Summary
- This fund is trading at a premium to NAV with an 11% dividend.
- Management filed a prospectus in February to sell up to $500 million in new shares.
- The double-digit dividend has not been covered by earnings this fiscal year. And the three-month coverage ratio is 32%.
- Can a portfolio with a 5.5% rate support an 11% dividend?
Today we're looking at PIMCO Dynamic Income Opportunities Fund ( PDO ), a closed-end fund ((CEF)) focused on fixed income investments including mortgage-related assets, securities related to " emerging market " countries, investment grade sovereign debt, and bank loans. Rather than focusing on a specific area the manager takes an opportunistic approach to finding investments which meet their primary objective of current income and capital appreciation as their secondary. In their words :
The fund utilizes an opportunistic approach to pursue high conviction income-generating ideas across credit markets to seek current income as a primary objective and capital appreciation as a secondary objective.
In managing the fund, PIMCO employs a dynamic asset allocation strategy across multiple fixed income sectors based on, among other things, market conditions, valuation assessments, economic outlook, credit market trends and other economic factors. With PIMCO's macroeconomic analysis as the basis for top-down investment decisions, including geographic and credit sector emphasis, PIMCO manages the fund with a focus on seeking income generating investment ideas across multiple fixed income sectors, with an emphasis on seeking opportunities in developed and emerging global credit markets."
Fellow contributor David Alton Clark recently selected the fund as their " Top High-Yield CEF Pick for 2023 " . My article reflects a more pessimistic analysis though I encourage readers to consider both sides.
Data as of January 31st, 2023 shows that the fund is predominantly (27.42%) invested in high yield credit. The mortgage sector, almost entirely in non-agency mortgages is their second largest exposure at 21.57%. Another 18.6% is invested in corporate mortgage backed securities. Their top three sectors represent 67.59% of their portfolio.
Fund Website: Sector Allocation %.
Net asset value as of February 28th, 2023 was $13.37. With the stock trading at $13.60 that means it is at a slight (1.7%) premium to NAV.
How has it performed?
We are reviewing today a relatively young fund which was only conceived in January 2021 at $20.00 per share. Since then the performance has been in one direction.
Fund Website Historical Data. Author's Chart of Daily NAV.
Over the last two years NAV has decreased 33.1% - or -16.6% annually. For comparison we look at two ETFs: the iShares iBoxx $ High Yield Corporate Bond ETF ( HYG ) and the Vanguard High Dividend Yield ETF ( VYM ). The iShares fund is passively managed and invests predominantly in high yield corporate bonds. The Vanguard ETF is not exactly comparable in terms of portfolio construction, but rather it is an alternative for those seeking income investments.
We can see that since inception total return for either of the ETF funds outperformed PDO. And they both did so with less management costs.
Ticker | Total Assets (billions) | Dividend Yield | Total Expense Ratio |
PDO | $2.76 | 11.25% | 2.79% |
HYG | $18.00 | 5.37% | 0.48% |
VYM | $64.00 | 3.04% | 0.06% |
A simple heuristic in evaluating the long-term performance of a fund like this is whether or not it achieves positive total returns. Clearly PDO has not done this yet, though the past does not prologue. Investors are likely enticed by the ~11% annual dividend yield which has also included two special dividends over the years. But as we will see later, this dividend seems suspect.
Evaluating PDO's Portfolio: The CMBS Adjustment
As we noted earlier, the majority of the book is actually invested in non-agency mortgages and CMBS. Taken together this represents 40.23% of their portfolio. That's a big chunk and noticeable to me given I've reviewed a number of mortgage REITs over these last six months. What I note particularly in the commercial mREITs is that many of them are trading below book value given an assumption that the current credit cycle is going to cause losses.
For example, here's a table I prepared for my recent article reviewing TPG RE Finance Trust ( TRTX ) which is a commercial mREIT trading well below book value. It also trades with an annual dividend yield above 11% (which I think is sustainable).
Peer | P/B | Market Capitalization (Millions) |
Ladder Capital Corp ( LADR ) | 0.94 | $1,400 |
Starwood Property Trust ( STWD ) | 0.93 | $6,000 |
Ares Commercial Real Estate Corp ( ACRE ) | 0.84 | $615 |
Blackstone Mortgage Trust ( BXMT ) | 0.82 | $3,700 |
BrightSpire Capital ( BRSP ) | 0.69 | $939 |
KKR Real Estate Financial Trust ( KREF ) | 0.65 | $1,000 |
TPG RE Finance Trust ( TRTX ) | 0.60 | $663 |
Granite Point Mortgage Trust ( GPMT ) | 0.32 | $310 |
Acres Commercial Realty Corp ( ACR ) | 0.19 | $83 |
Average | 0.66 | $1,634 |
*Data pulled from TD Ameritrade on 2.27.2023.
These commercial mortgage REITs are seeing the unprecedented rise in interest rates pressure their book as many of the loans are at floating rates. There are concerns that property values will also see declines and in some sectors, like office, this has already happened.
Why this matters here is that the CMBS component of their portfolio may be in for some losses if the sector businesses are already seeing them. With CMBS representing 18.66% of the portfolio and total managed assets of $2,759 million we can estimate this position to be around $515 million. If we apply the average P/B multiple above of 0.66x to this position to reflect the market's expectation of losses we get an estimated value of ~$340 million.
Fund Site: Portfolio Overview.
Adjusted total managed assets in this case would be $2,584 million. The fund utilizes $1,250 million in leverage mostly via reverse repurchase agreements. That brings common net assets to $1,334 million. Shares outstanding as of January were 110.4 million meaning net asset value would come to $12.08.
That compares with NAV as of February 28th at $13.37. Our CMBS adjustment resulted in an NAV adjustment of about 10%. That's pretty significant given the current stock price of PDO is at a premium to both reported and adjusted NAV.
According to historical data you can download from the fund site, since inception the fund has traded at a daily average discount to NAV of -0.71% with a standard deviation of 5.16%. If we take my adjusted NAV of $12.07 then the stock is trading at a 12.7% premium - a full two standard deviations above the mean. That would suggest that these shares are overvalued. And this is without evaluating any potential losses across the rest of the portfolio.
While we can debate the multiple applied to the CMBS portion of the book, this exercise I think reflects the potential for losses PDO shareholders may see. The commercial mREITs are a bellwether for this portion of their book and the signs are pointing to some degree of losses.
Another Worrisome Feature - The Dividend
The company pays out a monthly distribution currently of $0.1279. Annually this comes to $1.53 and represents an 11.25% dividend yield for the stock. I say this feature is worrisome because a closer look at their holdings reveals an average rate on their holdings of 5.55%. How can a portfolio of securities with this average rage support a dividend more than twice that? Average position size is just 0.58% meaning there's not likely to be a standout in performance somehow that might mitigate this reality.
The entire table of this data is over 300 rows so I'll simply include a portion here for reference. But definitely take a look for yourself at the full set. This table represents their non-agency MBS holdings and averages the rate and position size.
NON-AGENCY MORTGAGE-BACKED SECURITIES | RATE | DATE | OWNED | VALUE | NET ASSETS |
280 Park Avenue Mortgage Trust | 7.064% | 09/15/2034 | 4,750,000 | 4,284,126 | 0.292% |
Ashford Hospitality Trust | 6.418% | 04/15/2035 | 2,500,000 | 2,305,914 | 0.157% |
Ashford Hospitality Trust | 7.418% | 04/15/2035 | 8,700,000 | 7,982,305 | 0.545% |
Atrium Hotel Portfolio Trust | 7.618% | 12/15/2036 | 1,111,000 | 995,365 | 0.068% |
Atrium Hotel Portfolio Trust | 7.718% | 06/15/2035 | 11,037,000 | 10,188,656 | 0.695% |
Austin Fairmont Hotel Trust | 6.568% | 09/15/2032 | 6,000,000 | 5,694,663 | 0.389% |
Banc of America Funding Trust | 4.629% | 06/26/2036 | 3,506,442 | 2,817,418 | 0.192% |
Banc of America Funding Trust | 5.750% | 05/26/2036 | 344,161 | 238,026 | 0.016% |
Banc of America Funding Trust | 6.585% | 09/26/2036 | 4,499,305 | 3,436,021 | 0.234% |
Barclays Commercial Mortgage Securities Trust | 3.688% | 02/15/2053 | 15,650,000 | 11,065,378 | 0.755% |
Barclays Commercial Mortgage Securities Trust | 7.868% | 07/15/2037 | 4,278,000 | 3,985,090 | 0.272% |
Barclays Commercial Real Estate Trust | 4.563% | 08/10/2033 | 16,240,000 | 13,589,720 | 0.927% |
Bear Stearns Commercial Mortgage Securities Trust | 5.566% | 01/12/2045 | 46,067 | 44,504 | 0.003% |
Beast Mortgage Trust | 7.768% | 03/15/2036 | 5,750,000 | 4,641,076 | 0.317% |
Beast Mortgage Trust | 8.768% | 03/15/2036 | 7,125,000 | 5,543,159 | 0.378% |
Beneria Cowen & Pritzer Collateral Funding Corp. | 6.810% | 06/15/2038 | 10,000,000 | 8,623,270 | 0.588% |
Beneria Cowen & Pritzer Collateral Funding Corp. | 7.956% | 06/15/2038 | 5,000,000 | 4,117,773 | 0.281% |
Braemar Hotels & Resorts Trust | 6.718% | 06/15/2035 | 7,900,000 | 7,294,483 | 0.498% |
Citigroup Commercial Mortgage Trust | 3.518% | 05/10/2035 | 1,300,000 | 1,148,914 | 0.078% |
Citigroup Commercial Mortgage Trust | 3.790% | 12/15/2072 | 4,600,000 | 2,892,029 | 0.197% |
Citigroup Commercial Mortgage Trust | 7.243% | 12/15/2036 | 8,811,000 | 8,372,901 | 0.571% |
Colony Mortgage Capital Ltd. | 7.039% | 11/15/2038 | 15,000,000 | 13,837,352 | 0.944% |
Commercial Mortgage Trust | 5.618% | 06/15/2034 | 2,300,000 | 1,979,604 | 0.135% |
Commercial Mortgage Trust | 5.868% | 06/15/2034 | 4,950,000 | 4,178,904 | 0.285% |
Commercial Mortgage Trust | 6.712% | 06/15/2034 | 7,400,000 | 5,999,800 | 0.409% |
Connecticut Avenue Securities Trust | 6.678% | 12/25/2041 | 4,300,000 | 3,978,989 | 0.272% |
Countrywide Alternative Loan Trust | 6.250% | 12/25/2036 | 4,820,260 | 2,200,162 | 0.150% |
Credit Suisse Mortgage Capital Trust | 7.618% | 07/15/2032 | 19,982,000 | 18,248,248 | 1.245% |
CRSNT Commercial Mortgage Trust | 7.820% | 04/15/2036 | 7,000,000 | 6,183,113 | 0.422% |
DBWF Mortgage Trust | 7.457% | 12/19/2030 | 29,075,000 | 27,436,275 | 1.872% |
Deutsche Mortgage & Asset Receiving Corp. | 3.854% | 11/27/2036 | 6,326,815 | 5,518,676 | 0.377% |
DOLP Trust | 0.665% | 05/10/2041 | 309,500,000 | 12,431,454 | 0.848% |
DOLP Trust | 3.704% | 05/10/2041 | 29,000,000 | 17,813,899 | 1.215% |
DROP Mortgage Trust | 7.070% | 10/15/2043 | 5,500,000 | 4,889,958 | 0.334% |
Extended Stay America Trust | 8.018% | 07/15/2038 | 18,352,414 | 17,279,341 | 1.179% |
Freddie Mac | 7.678% | 02/25/2042 | 8,400,000 | 7,926,141 | 0.541% |
Freddie Mac | 8.678% | 02/25/2042 | 2,600,000 | 2,385,297 | 0.163% |
Freddie Mac | 9.428% | 01/25/2034 | 4,000,000 | 3,156,917 | 0.215% |
Freddie Mac | 11.428% | 10/25/2041 | 22,000,000 | 18,817,731 | 1.284% |
Freddie Mac | 12.428% | 02/25/2042 | 1,200,000 | 995,152 | 0.068% |
GCT Commercial Mortgage Trust | 7.668% | 02/15/2038 | 49,700,000 | 36,270,319 | 2.475% |
Greenwood Park CLO Ltd. | 0.000% | 10/20/2030 | 13,000,000 | 175,891 | 0.012% |
Greenwood Park CLO Ltd. | 0.000% | 04/15/2031 | 27,000,000 | 379,036 | 0.026% |
GS Mortgage Securities Corp. Trust | 6.868% | 11/15/2032 | 10,782,000 | 10,273,507 | 0.701% |
GS Mortgage-Backed Securities Corp. Trust | 0.000% | 12/25/2060 | 192,761 | 185,396 | 0.013% |
GS Mortgage-Backed Securities Corp. Trust | 0.000% | 12/25/2060 | 183,900,515 | 6,432,840 | 0.439% |
GS Mortgage-Backed Securities Corp. Trust | 0.165% | 12/25/2060 | 161,230,349 | 1,889,668 | 0.129% |
GS Mortgage-Backed Securities Corp. Trust | 2.392% | 12/25/2060 | 34,467,608 | 18,496,080 | 1.262% |
Hawaii Hotel Trust | 7.068% | 05/15/2038 | 5,000,000 | 4,764,328 | 0.325% |
Hawaii Hotel Trust | 7.068% | 05/15/2038 | 34,720,000 | 33,083,490 | 2.257% |
Hilton Orlando Trust | 7.218% | 12/15/2034 | 10,953,000 | 10,508,066 | 0.717% |
HPLY Trust | 7.468% | 11/15/2036 | 1,676,079 | 1,587,234 | 0.108% |
JP Morgan Alternative Loan Trust | 4.669% | 03/25/2037 | 15,474,027 | 14,987,259 | 1.023% |
JP Morgan Chase Commercial Mortgage Securities Trust | 6.518% | 02/15/2035 | 1,000,000 | 936,442 | 0.064% |
JP Morgan Chase Commercial Mortgage Securities Trust | 6.672% | 07/05/2033 | 5,012,000 | 4,505,525 | 0.307% |
JP Morgan Chase Commercial Mortgage Securities Trust | 7.022% | 07/05/2033 | 10,000,000 | 8,909,573 | 0.608% |
JP Morgan Chase Commercial Mortgage Securities Trust | 7.418% | 03/15/2036 | 25,550,000 | 23,272,872 | 1.588% |
JP Morgan Chase Commercial Mortgage Securities Trust | 8.168% | 03/15/2036 | 9,500,000 | 8,563,528 | 0.584% |
JP Morgan Resecuritization Trust | 1.550% | 12/27/2046 | 8,712,923 | 6,970,928 | 0.476% |
Lehman XS Trust | 4.989% | 08/25/2037 | 23,373,820 | 19,242,334 | 1.313% |
Mill City Mortgage Loan Trust | 0.000% | 04/25/2057 | 310,908,488 | 3,809,951 | 0.260% |
Mill City Mortgage Loan Trust | 0.000% | 11/25/2058 | 129,719,704 | 542,280 | 0.037% |
Mill City Mortgage Loan Trust | 0.000% | 11/25/2058 | 129,719,704 | 330,941 | 0.023% |
Mill City Mortgage Loan Trust | 0.257% | 11/25/2058 | 16,205,000 | 9,033,724 | 0.616% |
Mill City Mortgage Loan Trust | 1.556% | 04/25/2057 | 19,585,571 | 12,188,436 | 0.832% |
Morgan Stanley Capital Trust | 6.562% | 12/15/2036 | 4,294,000 | 3,238,419 | 0.221% |
Morgan Stanley Capital Trust | 6.643% | 11/15/2034 | 5,370,000 | 4,963,522 | 0.339% |
Morgan Stanley Capital Trust | 7.593% | 11/15/2034 | 3,357,000 | 3,077,114 | 0.210% |
Morgan Stanley Re-REMIC Trust | 2.666% | 03/26/2037 | 3,437,209 | 3,219,732 | 0.220% |
MRCD Mortgage Trust | 2.718% | 12/15/2036 | 28,715,000 | 23,989,828 | 1.637% |
Natixis Commercial Mortgage Securities Trust | 3.790% | 11/15/2032 | 15,192,000 | 12,114,043 | 0.827% |
Natixis Commercial Mortgage Securities Trust | 6.718% | 11/15/2034 | 6,000,000 | 5,769,647 | 0.394% |
New Orleans Hotel Trust | 7.007% | 04/15/2032 | 7,491,000 | 6,868,302 | 0.469% |
New Residential Mortgage Loan Trust | 3.528% | 07/25/2055 | 1,242,000 | 864,286 | 0.059% |
New Residential Mortgage Loan Trust | 3.988% | 07/25/2059 | 5,000,000 | 2,600,495 | 0.177% |
New Residential Mortgage Loan Trust | 4.328% | 07/25/2055 | 1,000,000 | 688,324 | 0.047% |
New York Mortgage Trust | 5.250% | 07/25/2062 | 28,444,644 | 26,800,797 | 1.828% |
PMT Credit Risk Transfer Trust | 7.287% | 02/27/2024 | 17,469,199 | 16,751,219 | 1.143% |
PRET LLC | 3.967% | 09/25/2051 | 17,900,000 | 15,071,694 | 1.028% |
Ready Capital Mortgage Financing LLC | 8.139% | 04/25/2038 | 7,000,000 | 6,460,781 | 0.441% |
Residential Accredit Loans, Inc. Trust | 4.809% | 06/25/2037 | 883,436 | 793,255 | 0.054% |
Seasoned Credit Risk Transfer Trust | 2.729% | 05/25/2057 | 17,855,720 | 6,652,313 | 0.454% |
Seasoned Credit Risk Transfer Trust | 4.250% | 09/25/2060 | 7,547,000 | 6,499,655 | 0.443% |
Seasoned Credit Risk Transfer Trust | 4.250% | 03/25/2061 | 3,263,000 | 2,590,304 | 0.177% |
Seasoned Credit Risk Transfer Trust | 4.750% | 10/25/2058 | 2,360,000 | 2,083,212 | 0.142% |
Seasoned Credit Risk Transfer Trust | 9.140% | 11/25/2060 | 5,547,310 | 4,255,683 | 0.290% |
Seasoned Credit Risk Transfer Trust | 11.761% | 09/25/2060 | 4,238,661 | 3,079,527 | 0.210% |
SFO Commercial Mortgage Trust | 7.218% | 05/15/2038 | 18,000,000 | 15,039,191 | 1.026% |
SFO Commercial Mortgage Trust | 7.968% | 05/15/2038 | 6,000,000 | 4,847,488 | 0.331% |
Tharaldson Hotel Portfolio Trust | 7.698% | 11/11/2034 | 5,024,928 | 4,709,730 | 0.321% |
Trinity Square PLC | 0.000% | 07/15/2059 | 10,000 | 20,904,333 | 1.426% |
Trinity Square PLC | 0.010% | 07/15/2059 | 10,843,000 | 10,609,312 | 0.724% |
Trinity Square PLC | 6.379% | 07/15/2059 | 10,843,000 | 12,513,263 | 0.854% |
Trinity Square PLC | 7.379% | 07/15/2059 | 5,421,000 | 6,273,585 | 0.428% |
Trinity Square PLC | 7.879% | 07/15/2059 | 10,844,000 | 12,935,389 | 0.883% |
VASA Trust | 7.468% | 07/15/2039 | 10,000,000 | 8,975,987 | 0.612% |
VASA Trust | 8.218% | 07/15/2039 | 7,000,000 | 6,250,978 | 0.427% |
Verus Securitization Trust | 3.195% | 10/25/2063 | 1,800,000 | 1,371,382 | 0.094% |
Waikiki Beach Hotel Trust | 6.348% | 12/15/2033 | 3,000,000 | 2,832,476 | 0.193% |
Waikiki Beach Hotel Trust | 6.998% | 12/15/2033 | 5,000,000 | 4,587,819 | 0.313% |
WaMu Mortgage Pass-Through Certificates Trust | 2.858% | 07/25/2047 | 2,275,350 | 1,823,205 | 0.124% |
WaMu Mortgage Pass-Through Certificates Trust | 5.439% | 12/25/2045 | 11,295,081 | 9,502,050 | 0.648% |
Wells Fargo Mortgage-Backed Securities Trust | 4.479% | 10/25/2036 | 266,822 | 244,173 | 0.017% |
Average | 5.57% | 0.53% |
We can see that this subset has an average very close to the portfolio average of 5.55%. Again, from my viewpoint the portfolio is structured in such a way that it seems impossible that the current dividend will be sustained.
We can also review PIMCO's UNII report to see some concerning trends.
Fund Name | Ticker | Current Fiscal Year End | Estimated Fiscal Year to Date Net Investment Income ((NII))(1) | Estimated Undistributed Net Investment Income - UNII/Estimated ((ROC))(1) | Estimated 3 Month Average Net Investment Income ((NII)) | Monthly Distribution per Common Share(2) | 3 Month Rolling Coverage Ratio(3) | 6 Month Rolling Coverage Ratio (3) | Fiscal Year to Date Distribution Coverage Ratio(4) |
PIMCO Dynamic Income Opportunities Fund | PDO | 30-Jun-23 | $0.85 | $0.00 | $0.04 | $0.127900 | 32.73% | 84.36% | 95.26% |
What stands out here is that the estimated 3-month average NII is only $0.04 - and the coverage ratio of 32.73% portends a distribution cut unless something turns around in the near term. We can see that over this entire fiscal year the company has not managed to cover their distribution.
Distribution coverage ratios are flashing a warning sign that anyone who looks at the portfolio can see. Something will have to give in this situation and my guess is it will be the dividend.
A Final Sign of Overvaluation: Management Selling Shares
The company filed a prospectus on February 8th, 2023 to sell up to $500,000,000 in common shares. Shares were trading at a slight premium to reported NAV at the time, but recall that reported NAV likely is overstated as well. What this means, I think, is that management is looking to cash in on the premium the stock is trading.
Total managed assets is at $2,759 million meaning this prospectus envisions raising around 19% of their total managed assets. This might help raise cash to prevent a distribution cut, but it also reflects likely overvaluation. If management believed the stock was undervalued they would likely not be selling it to the market for cash.
If the fund sells $500 million in shares at the current price of $13.60 that would represent another 36.8 million shares to pay a dividend. That would bring the total share count to 147.2 million. Paying these shares $1.53 annually would amount to a $225.2 million expense - meaning in under three years their dividend payment alone could eat through the capital raised.
Given our review of the portfolio above, it does not seem likely that the fund will be able to reinvest this capital at rates above the 11% dividend. What I surmise is likely is that after management sells as much as they can through this offering that a dividend cut is imminent.
PIMCO Dynamic Income Opportunities Fund In Summary
As a public fund PDO is untested through credit cycles. Its relative newness makes it difficult to rely on any long term trends or expectations here which suggest caution. When reviewing their portfolio it seemed that their CMBS portion alone could cause some erosion to NAV - and this assumes that the rest of the portfolio remains whole.
I believe that we are in the midst of an unprecedented credit cycle with the rapid rise in interest rates pushing the limits of the system. I don't see that this fund seems particularly prepared for that reality.
Most damning is that the underlying average rate of the portfolio is nowhere near supporting the annual dividend of 11%. This economic reality must be dealt with, and I suspect it will be after management is done selling stock at its current inflated value. After that is done I would suspect a dividend cut is likely.
For those interested in this level of yield still, I'd suggest taking a look at my recent write up on TRTX .
For further details see:
PDO: Watch For A Dividend Cut