14% Yield Funds - Too good to be true ?
Introduction.
I came across an interesting post by Investment Strategist, Michael Foster.
Sharing it so that you could decide if closed end funds (CEF) are for you.
When it comes to Investing, I believe that there is always something new to learn and help me to grow, in the process.
With that, let’s jump in.
No one wants to talk about the 2020 - 2021 lockdown.
Those dark days did do one thing “right” for the high-yield corporate-bond market: it made the so-called “junk bonds” too big to fail.
Investors are just starting to come around to this fact.
Most important takeaway is there is a nice opportunity to grab (a) historically large, and (b) stable, dividends from these corporate-bond funds.
This includes the closed-end fund (CEF) $PIMCO Dynamic Income Fund(PDI)$ — focus of this post.
Regulars of Michael Foster’s articles will recognize Funds record - PDI.
This is because he has mentioned about it many times over because:
Its high yields of 13.8% (while post is being written).
Its dividend growth.
Its issue of special dividends regularly.
The icing on the cake is the Dynamic Income Funds is run by PIMCO, one of the highest-regarded CEF managers for Fixed-income investment.
“Fed-Backed” Corporate Bonds
PDI vs JNK : Nov 2023 to Mar 2024
The green graph above is $SPDR Bloomberg High Yield Bond ETF(JNK)$, a benchmark for corporate bonds.
Its performance for the past 5 months is > +10%.
Over the same 5 months, PIMCO Dynamic Income Fund (PDI) gained an impressive +30%.
PDI, 02 Nov 2023 Analysis.
In Michael Foster’s November 2023 post - he highlighted PDI’s:
Value.
Sustainable payout.
Underpinned by its strong portfolio of high-yield bonds.
In that post, Michael had sensed that PDI was:
Setting up for capital gain.
Set to give investors at least $11,250 in monthly income on a $1 Million investment (in a “worst-case scenario”).
Looking at above chart, the capital gains have arrived. (see above)
Despite the strong performance — a good indicator of gains and upside investors could benefit from, the “junk bond” moniker turns off a lot of investors.
Junk Bond History to Gem.
In the late 1970s, high-yield corporate bonds were virtually unknown until a Wall Street trader named Michael Milken promoted them as an investment opportunity for:
Struggling companies to raise cash.
For investors to earn above-market returns.
This worked for a while.
By late 1980s, the combination of (a) high inflation and (b) big changes in the market resulted in these high-yield bonds performing poorly. (see below)
In the late 1980s and early 1990s, junk-bond defaults were a problem.
The dot-com bubble made things worse, causing defaults to approach 5%.
After the 2009 subprime-mortgage crisis, the Fed bought junk bonds to prevent them from failing.
This kept the rate of failures low for ten years; implicitly “guaranteeing” junk bonds were not going to default at that rate again.
Junk Bonds’ Hidden Safety
Global economy shutdown in 2020, created a huge default risk.
True to form, the Fed bought bonds (again), bringing default rates down to below 1%.
When the Fed began hiking interest (from March 2022 onwards) to manage inflation, it increased defaults probability (estimated default from 2.5% to 3%).
By then, the market has factored this in, at the same time.
Bonds Losing Lustre ?
In 2022 when US central bank began hiking interest rate, investors sold junk bonds (in droves), for fear of a spike in defaults.
What happened:
Investors sold off a group of bonds with >12% yield.
All because of a “lack of understanding” that a 3% default rate (at worst, 5%), would have been more than offset by the bond’s yield.
As a result, the high-yield bonds, were massively oversold.
It has taken a long time for market to realize this.
Finally, 2024 is a good year for junk bonds:
They offer high returns and huge discounts on bonds already issued.
Capped by a resilient US economy and the Fed's potential help in a downturn.
The Fed won't let junk bonds fail because they are a huge part of the corporate bond market (at 20%!) with a $2 Trillion value.
Additionally, PDI funds invest in similar assets and finds undervalued ones — buying cheap bonds, collecting the income, and eventually selling them for a profit.
This is how it is able to pay serious dividends.
Dividends & Special Payouts.
PDI's dividend has increased over time, but the big bonus is the extra payouts (orange spikes) from extra income they get. (see above)
PDI is a fund:
With high returns.
That keeps paying investors more.
That gives extra bonuses sometimes.
That has been doing the above for > 10 years.
Caution:
But remember, this does not mean it is always a good investment.
For instance, it has not fully recovered from the 2020 crash. (see above)
Meaning, there are still more upsides to be had when you do your homework to find your best entry and exit thresholds.
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