed income instruments, primarily mortgage-backed securities and high-yield debt, which have the potential to deliver price and value gains in the long term.

Recently, PIMCO Dynamic Income Fund’s net asset value premium has been diminished, presumably because inflation ticked up again. With that being said, the long-term inflation trend supports an investment in PDI, and passive investors can collect a monthly distribution at a marginal premium to net asset value.

Furthermore, in the long term, I would expect passive income investors to profit from a valuation recovery.

My Rating History

I have liked PIMCO Dynamic Income Fund for a while and think that investors are unappreciative of the closed-end fund. Fixed income-oriented closed-end funds have a role to play in asset allocation and provide passive income investors, particularly those with an equity bent, with diversification benefits.

A high distribution rate and fixed income exposure were reasons supporting my Buy classification in February .

Funds like the PIMCO Dynamic Income Fund contain mostly fixed-income instruments whose prices are inversely related to interest rates. Though inflation has seen a bit of a resurgence in August and September, the interest rate landscape is set to change for the benefit of the PIMCO Dynamic Income Fund in the long term, in my view.

Fixed Income-Focused, Monthly-Paying Closed-End Fund

The PIMCO Dynamic Income Fund owns a portfolio of interest-paying fixed income instruments, including mortgage-backed securities, commercial mortgage-backed securities, high-yield credit, and emerging market debt investments. The largest investment category in the closed-end fund are mortgage securities, which pay recurring interest that is passed through to fund investors. As of the end of August, the PIMCO Dynamic Income Fund managed a total of $4.65 billion.

The PIMCO Dynamic Income Fund had 28% of its funds invested in the mortgage business compared to 32% in March, while high-yield credit contracted from 23% to 20%. Still, the fund remains heavily overweight with mortgages and high-yield credit, which together account for close to 50% of the fund’s investments.

Temporarily Depressed Fund Returns

As you can see in the performance breakdown by investment period, the PIMCO Dynamic Income Fund has performed exceptionally poorly in the last three and five year periods, which is when the closed-end fund reported annual returns way below the fund’s long-term average. The blame for this goes to the sudden change in interest rates starting in 2022.

PDI: Now Only A Small Premium To Net Asset Value

The PIMCO Dynamic Income Fund has seen a gradual decline in its NAV premium since March, and the closed-end fund is now selling for just a 2.6% premium to NAV. The fund’s most recent net asset value was $16.47. The fund has traded largely at a premium to NAV, particularly during 2021 when interest rates were artificially suppressed by the central bank in order to provide monetary stimulus to an economy ailing from the after effects of the Covid-19 pandemic.

Inflation Resurgence Likely To Blame For Diminished NAV Premium

The long-term trend in inflation points south and supports the idea of interest rate cuts in 2024. With that said, inflation has seen a flare-up in August and September, which is when it re-accelerated to 3.2% and 3.7%, respectively.

The increase in inflation rates could delay the central bank’s interest rate decreases, which are widely expected to happen in 2024.

In my view, uncertainty around the future path of inflation (and interest rates) has resulted in a diminished NAV premium for the PIMCO Dynamic Income Fund most recently.

PDI: Risks And Valuation Opportunities

More than anything, the size of the PIMCO Dynamic Income Fund’s NAV premium or discount will be linked to the inflation trend in the United States. Inflation increased in the last two months, and a third consecutive inflation uptick could further narrow the premium to NAV. Higher interest rates are poison for fixed-income instruments, and closed-end funds that are primarily invested in rate-sensitive mortgage-backed securities would probably suffer if the inflation flare-up continues.

Thus, ongoing inflation pressure would speak against an investment in PDI. The PIMCO Dynamic Income Fund may only be suitable for investors who have an understanding of the behavior of fixed-income instruments in rising and falling interest rate environments.

My Conclusion

The PIMCO Dynamic Income Fund has, against my expectations, fallen into a downtrend in 2023, which probably relates to the recent uptick in inflation.

With that said, however, the closed-end fund is an attractive instrument for passive income investors, and the PDI has a role to play in active asset allocation, particularly for those investors that overly focus on equity investments.

The PIMCO Dynamic Income Fund pays a monthly distribution, and the diminished NAV premium is ever more reason for me to consider (and recommend) the closed-end fund for passive income investors that want to construct a well-balanced and diversified investment portfolio that throws off decent distribution income through different interest rate environments.

On my last purchase, I paid a slightly higher than 2.6% premium to NAV while locking in a 15.6% distribution yield.

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