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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. Scalper1 News
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