PIMCO Global Income Opportunities: enthusiasm vs reality

By Dan Hallett on March 27, 2014

Tom Bradley just posted a smart analysis of a new closed-end fund.  PIMCO’s newly-launched Global Opportunities Income fund attracted $600 million – the top end of its target.  That’s a very warm reception to say the least.  I won’t repeat Tom’s excellent analysis but would like to expand on a couple of points he made.

Higher return = higher potential risk

The fund is targeting a distribution equal to 6.5% of the initial value of the fund.  The prospectus highlights that the portfolio they’ve designed for this fund boasts a recent yield of 7.2% per year.

With GIC rates and government bond yields so low, too many investors assume that managers like PIMCO – considered an elite bond manager – can achieve high returns without exposing investors to higher risk.  As I stated at the MFDA’s Seniors Summit last September – coincidentally on a panel with Tom – investors and advisors must assume that higher potential risk always accompanies the potential for higher returns.

With 7- and 10- year Canada bonds yielding 2% and 2.5% per year respectively anything offering a gross yield north of 7% must – by definition – have significantly higher risk potential than those guaranteed options.  The benefits of an offering like this will be obvious but you’ll have to dig a little to uncover the true associated risk factors.

Leverage & fees

Tom notes that the fund’s 1.25% management fee is charged not on the net asset value but on the total – or ‘gross – asset value.  For most funds this is little difference between these two descriptions.  But it’s an important distinction for a fund employing leverage – i.e. borrowing money to increase total investment assets.

The fund will initially employ leverage equal to 25% of total assets, which equals 1/3rd of the initial net proceeds raised.  But management expense ratios are computed on net assets.  So charging a 1.25% fee on total assets with 25% leverage equates to a management fee of 1.88% including HST.  With its maximum leverage of 1/3, the management fee would be 2.12% including HST on the fund’s NAV.

These figures exclude interest costs from borrowed funds, which could push the fund’s management expense ratio toward 3% annually or higher depending on how much leverage is employed and how long it is maintained.

PIMCO_GlobalIncomeOpps_Leverage_Fees

IPO investors starting deep in the hole

I’m not a fan of buying a closed-end fund at IPO because the most eager investors effectively shoulder all of the costs of listing the fund on the stock exchange.  IPO investors ponied up $600 million, out of which they paid $30.2 million in issuance costs.  Investors, then, start more than 5% under water out of the gate.  Factor in fees and taxes and the fund must generate a total return of 7.2% in year 1 – gross of fees – to get back to square one.

Extending the above calculation, I also find that the fund’s distribution policy – i.e. 6.5% of the initial net proceeds – requires a total return of 13.7% in year one (gross of fees) to cover the issuance costs and the cash distribution.  After year one, the fund will need to sustain a minimum total return of 8.4% per year before fees to sustain the distribution longer-term without eroding the unit price.

PIMCO_GlobalIncomeOpps_ReturnTargets

While these return thresholds are calculated gross of fees, they don’t take into account the impact of interest costs – which bumps up fees.  While the fund’s U.S. cousin – PIMCO Dynamic Income – has generated strong USD returns, this was achieved by taking risk that will materialize the next time credit markets hit a soft patch.

Perhaps this will be a fine investment.  But if you invest for yourself or recommend it to clients, make sure you flesh out the above issues and other relevant risks in much greater detail.

About Dan Hallett

Dan Hallett is Vice President and Principal at HighView. With over 20 years of industry experience, he is widely recognized as an investment expert. His professional opinion is regularly sought by print, TV, radio, and online media publications. He has also contributed to several best-selling personal finance and investment books.
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