piranka
~ By Snehasish Chaudhuri, MBA (Finance)
The PIMCO High Income Fund (NYSE:PHK) is a closed ended fixed income mutual fund (CEF) that invests in the public fixed income markets across the globe. It balances its portfolio with high yielding low rated corporate bonds and highly secured low yielding government bonds. This US-based fund was formed on April 30, 2003, and for almost 20 years it paid consistent monthly dividends. The annual average yield over the past 10 years ranged mostly between 11 to 14 percent, and for the year 2022, yield stands at 10.7 percent.
However, the monthly pay-out has gradually been reduced from $0.1219 in 2003 to $0.048 at present. As yield remained within that range, it means, PHK’s market price has been on a gradual decline. PHK’s stock did recover after the price-shocks it suffered during the global financial crisis, and the covid-19 pandemic. But, otherwise, the market price has been in gradual decline. So, it might not be shocking for PHK’s investors to witness a 25 percent price loss during the past 1 year, when the broader market itself has suffered immensely.
PHK is a Well Diversified and Well Managed Fixed Income Securities Fund
PIMCO High Income Fund was launched and is managed by Allianz Global Investors Fund Management LLC. The fund is co-managed by a subsidiary of Allianz SE (OTCPK:ALIZF), named Pacific Investment Management Company LLC. (PIMCO). PIMCO is an American investment manager that manages more than $2.2 trillion assets through various fixed income funds. Besides PHK, PIMCO also manages PIMCO Corporate & Income Opportunity Fund (PTY). PHK uses a dynamic asset allocation strategy among multiple fixed income sectors, which may include corporate debt, government and sovereign debt, mortgage-related and other asset-backed securities, taxable municipal bonds, etc.
PIMCO High Income Fund benchmarks itself with ICE BofA US High Yield Total Return Index. This index consists of US dollar denominated corporate debt that are of below investment grade i.e., rated below BBB. The component fixed income securities also have a remaining maturity greater than 1 year, a minimum amount outstanding of $100 million and a fixed coupon schedule.
The average duration of PHK’s portfolio is 6.8. Duration is the measured percentage change in price of a bond in response to 1 percent change in the yield of the bond. The fund earns a weighted average coupon of 5.94 percent on its assets, and has a high expense ratio of 1.18 percent. Asset quality of its corporate bond portfolio is relatively poor, as only 4 percent of the entire fund is invested in securities rated BBB and above. Thus, the fund possesses a higher degree of credit risk or default risk. However, my biggest concern regarding this fund is the possible adverse impact of economic recession.
Impact of Monetary Tightening on A Fixed Income Portfolio
Oil prices have soared and global supply chains and logistics networks have deteriorated due to the ongoing Russia-Ukraine conflict. Higher energy prices resulted in higher input costs for most manufactured goods, and subsequently high inflation. On the other hand, the supply chain crisis increased costs for the majority of consumable products. The inflation rate is expected to remain high in the coming months, although the US Federal Reserve (Fed) has tightened its monetary policy. During this year, Fed hiked the interest rate on four occasions, totalling 2.75 percent.
However, despite the fund offering the same yield, as interest rates rise, the real income of investors declines. This might be a probable reason why the price of this ETF has gradually decreased, even though theoretically it should increase under the current environment of interest rate hikes. The price may drop even further in the short run. However, this week, the Fed has hinted towards smaller hikes than before [see here also] in the coming months, which, if it happens, may work well for investors of this fund. Economists have warned that further monetary tightening may lead the economy towards a recession.
Investors looking to form a portfolio of monthly income streams may largely be benefitted from investing in PIMCO High Income Fund. This fund has successfully balanced its portfolio. 33 percent of its assets are invested in government bonds. An equal proportion of its portfolio is invested in corporate bonds, municipal bonds, mortgage securities, and derivatives. Bond’s price tends to drop when interest rates rise, as real income of investors of such bonds decreases. And as the bond price goes down, investors tend to receive higher yields. Thus, the investors who buy when the price is low (as is currently) will likely be able to enjoy a higher yield on their investments.
Investment Thesis
Increasing energy prices, supply side shortages, increasing housing prices and the resulting inflation did not have a positive impact on the market. As the market has become highly uncertain, and chances of economic recession still persist, investing in fixed income securities becomes a wise option. This is because dividends of common shares become highly uncertain, but the coupon income of bonds remains almost certain. PIMCO High Income Fund is such a fixed income CEF that has consistently generated exceptionally high yield, and is less likely to have a distribution cut, as its investments still generate the same coupon. However, over the past 20 years, the fund has encountered a gradual price loss, and is currently trading below $5.
Its corporate bond portfolio has a low credit rating, mostly non-investment grade, and thus is vulnerable during a period when investors are fearing a recession. However, if the Federal reserve doesn’t go for further monetary tightening, investors have much less reason to worry about. Moreover, this fund has taken the right decision by balancing its portfolio with high yielding low rated corporate bonds and highly secured low yielding government bonds. Probably due to these factors, the fund is currently selling at a marginal premium to its Net Asset Value (NAV). At a time when the broader market is surrounded with pessimism, PIMCO High Income Fund surely stands out, especially for its balanced portfolio and consistent double-digit yield.
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