2023-05-01 09:54:41 ET
Summary
- Investors are desperately in need of additional income to maintain their lifestyles in the face of the highest inflation that we have seen in more than forty years.
- PAXS invests in a portfolio of bonds and then applies a significant amount of leverage to boost its yield.
- The fund has underperformed the aggregate bond index over the past year and could deliver more near-term losses to investors.
- The fund has incredibly high leverage and failed to cover its distributions during the second half of last year.
- The price is very reasonable, but this appears to be a high-risk, high-return play.
It is unlikely to be debated that one of the biggest problems facing the average American consumer today is the incredibly high rate of inflation that has been dominating the economy. This is evidenced by the consumer price index, which has seen year-over-year appreciation of at least 6% in eleven of the past twelve months:
Fortunately, we have started to see the inflation rate cool off, but as I discussed in a recent blog post , this may not continue for very long since most of the improvement was caused by the decline in energy prices that we saw in the first half of the year. Regardless, real wage growth has been negative for 24 straight months, so this has clearly pressured the budget of the average American. We have seen a growing number of people have to spend down their savings and a surge in revolving credit card balances due to people being forced to borrow money just to maintain their standard of living. The obvious conclusion here is that people are desperate for additional sources of income in order to maintain their lifestyles.
As investors, we also have bills to pay and require food for sustenance, so we are hardly immune to the challenges of high inflation. However, we do not need to resort to methods such as taking on second jobs simply to maintain our lifestyles. This is because we are able to put our money to work for us in order to earn more money. One of the best ways to do this is by purchasing shares of a closed-end fund that specializes in the generation of income. These funds are, unfortunately, not very well-followed in the financial media and most financial professionals are unfamiliar with them. As such, it can be difficult to obtain the information that we would like to have to make an informed investment decision. This is a shame because these funds offer a number of advantages over open-ended and exchange-traded funds. In particular, they are able to employ a number of strategies that have the effect of boosting their yields well beyond anything else in the market, which is exactly what we want out of an income play.
In this article, we will discuss the PIMCO Access Income Fund ( PAXS ), which is a fund that investors can employ to earn an income. The fund’s very attractive 12.47% current yield is proof of this income focus. I have discussed this fund before, but several months have passed since that time so obviously a great many things have changed. This article will therefore focus specifically on those changes as well as provide an updated analysis of the fund’s financial performance. Let us investigate and see if this fund could be a good addition to your portfolio today.
About The Fund
According to the fund’s webpage , the PIMCO Access Income Fund has the objective of providing its investors with a high level of current income. This is hardly surprising considering that the name of the fund implies that it is intended to be an income solution. In addition, PIMCO funds are typically fixed-income funds and this one is no exception:
CEF Connect
As we can clearly see, the fund is almost entirely invested in bonds. The reason for the negative allocation to cash comes from the fact that this fund uses leverage as a way to boost its effective yield, which we will discuss later in this article. For now, the important thing is that this is a bond fund.
One of the defining characteristics of bonds is that they are designed to deliver their returns as direct payments to investors. Their potential for capital gains is quite limited, especially when compared to common stocks. This is because bonds have no inherent link to the growth and prosperity of the issuing company. After all, a company will not increase the amount of money that it pays to its creditors just because its income went up. Thus, the amount that the bond will pay to its investors is fixed at issuance and since the investors receive face value at maturity, ultimately the only return that will be received by someone that holds the bond to maturity is the yield.
With that said, bond prices do fluctuate with interest rates, which provides some capital gains potential for bond traders. It is an inverse relationship, so bond prices go down when interest rates go up and vice versa. As everyone reading this is no doubt well aware, the Federal Reserve has been aggressively raising rates over the past year as part of an effort to combat the high inflation that has been plaguing the economy. In March of 2022, the effective federal funds rate was 0.20% compared to 4.65% today:
There have been very few periods in history in which interest rates were increased so quickly. As might be expected, this has had a devastating effect on bond prices and by extension bond funds. The PIMCO Access Income Fund is down 21.12% over the past twelve months:
It is likely that the fund will continue to exhibit some weakness for a bit longer. The Federal Reserve is currently expected to raise interest rates another 0.25% in May and then stop its monetary tightening regime while it evaluates the effect that the higher rates are having on the broader economy. However, most of the improvements that we have seen in the inflation rate so far have been caused by falling energy prices. The core consumer price index, which excludes food and energy, has not gone down. In fact, it has begun to tick upward:
As a result, should energy prices start to increase in the near future, it could very easily cause the Federal Reserve to raise rates much more than anyone is currently projecting. This is a very real possibility given the current supply-demand dynamics in the market. Thus, while the worst is probably behind us as far as bond prices are concerned, the fund could still see some share price declines in the near term.
However, it is important to keep in mind that the fund’s market price return does not tell the whole story for two reasons. The first of these is that the fund made distributions over the course of the past year, which provided a return to shareholders that is not reflected by just looking at the market price. As such, an investor in the fund would not have actually lost 21.12% over the period, particularly if the investor is reinvesting the distributions. The second reason is that it is not unusual for shares of a closed-end fund to perform differently than the fund’s actual portfolio. This can sometimes create opportunities to purchase the fund’s assets for less than they are actually worth, which will be discussed later in this article. Over the past year, the PIMCO Access Income Fund’s portfolio delivered a –8.24% total return:
Over the same period, an investor that reinvested all of the fund’s distributions in the fund would have suffered a 9.58% loss. That is certainly better than the 21.12% loss that the market price would have us believe! However, this fund still underperformed the Bloomberg U.S. Aggregate Bond Index ( AGG ), which had a –4.75% total return over the twelve-month period that ended on March 31, 2023. That is almost certainly going to disappoint any investors that are looking to purchase bonds as a way to preserve capital. Then again, if principal protection is your goal, it is typically best to purchase the individual bonds yourself as opposed to any bond fund. This is because, barring a default, you will not lose money by purchasing brand-new bonds and holding them until maturity. Bond funds like this one typically engage in trading activities to try and earn capital gains from bonds in addition to the interest payments.
As just mentioned, the PIMCO Access Income Fund engages in bond trading in an attempt to boost its returns beyond what it can receive simply by holding the bonds and collecting the interest payments. However, this fund does not appear to be particularly aggressive in its trading strategy as its annual turnover was only 16.00% for the full-year period that ended on June 30, 2022 (the most recent period for which data is currently available). That is not an especially high turnover for a fixed-income fund and as such it is rather nice to see. This is because it costs money to trade bonds or other assets, which is billed directly to the shareholders of a fund. This creates a drag on the portfolio’s performance and makes management’s job more difficult. After all, the fund managers need to earn a return sufficient to cover these additional expenses and still have enough left over to give an acceptable return to the shareholders. This is a challenging task that most management teams fail to accomplish consistently. This is one reason why many actively-managed funds fail to beat their benchmark indices. As we have already seen, despite PIMCO’s reputation as a very high-quality bond manager, the PIMCO Access Income Fund failed to beat the bond index over the past year, so this fund unfortunately does not appear to be an exception to the rule.
Leverage
As mentioned earlier in this article, closed-end funds like the PIMCO Access Income Fund have the ability to employ certain strategies that have the effect of boosting their yields beyond that of any of the underlying assets. One of the ways that this fund accomplishes this feat is the use of leverage. In short, the fund borrows money and then uses those borrowed funds to purchase bonds. As long as the purchased bonds have a higher yield than the interest rate that the fund has to pay on the borrowed money, this strategy works pretty well to boost the effective yield of the fund’s portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates so 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. This could help to explain why this fund lost more than the index over the past twelve months. As a result of this simple fact, we want to ensure that the fund is not employing too much leverage since that would expose us to excessive risk. I generally do not like to see a fund’s leverage exceed a third as a percentage of its assets for this reason. Unfortunately, the PIMCO Access Income Fund substantially exceeds this limit. As of the time of writing, the fund’s levered assets comprise 46.43% of the portfolio. That is an incredibly high level of leverage that is easily one of the highest levels that I have ever seen a closed-end fund possess. As such, the fund appears to be exposing its investors to a lot of risks. Risk-averse individuals may want to avoid this fund for that reason as it will likely be far more volatile than other fixed-income funds that do not have such a high level of debt.
Distribution Analysis
As mentioned earlier in this article, the primary objective of the PIMCO Access Income Fund is to provide its investors with a very high level of current income. In order to achieve this objective, the fund purchases bonds that provide their returns in the form of direct payments to their holders. The fund then applies a layer of leverage in order to boost the effective yield of the portfolio. It also engages in a certain amount of bond trading in an attempt to generate capital gains that can also be paid out to the investors. As such, one might assume that this fund would have a remarkably high distribution yield itself. That is certainly the case as the PIMCO Access Income Fund pays a monthly distribution of $0.1494 per share ($1.7928 per share annually), which gives the fund a 12.47% yield at the current price. As this is a relatively new fund, it does not have much of a distribution history but what it does have is very encouraging:
As we can see, this is one of the only bond funds that did not cut its distribution in response to the Federal Reserve’s rate hikes. In fact, the fund increased its payout in October 2022 and has kept it steady since that time. This will undoubtedly appeal to those investors that are seeking a safe and secure source of income with which to use to pay their expenses or otherwise finance their lifestyles. However, anytime a fund obtains a double-digit yield like this one, the market has some concerns about its ability to sustain the payout over the long term. As such, we want to have a look at the fund’s finances. After all, we do not want to be the victims of a distribution cut since that would both reduce our incomes and almost certainly cause the fund’s share price to decline.
Fortunately, we do have a fairly recent document that we can consult for the purposes of our analysis. The fund’s most recent financial report corresponds to the six-month period that ended on December 31, 2022. As such, it will not include any information from the first quarter of this year, but this is a much more recent report than we had available to us the last time that we discussed this fund and should give us a pretty good idea of how well it handled the bulk of the Federal Reserve’s monetary tightening push that caused havoc in the bond markets. During the six-month period, the PIMCO Access Income Fund received a total of $61.162 million in income and $1.078 million in dividends from the assets in its portfolio. This gives the fund a total income of $62.240 million during the period. It paid its expenses out of this amount, leaving it with $43.395 million available for the shareholders. Unfortunately, this was not enough to cover the $59.433 million that the fund paid out in distributions during the period. This is something that may be concerning at first glance since the fund’s net investment income is not enough to cover its distributions.
As has been mentioned throughout this article, the PIMCO Access Income Fund does have other methods through which it can obtain the money that is needed to cover its distributions. One of these is capital gains, which the fund endeavors to get as a way to pay out more than it otherwise could. As might be expected from the challenges that the bond market suffered over the course of 2022 though, the fund failed miserably at this task. During the six-month reporting period, the fund had net realized losses of $25.578 million and suffered another $26.087 million in net unrealized losses. Overall, the fund’s assets declined by $67.411 million over the six-month period after accounting for all inflows and outflows. This is concerning as it is a sign that the fund cannot afford its distributions. Fortunately, the bond market has improved somewhat in 2023, but there are still some reasons to be concerned that it will not be able to maintain its current distribution going forward. We will want to analyze its full-year report in great detail when it is released this summer.
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 PIMCO Access 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 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 April 27, 2023 (the most recent date for which data is available as of the time of writing), the PIMCO Access Income Fund had a net asset value of $15.27 but the shares currently trade for $14.38 each. This gives the fund’s shares a 5.83% discount on the net asset value. That is a much better price than the 2.62% discount that the shares have had on average over the past month. It also makes this one of the only PIMCO closed-end funds to trade at a discount. As such, the price certainly looks reasonable today if you are looking to buy into the fund.
Conclusion
In conclusion, the PIMCO Access Income Fund appears to have a lot to offer someone seeking income today. Although the fund has underperformed the broader bond index, it does have a much higher yield than most other bond funds and that could certainly be appealing to anyone seeking income. The worst of the bond market carnage is probably behind us, but energy prices remain a wild card that could ignite inflation once again and induce the Federal Reserve to raise rates beyond what is currently expected. This fund unfortunately appears risky as it is highly leveraged and may not be able to sustain its distribution. As the price is very reasonable though, it does hold some appeal as an investment for someone that is willing to assume the risks here.
For further details see:
PAXS: A High-Risk, High-Reward Bond CEF