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By Jeremy Glaser and Steven Pikelny | 06-28-2012 11:00 AM

Is This PIMCO Fund Worth the Hype?

Although this CEF's distribution rate is high, Morningstar's Steve Pikelny says the numbers are misleading and that the fund shop has a less-risky alternative.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Investors seeking income have increasingly been turning to PIMCO High Income, a closed-end fund. I am here today with Steve Pikelny, a closed end fund analyst at Morningstar, to take a closer look and see if it’s a good place for investors to place their bets. Steve thanks for joining me.

Steve Pikelny: Thanks for having me.

Glaser: So let's take a look at this PIMCO fund. I know it's always on lot of people's minds at conferences and elsewhere. Can you tell us a little bit about it?

Pikelny: Well, this is a very weird fund for I think two main reasons. One is the fact that it most notably trades at 73% premium which is enormous even in the closed-end world. It's one of those things when you're a conference, and two closed-end fund analysts are talking to each other, it's kind of something that you can bring up to break the awkward silence because you are aware of the fact that the other analyst knows of it. I mean it is odd that it trades at such a high premium and one thing that you have to ask yourself, is why is that?

The first reason I think is because it's managed by Bill Gross. So a lot of people see the name Bill Gross, who was Morningstar's Fund Manager of the Decade [for fixed income], and they think they are getting a good deal. The second reason is if you just look at the posted distribution rate of 18.8%, that looks enormous, and like you said for investors looking for high income that can be very attractive.

Glaser: That distribution certainly sounds attractive, but is it deceiving?

Pikelny: Yes, in fact it is very deceiving for a few reasons. One is that when you actually include the high premium, you can knock that rate down to somewhere around 10.8%. Another thing is the fact that the fund distributes a lot of shareholders' money back to them; it’s a lot of return of capital. So once you take that into account, it gets kind of knocked down to 7.9%. If you want to peel one more layer back, the fact that investors have to reinvest this return of capital at such a large premium, the rate that they actually realize is probably closer to around 6.3%, and this is mainly because since it's trading at a 73% premium, for every dollar that investors reinvest into the fund, they are essentially getting something like $0.55 back.

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