PIMCO's PTY Is Rebounding And Still Yielding 9.88%

Dec 06, 2023

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Shares of the PIMCO Corporate and Income Opportunity Fund (NYSE:PTY) fell to its lowest point since the pandemic, reaching $11.25 per share. After bottoming in the Fall of 2022, shares of PTY have appreciated by 28.62% and have appreciated by 18.03% YTD. Since I wrote my first article on PTY (can be read here) on January 16th, 2023, shares have returned 16.04% compared to 12.56% for the S&P 500. Pre-pandemic PTY traded in the high teens and almost reached the $20 per share level, and in the 2021 rally, shares exceeded $20 for a short period. PTY has bounced off the bottom, but there could still be some more room left for it to run while generating an enticing distribution. With the Fed's tightening coming to an end and rates set to decline in 2024, PTY could become a sought-after income play as capital matures from short-duration CDs and Bonds.

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Over the past year, the Fed has raised rates quicker than at any point in the past 25 years. This has caused risk-free assets to generate lucrative yields. After the recent hike, the 2-year T-bill is now yielding 4.89%, while you can get over 5% from a 1-year CD, the current yield on a Fidelity Money Market is 4.98%, and financial institutions such as SoFi Technologies (SOFI) are offering 4.5% on checking and savings when you sign up for direct deposit. Getting a risk-free rate at these levels has created a situation where nearly $5 trillion is parked in money market accounts, according to CNBC.

The markets have been on fire in 2023, and at this rate, there is a chance that new highs will be reached in 2023. The problem for many people is that a portion of their investment capital was allocated toward risk-free assets, and they have been on the sideline during the 2023 rally. CDs and T-bills yielded around 4% at the beginning of 2023 when the fears of recession, the impacts of inflation, and a rising rate environment enticed people to take the flight to safety in risk-free assets. The problem has now become that capital was committed for a period of time, and in order to get the desired yield that they signed up for, the capital will need to stay locked up for the duration. For those that purchased a 1-2 year CD or a 2-year T-bill, selling now, taking the penalties, and losing the yield isn't enticing. The yield that enticed them will evaporate, and the current upside has already been factored into the market.

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A large capital inflow could be injected into the market when risk-free assets mature. The rising rate environment made risk-free assets look attractive because they offered a larger yield than many equities, and there was no downside risk. Investing in The Coca-Cola Company (KO) at a 3% yield for an income investor when downside risk needed to be factored in wasn't as enticing when rates hit 4% compared to when rates were under 1%.

St. Louis Fed

The St. Louis Fed indicates that rates will decline to 4.6% in 2024 and 3.4% in 2025. As the money that was locked up in CDs and T-bills starts to mature, the Fed is projected to start rate cuts. In a rising rate environment, it seems like a good idea to grab risk-free assets with mid-single-digit yields, but when rates are falling and capital is maturing, those same assets won't be as attractive. When capital starts maturing, income investors on the sideline will consider entering the market again, which is good for funds such as PTY. While capital will flow to an array of areas, high-yielding CEFs such as PTY, which is generating close to a 10% yield, should see elevated levels of inflows. An inflow of capital from the sidelines should help the market appreciate, and if PTY becomes a new home for capital to generate yield its shares should move higher. PTY has gradually been grinding higher from its lows, and I wouldn't be surprised if we see shares of PTY get back to the $17-$20 level in 2024.

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When you buy a business, you don't have a sign hanging over its location updating its value daily. You buy a business for the cash flow and to make money. Some investors are not enthusiastic about income investing because they're looking for capital appreciation. Others, who many classify as an income investor, are looking at the cash flow an investment generates and how it can compound into additional cash flow in the future. I invest in all types of companies, but a portion of my portfolio is dedicated to income-producing assets. If you're looking to generate capital appreciation, PTY is as exciting of an opportunity as investing in an S&P 500 index fund or just buying Apple (AAPL), in my opinion. PTY is still interesting if you're looking for a CEF that invests in many different income-producing assets and generates a strong yield.

PTY is a hybrid CEF as it aims to generate a maximum total return by creating current income that is distributed to investors and generating capital appreciation. PTY allocates 80% of its investible assets and borrowings toward an array of assets that include corporate debt, 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. PTY uses a dynamic asset allocation strategy among multiple fixed-income sectors in the global credit market. PTY has an effective leverage ratio of 28.62% that allows them to enter into transactions that include selling credit default swaps, futures, and forward contracts, total return swaps and other derivative transactions, loans of portfolio securities, short sales, and forward commitment transactions.

The real question becomes, can an investment that has basically done nothing from a capital allocation standpoint still make a good investment? My answer is yes if the distributions are large enough. Just like a business owner, I am not looking at shares of PTY's price day in and day out, I am looking at it from an income generation perspective. PTY had an IPO market price of $15, a 4.68% premium to its initial net asset value (NAV) of $14.33, and after just more than 2 decades, shares are trading at $14.55, down -3% since inception. In the capital appreciation world, this would be a tragedy, but PTY generates a monthly distribution that needs to be accounted for in addition to special distributions and capital gains. Since February of 2003, PIMCO Corporate and Income Opportunity Fund has distributed $38.65 of income.

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From an income perspective, if I was focusing on income and you told me that for every $1,500 invested, I would generate $3,865 of income over a 21.83-year period, and my original investment would be worth -3% lower at $1,433 I would make that deal. Between the original investment being worth $1,433 and the income generated of $3,865, your investment would be valued at $5,298, which is a 253% return on invested capital, as you would be in the black by $3,798. This is an 11.6% annualized return based on the 21.83-year period. The investment would have paid for itself multiple times and is still producing forward income. At this point, you're playing with the house's money several times over, and you have an underlying asset that you can still sell in the future after it generates more income if you choose to do so.

I get it, there are many people who couldn't imagine holding something for 21.83 years. If you had purchased shares of PTY 5 years ago, shares were trading at $17.79, and since then, there has been a -19.45% depreciation in shares. PTY has generated $7.39 in income over the past 5 years, and when you combine the underlying asset at $14.33 and the $7.39 of distributable income, the overall investment would be worth $21.72. The original share price may be down -19.45%, but you would be up 22% on the investment with an underlying asset that is still producing forward income. From an income perspective, PTY is very interesting because buying an income-producing asset that has proven over the long term can produce double-digit returns on an annualized basis, and in the short term, while shares are down, it can still provide a positive ROI on invested capital.

I like PIMCO's CEFs as income-producing assets, and PTY is interesting in the future. Shares have started to rebound, and over the next 12-24 months, I feel there is a strong possibility that capital allocated to risk-free investments will find its way back into the market as CDs and T-bills face declining yields. I think PTY will be a strong candidate for income investors as it has a multi-decade track record of generating ongoing income, and since its inception, PTY has distributed 257.67% of its original share price in income. I plan on adding to my position in PTY and reinvesting the distributed income before money flows into the markets from the sideline.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of PTY, AAPL, KO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Disclaimer: I am not an investment advisor or professional. This article is my own personal opinion and is not meant to be a recommendation of the purchase or sale of stock. The investments and strategies discussed within this article are solely my personal opinions and commentary on the subject. This article has been written for research and educational purposes only. Anything written in this article does not take into account the reader’s particular investment objectives, financial situation, needs, or personal circumstances and is not intended to be specific to you. Investors should conduct their own research before investing to see if the companies discussed in this article fit into their portfolio parameters. Just because something may be an enticing investment for myself or someone else, it may not be the correct investment for you.

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