Friday, February 4, 2011

Investing Solo – Bill Gross’s PTY and Its Sister Closed End Funds PFN, PFL, and PCN

When will interest rates really start to rise? How much inflation do we really have? Read the WSJ or watch the Kudlow show and see the experts’ answers range from soup to nuts. I pay, however, particular attention to Bill Gross of Pimco, who, in the annual Barron’s roundtable interviews (link) published last month and in a recent post for Pimco investors (link), opines that the Fed will keep interest rates low for a good while longer, however injurious such rates are to savers and pensioners, in the interest of propping up assets, particularly stocks and real estate, for the benefit of banks and financiers. He advises us mere mortals to adjust to the interest rate realities and adapt our fixed income strategies. Gross: “Once [quantitative easing] disappears, how long will the federal-funds rate stay at 25 basis points?…. For a long, long time, I think. Short-term rates will stay there for at least two years and maybe three, because of high unemployment, excess capacity and, at the moment, an inherently low inflation rate. There would be no rationale for the Fed to raise interest rates other than to counter an attack on the dollar.”

To that end, in Barron’s he once again recommended one of the Pimco diversified taxable debt closed end funds (CEFs) – PTY. Gross’s argument: “[I]f you don't want to own assets [like treasuries or money market funds] yielding negative real rates [interest rates net of inflation], why don't you borrow at such rates, or find companies that do?” I own two sister funds to this one – PFN and PFL, the former of which in the June 2010 Barron’s Gross called a “look-alike” to PTY. Not unexpectedly, the price of PTY shares jumped high, while the unmentioned PFN and PFL only hopped up a bit, despite only modest to moderate differences among them and the fourth sister of the quartet, PCN. I don’t know why Gross mentions only one of them at a time in these interviews rather than discussing the quartet as a whole. In fact, the average durations of the PFN and PFL portfolios are shorter than PTY and PCN, giving them a little more safety should interest rates rise a lot from here. For me, when I first bought into PFN and PFL I liked their valuation metrics a bit better than those of PTY and PCN, and especially given the run up in share prices recently that still seems the case to me now.

All of these funds to my eyes have exceptional metrics among debt CEFs – particularly for me net investment earnings well in excess of monthly distributions, a substantial cushion of undistributed net investment income, and insignificant amounts of the subjectively valued “level 3” securities. The portfolios are mostly corporate bonds, both investment grade and high-yield, and mortgage-backed securities. All these funds are managed by Gross himself (he’s also a large personal shareholder) and have great track records, employing leverage to achieve regular distributions of well over 7% annually plus a history of special one-time year end payouts on top of that.

Of concern is the particular risk seemingly on everyone’s mind right now -- future interest rates, but again, Gross thinks they’ll stay low for quite a while longer. Also, this quartet of CEFs now trade at a premium to net asset value, but I suspect that’s because of Gross’s great track record as a fund manager and because the annualized rate of monthly distributions does not take into account special year-end distributions.

I have been taking a hard look at my fixed-rate funds not expressly intermediate-term in focus that I have left after my reallocation over the past year almost completely out of long-term funds. I look at PFN and PFL as essentially intermediate-term funds with great fundamentals, yields, and management, but with a fixed rate portfolio. After re-assessing the rewards versus risk, I’ve decided to hold firm with them despite the recent run-up in price to mild premiums over net asset value and the inherent interest rate risk.

I’m an individual investor with no background in finance or securities, writing things down to help organize and clarify my thinking. Of course, nothing I say constitutes investment advice of any kind – merely an account of my personal observations and decisions. My core portfolio is a conservative and diversified mix of equity and debt mutual funds, ETFs, and some closed-end funds (CEFs) across investment styles, management firms, and accounts, and I invest a relatively small amount (about 10%) somewhat more aggressively in the perhaps ultimately futile pursuit of alpha.

Mike Parenti

PTY profile at Nuveen’s CEF Connect web site

Related Posts:
Investing Solo – Floating-Rate Debt - GFY
Investing Solo – Floating-Rate Debt
Investing Solo in Floating-Rate Preferred Stocks

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