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PIMCO Versus DoubleLine CEFs: Which Are Better?

Summary PIMCO multi-sector CEFs outperformed DoubleLine over a 3-year period, but DoubleLine was best over the past year. PIMCO and DoubleLine multi-sector CEFs were not very correlated with one another. High premium funds, like PGP and PHK, have had relatively poor performance. As a retiree seeking income at a reasonable risk, I have allocated a significant portion of my portfolio to bond funds. I do not have the time or requisite knowledge to select suitable individual bonds, so I purchase professionally-managed Exchange Traded Funds (ETFs) or Closed-End Funds (CEFs). The ETFs are typically passive funds that track an index while the CEFs are actively managed. In the current environment of potentially risking rates, my preference is to invest in CEFs where the manager has the flexibility to reduce interest rate sensitivity by revamping their bond portfolio and diversifying away from indexes. Two of the most popular firms offering bond CEFs are Pacific Investment Management Company, better known as PIMCO, and DoubleLine. PIMCO had some rough times last year when “bond king” Bill Gross quit to take a position at Janus Capital. Allianz, PIMCO’s parent company, bled over 5 billion in market cap in a panic sell-off shortly after Gross left. However, it is still generally recognized that PIMCO has an excellent staff with deep experience in the bond market. Jeff Gundlach launched DoubleLine Capital in December 2009. With the departure of Gross from PIMCO, Gundlach has been crowned by many as the new “bond king.” Both PIMCO and DoubleLine have great reputations, so I decided to compare the multi-sector CEFs offered by these two companies to assess which company has had the “best” performance. There are many ways to define “best.” Some investors may use total return as a metric, but as a retiree, risk is as important to me as return. Therefore, I define “best” as the fund that provides the most reward for a given level of risk and I measure risk by the volatility. Please note that I am not advocating that this is the way everyone should define “best;” I am just saying that this is the definition that works for me. PIMCO Multi-Sector CEFS These funds are actively managed and their holding may change without prior notice. The funds typically use a combination of leverage and derivatives to enhance distributions. This strategy can generate above average income but can also run into trouble, like the 2008 bear market, where many of the PIMCO CEFs had substantial losses. The multi-sector bond CEFs are summarized below. PIMCO High Income Fund (NYSE: PHK ). On Wednesday, September 24, 2014 (the day before Gross announced his decision to leave PIMCO), this CEF was selling for a whopping 47% premium. This was not unusual since this fund typically sold at premiums of 50% or more. The premium has now dropped to about 42%; still large but well off the highs. The portfolio consists of 298 bonds, partitioned among corporate (39%), asset backed (28%), municipal (13%), loans (12%), and Government (5%). The effective leverage-adjusted duration is 4.2 years. The fund utilizes 26% leverage and has an expense ratio of 1.2%. The fund has an extremely high distribution of 13.7%, with no return of capital (ROC) over the past year. Note that in 2008, the price dropped 45% and in 2012, the fund hit another rough patch as the price only increased by 4.8% even though the Net Asset Value (NAV) soared over 40%. This divergence in 2012 was because the premium sharply declined from 70% to “only” 35%. PIMCO Income Strategy Fund (NYSE: PFL ). This CEF sells at a discount of 6%, which is unusual since the fund typically sells at a premium. Over the past 3 years, the fund has sold at an average premium of 2.4%. The fund holds 231 bonds allocated among corporate (43%), asset backed (24%), Government (12%), and loans (9%). The effective leverage-adjusted duration is 3.1 years. The fund utilizes 27% leverage and has an expense ratio of 1.2%. It has a distribution of 10%, with no return of capital. In 2008, the fund lost about 50% in both price and NAV. PIMCO Income Strategy Fund II (NYSE: PFN ). This CEF currently sells at a discount of 3.4%. In 2010, the fund strategy was revamped to decrease the focus on floating rate loans and enable the managers to invest in a wider range of fixed income assets. This is a sister fund to PFL and invests in securities with durations in the low-to-intermediate range. The effective leverage-adjusted duration is 3.2 years. The portfolio holds 260 securities partitioned among corporate (40%), asset backed (29%), Government (9%), and loans (9%). The fund utilizes 23% leverage and has an expense ratio of 1.2%. The distribution is 9.6%, with no return of capital. PFN was hit hard in 2008, losing over 50% in both NAV and price. This fund also struggled in 2013, with the price declining by 1%. PIMCO Global StockPLUS & Income Fund (NYSE: PGP ) . This CEF currently sells for a huge premium of 48% but this is a large drop from 52 week average premium of 67%. Over the past 5 years, the average premium has been 63% but on occasion, the premium has dropped to 30%. This fund utilizes an innovative approach by investing in S&P 500 and MSCI EAFE futures as well as bonds. The fund may also employ an equity index option strategy to increase income. The bond portion of the portfolio is focused on asset backed (46%) and corporate bonds (26%). The fund utilizes 38% leverage and has an expense ratio of 2.3%. The effective leverage-adjusted duration is only 1.2 years. The distribution is a high 11.6%, with no ROC over the past year. In 2008, the fund lost almost 50% in NAV and the price declined by 37%. The price of the fund also had losses in 2011 and 2014. PIMCO Income Opportunity Fund (NYSE: PKO ). This CEF currently sells at a discount of 2.5%, but over a 5-year period, this fund had an average premium of 2.6%. The portfolio has 421 holdings, allocated primarily among asset-backed bonds (43%) and corporate bonds (35%). Only about 70% of the bonds are from the USA. The fund utilizes 44% leverage and has an expense ratio of 2%. The effective leverage-adjusted duration is 3.4 years. The distribution is 9%, with no ROC over the past year. During 2008, this fund lost a little over 20% in both price and NAV but has not had a losing year since. PIMCO Dynamic Credit Income Fund (NYSE: PCI ). This CEF sells at a discount of 11.8%, which is a larger discount than the 52-week average of 8.9%. The fund was launched in January 2013, so it does not have a long history. It holds 625 securities, spread across corporate (32%), asset-backed bonds (44%) and cash equivalent (9.3%). The fund utilizes 43% leverage and has a 2.4% expense ratio. The effective leverage-adjusted duration is 3.2 years. The distribution is 9.2%, with no return of capital. PIMCO Dynamic Income Fund (NYSE: PDI ). This CEF sells for a discount of 6.7%, which is a larger discount than the 52-week average of 3.3%. This fund was launched in May 2012, so does not have a long history. It holds 397 securities, invested primarily in asset-backed bonds (68%) and corporate bonds (17%). The fund utilizes 46% leverage and has a high 3.1% expense ratio. The effective leverage-adjusted duration is 3.4 years. The distribution is 8.6%, with no return of capital. DoubleLine Multi-Sector CEFs DoubleLine funds have over $63 billion of assets under management and the founder, Jeffery Gundlach, has received many accolades from the investment community. The first DoubleLine multi-sector fund was not launched until 2013, so there was no way to assess the performance during the 2008 bear market. DoubleLine Opportunistic Credit Fund (NYSE: DBL ). This CEF sells at a discount of 1.9%, which is unusual since the fund usually sells at a premium (average premium over past 3 years was 3.7%). The portfolio has 213 holdings, most (96%) are invested in asset-backed bonds. The effective duration is 8.23 years. The fund employs 17% leverage and has an expense ratio of 1.7%. The fund has an inception date of January 2012, so it only has 3.5 years’ performance history. The fund has a distribution of 8.7% without any return of capital. DoubleLine Income Solutions Fund (NYSE: DSL ). This CEF sells at a discount of 10%, which is a larger discount than the 1-year average of 8%. The fund was launched in April 2013, so it does not have a long history. The fund utilizes 32% leverage and has an expense ratio of 2.2%. The effective duration is 6.3 years. The distribution is 9% with no return of capital. Risk versus Reward To assess the risk versus reward of these multi-sector funds over the past 3 years, I plotted the annualized rate of return in excess of the risk-free rate (called Excess Mu in the charts) versus the volatility of each of the funds. I used 1% as an estimate of the risk-free rate. The Smartfolio 3 program was used to generate the plot that is shown in Figure 1. Note that DSL and PCI were not included because they did not have a 3-year history. (click to enlarge) Figure 1. Risk versus reward over past 3 years As is evident from the figure, multi-sector bond funds have had a wide range of returns and volatilities. To better assess the relative performance of these funds, I calculated the Sharpe Ratio. The Sharpe Ratio is a metric developed by Nobel laureate William Sharpe that measures risk-adjusted performance. It is calculated as the ratio of the excess return over the volatility. This reward-to-risk ratio (assuming that risk is measured by volatility) is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. In Figure 1, I plotted a red line that represents the Sharpe Ratio associated with DBL. If an asset is above the line, it has a higher Sharpe Ratio than DBL. Conversely, if an asset is below the line, the reward to risk is worse than DBL. Some interesting observations are apparent from Figure 1. The PIMCO CEFs outperformed the DoubleLine CEFs in terms of overall returns and risk-adjusted returns. DBL had about the same risk-adjusted return as PHK. Most of the ETFs had similar volatilities except for PHK and PGP, which were substantially more volatile. This illustrates that CEFs with large premiums tend to be more volatile since the fluctuations in premium add to the overall risk. Even though PHK and PGP had large distributions, this did not translate into the best risk-adjusted return. In fact, PHK and PGP lagged the other PIMCO funds in risk-adjusted return. PDI was easily the best performer on a risk-adjusted basis. I next wanted to assess if the relative outperformance of PIMCO continued during a more recent past. I reduced the look-back period to 2 years, which allowed me to include DSL and PCI. The results are shown in Figure 2 and are similar to the 3-year data. Again, PIMCO outperformed DoubleLine. PDI continued to be the best performer. The new kid on the block, DSL, lagged. PHK and PGP still had the largest volatility. (click to enlarge) Figure 2. Risk versus reward over past 2 years As a last analysis, I reduced the look-back to the last 12 months, and the results are shown in Figure 3. What a difference a year made! Generally, the multi-sector bond funds have had a rough time over the past 12 months, with interest rate fears dragging down performance. During this period, only 4 of the ETFs (DBL, PDI, PFN, and PKO) managed to stay in positive territory. Over the past 12 months, DBL was the best performer on both an absolute and risk-adjusted basis. PGP was by far the worst performer, due primarily to the reduction in premium, which resulted in both increased volatility and decreased price performance. This illustrates the risks inherent in buying a CEF with a huge premium. DSL was in the middle of the pack. (click to enlarge) Figure 3. Risk versus reward over past 12 months Diversification To round out the analysis, I assessed the diversification associated with these CEFs. To be “diversified,” you want to choose assets such that when some assets are down, others are up. In mathematical terms, you want to select assets that are uncorrelated (or at least not highly correlated) with each other. I calculated the pair-wise correlations associated with the funds over the past two years and the results are shown in Figure 4. (click to enlarge) Figure 4. Correlation matrix over the past 2 years The figure presents what is called a correlation matrix. The symbols for the funds are listed in the first column on the left side of the figure. The symbols are also listed along the first row at the top. The number in the intersection of the row and column is the correlation between the two assets. For example, if you follow PKO to the right for three columns, you will see that the intersection with PFL is 0.550. This indicates that, over the past 3 years, PKO and PFL were only 55% correlated. Note that all assets are 100% correlated with themselves, so the values along the diagonal of the matrix are all ones. It was somewhat surprising to see the small pair-wise correlations among these funds. The only exceptions were the sister funds PFN and PFL, which were 80% correlated with each other. This means that you can gain diversification if you purchase more than one of the funds. In particular, DoubleLine ETFs have a low correlation with PIMCO ETFs. So if you cannot decide which is best, you can diversify by buying one from each investment house. Bottom Line Unfortunately, the analysis was not definitive. PIMCO outperformed over the longer term, but DoubleLine was best over the past year. I believe the PIMCO problems stemmed mainly from the selling after Gross quit, which resulted in an erosion of premiums that translated into reduced prices. Of the PIMCO CEFs, PDI was the best performer. For DoubleLine, the prize went to DBL. In today’s volatile environment, I would definitely avoid funds with huge premiums such as PGP and PHK. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Why The Strong U.S. Dollar Is Still A Headwind For International Consumer Staples Stocks

[Editor’s Note: This is the fourth and final installment in our series on consumer staples stocks. See also: – Part I : The Monsters Under the Bed are Real for Consumer Staples Stocks – Part II : Don’t Get Caught Holding This “Safe” Stock When the Fed Hikes Rates – Part III : What Happens When “Engineered Growth” is No Longer Viable Please let us know what you think of the series. Use the comment section below..] As we approach the end of the second quarter and enter earnings season, currency headwinds are likely to significantly cut into earnings for international consumer staples stocks. Investors in consumer staples stocks are already facing some serious challenges. We’ve discussed the high valuations as a result of income investors reaching for yield . These valuations are still well above average levels even after many of these stocks have sustained declines. As this reach for yield unwinds, valuations should contract, sending stock prices even lower. A second challenge comes from the end of an ” engineered growth ” phase. Companies have had an incentive to borrow money cheaply and buy shares of their own stock. This has reduced the share count, thereby artificially inflating earnings per share. But with valuations now inflated and with higher rates making it more expensive to borrow, the buyback fad will likely end. Investors who became accustomed to this engineered growth may be disappointed with lower growth rates in subsequent quarters. Today, we’re going to discuss the very real challenge of the strong U.S. dollar, as it relates to consumer staples companies who do business around the world. How the U.S. Dollar Affects Business Basic economics tells us that a weak currency helps to promote a country’s exports. This is because other countries’ currencies go farther towards purchasing goods and services, making the country with a weak currency more competitive. The opposite is true as well. When a country’s currency is strong, it becomes more challenging for that country to export products or services. The strong U.S. dollar has become a significant headwind for domestic companies who generate a significant amount of revenue overseas. Today, a U.S. company selling a product in international markets must choose between two options: Sell the product at a competitive price. In this scenario, the company may collect a steady amount of profit in euros (using just one currency as an example). But since each euro represents fewer U.S. dollars, the company’s profit margin will decline in dollar terms. Sell the product at a standard U.S. dollar price. In this scenario, the company can protect its profit margins by selling at a high enough price to keep profits per unit at a steady level. But since this price will be higher in euro terms, the product will be less competitive when compared to competing products. There is perhaps no better example of this problem for consumer staples stocks than Philip Morris International (NYSE: PM ). The company has the third largest position in the S&P Consumer Staples SPDR (NYSEARCA: XLP ) Philip Morris International is the international sister company of Altria Group (NYSE: MO ) following the company’s split. Philip Morris sells cigarettes and tobacco products outside the United States while Altria operates in the U.S. In the first quarter, PM reported 7.8% growth in sales when calculated on a “constant currency” basis. But when international sales were translated into dollar figures, revenue actually fell more than 4%. Adjusted earnings were also reported 2.5% lower than last year’s results, all a result of the strong U.S. dollar. We should note that when PM reported its results, shares traded higher. Investors chose to focus on the strength of PM’s international sales, hoping that the strong U.S. dollar would be a temporary factor, while expecting further international growth from PM. In addition to Philip Morris, many other international consumer staples companies have reported weakness due to the strong U.S. dollar. Here are just a few… Johnson & Johnson (NYSE: JNJ ) cut its guidance in April due to the strong U.S. dollar. The Coca-Cola Company (NYSE: KO ) reported a 6% cut to revenue as a result of the U.S. dollar Procter & Gamble (NYSE: PG ) reported a 5% negative impact to its sales due to the U.S. dollar Unfortunately, for international consumer staples stocks, it doesn’t look like this trend will reverse any time soon. It’s Still a Bullish Environment for the U.S. Dollar After advancing sharply in the second half of 2014 (and the first few months of 2015), the U.S. dollar has been trading in a more stable range the last several months. Many believe that the sharp rise in the dollar is complete and that while the trend may not reverse, the dollar is not likely to trade materially higher. Currencies have a reputation for long-term trends extending several years. Below is a long-term chart of the U.S. dollar index that we marked up to show the amount of time (and level of change) between peaks and troughs. Since the 1970s, the U.S. dollar has experienced five major trends lasting anywhere from 6 years to nearly 10 years. The average advance has been near 70% and the average decline near 45%. (Admittedly, this is a small sample size, but it is at the very least a rough gauge of the magnitude of typical U.S. dollar trends). While the current rally in the U.S. dollar has lasted seven years from its trough in 2008, the dollar has only advanced 38%. If the dollar were to continue to rally, it wouldn’t be outside the “normal” band for currency movements. Plus, one could argue that the true bottom didn’t occur until 2011 when the dollar bottomed against the yen and the Australian dollar. Fundamentally, there are compelling reasons why the dollar could continue to rally. The three biggest are: Continued uncertainty surrounding sovereign debt for Eurozone countries could cause institutions and individuals to gravitate away from euros and towards U.S. dollars. A weakening Chinese economy and lower oil prices are challenges for natural resource countries like Canada and Australia. This trend is just beginning and should continue to weigh on the Canadian and Australian dollars. Rising interest rates in the U.S. should make dollar-denominated deposits more attractive. As treasury yields rise, more international investors will convert savings to dollars and buy government bonds. While short-term movements in currencies are difficult to game, we believe that the bullish trend for the U.S. dollar is still intact, and that it will pressure earnings for international consumer staples companies. The U.S. Dollar Remains a Challenge for Q2 Results Despite a few weeks of sideways trading, the U.S. dollar remains significantly elevated from where it was last year. Today, the U.S. dollar is 21% stronger versus the euro than at this time last year. The U.S. dollar is 18% stronger versus the Australian dollar than at this time last year. The U.S. dollar is 13% stronger versus the Canadian dollar than at this time last year. When U.S. consumer staples companies with international sales report second quarter metrics next month, they will be up against a significant headwind. Last year during the second quarter, these companies did not face a strong dollar. This year, earnings will not compare favorably to last year’s numbers. At this point, it doesn’t matter what the U.S. dollar is going to do when it comes to second quarter results. Instead, it matters where the dollar is versus at this time last year. The key will be how investors respond to the reports. If they see the strong U.S. dollar as a temporary issue, investors may once again look the other way and the stocks may hold up. But if investors are worried about continued strength in the U.S. dollar, we believe that international consumer staples companies will trade lower in the days leading up to and following their second quarter announcements. With the Fed on tap to release its June statement tomorrow (this article is being penned after the close on Tuesday, June 16th), we could be in danger of seeing another spike in the U.S. dollar this week. Any hawkish rhetoric from the Fed, or any indication that the first rate hike will come in September could send the U.S. dollar higher. In an environment where the dollar is once again on the move, we don’t expect investors to give international consumer staples stocks the benefit of the doubt when it comes to the second quarter earnings announcements. Three Major Challenges So when it comes to consumer staples stocks, we’re decidedly cautious. We prefer to avoid these risky shares while waiting for three major challenges to pass. These challenges are: An unwinding of the “reach for yield” A curtailment of “engineered growth” A strong U.S. dollar headwind.

Fire The CEO, Then Buy The Stock?

There is a widely-held perception that CEOs don’t tend to last very long at big companies – maybe just three or four years on average. The truth, however, is not that bad if you are a CEO (or a person who loves one). The average CEO at a Fortune 500 company actually lasts about 8 to 10 years. Still, because the CEO is the face of the company and critical to its success, CEO turnover can cause volatility in a stock’s price – especially if it is unexpected and especially if the CEO leaves in less-than-voluntary circumstances. The latest example comes from Twitter (NYSE: TWTR ). Dick Costolo, who has announced he will be gone effective July 1, had served as Twitter’s CEO since 2010 and helped take the company public in 2013. The nice thing about being the CEO of a private company is that you have the luxury of time. You can more easily focus on the long term. Once you go public, however, you have a stock price that investors constantly monitor. Your stock is like a voting machine, and your stock price tells you how investors think you’re doing. Investors were telling Dick Costolo that he wasn’t doing well at all. After a brief run-up following the IPO, shares of Twitter, which has never been a profitable company, faded. Today, the stock sells for less than the first trade at the IPO. Investors were telling Costolo loud and clear that it was time to go. He asked the Board of Directors to name a replacement. That’s all well and good, but from my perspective, I don’t really care if Costolo was a good or bad CEO. As far as I’m concerned, the more important question is, does it make sense to buy the stock now that the CEO is gone? That’s what lots of investors thought when Costolo’s departure was announced. Twitter stock rallied almost 7% in after-hours trading right after the company announced that Costolo was stepping down. (That may have been a blow to his ego, although it did boost the value of his own shares and options by millions of dollars – at least temporarily.) However, the euphoria did not last. When the market opened for trading the next morning, half the gains were gone. By the end of that day, the stock was back to pre-resignation levels. And by the end of the following trading day, the stock had tanked 3.2% below where it had been just before the announcement of Costolo’s resignation. Investors apparently came to the conclusion that Twitter’s problems went well beyond Costolo’s personal inability to implement a winning strategy. McDonald’s (NYSE: MCD ) provides a bit of a counter example. When CEO Don Thompson resigned in January, the stock rallied 5.1% by the end of the following day. But in McDonald’s case, the stock kept going higher. In fact, it rallied for more than a month. It has given up some ground since, but it remains higher than it was before Thompson’s resignation. With McDonald’s, investors seem to believe that the problems were more closely associated with the CEO than they were with any fundamental problem with the business. McDonald’s has to make its hamburgers more popular and it has a lot to prove, no doubt. But Twitter, remember, as popular as its service already is, has yet to prove that it even can be a profitable business. So, in general, does it make sense to buy the stock when an unpopular CEO steps down? For the short term, the answer appears to be yes; but only if you can act quickly enough to buy the stock before the run-up. Keep in mind that these kinds of announcements are typically made during non-trading hours. For you to have made money on Twitter, you would have had to be sitting at your trading desk rapidly buying and selling when the market was closed. For the longer run, the answer depends. The more investors believe that the company’s troubles are due to bad management and not to a broken business model, the more the stock will rally – and keep rallying – when the unpopular CEO resigns. But if investors think the company’s problems are so endemic that even a new star CEO can’t fix them, you will be better off taking a pass.