A Bill Gross Fund Serves Proof the Market is Not Efficient

By on February 17, 2012

Bloomberg’s Sree Vidya Bhaktavatsalam and Alexis Leondis report that six of the 10 most expensive bond closed-end funds are managed by Bill Gross or his colleagues at Pacific Investment Management Co. (PIMCO).

The Pimco High Income Fund (PHK), managed by celebrated bond fund manager Gross, recently traded at an incredible 66 percent premium to Net Asset Value (NAV); above its three-year average premium of 49 percent. Bhaktavatsalam and Leondis attribute the overpricing of the fund to investors’s clamoring for yield.

What the mind-boggling premium of PHK also appears to provide is evidence that investors, and therefore the market, exhibit irrational and inefficient behavior.

According to the article, the premium to NAV rose when Gross recommended buying the fund in 2009. What a great reason to pay an exorbitant premium for a fund; because the manager said it was a good buy over two years ago.

Granted, PHK currently has a substantial yield of 11.5% according to the article. However, approximately 16% of PHK’s payout in December was estimated to be return of capital, according to insurer Allianz SE (ALV), Pimco’s parent.

How are some of these closed-end funds able to provide such a high distribution, or what some may call a dividend? Along with paying out investor capital, they are leveraged to some degree. According to the Closed End Fund Association (CEFA), PHK has leveraged assets of 21%.

When the bond market turns south this fund will almost certainly tumble hard as interest rates rise, or even as the economy weakens due to its exposure to the high-yield market. This makes it an unsuitable investment for conservative investors.

In my opinion, PHK should be avoided by all investors and is practically guaranteed to underperform any similar asset over any future timeframe you want to look at.

PHK is so mispriced it calls into question the notion of an efficient market. Bill Gross certainly has demonstrated his fallibility with his avoidance of U. S. Treasuries early last year only to jump back on the bandwagon after their huge rally.

Data from CEFA on PHK:

Closed End Funds Premium to NAV

Source: Bloomberg

One Comment

  1. New Low Observer

    February 17, 2012 at 2:47 pm

    Thank goodness the markets are inefficient. It gives small investors an opportunity to buy quality when others are looking the other way.

    Thanks for the great site.

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