Tag Archives: closed-end-funds

Opportunity In Calamos Convertible Opportunities And Income Fund

Summary The recent sell-off in the CEF space has brought CHI to a discount value not seen since the financial crisis. 2- and 4-year z-scores in excess of negative 3.5 indicate extreme oversold conditions. CHI offers a current 10.91% yield with a possible chance of capital appreciation. With a fixed number of shares, CEFs can exhibit substantial premia or discounts to their net asset values [NAVs]. When investors become pessimistic, they become inclined to sell their CEF holdings even it if means selling at a price below the intrinsic value of the fund. Not surprisingly, the recent market turmoil has punished CEFs especially hard. As detailed in my recent article entitled ” Sell-Off In CEF Space Brings CEFL’s Discount To Record High “, 20 of the 30 constituents of the fund-of-funds CEFL (NYSEARCA: CEFL ) are at or close to 52-week high discounts. Exploiting of mean reversion in CEFs is a potential strategy to lock in higher yields as well as the chance for capital appreciation. In a July 2014 paper entitled Exploiting Closed-End Fund Discounts: The Market May Be Much More Inefficient Than You Thought , authors Patro, Piccotti and Wu provide significant evidence of mean reversion in closed-end fund premiums. This article identifies an opportunity to buy the Calamos Convertible Opportunities And Income Fund (NASDAQ: CHI ) at a greater discount than any time since the financial crisis. The fund Pertinent details for the fund are shown below. Details were obtained from Morningstar , CEFConnect or Calamos . CHI Inception 6/2002 AUM $731M Avg. volume 293K Yield (on price) 10.92% Yield (no NAV) 9.72% Adjusted yield (on price) 8.51% Adjusted yield (on NAV) 7.57% Leverage 28.34% Premium/discount -10.91% 5-year average P/D -0.30% Expense ratio 1.35% Active expense ratio 0.65% Morningstar rating **** As can be seen from the table above, CHI currently sports a 10.92% yield on price, while distributing 9.72% on its NAV. The reason for this discrepancy is due to its wide discount of -10.91%. Additionally, CHI uses 28.34% leverage. The adjusted yields shown assume 100% leverage for easier comparison to an unleveraged fund. CHI charges a total expense ratio of 1.35%. I previously devised an “active expense” metric that takes into account two factors: leverage and the expense ratio charged for a corresponding passive instrument. Taking into account the 28.34% leverage of CHI and the 0.40% expense you would to pay for the SPDR Barclays Convertible Securities ETF (NYSEARCA: CWB ), the price for the active management of CHI is a reasonable 0.65%. In terms of composition, CHI has its majority of assets in convertibles (57.06%), followed by corporate bonds (38.54%). Short-term debt and equity make up a very minor component of CHI. Widening discount Until recently, both CHI and the benchmark ETF CWB have had robust performances over the past few years. As can be seen from the graph below, CHI and CWB moved very closely from Jan. 2013 to around Mar. 2015 of this year. However, a major divergence suddenly appeared over the last few months, causing CHI to underperform by some 15% over brief period. What was the cause of CHI’s underperformance? Tracking the market price and NAV changes of the fund reveals the answer. As can be seen from the graph below, while the NAV of CHI decreased by around 10% over the past few months, mainly due to a general malaise in the high-yield credit market, the market price of CHI slumped by 20% over the same time period. The premium/discount chart of CHI over the past 1-year period shows this clearly (source: CEFConnect). Historical premium/discount Just having a wide discount alone is not good reason to buy a CEF. For mean reversion to take place, one must consider the historical premium/discount behavior of the fund. As can be seen from the chart below (source: CEFConnect), the current discount of CHI has reached levels that have not been seen since the financial crisis. Moreover, that was also the only time that the discount has exceeded -10%. In the boom years of 2002 to 2007, CHI actually experienced premia of 10%-20%, although this is unlikely to be replicated given that the ETF CWB became available from 2009 onwards. The following chart shows the current, and 1-, 3- and 5-year premium/discount values for CHI (data from CEFConnect). The z-score is a measure of the deviation of the premium/discount value of CEF from its historical value taking into account the volatility of said value. The following chart shows the 1-, 2- and 4-year z-scores for CHI (source: CEFAnalyzer). Mathematically, the 1-year z-score of -2.59 means that the discount would be expected to appear 0.48% of the time, the 2-year z-score of -3.52 corresponds to a 0.02% probability of appearance, and the 4-year z-score of -3.93 represents a measly 0.004% probability of occurrence. However, one should understand that this doesn’t mean that there’s a 99.996% chance that the discount will narrow, only that the observed discount is an extremely rare statistical occurrence. Moreover, it could be that the current discount represents a “new normal” of sorts, rendering the historical premium/discount value meaningless. Nevertheless, the z-score is a good starting point for gauging the sentiment of CEFs. Historical performance Besides having a large and negative z-score, it is also important to consider the historical performance of a fund. The following chart shows the total return performances of CHI, CWB and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ) since early 2009, the inception date of CWB. CHI Total Return Price data by YCharts We can see from the chart above that CHI has remained competitive with CWB and JNK from early 2009 to the start of 2015. As the premium/discount of CHI remained within a narrow range of +5% to 5% during this time, the price total return profile of CHI during this period roughly approximates its NAV total return profile during this time. The outperformance of CHI over CWB and JNK during rising markets is expected due to CHI’s use of leverage. Moreover, CHI has posted respectable NAV returns since inception in 2002. The following chart shows the annualized price and NAV returns of CHI over various historical time periods (source: Calamos). We can see that CHI’s historical performance has been very strong, with a 10.0% annualized return since 2002, and a 10-year annualized return of 7.3%. Keep in mind, however, that CHI uses leverage, which is currently at 28.34%. Distribution CHI pays a monthly distribution of $0.095, representing an annualized dividend yield of 10.92%. The following chart shows the dividend history of CHI since inception (source: CEFConnect). (click to enlarge) The dividend has been remarkably stable since 2008. However, one warning sign is that the fund has been paying out some of its distributions from return of capital over the past 12 months. My calculations show that 19.8% of the past year’s dividends consisted of return of capital. If this continues, the return of capital distributions will either erode CHI’s NAV, or force a distribution cut. Summary The sell-off in the CEF space has pushed CHI’s discount to levels not seen since the financial crisis. The extreme 2- and 4-year z-scores in excess of -3.5 indicate severe pessimism regarding the fund. Purchasing CHI now allows an investor to lock in a higher yield as well as the opportunity for capital appreciation if mean reversion takes place. Moreover, CHI has a strong historical track record since 2002, and its expense ratio is also reasonable. Risks of CHI include interest rate risk and credit risk of the underlying holdings, as well as a further widening of the discount value. The former risks can be somewhat reduced by pairing a long position in CHI with a short position in CWB and/or JNK, but the latter risk remains. (See my previous articles here and here for previous examples of where mean reversion allowed annualized profits of ~20% to be made on CEF pairs trades). Disclosure: I am/we are long CHI, CEFL. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This PIMCO CEF Has A 12.2% Distribution And A -9% Discount

Summary PIMCO Income Strategy Fund II is a closed-end fund with a broad mandate in fixed-income investments. It has kept pace with or beaten its peers for price and NAV returns. It is selling at a -9% discount, and yielding 12% at market. Editor’s Note, September 2, 2015: The author has revised the title and content to correct the erroneous distribution rate, as explained in the comments section. There has been a huge sell-off in high-yield, fixed-income closed-end funds. Uncertainties abound in high-yield fixed-income, so most carry substantial risk and are probably best avoided at this time. The more speculative investor, however, may be inclined to shop for bargains. One such bargain could be the PIMCO Income Strategy Fund II (NYSE: PFN ). Along with its peers, PFN has seen sharp moves in its discount, which has dropped to a point well below where it was a year ago. But, in a volatile space, PFN has quite consistently turned in respectable performances while paying out high distribution yields. Performance For openers, let’s note that the fund has performed reasonably well over time. The following charts (from cefconnect.com) show its performance in comparison to the category of Fixed-Income, Multi-Sector CEFS. (click to enlarge) As we see here, the fund has outperformed the category every year since 2008 on both NAV and market returns. Recent returns have been ugly for PFN but even so, the fund has managed to outperform the category where things have been even uglier. (click to enlarge) The fund has turned in a positive NAV return for 1 year and 6 month periods while its peers have been deep in the red. Although one-year return at market is in the red, the fund’s NAV total return for the period (from cefanalyzer.com) stands at 2.50%. This compares to a median for the entire fixed-income category of -0.26%. My point here is not that PFN has shown outstanding recent performance, nothing in this space has, but that it is sufficiently well managed to have consistently outperformed its peers through good and bad times. The fund was managed by Bill Gross prior to his departure from PIMCO a year ago. It has been managed by Mohit Mittal and Alfred T. Murata since Gross left. Along with several of the other funds that had been managed by Gross, the fund suffered with the management change. When I wrote about PIMCO funds at the time ( here ), several readers expressed strong confidence in the future of PFN. Despite the deepening of the discount discussed below, that confidence does not seem to have been misplaced. Discount and Distributions The current discount for PFN is -9.93%, well below its 52 week average discount of -2.96%. The 1-year Z-score (a measure of how far the discount is from its average value) stands at -2.45, which means the current discount is nearly 2½ standard deviations below the average for the past year. One can easily exaggerate the importance of Z-scores, but they help to identify potentially attractive entry points. The current distribution rate is 12.21%, which includes a special distribution in December. Without considering the special distributions, the fund yields 10.2% vs. a category median of 8.14%. The regular distribution of $0.08/share has been stable since 2012 when it was raised from $0.065/share. One might compare PFN to another PIMCO fixed-income CEF, the PIMCO High Income Fund (NYSE: PHK ) which has run substantial premiums (as high as 67% earlier this year). PHK currently pays 24.07% as its premium has fallen to 33.15%. It too is paying a special distribution, without which its yield is 15.43%. I have considered PHK’s massive premium to put the fund’s value at risk, but its exceptionally attractive yield continues to appeal to investors. As noted above, PFN has been a consistent performer over a long time scale. PHK, by contrast, is woefully underperforming its category on any measure but distribution yield. It will be interesting to see if that 15% yield can continue to sustain the still-outsized premium. Eli Mintz emphasized the relationship between NAV Yield and Premium/Discount as an indicator of value in municipal bond CEFs. Applying his observations here generates this chart. (click to enlarge) Following Mintz’s analysis, funds falling below the trendline are worth exploring for potential value. Clearly, by this criterion, PFN represents high value and PHK represents the lowest by a considerable margin. Be aware, however, that like most single metrics, the Mintz relationship is only an indication that may provide insight into funds worth looking at in some detail. for example, from this chart one might consider the Stone Harbor Emerging Markets Income Fund (NYSE: EDF ) and the Stone Harbor Emerging Markets Total Income Fund (NYSE: EDI ) as standouts. Their yields are high (above 15%) but even a cursory look at these funds might discourage investors who look beyond yield. Summary PFN appears at this time to be a strong candidate for an investor who considers high-yield fixed income to be ripe for entry. The fund has a solid history of outperforming its peers, pays an attractive and stable distribution, and is priced at a substantial discount relative to its recent history. It has effective leverage of 19.33%, below the category median of 30.26%. Leverage-adjusted portfolio effective duration is modest at 4.16 years (data from PIMCO ). Without question, the high-yield sector is a high-risk sector. This is particularly the case in today’s unsettled market. Disclosure: I am/we are long PFN. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I remind readers that this article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any fund mentioned here is suitable for his or her portfolio. As always I welcome your comments and critiques, particularly from those readers who have contrary opinions.

PIMCO High Income Fund – Next Stop, NAV

$PHK is a closed-end fund that had historically habitually traded at a large NAV premium, with the irrational bull thesis predicated on an unsustainable dividend. We had correctly predicted a dividend cut would be forthcoming. Now that dividend has been cut, the next stop for $PHK is NAV using $PHT as an analog. Target price of $7.11, represents -18% downside from current $8.62 price. This thesis is very simple. For the reasons articulated in our previous PIMCO High Income Fund (NYSE: PHK ) article , the bull thesis for $PHK trading at a significant premium to NAV was highly misguided as the dividend level was unsustainable. On 9/1/15, Pimco announced the predicted dividend cut in the September dividend announcement , cutting the monthly dividend by 15% to $0.103 from $0.122. $PHK’s stock price has decreased significantly today given the announcement, -8.8% currently to $8.62 from yesterday’s close of $9.45. Investors in $PHK or potential short-sellers may believe that the selling pressure will subside given the observed price action. However, this is misguided, as we have an analog for another high yield closed-end fund that had historically traded at a premium and had its dividend cut. Pioneer High Income Trust (NYSE: PHT ), which launched in Apr-2002 and cut its dividend in Feb-15 to $0.115/month from $0.1375/month (-16% dividend cut). This caused the fund to trade down dramatically from a ~45% premium to a current -1.5% discount to NAV, causing significant capital loss for CEF investors. (click to enlarge) $PHK’s current NAV is $7.11 (see ” Daily Statistics “), meaning that the current $8.62 price still represents a 21% premium to NAV. Now that the “dividend consistency” bull argument for $PHK has been discredited, there is no “NAV premium” floor for the fund and we expect $PHK to follow a very similar trajectory to $PHT, with $PHK ultimately trading to NAV in the near future. Note: In addition, there is adequate borrow for short-sellers. Caveat emptor. Disclosure: I am/we are short PHK. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The author and/or others he advises holds short a position in PHK at the time of publishing this article. The author may make trades in securities mentioned without notification. The information contained in this article is impersonal and not tailored to the investment needs of any specific person. You should consult with a professional where appropriate. The author shall not be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. The opinions expressed in this article are for informational purposes only and should not be construed as investment advice. The article is not a recommendation of, or an offer to sell or solicitation of an offer to buy, any particular security, strategy or investment product. The research for this article is based on public information that the author considers reliable, but the author does not represent that the research or the article is accurate or complete, and it should not be relied on as such. The views and opinions expressed herein are current as of the date of this article and are subject to change. Any projections, forecasts and estimates contained in this article are necessarily speculative in nature and are based upon certain assumptions. In addition, matters they describe are subject to known (and unknown) risks, uncertainties and other unpredictable factors, many of which are beyond the author’s control. No representations or warranties are made as to the accuracy of such forward-looking assumptions. It can be expected that some or all of such forward-looking assumptions will not materialize or will vary significantly from actual result.