A Fund With 6.5% Dividend But You Must Sell Before 2033
Contrarian Outlook | Jun 21, 2021 05:17AM ET
I get plenty of questions about specific closed-end funds from members of my CEF Insider service, which focuses on quick-moving smaller CEFs (here I mean those with sub-$1-billion market caps).
We love these CEF “small fry” because they hand us big dividends (7%+ yields are common in this corner of the CEF market) at a bargain, because these funds get little coverage from Wall Street and the mainstream media.
But when they do get “found,” their discounts disappear fast, catapulting us to some nice price gains to go along with our big payouts.
h2 New 6.5%-Yielding PIMCO Fund: Buy, Hold or Sell?/h2Recently, a reader wanted my take on the Pimco Dynamic Income Opportunities Fund (NYSE:PDO), which boasts a 6.5% dividend yield and was launched in late January 2021. You’ve probably heard of PIMCO: it’s an asset manager that’s the opposite of small and off-the-radar, with over $2 trillion under management.
And while PDO is outside our usual “small CEF” range (it has around $2.2 billion in assets), I’m always happy to take questions on all CEFs from CEF Insider members. So let’s dive in.
Aside from its heft, PIMCO also has plenty of expertise and research resources at its disposal, as we can see from the performance another of the company’s CEFs: its cornerstone PIMCO Dynamic Income Fund (NYSE:PDI), a 9% yielder that’s delivered a strong total return since it was founded in 2012:
h2 Established PIMCO Fund SoarsI mention PDI here both to draw your attention to PIMCO’s record (we’d be remiss to discuss PIMCO without mentioning it) and because it’s quite similar to newly launched PDO. Like PDI, PDO is a bond fund, and like PDI, PDO relies on PIMCO’s expertise in analyzing the future of interest rates in America and around the world to deliver a strong return.
And so far, it’s doing pretty well. Or so it seems.
h2 PDI Looks Like It’s Easily Beating the Market …
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Looking at the fund’s total-return price since inception—that is, its market price including price gains and dividends paid out—PDO (in orange above) is off to a solid start. It isn’t way ahead of the S&P 500 (in blue) like PDI (in purple) is, but it’s still ahead, and its advantage seems to be growing.
But there’s a twist here because CEFs trade at a market price that’s often different from the net asset value (NAV) of their portfolios, meaning they can (and almost always do) trade at a discount or premium. And PDO’s total NAV return has lagged a bit:
h2 …. But a Look Into Its Portfolio Reveals a Different PictureWith a 5.15% return (shown in orange above), it’s performing less than half as well as the market (in blue), and it’s behind PDI (in purple), too.
So why the higher price return? It comes back to PIMCO and, for want of a better term, brand recognition.
As I write this, PDO trades at a 7.2% premium to NAV. That’s right: investors are willing to shell out $1.07 for every dollar of PDO’s assets. That sounds absurd, but it’s normal for PIMCO funds because the company is a big name in the CEF world; its other funds trade at much higher premiums (10%, on average, with some boasting premiums as high as 17%).
h2 Short-Term Gains Could Be Ahead, but Mind PDO’s Limited Term/h2Now it is true that PDO’s premium has been rising toward the 10% PIMCO average since its January launch, and it looks like it’s closing in on that level as its market price outraces its NAV.
Will that pattern continue? While the fund is led by a great team with a strong track record, there is something of a built-in cap here: unlike PIMCO’s other CEFs, PDO is a limited-term fund that will liquidate in January 2033. And limited-term funds tend to trade at smaller premiums and discounts, and those deviations narrow over time.
So while PDO’s 7.2% premium could grow in the next few months, its premium will eventually disappear, and by 2033 it’ll go to zero. You can bank on it.
So where does that leave us? With a fund that could be a compelling swing trade for quick profits. But if you buy, you should be ready to sell fast because that 7.2% premium will disappear sooner or later.
Disclosure: Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. Click here to learn how to profit from their strategies in the latest report, "7 Great Dividend Growth Stocks for a Secure Retirement ."
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