PDO - When Others Are Selling I Buy PIMCO For Big Income

2023-11-15 07:35:00 ET

Summary

• PIMCO is seizing generational fixed-income opportunities through strategic reallocation during market uncertainty.
• The firm’s perceived “risky moves” are already paying off double-digit returns.
• PIMCO’s top CEFs PTY, PDO, and PDI, offer impressive yields of up to 15%.

Co-authored with "Hidden Opportunities."

Today's economic environment is increasingly uncertain. The Fed vows to keep interest rates higher for longer, and as a result, there is something for every style of investor in the debt market.

Remember, your starting point of yield is predictive of future returns if you have a long time horizon, and this starting point is significantly higher than past decades across all types of debt. Source .

Fixed income opportunities are higher up in the corporate structure and offer higher yields today. While deposit rates look attractive now, they will be quick to become something substantially lower in just a year from now, and cash is a zero-duration asset, quick to lose its earning potential with small changes in the rate climate.

Avoid this reinvestment risk; this is the time to lock in a very attractive yield level for several years, and income investors who pivot to fixed-income securities enjoy better resilience, predictability, and flexibility over the long term.

PIMCO is a leading investment management firm focusing on active management of fixed-income securities. Founded in 1971, the firm has successfully navigated some of the most challenging conditions of the modern era, while rewarding shareholders with reliable income and market-leading returns. PIMCO currently manages $1.74 trillion in Assets Under Management ("AUM") and is one of the highest-regarded firms when it comes to insights on the bond markets. This is because of their track record in playing with what is often perceived as a "stupid thing to do" amidst the risk scenario at the time but ending up with substantially higher returns as a result of their prudence, foresight, and knowledge about debt instruments.

Last year, amidst what was one of the worst years for fixed-income instruments, Wall Street banks offloaded billions of dollars worth of loans tied to risky private equity takeovers, also known as "hung debt." They pursued the sale by incurring steep losses to clinch deals with interested investors. One of the biggest interested parties was PIMCO. Source .

PIMCO swooped in and bought billions of debt at ~80 cents on the dollar, while banks were just happy to get out. Fast forward 14 months, and PIMCO has started selling chunks of that hung debt at massive double-digit premiums.

This action clearly emphasizes what PIMCO does. They don't fear the flames; they fan it and mold the metal to make gold over time. And patient investors reap big benefits from their foresight and market expertise.

This isn't the first time PIMCO has pulled out a rabbit from its hat.

Through 2H 2011, there were uncertainties over whether the Fed would embark on a third round of quantitative easing to shore up the anemic economy. PIMCO wasn't waiting to find out. Led by co-founder Bill Gross, the firm started buying tens of billions of dollars in mortgage-backed securities guaranteed by federal agencies. In Q3 2011, one of the firm's flagship funds, the world's largest mutual fund, doubled its holdings of these securities to $80 billion.

A year later, the firm began enjoying massive gains on these holdings. Towards the fall, the Fed announced a third round of QE to keep supporting the U.S. housing market, and PIMCO's Total Return Fund posted billions more dollars in gains.

Reuters once reviewed more than 14,000 trades by the Federal Reserve Bank of New York and PIMCO over the past five years, and the results showed that the firm has consistently been on the money in anticipating the Fed's actions in the bond markets.

This is why we hold an exceptional, out-sized allocation to PIMCO closed-end funds, or CEFs, via:

• PIMCO Dynamic Income Opportunities Fund ( PDO )
• PIMCO Corporate&Income Opportunity Fund ( PTY )
• PIMCO Dynamic Income Fund ( PDI ).

Notably, PTY is a time-tested flagship CEF from PIMCO, having outperformed the market over the long term through GFC, Fed policy changes, and the global pandemic.

Pick #1: PTY - Yield 10.9%

PIMCO Corporate&Income Opportunity Fund ( PTY ) is PIMCO's flagship CEF, which is time-tested with the firm's prudent navigation of economic conditions. PTY has handsomely outperformed the broader market over the long term while delivering predictable income to shareholders.

PTY offers a sizable 10.9% yield with attractive monthly payments.

Pick #2: PDO - Yield 13.5%

PIMCO Dynamic Income Opportunities Fund ( PDO ) is one of PIMCO's newest CEFs, having been launched during the post-COVID yield-less markets. A substantial portion of the fund matures in under three years, meaning the principal is fully recovered, and the CEF can redeploy the proceeds into higher-yielding instruments. Source .

PDO pays $0.1279/share monthly, yielding an impressive 13.5% annualized.

Pick #3: PDI - Yield 15.7%

PIMCO Dynamic Income Fund ( PDI ) maintains a core focus on mortgages, with non-agency MBS accounting for 27% of its holdings and 60% of its duration-weighted exposure. PDI also has material exposure to corporate credit and non-USD-denominated credit.

Today, PDI trades at a slight premium to NAV after Mr. Market sensed dovishness in the Federal Reserve's future policy-making. Source .

This jump is indicative of the true potential of PIMCO's holdings, and a teaser to the massive upside when the Fed actually begins cutting rates. We will collect our monthly distributions amounting to a 15.7% annualized yield.

Let's Talk About PIMCO's UNII Reports

Being actively managed, the firm is balancing out the tax obligation on their funds, pairing realized losses with realized gains, and paying distributions without Return of Capital. We see a lot of investors express concerns about distribution coverage from looking at the UNII reports.

With CEFs, it is never about distribution coverage. They aren't running a business that produces recurring earnings to retain some for growth initiatives. As fund managers, they invest their capital strategically to realize gains and distribute all of it to shareholders. The UNII report is indicative of realized gains meeting or exceeding the distributions, but as with any investment, the returns for the next month are not going to be the same as the past months. UNII provides no information about unrealized gains or losses, but is a measure of tax obligation.

With bonds at their lowest prices in 40 years, PIMCO doesn't have to look too hard to find unrealized losses in its portfolio. The firm is using these very efficiently to balance its gains from the interest rate swaps earlier this year and the sale of the hung debt at a massive premium. We see PIMCO CEFs producing $0 UNII in most months (and it will likely continue for the near term), and there will be no special distributions this year as the fund will be looking to strategically break even from a taxation standpoint.

Conclusion

PIMCO has a stellar record of delivering reliable income through turbulent markets. More importantly, the firm is known to aggressively allocate to sectors that are perceived to be very high risk, but they do so cautiously and realize massive gains.

Our Investing Group prioritizes the generation of current income to fuel our passive income needs in retirement and other life stages. When the broader market sells quality dividend-payers, we buy with both hands. Our "model portfolio" comprises +45 fixed-income securities with an overall yield of +9%, and we are purchasing these rare discounts to lock in high yields for the foreseeable future. Since our focus and strategy with fixed income match that of PIMCOs, we find attractive monthly-paying opportunities in their CEFs - PTY, PDO, and PDI.

PIMCO is not selling any of its holdings in fear of the current situation. Rather, they are strategically reallocating to optimize their tax liability while positioning the portfolio for long-term success, from changes to the monetary policy and beyond. The NAV of these CEFs will recover as rates fall down the cliff and deposit rates shrink. The fixed-income market presents a generational opportunity for reliable income amidst deeply discounted prices. Locking in big income would serve well for long-term investors, and massive yields on PIMCO CEFs will help you do that. When others are selling, we are buying PIMCO.

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