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When the world is burning—as it feels like it is now—it pays to remember the words of Howard Marks, the smartest money manager most people have never heard of.
The essence of Marks’s approach is contrarian thinking. In Chapter 11 of his excellent book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor, he writes:
The ultimately most profitable investment actions are by definition contrarian: You’re buying when everyone else is selling (and the price is thus low), or you’re selling when everyone else is buying (and the price is high).
But he admits this isn’t easy: “These actions are lonely and uncomfortable.”
Lonely? Uncomfortable? That’s exactly how corporate-bond buyers feel these days!
We’re not just tipping our hats to these brave “loners.” We’re joining them with two “tossed-in-the-bin” bond closed-end funds (CEFs) paying up to 12.3%!
Rates Up, Bond Funds Down—But Something’s Got to Give
If you’ve been investing for income for a while, you likely know the golden rule of Bondland: When rates rise, bond prices fall (and vice versa). It’s simple—too simple, in fact! And it’s precisely why bonds are on the outs now.
The Iran conflict is flaring. Oil (the engine of inflation) is spiking. And even Fed chair Kevin Warsh—appointed, remember, to cut rates—can’t seem to hold back the tide. Futures markets tell the tale: A year from now, they see two Fed rate hikes in the bag—and potentially more.
Target Rate Odds
CME Group
I know. This does not sound like the best bond-buying setup. But here’s the thing: Everybody knows it. The mainstream crowd—folks Marks calls “first-level investors” because they buy and sell on headlines—has already sold.
That’s fine for us “second-level” thinkers who dig deeper: It means the bad news is priced in. It also means it won’t take much for these funds’ discounts to reverse course and shrink.
The bottom line? Now is the time to buy.
To see what I’m getting at, consider the discount on the PIMCO Corporate & Income Opportunity Fund (PTY), one of the biggest corporate-bond CEFs.
As I write, PTY trades at a 2.7% premium to net asset value (NAV). That doesn’t sound cheap, but thinking any premium means a fund is pricey is another first-level blunder. With PIMCO funds, premiums—particularly big ones—are normal because of the company’s cachet in the CEF space.
Over the last five years, PTY has traded at a 20% (!) premium, on average. Take a look at this chart, showing its path to the bottom of the bargain bin:
This is a chart of PTY’s premium since its launch in 2002. As you can see, it’s cheaper than it’s been since 2015—and far cheaper than it was in 2022, when rates soared on the heels of an inflation rate that streaked to 9%!
Even the most extreme forecasts don’t put us near that today. And PTY’s overdone premium-drop, despite that fact, is the first reason why the fund looks attractive now.
Then there’s the dividend. As I write this, PTY pays 11.9 cents per share, per month, for a hefty 12.3% yield.
Other than a slight adjustment, from 13 cents to 11.9 during the pandemic, that payout held steady, with the odd special dividend (the spikes and dips in the chart below), too:
PTY Dividend
Income Calendar
PTY generates that income by handing its managers a wide mandate to scour the credit markets. The result is a portfolio that’s 59% US-based and mostly in high-yield bonds (29% of assets), non-US developed markets (16%) and emerging markets (17%).
The team at the top has also focused on bonds with a leverage-adjusted duration of 4.2 years. That’s a good place to be—long enough to rise significantly as rates fall, but not so long as to hurt substantially if rates surprisingly head higher than expected.
As I just hinted at, the fund does juice its returns by borrowing against roughly 29% of its assets. That’s modest and, again, will provide a tailwind as rates fall and PTY’s borrowing costs decline.
And yes, I do still see lower rates in the longer run. Let’s talk about that more before we move on to another corporate-bond CEF we like even more than PTY.
On the Interest-Rate Front, AI Beats Iran
When it comes to rates (or anything in investing), things rarely go in a straight line.
Despite the recent escalation in Iran, this conflict will eventually draw to a close. None of the participants in the conflict can afford any other outcome. Then there’s Warsh, who, as I mentioned earlier, Trump has charged with cutting rates. You can bet that as soon as the data allows him to justify such a move, he’ll push for it.
Third (and more important) is AI, which provides a sweeping level of automation to white-collar work that is highly deflationary.
In the 1990s, the Internet acted as a similar “deflator” on prices. The move from snail mail to email and from fax machines to web browsers made businesses wildly more efficient, which kept a lid on consumer prices—and a floor under bond prices. They rallied throughout the decade.
If rate cuts happen sooner, great. The discount on a buy made today will snap shut, giving us price gains on top of our double-digit bond-fund payouts. If it takes longer, fine. We’ll collect our divvies in peace (since these funds are already cheap).
Which brings me to another bond CEF I see as a savvy “second-level” buy today.
The “Bond God’s” 10.1% Payout
The 10.1%-paying DoubleLine Yield Opportunities Fund (DLY) is a holding of my Contrarian Income Report service that’s done exactly what we’ve wanted it to since we bought it in October 2021: deliver steady income.
The fund rolled down the skids at what would seem to be an inopportune time: February 2020, on the eve of the societal dumpster fire that was soon to ensue. But DLY’s manager, Jeffrey Gundlach (a.k.a. the “Bond God”) was the right manager for the time: He used the opportunity to snap up high-yielding bonds at discounts.
Since then, the fund’s dividend has been the picture of predictability, paying out steadily (and monthly) since launch, with two special dividends, to boot:
DLY Dividend
Income Calendar
Then there’s the discount, which has also gotten cheaper over the last 16 months, dropping from a slight premium to a 7.7% markdown.
That’s way too cheap for a fund run by Gundlach, who’s got a wide mandate to scour the credit markets. The discount’s widening has also raised the yield to that sweet 10.1%.
DLY, like PTY, is a textbook “Marks-style” contrarian play on today’s rate worries. We’re happy to grab this stout fund at a discount, and a historically high 10.1% payout, too.
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