Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on May 7, 2022.
High Income Funds (NYSE: PCF) is an interesting fund that is managed by Bulldog Investors. He arrived the same way as Saba Capital had taken over Saba Capital Income & Opportunities Fund (BR.W.), which was previously a Voya fund. Essentially, the activists here pushed the fund’s previous sponsors to drop those funds. This is not necessarily negative, but it does mean that current shareholders at the time would be invested in a different fund in the future.
For PCF, it was previously known as Putnam High Income Securities Fund until the name change in 2018 removed the “Putnam” portion. Since then, Bulldog Investors has basically turned it into a pretty attractive multi-asset investment fund. Investments in other closed-end funds mean they offer great diversification. It also means that investors can get discounts on rebates. It’s a big part of what makes PCF particularly interesting right now.
When we last discussed this fund, it was trading at a premium. This takes away some of the appeal of this fund, as rebates on rebates also result in fees on fees. So getting a discount on that fund takes some of that sting out of it.
Besides the general CEF widening that we have seen in this 2022 bear market, they had quickly lost their premium due to a rights offering. Stanford Chemist went into more depth on this topic. This ultimately led to the dilution of the net asset value and made the fund much larger. They raised over $67.2 million by issuing an additional 8,042,590 shares. That might not seem like much, but the fund only had about $88 million in total assets under management the last time we covered it.
- Z-score over 1 year: -0.69
- Discount: 4.52%
- Distribution yield: 11.51%
- Expense ratio: 0.84%
- Leverage: N/A
- Assets under management: $144.8 million
- Structure: Perpetual
The investment objective of PCF is “to provide high current income as a primary objective and capital appreciation as a secondary objective”. The fund intends to achieve this by investing “under normal circumstances at least 80% of its net assets in the value-priced securities of income-oriented closed-end investment companies, business development companies, fixed income securities, including debt securities, convertible securities, equity preferred stocks and special purpose acquisition companies. The fund also invests in high yielding non-convertible securities offering the potential for capital appreciation.
Something about these activist-run funds is that the managers seem to have a sleeve of SPAC involved. I don’t think it’s negative when you have some SPAC exposure. However, they often carry such large numbers that it doesn’t do much for the NAV, even when they could get a SPAC in small groups. Instead, the call here appears to be a place to basically park cash that shouldn’t carry much downside risk.
The fund does not currently use any borrowings, unlike the underlying investments. There are therefore still high risks via their underlying holdings.
Also, the expense ratio here is worth highlighting. With their last semi-annual report, it is quite low. This could be because the fund has become much larger. However, I would like to warn that we might see this increase as the past three years have seen the expense ratio at 1.57%, 1.89% and 1.18%, respectively.
Ideally, we would see this lower expense ratio in the future, as it contains a plethora of other CEFs. These will also have their own expense ratios, of course. This can push spending on a fund up to 3 or 4% in some cases.
Performance – Discount introduces itself
So far through 2022, most investments have gone down. It’s no different with PCF. Although, based on net asset value, the fund held up relatively well. A bright spot that is probably due, in part, to this SPAC exhibition.
Even when the fund struggles against widening haircuts across the CEF space. Several weeks ago, I mentioned the magnitude of the discounts that have widened since the beginning of the year. As remittances widen, their CEF wallet will also experience this widening and will be reflected in PCF’s net asset value.
In general, the widening we’ve seen across CEFs is due to higher volatility. This is an observation that we have seen in all market sell-offs. Moreover, valuations were getting quite tight in 2021; it’s a bit of a denouement of that now too.
PCF’s discount is trading only slightly above its three-year average. I think that makes him a much more interesting candidate than he had been until 2021 with prime.
They report the NAV weekly. Here is the latest daily net asset value published at the time of writing.
Distribution – 10% Managed Plan
The fund operates with a 10% managed distribution plan that resets annually. That is, whether or not the fund earns the payout since it is a target base on the net asset value at the end of the year.
Under the Fund’s managed distribution plan, the Fund intends to make monthly distributions to common stockholders at an annual rate of 10% (or 0.8333% per month) for 2022, based on the value net asset value of $8.75 of the common shares of the Fund on December 31, 2021.
Since the fund started this distribution policy, it has unfortunately only been reduced. However, this means that the fund still pays a fairly high distribution yield to shareholders. This seems to be a more appropriate holding in the high income side of a portfolio and not the constant/stable income side.
I believe managed distribution plans are great for the simple fact that they make them predictable. You know exactly what you will get and when it will fit.
We can take a look at the cast coverage. However, this is one of those cases where it doesn’t really matter. They will pay this managed plan at 10%, whatever.
We can see that they will rely more on capital gains to earn the distribution. Net investment income had increased quite dramatically since the end of the previous year. The figure we see above, the $1.6 million, is only for six months. This appears to be largely due to the substantial increase in assets from the rights offering and then that capital being put to work afterwards.
We can also see that in fiscal year 2021 they had done a rights offering, raising capital at that time as well.
For tax purposes, the last two years show a big difference.
This can make it difficult to estimate what tax classifications might be in the future. That’s true for any fund, but sometimes we get some sort of general consistency from others. This implies that if you are in a situation where you are sensitive to even small tax changes, it may be best to keep this fund in a tax-sheltered account to reduce risk.
CEFConnect lists that PCF carries a total of 170 holdings. One thing I find interesting about this is that the portfolio was mostly comprised of investment companies (CEF/BDC) and preferred stocks. SPACs were also a fairly large weighting.
However, when you go through the full list of holdings, they definitely have a higher number of SPAC positions compared to other categories. They’re just in just lower weights for the most part. That’s why I believe these SPAC allocations are more of a place to park money rather than actually waiting for performance.
After the cash position, their largest holding at the time of this report was in FS KKR Capital Corp (FSK). This is a weighting of almost 5.4%. This is a business development company that had done all the transformation last year. They had merged with their other BDC which they had managed.
FSK itself is one such investment that is discounted from its own net asset value. They have declared a net asset value of $27.17 at the end of 2021. Based on the current market price, this would give us a discount of 22.56%. That sounds pretty substantial, but we’ll have to look to the new quarterly NAV update to better see where it might be now. They’re supposed to report on May 9, so we only have to wait a few days in that case.
The second largest position was in Steel Partners Holding LP (SPLP). This is the preferred stake of this name which comes with a dividend rate of 6% (SPLP.PA). It is currently trading below par, increasing the yield to 6.32%.
From there we have Highland Income Fund (HFRO). It is certainly an interesting fund that seems to be the subject of much discussion. One of the reasons is that it is one of the smallest CEFs around. However, this is usually for a good reason, as the management of the fund has a questionable history. The latest was an attempted conversion into a diversified holding company from a CEF. They eventually withdrew the proposal.
PCF is an interesting fund now that it is in discount territory. On top of that, many of its underlying holdings are trading at discounts, which adds to the appeal. 2022 has expanded many discounts in the CEF space due to volatility. The fund holds FSK and HFRO in its top holdings, which I wouldn’t necessarily put in my portfolio after reviewing them previously. However, the fund is much more than these two names. PCF could be a great fund to provide great diversification through a single purchase. At the same time, the 10% managed distribution plan should mean that there remains a more profitable fund.