Income investors don't have to pick specific dividend stocks and bonds to buy. They can instead put their money into funds. The best of these funds have managers with the expertise to find opportunities that individual investors would normally be unable to spot.
Pimco Dynamic Income Fund (PDI 0.05%) is a great example. Here's why buying this 14.5%-yielding fund could be a brilliant move.
An income investor's dream
Many income investors' mouths will probably water, thinking about a 14.5% yield. But the story for Pimco Dynamic Income Fund (PDI) gets even better. This closed-end fund (CEF) pays its distributions monthly instead of quarterly.
PDI's lead manager, Dan Ivascyn, took the helm as PDI's chief investment officer in 2014, following in the footsteps of the "Bond King," Bill Gross. Ivascyn has his own nickname: His colleagues have described him as a "beast" for his work hours and market savvy.
Under Ivascyn's leadership, PDI scours fixed-income sectors across the globe to find great investment opportunities. The fund currently has net assets of nearly $4.5 billion. It owns bonds issued by the U.S. government, municipal governments, and emerging market countries. However, PDI is also heavily invested in mortgage-related securities and other income-generating assets.
Since its inception in 2012, PDI has delivered an average total return of around 10%. Its net asset value (NAV) increased every year during that period, except in 2022 when a string of big interest rate hikes by the Federal Reserve hammered bond prices.
The price is right
There's a simple way to know whether a fund is a bargain. Just compare its current price to its NAV. If the price is below the NAV, the fund is trading at a discount.
Currently, though, PDI's price is roughly 4.8% above its NAV. Don't think the fund is too expensive, however. Actually, PDI has typically traded at an even higher price-to-NAV premium. The gap between price and NAV in the following chart illustrates this.
More importantly, there's good reason to expect PDI's price to increase in the not-too-distant future. Why? When interest rates move lower, PDI's price moves higher. And interest rates should come down, especially if the U.S. economy enters a recession, as many economists predict.
PDI's price could rise well before interest rates decline. Bond traders, like most investors, are forward-looking. If they think rates are likely to come down in the near term, bond prices (and the prices of funds, like PDI, that own bonds) will move higher in advance of the interest rate decline.
Playing devil's advocate
There are admittedly a few knocks against buying PDI. For one thing, interest rates could remain high for much longer than many anticipate. That could put a damper on any upward momentum for the fund.
PDI's fees are also steep relative to many funds. Its management fee is currently 1.1%. Total expenses are even higher. For example, PDI uses leverage (borrowing), which means it incurs interest expense.
The bonds PDI buys have a risk of default. This risk is lower with debt issued by stable governments. But the fund also owns a lot of riskier assets.
Brilliant move?
Even if interest rates don't decline soon, it seems likely that they won't move much higher. Income investors probably won't mind receiving an ultra-high yield while their initial investment doesn't change much.
Sure, PDI's fees are high. But they also give investors access to some of the greatest bond experts on the planet. And the fund's yield of 14.5% is net of all fees.
Especially risk-averse investors will probably be better off looking elsewhere. For those seeking high income and willing to accept some risk, though, buying PDI could be a brilliant move.