Lately, I have been looking to increase the fixed-income allocation in my portfolio and have started to look at alternative investments. One such investment is PIMCO Dynamic Income Fund (PDI, Financial), which has been on my watch list because of its high dividend. The stock looks interesting from a technical point of view as it is clearly forming a bottom and the moving averages are converging.
The closed-end mutual fund is managed by Joshua Anderson and Alfred T. Murata of PIMCO, a leading asset manager and fixed income specialist. The fund invests and manages a diversified fixed-income portfolio with a goal of high current income as a primary objective and capital appreciation as a secondary objective. This multi-sector bond fund provides access to PIMCO's premier income-generating concepts spanning various global fixed-income domains. Its primary objective is to secure current income, while secondary to this is achieving capital appreciation.
The fund's customary approach involves investing around the world in a collection of debt commitments and other assets that generate income, spanning different kinds and levels of creditworthiness. This encompasses a range of maturity periods as well as associated derivative tools. The fund's scope of investment includes mortgage-backed securities, corporate bonds of both investment-grade and high-yield nature, sovereign and corporate bonds from developed and emerging markets as well as other income-generating assets and related derivatives.
Typically, the fund allocates a minimum of 25% of its total assets to privately issued mortgage-related securities (commonly termed non-agency securities). Additionally, it may invest up to 40% of its total assets in securities linked to the economies of emerging market nations. Currently, the fund's country weighting is as follows:
| Market Value Exposure % | |
| United States | 71.07 |
| United Kingdom | 5.73 |
| Spain | 3.84 |
| France | 2.62 |
| Luxembourg | 2.42 |
The fund usually maintains an average portfolio duration ranging from zero to eight years. Currently, its average duration for fixed income is 3.79 years.
The PIMCO Dynamic Income Fund's long-term performance (at net asset value) is provided in the chart below. The near-term performance has been weak due to the worldwide bear market in bonds (which is now recovering). However, longer-term performance has been impressive with 10.28% annualized returns since inception in June 2012.
What is PIMCO?
PIMCO's history of managing income-yielding assets extends back to the company's inception in 1971. Its investment methodology blends a high-level, worldwide macroeconomic perspective with detailed analysis from one of the industry's most seasoned fixed-income research team.
Short for Pacific Investment Management Company LLC, PIMCO has become one of the world's largest and most well-known investment management companies, particularly renowned for its expertise in bond and fixed-income markets. The company offers a wide range of investment products and services to institutional investors, financial advisors and individual investors.
The company's investment strategies cover various asset classes, including bonds, stocks and alternative investments. PIMCO is known for its active management style, employing experienced portfolio managers and analysts to make investment decisions based on economic analysis, market trends and other factors. PIMCO is owned by Allianz SE (XTER:ALV), a German multinational financial services conglomerate, which acquired it in 2000.
What are closed-end funds?
Closed-end mutual funds, also known as closed-end funds, are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities, such as stocks, bonds or other assets. However, unlike traditional open-end mutual funds, closed-end funds have a fixed number of shares that are issued during an initial public offering. Once these shares are sold to investors, the fund's capitalization is fixed and does not change based on investor demand.
Key characteristics of closed-end funds include a fixed number of shares. Closed-end funds issue a specific number of shares during their IPO. These shares trade on stock exchanges or over-the-counter markets, and their prices are determined by supply and demand in the market, which can lead to the shares trading at a premium or discount to the fund's net asset value. Currently, the PIMCO Dynamic Income Fund has 257.55 million shares outstanding.
Further, unlike open-end funds, where the share price is directly tied to the NAV and is calculated at the end of each trading day, the share price of a closed-end fund can fluctuate throughout the trading day based on market supply and demand.
Most closed-end funds are also actively managed, meaning that professional portfolio managers make investment decisions on behalf of the fund, aiming to achieve its investment objectives. However, some closed-end funds may use leverage to potentially enhance returns. This leverage can amplify both gains and losses. The Dynamic Income Fund does use leverage and currently has a leverage of 43.87%.
Next, closed-end funds often distribute income and capital gains to shareholders in the form of dividends. These distributions can be appealing to income-focused investors.
There is also limited redemption. Unlike open-end funds, which allow investors to buy and redeem shares directly with the fund at the NAV, closed-end funds do not generally offer redemptions. Instead, investors can sell their shares on the secondary market to other investors.
Another unique aspect of closed-end funds is that their market prices can deviate from their net asset value. When the market price is lower than the NAV, the fund is trading at a discount; when it is higher, the fund is trading at a premium.
Closed-end funds can offer benefits such as the potential for higher income through their distributions and exposure to specialized investment strategies managed by professionals. However, their share prices can be more volatile due to the market-driven pricing, and the discounts or premiums to NAV can affect investor returns. Additionally, closed-end funds might be less liquid than more commonly traded stocks or open-end mutual funds.
It is important for investors to research and understand the specific closed-end fund's investment strategy, management team, fees and historical performance before investing.
Distribution
Most of Dynamic Income Fund's historical return has come from distributions and not capital appreciation, as can be seen in the charts below, which compares the performance without and with dividends.
 |  |
| Performance without Dividends | Performance with Dividends |
Currently, the closed-end fund is yielding 13.66%. It has maintained a consistently high dividend rate throughout its life.
Expenses
The fund's management fee and expenses are as follows:
| Management Fee | 1.10% |
| Total Expense Ratio (excluding interest expense) | 2.00% |
| Total Expense Ratio (including interest expense) | 2.64% |
Premium to net asset value
The fund usually trades at a premium to net asset value. Currently, the premium is 12.49%. According to Morningstar, the one-year Z-statistic is 1.65. The Z-statistic measures relative discounts and relative premiums for closed-end funds. The score can add context to a closed-end funds' current discounts and premiums. A positive score implies the current premium is higher than average.
Insider purchases
Another good sign is that PIMCO Dynamic Income Fund insiders have been buying up shares for their personal account.
Famed investor Peter Lynch noted that insiders sell shares for many reasons, including taxes, estate planning, diversification, funding a large purchase or perhaps after getting fired or divorced. On the other hand, they buy (like most of us) for one main reason…they think the stock is going higher. It, therefore, makes sense to pay particular attention when we see insider buying a stock we are interested in.
Discussion
I think investors should consider increasing the weights of bonds and other fixed-income investments in their portfolio. The U.S. equity market looks frothy with a pric-earnings ratio of over 25. A traditional well-rounded investment portfolio typically consists of a 60% allocation to stocks and 40% to bonds. However, over the past decade and more, the bond segment has often proven unmotivating due to its lackluster yields, which translated into meager or even negative returns after accounting for inflation.
Nonetheless, the economic environment changed dramatically last year as both interest rates and bond yields experienced substantial surges as central banks sought to control inflation and started to raise interest rates. This resulted in bond prices, which move inversely to yields, suffering notable declines. This turn of events came as an unwelcome shock to those who had regarded bonds as secure, low-risk holdings. It is unsurprising that many investors have developed an aversion to bonds in light of this shock. Nevertheless, it might be prudent to reconsider this stance. As seen in the chart above, which compares the Vanguard Long-Term Bond ETF (BLV) with the S&P 500 ETF (SPY), when the Federal Reserve began to tighten in the spring of 2022, both exchange-traded funds fell, but the latter has recovered while the former has not (but looks like it has formed a bottom).
In the wake of the significant surge in interest rates, bonds are currently offering some of the most attractive yields they have presented in years. While the current elevated yields are offset by higher inflation, there is potential upside. If forecasts hold true and inflation recedes to around 2% over the next couple of years, the prevailing 4% yield on a 10-year Treasury starts to appear quite compelling for investors with a long-term horizon. In contrast, the S&P 500 at a price-earnings ratio of 25 is offering an earnings yield of less than 4% (see chart below). Given that equities carry much more risk than (risk-free) government bonds, this stock market is offering investors no risk premium for taking on substantial risk. So why bother taking on unnecessary risk?
Given this reality, it may be an opportune time to dive into bonds. Should inflation and interest rates recede in the coming year, bond prices will move in the opposite direction to falling interest rates, potentially yielding substantial profits. Even if this scenario does not materialize, bonds still offer a reliable and low-risk return at a time when the economic and stock market outlook is fraught with uncertainty.
PIMCO Dynamic offers an interesting vehicle to play the expected declining interest trend as it is an astute manager with proven expertise in managing fixed income. While the 1.1% management fee is high, it is not outrageous given the solid long-term performance of the fund. Currently, most analysts are expecting either a soft landing, where we avoid a recession or get off with a mild recession. A small minority expects a hard landing (i.e., a full-blown recession). The PIMCO Dynamic Income Fund is more oriented toward a soft landing scenario because it does not invest in Treasuries, which will benefit the most in a hard landing scenario. It is a good middle of the road option for investors hedging between overpriced equities and U.S. Treasuries. If you lean toward the hard landing school, I would recommend the Vanguard Long Term Bond ETF, which has miniscule expense ratio of 0.04% and a yield of 4.99%.
