An often overlooked area in the investment universe are closed-end funds (“CEF”). These investment vehicles look and feel like mutual funds and ETFs, but they are “closed.” That is, once they are set up, no new shares are issued (usually) and investors must buy and sell shares on an exchange. Unlike ETFs that are structured to trade on an exchange with “authorized participants” bidding shares close to the net asset value (“NAV”), CEFs have no like structure. In fact, it is unusual for a CEF to trade close to its NAV, with the most often situation being CEFs trading at a discount to NAV.
Many advisory firms manage CEFs that target the bond universe. However, due to the active (some of which are hyper-active) nature, calling these vehicles “bond funds” is a misnomer. Many of these vehicles have risk/return profiles that are equivalent to equity-type investment. One such CEF is the PIMCO Corporate & Income Opportunity Fund (PTY).
Looking at this “bond” fund is an exercise in awe! Its 15-year annual total return ended March 17, 2019 is 13.43%; that blows away the Bloomberg Barclays Aggregate Bond Index of 3.63% and trumps the S&P 500 of 8.57%; but at a bit higher standard deviation risk of 15.32% compared to the S&P 500 risk of 13.58%.
The reason for this is clear. Though PTY is a “bond” fund, it is a “black box” hyper-active bond trading strategy – you are really paying the investment manager (PIMCO) to make all kinds of bets hoping it pays off; any bond-like performance you may see (such as coupon payments) is incidental. The fund is active in derivatives (interest rate swaps) and uses a lot of leverage.
This ultra high risk/return profile has not gone unnoticed in some circles. PTY has historically traded at a relatively high premium to NAV (often in the 20% range) as return seeking investors bid up shares hoping to cash in on its strong historical performance that has continued to defy gravity for 9 of the last 10 years with high top quartile performance. Volatile markets caused the premium to crater in Q4 2018, but it has pushed back up to the 20% range during Q1 2019.
In addition to PTY’s high historical total return performance, the fund has a strong record of paying a flat $0.13 per share distribution every month. This $0.13/share payment equates to a yield of 9.06% at a price of $17.21 (as March 14, 2019). In the case where PTY does not generate enough income to cover the $0.13 distribution, it continues to pay $0.13/share by including a true-up “return of capital” to keep the payment level constant. This is useful to an investor who is using the distributions to cover living expense in retirement and counting of consistency.
Some investors who can afford the relatively high risk profile could benefit from the high level of income and high total return profile. Most of the income is taxed as ordinary income, but the high yield rate makes it still attractive on an after-tax basis.