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PIMCO Dynamic Income Fund (NYSE:PDI) is my largest closed-end fund position and forms a core holding of my income portfolio. There is so much to be enthusiastic about here. The monthly payout structure forms a salary-like source of consistent recurring income that is not only ahead of currently elevated CPI inflation but ahead of the long-term historical return of the S&P 500 when viewed in isolation. A monthly per share cash dividend payout of $0.2205 was last declared, in line with the prior, for a yield of 13.8% against the current price of the CEF. Further, there is a certain reassurance that comes with investing in a diversified basket of fixed-income securities through a PIMCO-run fund. The firm has built a more than half a century reputation of active fixed income investing and is the most well-known active fixed income manager.
Hence, the concern shifts to how safe the dividend is and how much capital loss is palatable for any such regular income. The last 12 months have not been great as a myriad of economic factors sparked carnage across most fixed income asset classes from high-yield credit to non-agency mortgage-backed securities and preferred stocks. PDI is down 14.85% on a total return basis over this period.
Shareholders face a cocktail of macroeconomic risks which will continue to pose headwinds to PDI’s NAV. Indeed, reverse repurchase agreements form around 41% of the PDI’s total managed assets and rising Fed fund rates have raised the cost of borrowing money in the overnight lending market. Rising rates are broadly inversely correlated with the value of non-agency mortgage-backed securities, as well as high-yield credit, two fixed-income asset classes that form the bulk of the NAV.
The NAV Faces Pressure On Macro Headwinds
High-yield credit and non-agency mortgage-backed securities form over 50% of the NAV with a smaller showing from investment-grade debt and municipal bonds.
PIMCO
The outlook for interest rates looks positive with CPI likely to have peaked in the US and other developed markets. Further, with natural gas collapsing to start the year, we could see forecasts for inflation moving closer to the Fed’s 2% target likely come to fruition in the second half of the year.
Trading Economics
Annual US inflation fell for its fifth consecutive month to 7.1% in November last year with the consensus that this will fall to 6.5% when December figures are published. This is important as NAV should start to stabilize once the Fed stops raising rates after an expected peak between 5% to 5.25%. The next threat comes from a possible recession. A survey of 38 economists by Bloomberg last year in December put the chance of a 2023 US recession at 70%, up from 65% in the same survey conducted in November. A soft landing would of course be the best possible scenario, but the likelihood of a recession is high and means continued downward pressure on the price of the CEF.
As the market price of PDI is driven by normal supply and demand dynamics, it often trades at discounts and premiums to its underlying net asset value. We could see this get drawn down to a discount in the event of a global recession which the energy markets are pricing in. Hence, bears could rightly flag that the current 7.62% premium to NAV presents a possible reason to avoid the CEF as this would quickly get eviscerated in a hard landing.
A Dividend-Based Future
Fundamentally, it’s the income that matters. The focus on unrealized capital movements formed my prior investment strategy. Stocks go up and down, but dividends form a tangible and recurring hard source of return on investment. PDI also recently paid out a special year-end dividend of $0.65 per share.
This was the highest special year-end dividend in over five years and came in a year when the price of the CEF fell markedly. It highlights just how critical income is and the strength of PDI’s diversified portfolio even against economic disruption.
PIMCO
With around 35% of the portfolio maturing within a year, the CEF is in an attractive position to cycle out to higher rates when its current securities mature. It’s the income that matters, and this relatively young maturity profile acts as a partial hedge for income against the current environment. PDI will allow my portfolio to benefit from highly diversified exposure to over 1,000 positions across numerous industries and asset classes.
Avoiding capital loss would otherwise form the base of other non-dividend paying investments, but with PDI, the income comes first. This forever income should form the core reason for holding PDI. It’s a certain stability and rock against the unrelenting entropy of the stock market. I intend to add to my position with a view to holding it long-term.
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