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Even After Recent Drop, PGP Is A Sell

PGP trades at a large premium, putting it at risk for a steep decline. When rates rise, high premium and highly leveraged funds will suffer. Friday’s drop is a sign of how risky the fund truly is. The purpose of this article is to evaluate PIMCO Global StocksPLUS & Income Fund (NYSE: PGP ) as an investment option. To do so, I will evaluate the fund’s characteristics, recent performance, and trends within the industry as a whole to attempt to determine if PGP will be a profitable investment going in to 2016. First, a little about PGP. PGP’s stated objective is to seek a total return comprised of current income, current gains, and long-term capital appreciation. The fund attempts to achieve this objective by building a global equity and debt portfolio and investing at least 80% of the fund’s net assets in a combination of securities and instruments that provide exposure to stocks and/or produce income and by utilizing call and put options to generate gains from options premiums and protect against swift market declines. Currently, the fund is trading at $16.91/share, after Friday’s decline of 8.62%. The fund pays a monthly dividend of $.18/share, which translates to an annual yield of 12.77%. While the fund has come under pressure over the past few trading sessions, performance in the past few months has been strong, with the fund up almost 15% in the past three months, excluding dividend payments. Given that performance, and its high yield in this low rate environment, PGP may seem like a sound investment. However, there are a few reasons, which I will outline below, why I would avoid PGP going forward. First, and probably most important, PGP trades at an enormous premium to Net Asset Value (NYSE: NAV ), currently at 56.24%. This in and of itself is a red flag for any fund, as it indicates investors are paying well above the fair market rate for future performance. PGP has been able to maintain this high premium because it has a history of reliability for its dividend payout, which is high, and investors have flocked to PGP and other similar funds to earn this yield while interest rates have remained at record lows. While this strategy may have paid off during that environment, once rates start to rise, investors will shift out of riskier funds and in to safer asset classes that will begin to pay more. Funds that demand a high premium, such as PGP, will be most at risk. This was evident during Friday’s drop, as credit markets were rattled over Third Avenue’s decision to suspend redemptions on one of its credit mutual funds. This decision hit many Pimco funds hard on Friday, but funds that trade at large premiums were hit the hardest. For example, PHK, which also trades at a premium (albeit at only 10%) dropped over 7%, which was similar to PGP’s drop. Meanwhile , PCN, which trades at a 7.62% discount to NAV, dropped only 2.44% and PCI, which trades at an almost 16% discount to NAV , dropped only 1.18%. While this is just a snapshot of one trading day, it demonstrates how funds with high premiums are more sensitive to market swings and are riskier for the initial principle investment. Second, interest rates are likely to increase this week, as 92% of economists surveyed by the Wall Street Journal are predicting a December rate hike to be announced during the Fed’s meeting this week. If Yellen announces a hike, and lays out the groundwork for future hikes in 2016, investors may begin to exit riskier funds like PGP, as yield on safer investments, such as Treasury bills, will begin to be higher. Again, due to its large premium, PGP will probably suffer more than most and the drop could be steep. In the past month, as expectations for the first rate increase became more pronounced, PGP has suffered, down about 5% (excluding dividends). With the rate hike becoming more evident, I expect this decline to continue. Third, while PGP has traded at an ultra-high premium for quite some time, historically the fund has traded at NAV, or at a discount. It wasn’t until the depths of the of the financial crisis and the near zero interest rates in 2009 that PGP began to sell at a premium. Investors have irrationally bid up this fund to the point where owning it now sets up the investor for a very quick, steep drop in principle. When rates rise, I expect PGP to return to pre-recession valuations, which would mean a dramatic decrease in share price from where it stands today. Of course, avoiding PGP has risks of its own. The fund has traded at a premium successfully for years, and its high yield, along with capital appreciation, has rewarded investors handsomely. If Yellen announces that the Fed will yet again delay raising rates, or lays out a dovish stance for future increases in 2016, funds like PGP could rally, as that could indicate the low rate environment will be around for longer than anticipated. Additionally, PGP’s yield of almost 13% could be enough to entice investors to stay the course throughout 2016, even with rising rates. While rates rising seems to be an almost certainty, those rates will most likely still be at historically low levels. Investors may decide that the high yield and below investment grade credit sectors that compose PGP could be worth the risk. However, I expect the Fed to follow through with the December rate hike, and lay a groundwork for a few rate hikes in 2016. This albeit slow rate of increases will gradually steer investors out of high-yielding closed-end funds, and PGP should fall quicker than others. Bottom-line: PGP has paid a reliable, high-yield during a period of ultra-low interest rates, rewarding investors with high income during a time when such income was hard to come by. The fund has also performed strongly from its 2009 lows, more than doubling in share price. However, this performance has priced PGP well above NAV, and has shown itself prone to dramatic losses when the market gets rattled, such as on Friday. With volatility expected in the credit markets in the coming months as interest rates are set to rise, the risk-reward of PGP is just not there. While the yield is high, and PGP has proven to pay it reliably, there are other Pimco funds available with similar yields, that won’t expose investors to such a large potential loss in principle. Heading in to the new year, I would caution investors away from PGP at this time.

Buy DVY Ahead Of The Fed Announcement

Regardless of Thursday’s announcement, rates will be low for a while. Utility stocks have taken a beating, and seem poised for a rebound. Dividend funds are a long-term trend that is not going away. The purpose of this article is to determine the attractiveness of the iShares Select Dividend ETF (NYSEARCA: DVY ) as an investment option. To do so, I will review DVY’s recent performance, current holdings and weightings, and trends in the market to attempt to determine where DVY may be headed for the rest of 2015, and in to the new year. With the Fed’s meeting tomorrow regarding interest rates, investors may want to initiate positions ahead of their announcement. First, a little about DVY. The Fund seeks investment results that correspond with the price and yield performance of the Dow Jones U.S. Select Dividend Index . The Index is generally made up of companies with relatively high dividend yields and that have maintained these yields for a long stretch of time, the minimum being 5 years. Because of its diversity and inclusion of only high dividend payers, DVY is not representative of the general market and or the DOW as a whole, but is weighted towards certain sectors specifically. DVY is currently trading at $73.87/share and pays a quarterly dividend of $.65/share, which translates to an annual yield of 3.52%. The fund has struggled in 2015, heading lower with the market as a whole. Year to date, DVY is down about 7%, excluding dividends. This compares to a drop of about 6.5% in the Dow Jones Index (NYSE: DOW ), a popular benchmark. Given its yield, DVY has slightly outperformed the DOW, but it is important to consider the Fed’s influence on the market before deciding to invest in DVY going forward. There are a few reasons why I like DVY, regardless of what the Fed decides to do, as I see the fund performing strongly in either scenario. First, if the Fed decides to not raise rates after tomorrow’s meeting, high-yielding safe sectors like utilities should outperform, as investors will scramble back into those stocks to earn that higher yield. This is important for DVY because the fund has a weighting of almost 33% towards the utilities sector . Over the past few years this sector has rallied each time the rate increase is delayed, or when there is speculation that it will be delayed. And this type of delay is precisely what most traders are betting on this time around, as most traders are betting the central bank will not increase rates at its Sept. 16-17 meeting. Traders are pricing in a 28 percent chance of action on Thursday. Odds of a move at the December gathering are about 59 percent, according to data compiled by Bloomberg. Given the very real possibility of a September delay announcement by the Fed, investors could profit by getting in to DVY ahead of time. Second, I also believe DVY should perform well even if the Fed does decide to raise rates. I believe this is the case because the increase is sure to be modest, and will likely not be followed by another increase this year. Because of this, investors will continue to be subject to ultra-low rates by historical standards, and will continue to look at dividend-focused exchange traded funds, as has been the long-term trend for years now. While most investors are increasingly conflicted about whether or not the Fed will raise rates, the amount of the increase, if it happens, seems to have a consensus that the rise will be to .25%, with a small possibility of .50%. Given that DVY is currently yielding 3.50%, and has the potential of price appreciation through stock gains, the potential return of this fund will still beat investing in U.S. Treasuries. Of course, investing in DVY is not without risks. As the past few months have shown, the Fed’s action (or lack thereof) on interest rates can heavily influence the markets. If the Fed decides to raise rates more aggressively than anticipated, funds like DVY will fall, and fall sharply, given that most traders are betting on the Fed being more dovish. Additionally, dividend funds have been falling out of favor with investors over the course of 2015, as some investors are predicting the years-long bull run for these funds to be ending. Data compiled by Bloomberg has shown outflows for popular dividend funds like DVY, and others, over the course of 2015. However, these are not scenarios I expect to occur. The Fed has been very straightforward about their intentions, and I do not believe they have any desire to “spook” the market with a large increase. I also expect, for reasons I outlined in the above paragraph, for the trend towards dividend ETF’s to continue to be profitable going in to the new year, as rates stay historically low for at least another six months. Bottomline: The market has undergone some volatility over the last few months and trended lower, and DVY has not been immune to this trend. However, the drop in stock price has pushed DVY’s yield above 3.50%, and offers a reasonable value while trading at 12.5 times earnings. The fund has suffered disproportionately as investors fret over a coming rate hike, but the rate hike will be small and could very well be delayed. If so, investors will look to get back in to DVY and similar funds as safe, high-yield alternatives will continue to be scarce. With a above-average yield and a beta of only .69 (indicating it is less volatile than the market as a whole), DVY provides investors with a relatively safe play to ride out any forthcoming volatility. I would encourage investors to take a serious look into this fund, regardless of the Fed’s decision this week. Disclosure: I am/we are long DVY. (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.