The Story So Far
The focus of this article is to assess the PIMCO Corporate & Income Strategy Fund (NYSE:NYSE:PCN) as an investment option. This closed-end fund aims “to seek high current income, with a secondary objective of capital preservation and appreciation.”
I keep tabs on PCN several times a year as it has been a part of my trading journey since the onset of my investment career. When 2023 kicked off, I saw little value in it and believed there were better opportunities in the market. Looking back, I made the right call to steer clear of this fund this year as the return since my February analysis has been negative:
As usual, at the start of a new year, I approach each fund I cover with fresh eyes. This has brought me back to PCN after a gap of eleven months, to reassess its rating. After re-evaluating, I still believe this fund is overpriced, and that better value can be found elsewhere. Therefore, my “hold” stance remains, and I will explain why in more detail below.
The Premium Persists
The first and most obvious observation is that PCN’s market price remains too steep. My followers know I steer clear of funds trading at excessive premiums, and that includes PCN. Although the premium has narrowed since my February analysis – when it was around 15% – the current level in the single digits does not align with the value I seek:
To me, PCN’s price, despite being cheaper than in February, is too high for me to recommend a “buy” option in isolation. There would need to be multiple other compelling attributes to overcome this premium in my view. This alone inclines me towards at least a “hold” stance, which is consistent with my general outlook on CEFs and valuations that I have held over the years.
Limited Opportunity In High Yield
My next concern revolves around a discussion on PCN’s underlying holdings. In line with the fund’s strategy, this represents a significant bet on the high-yield credit sector. While PCN holds various types of securities, below Investment Grade-rated debt constitutes over 38% of total fund assets:
This implies that one must be bullish on high-yield securities if considering buying or holding this fund. If you are not optimistic about the prospects for this sector, investing in this fund would not make much sense.
Given the title of this article, readers have likely deduced that I am not a bull on the high-yield credit sector at present. That assumption is accurate. Although it has performed well recently, I have reservations about its future potential. This stems from the fact that spreads are very narrow compared to their position over the last year and a half:
What this indicates is that the opportunity was much clearer in the past. Although spreads could narrow further, leading to more positive returns, historical trends suggest that we are nearing a crucial resistance level in the short term. Buyers will need to continue accepting a progressively lower level of income on an adjusted basis.
This does not present a favorable risk-reward backdrop. Coupled with the fact that PCN demands a premium to own it, I fail to see the value. Why pay extra for a sector that seems to be reaching its peak? It is difficult for me to make that case and it certainly helps explain why a neutral rating makes sense to me for now.
The Passive Market
My next concern is on a macro-level. This relates to the overall calm dominating the markets for the past few months. Both stocks and bonds have surged without any significant pullback since October. While this is “good” for investors, it feeds into my broader worry that things may have gone a bit too far. When gains accumulate too rapidly, I become cautious by default.
To emphasize this, take a look at the VIX index. This measure of volatility reveals that the broader market is excessively passive and hardly pricing in any future risk or market shocks:
So, why does this matter to a fund like PCN? Because PCN is a leveraged, risk-on bet that will almost certainly witness a surge in volatility if the broader market also becomes volatile. We know this because, as mentioned earlier, PCN holds a considerable portion of below Investment Grade quality debt. This high-yield segment of the market tends to be highly correlated with equities. While there is some diversification between the two asset classes, the strength of the correlation is evidently clear and well above what other fixed-income sectors offer:
My conclusion here is that the VIX cannot remain at rock bottom levels indefinitely. There is likely to be an increase in market volatility, probably sooner rather than later. If that occurs, stocks will experience swings, and the high-yield credit sector is unlikely to escape unscathed. This implies that PCN will also experience swings by extension. This suggests to me that waiting for a better entry point is