rumi
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Post by rumi on Sept 25, 2022 11:36:16 GMT
Hello everyone,
I've recently developed an interest in CEFs. I'm currently holding PDI, PTY, PDO and PCN. I selected them on their high UNII balances, meaning that their income from investments must comfortably cover the distributions that they pay out.
However, I sometimes wonder if an unforeseen future event could cause lots of defaults, and erode shareholder value. Are my worries legitimate?
My biggest fear is that NAVs decline for many years in a row, and never recover. Why do I worry about that? Well..In the last few months, I've looked up dozens of CEFs, and I've noticed plenty of such situations. Some of these CEFs did great for the first 10 years, but then kept declining the decade after. It goes to show that even a good 10 year track record doesn't necessarily prove much.
I'm assuming there's a graveyard filled with hundreds of now-defunct CEFs that got wiped out in 2008-2009. So the CEFs that I looked up are subject to survivorship bias. In other words: The reality might be even uglier than what I've seen, because the worst CEFs that went defunct years ago didn't even land on my radar.
Now to my questions: Are my worries justified? Is such a doom scenario even possible? And if so, under what circumstances would it cocur? Also, how can an investor best protect themselves from CEFs that erode value?
I welcome any thoughts. Thanks.
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Post by chang on Sept 25, 2022 11:39:28 GMT
Check out the once beloved Dreman Claymore Dividend fund, DCS.
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Post by Deleted on Sept 25, 2022 12:15:48 GMT
If it's any consolation, any type of security can erode value when trading consistently far below its IPO value over time. Stocks, bonds, and mortgages are 'correcting' in the midst of the FED's QT. It's not just PIMCO CEFs taking it on the chin.
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Post by uncleharley on Sept 25, 2022 12:28:06 GMT
Yes, your worries are justified, but probably to a lesser degree than the worry which prompted you to start this thread. I think such a doomsday scenario could be possible for many CEFs that specialize in debt securities if our rising rate environment persists for much longer than expected and rates go higher than is a historical norm. The Volcker era was not the norm, but history might could make it the norm. You & anyone else can best protect themselves by not buying when their NAV is trending down and being selective when the market turns. I am a wannabe Pimco CEF holder with a position in PDO. When my shorts stop working or shortly thereafter, I intend load up on the CEFs you mentioned in your O P.
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Post by Chahta on Sept 25, 2022 12:54:26 GMT
Interesting post uncleharley. What is it that attracts you to CEFs once your shorts are done? Must be a good trading opportunity. Hello rumi. If you are that worried about CEFs I am curious why the attraction? The only attraction I would think is the high yields. Maybe a trade opportunity since many are beat down so much? I am not sure PTY can yield 11.3% forever.
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Post by mnfish on Sept 25, 2022 12:58:27 GMT
Occasionally I look at Wells Fargo's list of recommended CEFs. They very, very seldom recommend one trading at a premium. They consider exposure, dist stability, valuation, leverage and liquidity. They never mention UNII for some reason. I then pick out a few and go to CefConnect and check out their price and distribution history. I don't think I've ever found one that doesn't trade at about half of its original price and most pay about half of the dist they began at. Pimco is by far the leader and the two older ones you have, PCN and PTY, are the exception to the above results I have found. PDI has raised their monthly dist since inception and PDO seems ok as well. In June I put in a lowball order for PDO @ $12.65 but it never filled.
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Post by yogibearbull on Sept 25, 2022 13:14:59 GMT
One should certainly be aware of the risks of CEFs.
I have posted previously on 2 underappreciated risks of CEFs - understated leverage (by stating debt as % of gross assets, not net assets) and forced-deleveraging of bond CEFs (in meeting regulatory leveraging requirements) that can lead to permanent losses.
I have also noted new changes in the CEF world - like the term-structures of the newer CEFs such as PDO, PAXS (vs larger and older cousin PDI) and TBLD (vs giant OEF cousin TIBAX/TIBIX). At least the discounts on these term-structure CEFs will eventually disappear, so they have some advantages. Many won't touch these new CEFs because they are new (well, their life is 12.0-13.5 years, and new ones will keep coming, like a series), but remember that they are better clones of something older and well-known.
This has been a very difficult environment for the bond market. It is being called a bond crash and one has to go back to 1931 or 1949 to find similar times for bonds. While equities are also suffering, there is nothing historic about this typical run-of-the-mill equity bear market.
What is indeed unusual is that both stock and bond drawdowns are now happening simultaneously.
But this is the time to rationally analyze what you hold, assess risks, make appropriate portfolio changes and trade wisely.
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Post by uncleharley on Sept 25, 2022 14:01:09 GMT
Interesting post uncleharley . What is it that attracts you to CEFs once your shorts are done? Must be a good trading opportunity. Hello rumi . If you are that worried about CEFs I am curious why the attraction? The only attraction I would think is the high yields. Maybe a trade opportunity since many are beat down so much? I am not sure PTY can yield 11.3% forever. The change would be in anticipation of not being mentally acute enough to time a trade and the potential for a minor lifestyle upgrade while not spending my assets.
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Post by Deleted on Sept 25, 2022 14:38:45 GMT
The change would be in anticipation of not being mentally acute enough to time a trade and the potential for a minor lifestyle upgrade while not spending my assets. A good reason for taking the pension/annuity at retirement, which involves long term planning beyond thinking, "I am in great physical health now and know what I am doing."
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Post by rhythmmethod on Sept 25, 2022 15:12:56 GMT
I would consider PIMCO CEFs to have an equity-type risk. Knowing why you are holding these instruments and your plan for when (not if) they go lower is essential. I hold PDI, PDO, PFN, PTY, FPF, UTG in approximately 15% of the total portfolio value, and I do so because they nearly throw off enough cash to meet my income needs for the following year. I am currently reinvesting dividends and consider them a tool in the kit. More experienced CEF holders hold in high percentage and others trade. Renowned CEF guru CapeCod, said these are at a historically crazy low point. He also sold a bunch and said they would likely bleed profusely in the short/intermediate term. (my wording). You can be confident that they will not run away anytime soon. If you are new to these and want to experiment, I'd recommend holding a small amount and experiencing the pain/reward quotient. I believe they continued paying dividends during the 2008-2009 crash and proved good entry points then. IMO, the PIMCO group is the best at this precarious game. Do not feel lonely; the entire universe is inside you. - RM
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Post by racqueteer on Sept 25, 2022 16:07:24 GMT
I'm no guru, but I was invested in them (PCI, PDI) at one point. Imo, Capecod is the guy to follow, and he's not afraid to sell these whenever risk is off the table (total return investing). As noted, they tend to behave like equity does. By that token, whenever the price becomes stable, assuming the distribution remains earned, they will appreciate as well as distribute. OTOH, equities will ALSO be rising; so it's a toss-up as to which is better. If you're in them as an annuity with survivorship benefits, you may view things differently. Ideal for cefs, in comparison with equities, would be a stable market with decent rates. The mis-pricing of mortgages during the 2009-on period was a fortuitous anomaly; imo, of course. Recently, they were buoyed by the artificially-low interest rates. So, at THIS point, I would say that 'buyer beware' applies!
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Post by liftlock on Sept 25, 2022 17:06:52 GMT
I have been reluctant to invest in most of the Pimco CEFs for the simple reason that I have never understood how they generate such high distributions. I get that leverage is part of the reason and that the Pimco team is skilled in generating profits by trading derivative products. Beyond that, I do not understood the underlying income generating nature of products these funds are investing in. They strike me as "black boxes" and it's difficult for me to judge the risk they may entail. I wonder how many invest in them because they simply like the high income generated by the black boxes. Beyond that, the duration of these funds suggests an ongoing risk that NAVs will continue to decline as interest rates rise. My solution is to avoid investing in what I don't understand. Others stay clear of these investments unless they can buy them cheaply or when there is a favorable price trend. Some claim that the premiums these funds trade at is a vote of investor confidence in the quality of the fund. Buy and hold investors appear to have high confidence in the funds.
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Post by ECE Prof on Sept 25, 2022 19:22:05 GMT
I expect to get my money back at the current rate of distribution in less than 4 years. Although I have been paid consistently during the 5 years, I have been buying new shares almost every year, the years that it takes to get back my money keeps going up. Otherwise, I would take less than 2 years. So, as long as I get paid beyond the 4 years, it is all free money. What ever residual money is left over after that is also free. I trust PIMCO will keep paying me as they did even during the pandemic, even though the coverage went to as low as 87%. Now, the coverage ratio is well above 100% with pretty healthy UNII, PDI is in a strong position to pay not only the regular monthly payments, but also year extra payment as much as $1/sh this year. So, I am the least bit concerned about the recent price and NAV reductions with increasing interest rate because, with increasing interest rate, PDI will make more money for its customers.
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Post by uncleharley on Sept 25, 2022 19:28:07 GMT
They generate their returns by using leverage. borrow against your principle at 2%, invest at 6%. That is an 8% return on your capital for as long as the 2/6 holds up. That is the risk that many investors do not appreciate.
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Post by ECE Prof on Sept 25, 2022 20:07:37 GMT
They generate their returns by using leverage. borrow against your principle at 2%, invest at 6%. That is an 8% return on your capital for as long as the 2/6 holds up. That is the risk that many investors do not appreciate. Leverage means OPM. I do appreciate and love OPM.
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Post by steelpony10 on Sept 25, 2022 20:09:24 GMT
rumi , Sure your fears are justified. If that’s how you feel about high income leveraged bonds (mostly) then switch to something else. My greatest concern is a sudden increase in required income like home healthcare, assisted living or LTC while a spouse lives outside that situation. I personally managed my patents portfolio during that event. I know 3 families now in that situation, spending down a depleted portfolio going no where while the wife lives in an apartment. CEF income (or any income) can slow spend down in poor markets which is my solution. I saw how that works already. Waiting on Mr. Market to save me is just gambling on an unknown which could leave a spouse living in poverty a lot quicker. I started investing in CEF’s for my wife and I about 7 years before retirement. I wish I had started way sooner. With most of ours we’ve received all our investment back by now (72/8-10%) and it’s all free money from now on for us. I’ve only added all available cash to our 12 (7 are PIMCO) since then in 2020 and about 3 weeks before this summers’ rally during those great sales. I hope to have many more chances during this market lull. So all our extra money beyond those investments for now lets us live a much higher quality lifestyle and who knows if those situations will ever arise for us. That’s how we handle that unknown. Incidentally CEF’s predate OEF’s as an investment option by about 50 years if I remember correctly. There’s a wealth of management experience in that segment. There is no holy grail of solutions for anyone’s future retirement needs no matter what anyone states including me. I kick myself every time a bunch of outside events out of my control affects my retirement. I’d really prefer an all income portfolio if ever forced to spend down over market luck at some point in the future just like I did with my parents. Cash always flowed (8-10% cash similar to the long term TR of VTI) in good markets and bad. That helped their modest portfolio and lifestyle last from 1982-2017.
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Post by ECE Prof on Sept 25, 2022 21:58:50 GMT
" I wish I had started way sooner. "
+1. Amen.
I wish that I had learned of this back in 2004. I would not have to surrender a lot of cash to the State of Tennessee to buy the state retirement. Not only that, but I would have transferred from TIAA to Vanguard and would have spent a small fraction in PIMCO CEF and rest in VOO (VFINX or some Admiral shares of ETF at that time). No need to trade, and just reinvest the distributions.
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rumi
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Post by rumi on Sept 26, 2022 1:13:11 GMT
Thanks, everyone. I appreciate the replies. Hello rumi . If you are that worried about CEFs I am curious why the attraction? The only attraction I would think is the high yields. Maybe a trade opportunity since many are beat down so much? I am not sure PTY can yield 11.3% forever. Hi @chahta. I’m attracted to CEFs due to their high yields. Why would I like high yields? For one, it could cover some of my expenses. Alternatively it could be reinvested (maybe even partly in HFEA). The better CEFs seem to have highly reliable distributions. Take PTY and PCN for example. They’ve been paying for 20 years. DNP is another durable one, it has existed since 1987 (I wasn’t even born then) and never missed a distribution. And understanding how the yield is produced, how the engine works under the hood gives me some confidence. Occasionally I look at Wells Fargo’s list of recommended CEFs. They very, very seldom recommend one trading at a premium. They consider exposure, dist stability, valuation, leverage and liquidity. They never mention UNII for some reason. I then pick out a few and go to CefConnect and check out their price and distribution history. I don’t think I’ve ever found one that doesn’t trade at about half of its original price and most pay about half of the dist they began at. Hm. Why do you even check the Wells Fargo’s recommded CEFs if they lack a basic understanding of them? Remember that there’s many incompetent people employed as freelance finance blogger. They're tasked with pooping out 20 articles per week for various organizations. If the audience consist of gullible nitwits, the articles don’t even need to be accurate, as long as they’re written in a believable way. But maybe I'm wrong and there's good reasons for recommending seemingly terrible CEFs. I have posted previously on 2 underappreciated risks of CEFs - understated leverage (by stating debt as % of gross assets, not net assets) and forced-deleveraging of bond CEFs (in meeting regulatory leveraging requirements) that can lead to permanent losses. What’s the difference between gross assets and net assets? This has been a very difficult environment for the bond market. It is being called a bond crash and one has to go back to 1931 or 1949 to find similar times for bonds. While equities are also suffering, there is nothing historic about this typical run-of-the-mill equity bear market. Oh interesting. I’d love to learn more about those historic bond crashes. I’m guessing interest rates went up a lot during those two periods? Since interest rates work like gravity for assets, their prices must decline. I’m even curious to know this: When bonds crashed during those two eras, was the price decline temporary? Or was the destruction permanent (like you'd see if there were many defaults)? Because it’s much easier to live through a steep drawdowns if you know that in the end, the bonds will end up paying the par value once they mature. Maybe lessons from the past can teach us about it today. I hold PDI, PDO, PFN, PTY, FPF, UTG in approximately 15% of the total portfolio value, and I do so because they nearly throw off enough cash to meet my income needs for the following year. I am currently reinvesting dividends and consider them a tool in the kit. More experienced CEF holders hold in high percentage and others trade. Renowned CEF guru CapeCod, said these are at a historically crazy low point. He also sold a bunch and said they would likely bleed profusely in the short/intermediate term. (my wording). You can be confident that they will not run away anytime soon. If you are new to these and want to experiment, I’d recommend holding a small amount and experiencing the pain/reward quotient. I believe they continued paying dividends during the 2008-2009 crash and proved good entry points then. IMO, the PIMCO group is the best at this precarious game. Do not feel lonely; the entire universe is inside you. - RM So if I understand you correctly, you have all your money invested in six different CEFs? I’d love to put all my money in them. I just lack the testicular fortitude to do so. Although that might change once I understand CEFs more. I’d be able to live off the yield. And maybe even reinvest one third into a 60/40 portfolio to have some long term growth and keep up with inflation. I find UTG interesting too. I held it for a few weeks last month but sold as it went up. I’d love to own it again. UTG has a long track record of growing distributions. Also, who is CapeCod? CapeCod seems to be a respected source here and people on this forum keep mentioning him. I found out he’s a commentor on Seeking Alpha articles, but he’s probably more than that. I was fantasizing that it’s Bill Gross his pseudonym? So, I am the least bit concerned about the recent price and NAV reductions with increasing interest rate because, with increasing interest rate, PDI will make more money for its customers. How does PDI make more money as interest rates go up? I suppose it's because newly issued bonds will pay a higher yield, right? But then there's also two disadvantages to higher rates: 1. PIMCO borrows money, and would have to pay more interest 2. I suppose only a small fraction of PDI's holdings can be invested in the newly issued bonds which earn a higher yield
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Post by yogibearbull on Sept 26, 2022 1:35:43 GMT
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Post by anitya on Sept 26, 2022 1:46:20 GMT
IMO - especially when risk asset prices are falling, I would buy for total return not for yield of levered risk assets.
If you look at Capecod's activity pre-Covid, he was one of the most active traders of CEFs. In that era, he hardly ever lost and had a short trigger. He more often than not bought and sold using charts, with no tolerance for avoidable losses. Of course, sometimes he sold too early and gave up some upside but that was OK under the overriding principle of intolerance for losses. He was unforgiving if somebody just watched their CEF prices drop and not sell with stop loss orders (mental or real).
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Post by rhythmmethod on Sept 26, 2022 3:27:47 GMT
rumi , i f I understand you correctly, you have all your money invested in six different CEFs? I’d love to put all my money in them. I just lack the testicular fortitude to do so. Although that might change once I understand CEFs more. I’d be able to live off the yield. And maybe even reinvest one third into a 60/40 portfolio to have some long term growth and keep up with inflation.I find UTG interesting too. I held it for a few weeks last month but sold as it went up. I’d love to own it again. UTG has a long track record of growing distributions.
Also, who is CapeCod? CapeCod seems to be a respected source here and people on this forum keep mentioning him. I found out he’s a commentor on Seeking Alpha articles, but he’s probably more than that. I was fantasizing that it’s Bill Gross his pseudonym.Hi rumi, No. I have 15% of the total portfolio in the above-mentioned CEFs. They and my holding of PIMIX and a few other high dividend equities throw off enough for my cash needs. I'm lucky to still be working and bringing in monthly income, even though I'm at retirement age. Capecod is a poster from previous forums who was a professional bond trader. It sounds like you know the score somewhat. I'd urge you to go slow with these things. When they unwind it's a sight to behold! Take care, RM
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Post by Deleted on Sept 26, 2022 5:05:39 GMT
RM: Capecod is a poster from previous forums who was a professional bond trader. From the bio in his SA profile: " Proprietary trader/manager for several Primary Treasury Securities Dealers and other Street firms for 28 years ---- then management consulting, largely investigating and reporting to boards about trading busts, for the last 15. Now retired --- where else? --- on Cape Cod. Familiarizing myself with retail products in retirement, I found bond-ish CEFs and never looked back. " seekingalpha.com/user/52216490/commentsFrom his postings over the years I have received an education in aspects of CEF internals and bond-market activity plus reminders of how much I still don't know/understand about all this. He also seems to enjoy jousting in the political arena with acerbic and witty comments. --- Frank
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Post by mnfish on Sept 26, 2022 10:23:28 GMT
21 hours ago mnfish said: Occasionally I look at Wells Fargo’s list of recommended CEFs. They very, very seldom recommend one trading at a premium. They consider exposure, dist stability, valuation, leverage and liquidity. They never mention UNII for some reason. I then pick out a few and go to CefConnect and check out their price and distribution history. I don’t think I’ve ever found one that doesn’t trade at about half of its original price and most pay about half of the dist they began at. rumi - "Hm. Why do you even check the Wells Fargo’s recommded CEFs if they lack a basic understanding of them? Remember that there’s many incompetent people employed as freelance finance blogger. They're tasked with pooping out 20 articles per week for various organizations. If the audience consist of gullible nitwits, the articles don’t even need to be accurate, as long as they’re written in a believable way. But maybe I'm wrong and there's good reasons for recommending seemingly terrible CEFs" rumi, - Your original post mentioned "the graveyard of CEFs" so I posted about Wells Fargo's CEFs list, which I should have mentioned was a "current" recommendation list, and how many of them would not have been good long-term holdings based on what has happened to the price and dist over time. Some of those CEFs may very well be good "current" picks.
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Post by retiredat48 on Sept 26, 2022 15:13:48 GMT
Someone from Capecod posted the following (after having sold some PDI last week):
"Bought a tiny bit of PAXS to keep it visible/so I don't forget it. Noted over the weekend that the PAXS portfolio was constructed about a year after PDO as yields had started up. MAYBE the fundamental portfolio had a superior starting yield and is managed using the same broad strategies. IMO worth (a little) watching."
------------------------------------------ I have PAXS on my watch list.Likely my next buy of CEFs.
R48
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Post by retiredat48 on Sept 26, 2022 15:29:45 GMT
at rumi,...who asked: Yogi: This has been a very difficult environment for the bond market. It is being called a bond crash and one has to go back to 1931 or 1949 to find similar times for bonds. While equities are also suffering, there is nothing historic about this typical run-of-the-mill equity bear market.rumi reply post: Oh interesting. I’d love to learn more about those historic bond crashes. I’m guessing interest rates went up a lot during those two periods? Since interest rates work like gravity for assets, their prices must decline. I’m even curious to know this: When bonds crashed during those two eras, was the price decline temporary? Or was the destruction permanent (like you'd see if there were many defaults)? Because it’s much easier to live through a steep drawdowns if you know that in the end, the bonds will end up paying the par value once they mature. Maybe lessons from the past can teach us about it today. --------------------------------------------------------------------------- R48 reply: The bond losses in the great depression were not severe, and mostly due to defaults, not rising rates. BTW...there are no such thing as "bond bubbles". If one holds for two years or more, no one loses. RECENTLY in Q1, and partly due to a phenom called CONVEXITY, bonds declined a lot in NAV fund price. But hold for "duration" of your funds, and you will have a positive CAGR. Convexity is no no longer a severe factor. For more on bond bubbles...for everyone, here is a great thread on Bogleheads.org by nisiprius (OP): linkhttp://www.bogleheads.org/forum/viewtopic.php?t=57313&mrr=1278467602
Enjoy...hint...there are no bond bubbles. R48
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Post by ECE Prof on Sept 26, 2022 16:23:09 GMT
I do not know anything about the "experts." But, I know one thing for sure from my common sense. Increasing interest does not only increase the cost of leverage, but it also increases the earnings of the CEFs. The increased earnings will be more than the increase in the cost because the total assets that earns money is (equity + leverage) and it makes money at the increased interest rate. So, the earnings will be supercharged because of double whammy. IF the NAV decreases, it is a good deal for me and people like me, who buy more and more shares at discounts with a high yield. I have done it before, and I will do it again. So, sell baby, sell. Mr. Powell: Are you reading this? Increase the interest rate more and soon.
This is without any retributions to those "experts."
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rumi
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Post by rumi on Sept 26, 2022 16:53:30 GMT
Increasing interest does not only increase the cost of leverage, but it also increases the earnings of the CEFs. The increased earnings will be more than the increase in the cost because the total assets that earns money is (equity + leverage) and it makes money at the increased interest rate. How do higher interest rates increase the earnings of the CEF? I suppose only the bonds that have a floating rate will benefit from higher rates? I also wonder, what percentage of PDI or PTY's holdings consist of bonds with a fixed vs floating rate? I couldn't find this on CEFConnect.com
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Post by rhythmmethod on Sept 26, 2022 16:59:18 GMT
Increasing interest does not only increase the cost of leverage, but it also increases the earnings of the CEFs. The increased earnings will be more than the increase in the cost because the total assets that earns money is (equity + leverage) and it makes money at the increased interest rate. How do higher interest rates increase the earnings of the CEF? I suppose only the bonds that have a floating rate will benefit from higher rates? I also wonder, what percentage of PDI or PTY's holdings consist of bonds with a fixed vs floating rate? I couldn't find this on CEFConnect.com The PIMCO folks attempt to establish a "trend" and exploit it with swaps, etc. It's complicated stuff. If you dig deeper into these things, you probably won't want to go there. Me, I hold some and spend the money. Perhaps @steelpony or others have more insight. Good luck.
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rumi
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Post by rumi on Sept 26, 2022 17:02:12 GMT
The PIMCO folks attempt to establish a “trend” and exploit it with swaps, etc. It’s complicated stuff. If you dig deeper into these things, you probably won’t want to go there. Me, I hold some and spend the money. Perhaps @steelpony or others have more insight. Good luck. What does it mean for PIMCO to "establish a trend" in this context? And I'd love to go there. I want to learn as much as possible about how these CEFs work. If anyone wants to inform me how these swaps work, or how high rates benefit certain CEFs, feel free to chip in!
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Post by Deleted on Sept 26, 2022 17:03:15 GMT
About 42% of the 44% PDI's leverage is Reverse Repurchase Agreements and 2% is Credit Default Swaps. If interested, look up what they are. The NY FED has an overnight open market desk trading reverse repos. I wonder if PIMCO is a trading partner.
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