PIMCO High Income Fund (NYSE: PHK), PIMCO Corporate & Income Strategy Fund (NYSE: PCN), and PIMCO Corporate & Income Opportunity Fund (NYSE: PTY) (each a “Fund” and, collectively, the “Funds”) each announced that its Board of Trustees has approved changes to its non-fundamental investment policies as noted below. The changes and new policies take effect immediately.
PHK has eliminated its non-fundamental investment policy to, under normal market conditions, invest at least 50% of its net assets in debt securities that are, at the time of purchase, rated below investment grade (below Baa by Moody's Investors Service, Inc. (“Moody’s”), below BBB by either Standard & Poor’s (“S&P”) or Fitch, Inc. (“Fitch”), or unrated but judged by the Fund’s sub-adviser, Pacific Investment Management Company LLC (“PIMCO”), to be of comparable quality), which may be represented by forward contracts or derivatives such as options, futures contracts or swap agreements (the “50% Policy”). PHK may now invest any portion (or none) of its assets in below investment grade securities (commonly referred to as “high yield” securities or “junk bonds”), subject to the Fund’s other investment policies, including the revised policy noted below.
PHK has to date observed a non-fundamental policy to not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each rating agency rating the security or that are judged by PIMCO to be of comparable quality. This policy has been amended and restated in its entirety to read as follows:
PHK will not normally invest more than 20% of its total assets in debt instruments, other than mortgage-related and other asset-backed securities, that are, at the time of purchase, rated CCC or lower by S&P and Fitch and Caa1 or lower by Moody’s, or that are unrated but determined by PIMCO to be of comparable quality to securities so rated. The Fund may invest without limitation in mortgage-related and other asset-backed securities regardless of rating—i.e., of any credit quality.
PCN and PTY
Each of PCN and PTY have to date observed a non-fundamental policy that the Fund may invest up to 5% of its total assets in defaulted bonds when PIMCO believes that the issuer’s potential revenue and prospects for recovery are favorable. This policy has been amended and restated in its entirety to read as follows for each of PCN and PTY:
The Fund may invest up to 5% of its total assets in defaulted bonds when PIMCO believes that the issuer’s potential revenue and prospects for recovery are favorable (except that the Fund may invest in mortgage-related and other asset-backed securities without regard to this limit, subject to the Fund’s other investment policies).
The Funds’ investment manager, Allianz Global Investors Fund Management LLC (“AGIFM”), and PIMCO, the Funds’ sub-adviser, recommended these investment policy changes for the Funds because they believe the changes will provide the Funds with additional and useful investment flexibility in pursuing their investment objectives.
Regarding the elimination of the 50% Policy for PHK, although PIMCO expects to continue to invest PHK’s assets in below investment grade securities in varying amounts, PIMCO believes that eliminating the 50% Policy will potentially provide PHK with additional flexibility to tactically and strategically adjust exposure to what the portfolio manager views as more attractive asset classes in response to changing market conditions.
Regarding the other policy changes for PHK, PCN and PTY, PIMCO believes that these changes will be beneficial in providing the Funds with greater flexibility in pursuing opportunities in the below investment grade segment of the market for privately-issued mortgage-related and other asset-backed securities, which PIMCO believes may have attractive risk/return profiles in current and future market environments.
Mortgage-Related and Other Asset-Backed Securities Risk
Each Fund may invest in a variety of mortgage-related and other asset-backed securities issued by government agencies or other governmental entities or by private originators or issuers. The mortgage-related securities in which a Fund may invest include, without limitation, mortgage pass-through securities, collateralized mortgage obligations (“CMOs”), commercial or residential mortgage-backed securities, mortgage dollar rolls, CMO residuals, stripped mortgage-backed securities (“SMBSs”) and other securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property. A Fund may also invest in other types of asset-backed securities, including collateralized debt obligations (“CDOs”), which include collateralized bond obligations (“CBOs”), collateralized loan obligations (“CLOs”) and other similarly structured securities.
Mortgage-related and other asset-backed securities often involve risks that are different from or more acute than risks associated with other types of debt instruments. For instance, these securities may be particularly sensitive to changes in prevailing interest rates. Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates, and may reduce the market value of the securities. This is known as extension risk. In addition, mortgage-related securities are subject to prepayment risk—the risk that borrowers may pay off their mortgages sooner than expected, particularly when interest rates decline. This can reduce a Fund’s returns because the Fund may have to reinvest that money at lower prevailing interest rates. For instance, a Fund may invest in stripped mortgage-backed securities with respect to which one class receives all of the interest from the mortgage assets (the interest-only, or “IO” class), while the other class receives the entire principal (the principal-only, or “PO” class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on a Fund’s yield to maturity from these investments.
A Fund’s investments in other asset-backed securities are subject to risks similar to those associated with mortgage-related securities, as well as additional risks associated with their structure and the nature of the assets underlying the security and the servicing of those assets. For instance, certain CDOs in which a Fund may invest are backed by pools of high-risk, below investment grade debt securities and may involve substantial credit and other risks.
Due to their often complicated structures, various mortgage-related and asset-backed securities may be difficult to value and may constitute illiquid investments.
The values of mortgage-related and other asset-backed securities may be substantially dependent on the servicing of the underlying asset pools, and are therefore subject to risks associated with the negligence by, or defalcation of, their servicers. Furthermore, debtors may be entitled to the protection of a number of state and federal consumer credit laws with respect to these securities, which may give the debtor the right to avoid or reduce payment.
Investments in mortgage-related and other asset-backed securities may involve particularly high levels of risk under current market conditions.
Mortgage Market/Subprime Risk
The mortgage markets in the United States and in various foreign countries have experienced extreme difficulties over the past few years that may adversely affect the performance and market value of certain of a Fund’s mortgage-related investments. Delinquencies and losses on residential and commercial mortgage loans (especially subprime and second-lien mortgage loans) generally have increased during that period and may continue to increase, and a decline in or flattening of housing and other real property values (as has been experienced during that period and may continue to be experienced in many real estate markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of mortgage loan originators have experienced serious financial difficulties or bankruptcy in recent periods. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
High Yield Risk
In general, lower rated debt securities carry a greater degree of risk that the issuer will lose its ability to make interest and principal payments, which could have a negative effect on the net asset value of a Fund’s common shares or common share dividends. Securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal, and are commonly referred to as “high yield” securities or “junk bonds.” High yield securities involve a greater risk of default and their prices are generally more volatile and sensitive to actual or perceived negative developments, such as a decline in the issuer’s revenues or revenues of underlying borrowers or a general economic downturn, than are the prices of higher grade securities. Debt securities in the lowest investment grade category also may be considered to possess some speculative characteristics by certain rating agencies. An economic downturn could severely affect the ability of issuers (particularly those that are highly leveraged) to service their debt obligations or to repay their obligations upon maturity. Lower-rated securities are generally less liquid than higher-rated securities, which may have an adverse effect on a Fund’s ability to dispose of a particular security. For example, under adverse market or economic conditions, the secondary market for below investment grade securities could contract further, independent of any specific adverse changes in the condition of a particular issuer, and certain securities in a Fund’s portfolio may become illiquid or less liquid. As a result, a Fund could find it more difficult to sell these securities or may be able to sell these securities only at prices lower than if such securities were widely traded. To the extent a Fund focuses on below investment grade debt obligations, PIMCO’s capabilities in analyzing credit quality and associated risks will be particularly important, and there can be no assurance that PIMCO will be successful in this regard. Due to the risks involved in investing in high yield securities, an investment in a Fund should be considered speculative.
A Fund’s credit quality policies, if any, apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue. In determining whether to retain or sell such a security, PIMCO may consider factors including, but not limited to, PIMCO’s assessment of the credit quality of the issuer of such security, the price at which such security could be sold and the rating, if any, assigned to such security by other rating agencies. Analysis of creditworthiness may be more complex for issuers of high yield securities than for issuers of higher quality debt securities.
Stressed, Distressed and Defaulted Securities Risk
Each Fund may invest in the debt securities of financially stressed or distressed issuers, including those that are in default or the issuers of which are in bankruptcy. Investments in the securities of financially stressed or distressed issuers involve substantial risks. These securities may present a substantial risk of default or may be in default at the time of investment. A Fund may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of principal or interest on its portfolio holdings. In any reorganization or liquidation proceeding relating to an investment, a Fund may lose its entire investment or may be required to accept cash or securities with a value substantially less than its original investment. Among the risks inherent in investments in a troubled issuer is that it frequently may be difficult to obtain information as to the true financial condition of such issuer. PIMCO’s judgments about the credit quality of a financially stressed or distressed issuer and the relative value of its securities may prove to be wrong.
The investment objective of PTY is to seek maximum total return through a combination of current income and capital appreciation. PHK’s primary investment objective is to seek high current income, with a secondary objective of capital appreciation. PCN’s primary investment objective is to seek high current income, with secondary objectives of capital preservation and appreciation. There can be no assurance that the Funds will meet their objectives.
AGIFM, an indirect, wholly-owned subsidiary of Allianz Asset Management of America L.P., serves as the Funds' investment manager and is a member of Munich-based Allianz Group. PIMCO, an AGIFM affiliate, serves as each Fund’s sub-adviser.
The Funds’ New York Stock Exchange closing prices, net asset values per share, as well as other information, including updated portfolio statistics and performance, is available at http://www.allianzinvestors.com or by calling the Funds’ shareholder servicing agent at (800) 254-5197.
Statements made in this release that look forward in time involve risks and uncertainties and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such risks and uncertainties include, without limitation, the adverse effect from further declines in the securities markets and in the Funds’ performance, a general downturn in the economy, competition from other companies, changes in government policy or regulation, inability to attract or retain key employees, inability to implement their operating strategy and/or acquisition strategy, and unforeseen costs and other effects related to legal proceedings or investigations of governmental and self-regulatory organizations. Each Fund’s ability to pay dividends to common shareholders is subject to the restrictions in its registration statement and other governing documents as well as the Investment Company Act of 1940.