Today our eyes wander toward dividends… and specifically toward the “life-changing 12% dividend” promised by Brett Owens in ads for his Contrarian Income Report ($39 first year, probably renews at $99).

Owens has been promoting his income investing strategy for several years, mostly focused on buying closed-end funds and other high-yield investments that he thinks can provide good retirement income without forcing you to sell shares. We’ve covered his teaser ads in the past, most of which have ben for closed-end funds, but the most recent was his persistent pitch to buy TFS Financial (TFSL) in 2021 — that small bank, like many, has had some trouble adjusting to higher short-term interest rates, and they never were able to raise the dividend, as Owens suggested was imminent, so it has performed poorly (total return is negative 13.5% since we covered that January 2021 teaser ad, versus negative 9% for the regional banking ETF and a 55% return for the S&P 500), but, to be fair, most income investments have had a hard time keeping up with the dramatic change in interest rates over the past year.

And folks do love dividends, and more Baby Boomers retire every day and begin to think much more about “income” than about “returns” in their portfolios… so let’s see what Owens is pitching this time. Here’s a bit of the lead-in to the ad:

“If you think this sort massive dividend might be right for you, then I need to urgently warn you:

“You don’t have much time.

“You need to move now if you want to be among the select few who will claim their share, which will be determined in just a few days from now.

“If you miss the deadline to get on the list now, you’ll be leaving money on the table, and you may not have the chance to lock in at 12% when the next distribution comes around!

“But that’s not the only reason I’m writing to you today, because …

“This 12% Yielder Is Poised for Stock-Like Gains

“I’m also imploring readers to grab this fund now because it’s set up for big capital gains as the Fed moves from its current pause on rate hikes to actual rate cuts.”

That’s probably just marketing-speak, since every ad has to have an urgent “must buy now!” pitch in order to get our attention (and even used car salesmen know that you can’t risk giving people time to think it over if you want to make a sale)… but we’ll check on that in a minute.

That “stock-like gains” bit is really just a bet that bonds will have another good run if the Federal Reserve starts cutting rates sometime soon — as is widely expected, though there are other influences that might keep longer-term rates higher than expected, too, giving bond funds less of a boost than some might hope (those influences being primarily the extreme indebtedness of the government and some corporations, which raises risk and keeps rates higher, and the potentially persistent nature of inflation, which also drives investors to demand higher bond yields).

So yes, what Owens is teasing is primarily a bond fund, and it is, of course, a closed-end fund.

Closed-end funds are like other mutual funds or ETFs in some ways, they are managed by companies who charge a management fee, and they invest the capital into a variety of assets, including stocks and bonds, to try to earn a good return for their shareholders… but the big difference is that they have a set number of shares outstanding. Open-end funds, like most mutual funds and ETFs, create and destroy shares each day, depending on demand, and essentially always trade at very close to their fair value (the “net asset value” (NAV) of the portfolio, after fees and expenses). Because the number of shares is fixed, the funds trade at either a discount to their NAV, if there isn’t much demand for the fund, or a premium, if there are more people who want to buy than want to sell. Closed-end funds are often different in other ways, too, in that they often use leverage to boost their returns, and they tend to be focused on providing shareholders with a high dividend yield, though neither of those two characteristics is required.

On average, most closed-end funds trade at a pretty stiff discount to the overall market — that ranges from fund to fund, and is different for different kinds of closed-end funds, but an average discount in the 5-10% range has been pretty typical over the years. And they tend to have pretty high expenses compared to ETFs or open-ended mutual funds, partly because those shares are captive so the management team can get away with charging more… but their expense ratios look even higher, because the cost of their leverage is reported as part of that expense ratio, too, and the cost of borrowing has risen, so it’s not unusual for a closed-end fund to have an expense ratio of more than 5%.

That’s the backdrop… so which one is Owens teasing? Let’s get into the clues:

“… the company that runs this 12% payer really is the top name in the CEF space — I consider them the ‘Apple of CEFs,’ in fact.

“As such, its funds almost always trade at premiums to NAV, or the net asset value of the issues they hold.

“Heck, as I write to you today, one of this company’s CEFs trades at a 26% premium!”

OK, so that almost certainly means he’s talking about a PIMCO close-end fund… but let’s see what other clues we get:

“… buying attractively valued CEFs with big dividends and savvy managers is a proven way to build wealth over time.

“And the bond-buying pro running the fund we’re targeting today is, hands-down, the savviest of the bunch.

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“Morningstar previously named him a Fixed Income Manager of the Year, and he has been inducted into the Fixed Income Analysts Society Hall of Fame.

“When he took the top job at his management company, he displaced the firm’s founder — a legend who revolutionized bond trading in the ’70s and ’80s. His track record is a matter of public record.”

The ad also shows a chart for one of the other funds this same manager has run for the past nine years, and by matching that chart performance we can tell you that’s the PIMCO Dynamic Income Fund (PDI)… here’s what the performance has looked like since the current managers really took over at the end of September, 2014 (that’s when Bill Gross left PIMCO, though at that point this particular fund was already managed by a team that includes Alfred Murata, Joshua Anderson, and Dan Ivascyn, PIMCO’s current CIO who has a finger in most of their funds):

That compares PDI to the benchmark Owens chose in his ad, the SPDR Bloomberg High Yield Bond ETF (JNK), which is probably reasonable — pretty much any conventional bond fund or ETF over the past decade would have a total return somewhere in the 15-40% range. Until the past year or so, rates were often falling, which helps bonds, but they were also so insanely low already that falling rates couldn’t help very much, and total coupon yields were so low that generating any income was a big challenge.

And yes, essentially all of that return was in the form of dividends, by design, because investors in closed-end funds are almost always looking for high and relatively steady yields, not for a rising share price — here’s what the total return looks like for that fund if you ignore the high dividends:

And that’s the key with these funds — there’s some natural erosion in the net asset value, partly because of high fees and borrowing costs (they use leverage to amp up their returns), and partly because bonds lose value when interest rates rise, but investors accept that because the dividend is high enough, and steady enough, to more than make up for that erosion.   This particular closed-end fund has paid a monthly dividend of 22.05 cents since 2015, with occasional special dividends thrown in when they had bonus income (the last special dividends were all in the 75 cent-$1 range, paid in late 2018, late 2019, and mid-2022, none have been paid recently).

That’s the kind of stability that income-seeking folks look for in a closed-end fund, and it’s why a few other successful income funds, including some other funds from PIMCO, have usually traded at a pretty stiff premium, even though most closed-end funds have historically traded at a discount.

So presumably his “expert” is Dan Ivascyn, who worked with former “Bond King” Bill Gross at PIMCO for a good 20 years before taking over when Gross and PIMCO went their separate ways.   He is nowhere near as flamboyant or media-friendly as Bill Gross, and is not at all famous, but he did go into that “Hall of Fame” a few years ago, and does have a good record.  And yes, he was named Fixed Income Manage of the Year back in 2013 (along with Alfred Murata, his co-manager at the huge Pimco Income Fund, their flagship open-end mutual fund).

What other clues do we get?

“Our manager also has a team of 4 other bond experts backing him up that, between them, boast 95 years of experience.

“So we can be sure we’re getting the cream of the crop working for us here — and that’s particularly critical in the small world of fixed income, which isn’t as “democratic” as stocks.

“Well-connected managers get the first call when new issues roll out, and our top-flight manager and his team are at the top of the ‘to-call’ list.

“This, by the way, is why we always go with CEFs over ETFs for our bond picks. ETFs are simply tied to a ‘robotic’ bond index — so there’s just no way they can compete.”

And then we get some other hints… and importantly, though it’s a PIMCO fund, and Dan Ivascyn is one of the managers, it’s not yet trading at a huge premium like some of their other closed end funds:

“… because our 12% yielder is only a couple years old, CEF investors, conservative sorts they are, haven’t warmed to it yet. It trades at a premium, too, but at just under 4% that’s really a discount in disguise for this dynamic firm’s usually pricey funds.

“The bottom line is that when our pick hits premiums in the same range as its older cousins, it’ll drive the share price up double-digits.

“And that’s BEFORE the ‘baked in’ upside we’ll get as Powell shifts toward rate cuts.

“Plus, this one, like all of this legendary manager’s funds, has a broad mandate, so we get him completely unchained and working for us.

“This bond-trading legend is free to use his proven talents, his firm’s vast research resources and his deep contact book (essential in the cozy world of corporate bonds) to get first crack at the best new issues, whether they’re high-yield corporates, ultra-safe municipals or — a specialty — mortgage-backed securities (MBS).”

So which fund is Brett Owens pitching as the top income play with a “life-changing 12% dividend?”  Thinkolator sez that if you want this PIMCO management team, a yield of about 12% right now, and you want to pay a premium of something between 0-6%, there are a few choices — PIMCO Access Income (PAXS) or Dynamic Income Opportunities (PDO), both of which use roughly 40% leverage and have a lot of investing flexibility, PIMCO High Income (PHK), which also has a pretty open investing mandate in credit markets but uses less leverage, about 20%, or PIMCO Income Strategy (PFL) or Income Strategy II (PFN), both of which invest in floating rate debt and use less leverage (about 20%)… the other PIMCO closed-end funds all trade at double-digit premiums right now.

How else can we narrow it down?  Well, Owens said that the reason this fund trades at only a 4% premium is that it’s pretty new, only a few years old — so that means it’s not PFL, PFN or PHK, all of which trade at smallish premiums despite being publicly traded for decades.   So our only real candidates are PAXS (launched in 2022) or PDO (2021).  That makes PAXS the match if we’re actually to take Owens at his specific word with that “couple years” comment… but, since PDO actually has five named managers now (PAXS has six), PDO is the better match if we’re to take the specific “four other managers” clue seriously.

But there’s one more clue, too, so we can get a firm answer… we get some more specifics about the distribution…

“In addition to its monster 12% yield, this fund has a history of actually growing its payout: since its inception just two years ago, it has already increased its regular dividend by 8% and has paid two special dividends, too!”

And we get this image in the ad:

So we can tell you that yes, Brett Owens is teasing PIMCO Dynamic Income Opportunities (PDO), since that’s an exact match for their distributions page at CEFConnect (which is a great website for exploring closed-end funds)… here’s my screenshot of that page, just FYI:

So no, he was not being accurate and “current” with his “two years ago” comment, since PDO started trading publicly in early 2021… but close enough.

What else can we tell you about PIMCO Dynamic Income Opportunities?  This is from PIMCO’s description:

“The fund will normally invest at least 25% of its total assets in mortgage-related assets issued by government agencies or other governmental entities or by private originators or issuers. The fund may invest up to 30% of its total assets in securities and instruments that are economically tied to “emerging market” countries; however, the fund may invest without limitation in short-term investment grade sovereign debt issued by emerging market issuers. The fund may normally invest up to 40% of its total assets in bank loans (including, among others, senior loans, delayed funding loans, covenant-lite obligations, revolving credit facilities and loan participations and assignments). It is expected that the fund normally will have a short to intermediate average portfolio duration (i.e., within a zero to eight year range), although it may be shorter or longer at any time depending on market conditions and other factors.”

That relatively high exposure to mortgages does make it stand out a little, though many of Ivascyn and Murata’s other funds at PIMCO have also bet heavily on mortgages from time to time.  They currently offer a 11.5% yield at today’s market price (12.79 cents per share, per month, equals a total of $1.53/year, which is 11.51% of the current $13.33 share price).  The price has bumped up a little, it traded down to $12.50 back in April and dipped as low as $10 or so late last year… but the monthly distribution hasn’t changed since the last increase in July of 2022, and they haven’t paid a special dividend since December of 2022. Today the fund trades at a 4.5%+ premium (NAV as of July 5 was $12.72, current price is about $13.33, so that’s a premium of about 4.8% at the moment — the NAV is reported with a slight lag, the discount has generally been in the 3-5% range this year, but varies quite a bit). Here’s the total return for PDO since inception (early 2021), in purple, compared to the Bloomberg US Aggregate Bond Index:

So you can see it’s driven by the same forces as the bond market, generally speaking… but it’s much more volatile. Morningstar puts it in the bottom quartile of funds in the category for both 2022 and 2023… but in the top quartile so far this year.

Sound like the kind of thing you’d like to invest in? The opportunity to outperform, if there is one, probably comes from a gradual decline in interest rates and/or a rise in the premium at which PDO trades to its net asset value — I don’t know if we’ll see that in the future or not, but “moderating interest rates” is certainly an outcome that a lot of experts expect.  And there is some history of similar funds from PIMCO trading at larger premiums.

PDO’s bond portfolio has an average effective duration of about 4 years, longer than the more established PIMCO Dynamic Income (PDI) fund (3 years), so it might be a little more interest rate-sensitive, depending on which way rates go, but this is otherwise a pretty similar fund, with a big allocation to mortgages and about 40% leverage. PDI has a higher distribution than PDO right now, with about a 15% yield, and trades at a much higher premium (about 13%), and it has outperformed its younger and smaller sibling, despite the fact that the funds share three of their managers and have similar allocations. If you start three years ago, when the two funds both traded at a similar premium to where they’re valued today, here’s the total return for the two (PDO again in purple, YCharts gives the two funds the same name and omits the word “opportunities” for PDO for some reason)…

And because much of the argument for buying closed-end funds should focus on whether the fund trades at a discount or a premium, and how sustainable that might be, here’s the premium/discount history for those two over those same three years — they’ve mostly expanded or contracted at the same time, but the gap has persisted so far, people keep paying a much higher premium for the more-established (and somewhat higher-yielding) PDI than they do for the smaller and younger PDO, which has often traded at a discount (especially when bonds performed terribly last year due to rising rates, and everyone ran away), but has this year ranged from a 0-5% premium:

How about that potential for a rate cut from the Federal Reserve?  That’s part of the rationale for Owens’ recommendation, he thinks that the Fed will cut rates, which will boost the value of existing bonds… and that’s probably true, at least for some bonds (it should have less impact on longer-term rates like mortgages or the 10-year note, for example, but will dramatically shift the rates for 6-month T-bills).

There’s not a lot of recent evidence for how these funds perform when interest rates change — but here’s how a few PIMCO funds did while the Fed was cutting rates back in 2019 (they got slashed to zero during the COVID outbreak, which is certainly seared into our memory, but it’s easy to forget that before that the Fed had been on a mild rate-hiking cycle from 2016-2018, so the overnight rate topped out at 2.5% in January of 2019, and they started gradually cutting it that summer — I ended this chart in February of 2020, just because the COVID outbreak completely changed everything, but that’s PDI, which is the fund that is most similar to the PDO fund Owens is teasing today, in purple, compared to PIMCO High Income (PHK) in orange and the open-end fund PIMCO Income (PONAX) in blue, the pink line is the S&P 500, which had a great year going into COVID, perhaps partly spurred by those rate cuts, and the green line shows the actual cuts to the Fed Funds Rate in the second half of 2019:

So not a ton of data to go on there, but yes, those bond funds (and the stock market) did perform well the last time the Fed started to cut rates.  And yes, it’s probably true that investors are lusting for a similar impact this time around, and may even be counting on it.

And in case you’re wondering, yes, the PDI closed-end fund did also begin to trade at a slightly higher premium during that time when the Fed was cutting rates, though the PHK fund did not — here are those premium/discount calculations for PDI, which rose from an 18% premium before the rate cuts to max out at 25%, though it moderated to 21%, and PHK, which fell from a 30% premium to 21%:

That backs up the Owens argument at least a little bit — bond funds would likely do a little better if the Fed cuts rates, and the one that’s most similar to PDO did get a boost from a higher premium last time we saw rate cuts.  Doesn’t mean that’s how it will happen this time, the financial world is otherwise very different than it was in 2019, but it’s possible we’ll see a similar impact if the Fed has a few rate cuts over the next year or so.

So… what’s an investor to do? I actually agree that closed-end funds often make more sense than ETFs or mutual funds when it comes to bond investing, just because having that fixed pool of assets means they don’t have to redeem shares when bonds are doing poorly, but I’m not as income-focused as some folks, and I do find it hard to pay a big premium price to get into shares of a levered closed-end fund, even if the historical performance of a manager might justify that premium.

That might just be the experience of 2008 talking, since I remember so many levered closed-end funds getting clobbered back then — not because their portfolios crashed, though most did, but because the leverage bit hard, and at the worst moment.  Some funds had to sell a lot of their holdings near the bottom because they were using very short-term borrowing to lever up their portfolios, and suddenly that short-term borrowing just wasn’t available and the debt they had grown accustomed to couldn’t easily be refinanced in a hurry, so they had to either pay much more for their leverage or wind down the portfolios at the worst possible time.

Still, it worked out reasonably well for some of them, including some of the PIMCO closed-end funds managed by Bill Gross during the global financial crisis.  PDI and PDO weren’t around back then, but here’s how another levered PIMCO closed-end fund did, this is the total return for PIMCO High Income (PHK), which traded at about a 13% premium to NAV and paid out a 12% dividend yield when this chart begins, back in February of 2008, roughly six months before the crash really took hold (purple is the share price for PHK, orange is the total return including dividends):

Lessons from that?  Well, the dividend from PHK is similar today, still around 13% (it has mostly been in the 10-15% range for the past decade), and the long-term total performance has been solid because of that dividend, even though the share price of the fund has fallen by 60% or so in those 16 years… but that long-term chart also obscures the fact that you had to hold on through a period of substantial panic back there in late 2008 and early 2009, when the fund crashed by almost 75%.

Levered closed-end funds can provide a lot of income, but they can also be very volatile… and they usually participate, at least for a little while, if there’s any kind of panic in the stock market.   By contrast, the open-end PIMCO Income (PONAX and other tickers), a more traditional multi-sector bond mutual fund which is dramatically larger and isn’t designed to be as risky as PHK, has provided almost exactly the same total return as PHK over the past 16 years, with a lot less volatility (that open-end mutual fund is also designed to pay out high regular income, though in their case it’s mostly averaged 5-6%/year, not the 12%+ of PHK).

(Just FYI, if you like the more traditional mutual fund PIMCO Income, do note that it has several share classes, PONAX is just one of them, and that class has a front-end sales load, while others eschew that load but have a higher expense ratio — PIMCO has a good track record in bond funds, so it may be reasonable to decide that they’re worth the money, but just note that they’re higher-cost actively managed funds, not the lower-cost index funds that many investors prefer, so they’re pretty much at the opposite end of the spectrum to Vanguard when it comes to fees and expense ratios… and with these funds, where several versions are sold, the share class you choose can sometimes make a big difference to overall returns).

Shooting for higher returns — whether that’s higher short-term income or just higher overall returns — almost always means you take a little more risk.  And if you happen to be investing through a tumultuous period, taking more risk usually means that you see much bigger declines in your portfolio… which might end up being fine, if you can hold through it and avoid selling near the bottom, and if the fund or investment does recover, as one hopes, but it’s never easy.  And there’s no guarantee that every higher-risk investment will eventually bounce back from whatever the next crisis might be.

I’d like to think that the closed-end fund managers learned their lessons from the 2007-2009 craziness, and it might well be that they’re much more rational and careful with the leverage now… and it’s also probably true that the next crisis will be completely different from the last couple crises, since that’s the way the world usually works. But I think I still have too many 2008 scars to buy levered closed-end funds at premium prices, personally.

Luckily, you don’t have to have the same hang-ups as I do, and you can use your own experience, analysis, and biases to make your investing decisions… so, do you like the idea of these high-yield PIMCO closed-end funds? Think the one Owens is teasing, PIMCO Dynamic Income Opportunities (PDO) will join its near-peers (like PIMCO Dynamic Income (PDI)) in trading up to a steeper premium valuation in the future, as it keeps paying (or possibly growing) its 12% distribution?  Or is there too much risk in the premium valuation or in the leverage, or do you perhaps dislike the management decisions or relatively high management fees at PIMCO? Let us know with a comment below… thanks for reading!

P.S. What about that “gotta buy immediately” part of the tease? Do you have to move right-now-hurry-up-quick to get that next distribution, or forever regret your sloth? Not really. If you like PDO and want to buy into that ~12% yield, it’s paid out in smallish monthly dividends, so the impact of each dividend is limited. The next one will be 12.79 cents per share, and the ex-dividend date is July 11, so if you buy the shares in the next couple days, by Wednesday (July 10), you should get that next dividend (paid out in early August)… odds are very high that the next one will be exactly the same, paid to shareholders who own the stock by early August and delivered in September. Each monthly dividend amounts to just about 1% of the share price, and the share price itself has bounced around in roughly 2% range over the past two months, and should drop by close to 1%, all else being equal, at the open on Thursday morning, to account for that dividend, so I wouldn’t panic about catching one monthly payout — there’s no huge risk in thinking it over before your itchy “buy” finger mashes that keyboard. If there’s a big move in PDO over the next month, it will probably be because investor sentiment shifts when it comes to future interest rate, economic growth, or inflation expectations — but whether that next sentiment shift will be positive or negative is essentially a coin flip.

The next Federal Reserve Open Market Committee meeting to discuss interest rates will be July 30-31, with a press conference and announcement of their decision on the 31st, and no moves are expected at that meeting but a surprise could always emerge… or the wording of that announcement could impact opinions about whether a rate cut might be coming in future months… so unless there’s a surprise data point in the meantime, that’s probably the next time folks will be really ginned up about interest rate bets, and therefore when the prices of these income-focused investments might jiggle around a little more than usual.

Disclosure: I do not own any of the investments mentioned above, and will not trade in any covered investment for at least three days after publication.