Historically, during stock market selloffs, investors tend to move to bonds as a perceived safe-haven asset. This typically drives bond prices higher and yields lower, explains Rida Morwa, income specialist and editor of High Dividend Opportunities.
But this trend broke during the current bear market. The decline in bond prices and rising yields can be due to elevated inflation levels, aggressive quantitative tightening by the Fed, and shrinking investor appetite to lock themselves into fixed income in a rising-rate environment.
But there is a strategic way to take advantage of the bond market selloff and stay well-positioned for rising rates. Bonds with short-term maturity dates imply regular principal repayments, which can be reinvested at higher yields upon maturity.
Moreover, short-term bonds (particularly those with around 12 months to maturity) experience a 'pull-to-par' phenomenon. Pull-to-par reflects the reality that as a bond approaches its maturity date, it will begin to 'pull' to its par value as default risk becomes increasingly negligible and the cash price of the bond amortizes to the par value.
In such an environment, long-term bonds will suffer losses, while funds focused on short-term bonds will generate growing income.
With over 50 years of actively managing fixed income instruments, PIMCO is one of the best-rated firms for sustainable income production and delivering value to their investors. PIMCO is to CEFs what Apple (AAPL) is to technology.
Below we review two of PIMCO's newest CEFs, which are star performers when it comes to income production. Both these CEFs have recently raised their distributions and maintain substantial undistributed net investment income (‘UNII’), which are strongly indicative of special distributions at the end of the year.
PIMCO Dynamic Income Opportunities Fund (PDO) was born in a yield-less market in January 2021. This CEF comprises securities from multiple fixed income sectors with a total leverage-adjusted effective duration of 2.88 years.
Short-term fixed income instruments are valuable in a rising rate environment due to the ability to quickly rotate capital into higher yielding securities upon maturity, and ~33% of PDO's portfolio matures within the next 12 months.
PDO distributes $0.1279/share every month, a substantial 11.1% annual yield. It is noteworthy that PDO made an 8% distribution increase effective from August. This reveals the fund managers' confidence in the CEF's ability to sustainably support the payout. YTD, PDO has maintained excellent distribution coverage from its Net Investment Income (NII).
Despite the raise last month, PDO still holds $0.95 of undistributed NII, which is almost 7.5 months of dividends! PDO investors can expect another handsome special distribution in December, similar to the Christmas present we got last year.
Despite PDO executing well in all aspects, the fund has sold off this year amidst bear market fears. The CEF is now available at an attractive 6.1% discount to NAV. With solid distribution coverage, excellent prospects of a special payment, and a portfolio composition designed for rate increases, PDO is a great buy to navigate this market uncertainty.
PDO's younger sibling is another quality pea from the PIMCO pod. PIMCO Access Income Fund (PAXS) was born earlier this year, in February 2022, before the Fed began its quantitative tightening spree. PAXS maintains a portfolio of fixed-income securities with a total leverage-adjusted effective duration of 3.86 years, which is slightly more middle-term compared to PDO, yet attractive during rate hikes.
Right off the bat, PAXS has had the opportunity to expand the use of its leverage to buy higher-yielding short-to-mid-term bonds and support its distribution. PAXS has demonstrated fantastic distribution coverage in its infancy and recently announced a whopping 28% increase in monthly distributions to shareholders.
The current $0.1494/share monthly payment calculates to an attractive 11.3% yield. The CEF maintains $0.48 in undistributed NII, which is roughly equal to the distributions for three months. Like PDO, we expect PAXS to continue out-earning its payout and reward shareholders with a special dividend at the end of the year.
It appears that Mr. Market doesn't like growing dividends. PAXS trades at a 6.9% discount to NAV, a rare phenomenon for PIMCO CEFs. I am snagging this high yield at a bargain and look forward to a special distribution in December.