PTY: PIMCO’s Flagship CEF Is Still Worth Buying

Today, we’re going to circle back on one of the top high yielding closed end funds. Managed by PIMCO, the PIMCO Corporate & Income Opportunity Fund (NYSE:PTY) is a flagship CEF which has delivered monthly dividends for more than two decades. To put it simply, PTY is legendary and deserves the credit for outperforming nearly every competitor over the span of decades. In fact, PTY has outperformed the S&P 500 since inception, displaying the exceptional total returns of the fund despite rising interest rates over the past two years.

PIMCO is a massive Newport Beach-based asset manager focusing on fixed income. Over the years, PIMCO has become one of the most powerful and connected fixed income managers. The platform has grown beyond mutual funds, and today PIMCO is one of the largest managers in the world.

PIMCO now manages $1.8 trillion. Over the past five years, almost 85% of PIMCO’s AUM has outperformed its relative benchmark, net of management fees.

At the beginning of the year, we covered PTY providing an update and outlook for 2024. After nearly six months, it’s time to circle back on PTY and discuss what has changed internally and externally. We will provide an update on the fund, the portfolio, and the outlook.

The Fund

PTY launched in 2002 and has been a leading performer amongst fixed income closed end funds for more than two decades. The fund is diversified widely across assets, geographies, maturities, credit ratings, and other categories. Broadly, diversification is the name of the game for PTY. The fund’s website provides details on the investment strategy and holdings:

Under normal market conditions, the Fund seeks to achieve its investment objective by investing at least 80% of its net assets plus borrowings for investment purposes in a combination of corporate debt obligations of varying maturities, other corporate income-producing securities, and income-producing securities of non-corporate issuers, such as U.S. Government securities, municipal securities and mortgage-backed and other asset-backed securities issued on a public or private basis.

The fund may invest a maximum of 25% of its total assets in non-U.S.-dollar-denominated securities and a maximum of 40% of its total assets in securities of issuers located in emerging market countries. The fund will normally maintain an average portfolio duration of between zero and eight years.

Consistent with most PIMCO funds, PTY is leveraged, using primarily repurchase agreements and auction rate preferred securities to borrow. Recently, PTY and other funds have moved away from using auction rate preferreds which we will discuss.

Total effective leverage is around 18%, which has declined considerably over the past twelve months. As of our prior coverage roughly twelve months ago, PTY’s leverage was closer to 50% of the fund’s total assets. The fund’s asset allocation is detailed below including maturity ranges, geographies, and asset class. High yield credit still accounts for the largest component of PTY’s portfolio at 35%.

PTY’s management fee is also reasonable for a complex fund and compared to other funds in the lineup. The fund charges a base expense ratio of 0.65% on managed assets. Bear in mind, this expense ratio is charged on managed assets, meaning this includes leverage. For shares of PTY, this means the effective expense ratio is higher and fluctuates based on the leverage ratio being used by the fund. Based on current leverage metrics, this means PTY’s effective expense ratio is 0.78%.

In our last article, we provided a breakout of PTY’s expenses relative to peers from PIMCO.

Recent Performance

Since our previous coverage of PTY, the fund has performed well. At the end of January, we assigned a “Buy” rating to PTY. Under the thesis that rate cuts would not emerge as quickly as many hoped, PTY and similar closed end funds were positioned to reinvest into higher yielding assets, while benefitting from rate stability. As the Federal Reserve is unlikely to further raise interest rates, PTY’s price has stabilized over the past twelve months. Price stability means PTY’s supercharged yield could continue to compound for shareholders. Since our coverage, PTY has returned 7%, beating fixed income benchmarks.

PTY continues to carry PIMCO’s closed end fund offerings as one of the strongest performers. Over the past twelve months, the newly launched PIMCO Access Income Fund (PAXS) has outperformed PTY slightly, leading the lineup. Interestingly, the funds with more leverage have begun to outperform as rates stabilize. However, over the long term, PTY has been the best representative of PIMCO’s abilities, leading the lineup and category over periods longer than ten years.

PTY’s NAV performance has also beaten competing funds from PIMCO. PIMCO’s portfolio continues to outperform peers from the manager with consistency. However, NAV performance is not the only contributing factor to PTY’s exceptional long term return profile. PTY’s current valuation is a critical piece of the fund’s long term outperformance of peers and the market abroad.

Valuation

PTY discount to premium long term

PTY has begun trading at a consistent premium to net asset value over the past five to ten years. As low interest rates drove down bond performance, PTY leveraged PIMCO’s platform to keep pushing with a yield far above over income producing assets. This created investor fervor over PTY and similar funds, pushing their market price above NAV as investors still judged the fund’s distribution as an attractive risk adjusted yield. For PTY, this led share prices to consistently hover over 20% above net asset value.

While a premium to NAV can be interpreted as short-term overpricing, PTY has priced above NAV for years. Currently, PTY’s premium to net asset value is 27.4%, expanding by more than 10% since the beginning of the year. While the current premium aligns with the average premium to NAV over the past five years, it is still significant.

Since our prior coverage of PTY, the premium has expanded by an additional five percent, accounting for a portion of PTY’s superior performance outcome.

Buying PTY or other closed end funds at a premium to net asset value is not a risk alone. Instead, looking at share price relative to NAV over a historical period could be a better option. If a fund trades at a consistent premium to NAV over a period of years, it could reduce the likelihood of a near term reversion to NAV.

For PTY, this scenario played out several years ago, when the premium to NAV breached 50%. As the premium continued to climb above historical levels, this positioned PTY share prices to revert to their mean premium. As displayed by the chart below, the premium fell back to their historical average as opposed to reaching net asset value.

Updates & Outlook

Since our previous coverage, there have been two critical updates that will affect long term performance.

1. Reduced Leverage

First, PTY has significantly reduced leverage. In our previous coverage, PTY’s leverage ratio hovered around 50%, amongst the highest of the PIMCO lineup. As of May 31, PTY’s leverage ratio had reduced considerably to just 18.8%. How did this happen?

In March, PIMCO announced a tender offer for auction rate preferred shares or ARPS across the lineup of closed end funds. PIMCO intended to purchase up to 100% of its outstanding ARPS against their lineup of closed end funds. PTY and similar funds use ARPS as a primary source of leverage. In April, PIMCO announced the results of the offer. PTY tendered nearly 95% of outstanding ARPS.

As interest rates remain higher for longer, PTY’s borrowing costs and volatility increased significantly. PTY was highly levered during a stable period where rates were low, and the moves of the Federal Reserve were predictable. As rates begin to stabilize and the outlook is somewhat murky, PTY has reduced leverage at the fund level. Investors should remain on the lookout for PTY and similar funds to relever themselves through other means such as reverse repurchase agreements.

2. Are Interest Rates Coming Down?

The June Federal Reserve meeting proved a turning point in the sentiment of income investors. While PTY and similar funds are more complex than traditional bond funds, their NAV is still heavily correlated to movements in interest rates. At the June meeting, the Federal Reserve held interest rates steady as expected by most investors. With no surprise, the Federal Reserve appears to be sticking to their word of an inflation-based rate policy.

Now, investors are looking to the rest of the year, trying to predict if or when a rate cut may appear. Inflation remains above the Federal Reserve’s target rate, so it is not likely that the Federal Reserve will lower interest rates until that target is met.

CME FedWatch continues to forecast a 90% chance that interest rates will be held steady at the July meeting. The tool also provides forward data for the Federal Reserve’s meetings through September 2025. The tool is forecasting a 95% chance that rates will be cut by year end with the consensus landing on a 50bps reduction to the target rate.

One year from now, the overwhelming consensus points towards lower borrowing costs. The forecast of rate cuts over the next twelve months is 99.8% according to the tool. However, where rates are likely to land remains a topic of debate. In fact, the consensus lands on 100 basis points, but the distribution is nearly even. The low estimate of a target range is 325 – 350 basis points and nobody is forecasting rate hikes.

The data is significant for investors who are anticipating near term rate cuts. The silver lining remains that investors are predicting rates to come down within twelve months. More than likely, this will happen by year end, creating a significant tailwind for PTY.

The most important piece we can gather from the tool is simple. There are no predictions that rates will increase by year end. Predictability is critical and planning the Federal Reserve’s interest rate cycle is an important piece of the puzzle for PTY.

Conclusion

PTY is the flagship closed end fund from PIMCO, establishing a record of outperformance spanning decades. PTY remains a strong opportunity to capitalize on elevated interest rates, offering a high yield.

While the fund continues to trade at a generous premium to net asset value, there are a variety of tailwinds that stand to benefit the fund, including rate cuts and reduced leverage.

As rates peak, PTY has an opportunity to capitalize, reinvesting assets into higher yields before borrowing costs decline. Considering the updates and the current outlook, we reiterate the “Buy” rating on PTY as the outlook improves and risk factors remain muted.