PDI: I Sold A Chunk Of The Position But I Am Still Bullish Going Forward

Sometimes, investors sell part of a position or even an entire position that they are still bullish on. They may need to raise capital for a life event or for another reason. I have written about the PIMCO Dynamic Income Fund (NYSE:PDI) since the beginning of 2022 and have remained bullish the entire time. I found myself in a situation where I wanted to finish off my positions in Tesla (TSLA) and NVIDIA Corporation (NVDA), and I didn’t want to pull capital from my liquidity to do so. I fell into a situation where I looked at the opportunity cost and decided that I would liquidate PDI from one of my accounts to raise enough capital to finish off my TSLA position and get closer to finishing off my NVDA position. I still hold PDI in other accounts as I am bullish on the fund, and plan on reestablishing the position in the account I liquidated it from in the future. While I may get caught a bit offsides if the Fed cuts rates in July with the intention of repurchasing shares of PDI, that’s a risk I am willing to take as I believe PDI will trade sideways until the Fed starts its cutting cycle. If I hadn’t been working on the TSLA and NVDA positions for long-term capital gains and generating income from writing covered-call contracts, I wouldn’t have sold PDI from one of the accounts I hold. From an income perspective, I think that PDI is a strong closed-end fund (CEF) that will continue generating monthly income, and its shares could experience significant upside during a Fed cutting cycle.

Following up on my previous article about PDI

Since my last article about PDI was published on 4/3/24 (can be read here), shares of PDI have retraced -3.39% while its total return after the monthly distributions has been -0.04%. The S&P 500 has climbed 5.12% over this period, while TSLA and NVDA have both gone higher. In that article, I discussed why I felt PDI’s annualized distribution of $2.65 would remain intact and how I felt shares would appreciate into the back half of 2024. I am following up with a new article for 2 reasons. The first reason is that we have had several FOMC meetings since my last article, and I think the bull case is strong for PDI. The second reason is because I sold part of my position and wanted to be transparent about that, even though I am still bullish on the fund. I am going to go through my bull case for PDI and why I utilized part of my position in PDI for another investment.

Risks to investing in PDI

There are several risks to investing in PDI, and one of them is one I have just experienced. The first risk is opportunity cost, as PDI has trailed the market. If you’re not solely focused on income, then investing in PDI may not work out as well as you planned because you will likely compare it to what the S&P 500 is doing. The next risk is that the distribution is eventually reduced. If the companies which debt PDI holds faces unforeseen circumstances and default on their debt, then PDI could be forced to reduce the lucrative distribution. The third risk factor is the macroeconomic environment. There is no guarantee that the Fed will cut rates anytime soon, and if oil prices continue to increase, we could see inflation start to move in the wrong direction. If the Fed decides to tighten further by taking rates higher, it could cause a recession, and some of the companies whose debt PDI holds could be impacted. For PDI to flourish, rates need to decline, and there is no guarantee that will happen in 2024.

Why I liquidated part of my position in PDI

Since retracing below $16 in October 2023, shares of PDI have bounced back and spent the past several months trading between $$18.50 – $20. I have recently become a TSLA bull because of the Optimus platform, and I believe its robotics division will become much larger than its automotive business. PDI currently pays a distribution of 14.07%, and the monthly distribution is $0.2205 per share, which works out to 1.17% per month based on the current share price of $18.81. I can’t predict tops and bottoms, but I wanted to finish off my position in TSLA prior to Q2 earnings without moving more capital into this account before July. I decided to liquidate my PDI position in one of my accounts to finish off the TSLA position and continue working on my NVDA position. I eventually plan on repurchasing PDI in the account I sold it in, and I think I will have a few months to do so prior to PDI exceeding $20 per share.

There were 2 reasons why I didn’t want to wait until July to finish the TSLA position. I had a feeling that TSLA would start climbing into earnings, and that the covered-call premiums would be extremely lucrative. My cost basis on TSLA is $182.61, and in June, I wrote covered-call contracts against my position, then rolled them by repurchasing the contracts and writing new contracts out a few months later. I originally wrote contracts on the 7/5/24 chain at a $192.50 strike and got paid $3.45 per share. TSLA spiked, and my contracts ended up being significantly in the money. As TSLA climbed past $200, I rolled the contracts by repurchasing them for $9.67 per share and writing new contracts on the 9/20/24 chain at a $210 strike. I was able to increase my strike price by $17.50 and net an additional $6.41 per share because the contracts in September were sold for $16.39 per share. Currently, I have collected $9.85 per share in option premiums, which is 5.39% of my cost basis. If TSLA sells off, I may be in a position to repurchase my contracts at a fraction of the cost I sold them for, and write a new set sometime in August with a net additional premium. If TSLA spikes after earnings and exceeds the $210 strike price, I can always roll the contracts again and collect more premiums while taking my strike price higher. Ultimately, I feel that I will generate at least 20-30% annually with this strategy in option premiums and used the capital I had allocated toward PDI for this investment rather than waiting a month or 2 to inject new capital into the account.

What I am doing with the covered call strategy works for me, and I understand how to roll, how to reverse roll, and what the risks are. If anyone is interested in utilizing covered calls to generate income from their investments, my recommendation is to do a lot of research and make sure you understand the risks. I have been writing covered calls on my positions for a long time, and I have created a strategy that works for me. I went into this level of detail because I have written several bullish articles on PDI And wanted to be transparent as to why I liquidated part of my position. Options can be risky if you do not understand the mechanics or the risks involved, so please do your research if this strategy seems interesting to you.

Why I am still bullish on PDI for capital appreciation and income generation

We just got the latest personal consumption expenditure (PCE) report, and the index was unchanged in May after 3 consecutive increases of 0.3%. Goods prices declined by 0.4%, while services increased by 0.2%. On an annualized basis, PCE declined to 2.6%, which is the lowest rate since March 2021. CPI also came in at 3.3% in May after falling from 3.4% in April and 3.5% in March. At the June FOMC press conference, Fed Chair Powell indicated that the consensus was that the next move for rates would be lower. The Fed’s new outlook sees rates at 5.1% to close out 2024, then gradually declining to 4.1% in 2025 and 3.1% in 2026. Currently, the unemployment rate is 4%, which has increased by 0.5% over the past year. When the yield curve was inverted, everyone speculated that it was the preferred indicator for predicting a recession. I have frequently said that the yield curve wasn’t as important as the national unemployment rate.

Going back to 1948, every time we have seen unemployment increase by 1% it has continued to increase through a recession. Just because the yield curve inverts doesn’t mean people stop spending money. When jobs are lost, discretionary and even normalized spending gets impacted, and when companies aren’t bringing in the same amount of revenue, they are faced with the difficult decision of implementing layoffs. We are getting closer to a recession, and if unemployment keeps ticking higher, the chances of a recession will likely increase. If we look at 1957, 1970, and 2000, a recession happened after unemployment crossed over the 4% level and continued higher. The Fed has a dual mandate, and part of the mandate is for maximum employment. I think the Fed is going to start the rate-cutting cycle at the July or September meeting because unemployment is starting to rise to the point where it could throw the economy into a recession. CME Group now has the chances of a rate cut by the close of the September meeting at 64.1%. A lower rate environment will spur economic development as businesses will be more likely to borrow capital to expand, which will create more jobs in the economy.

Taking rates higher has been a disaster for PDI, as PDI’s assets consist of debt obligations and other income-producing securities, including mortgage-backed securities. As the Fed increased rates, the risk-free rate of return exceeded a 5% yield, and new corporate debt or MBS obligations originated with higher yields as the cost of funding the debt increased. This caused all the previous dent to decline in value because debt with a $100 face value yielding 3% isn’t as valuable as debt with a $100 face value yielding 5-8%. For investors to purchase older debt, they need to trade at a discounted rate to match the going rate for newly issued debt. This caused many of the holdings within PDI’s portfolio to decline in value.

PDI has $5.28 billion in net assets, and 49.70% of its market value is tied to agency MBS and high-yield credit. These are two of the hardest hit areas when interest rates increase, and a larger reason why shares of PDI have declined so aggressively. I believe that the Fed is going to cut rates in 2024 and feel they should have started cutting rates at the May meeting. Once a rate cutting cycle is initiated, the narrative should change, and as the cycle progresses, the risk to high-yield credit and agency MBS should be alleviated to some degree. Businesses and entities that took out mortgages will be able to refinance at levels that better fit their profitability model, and the interest being paid on floating rate will also decline. I like PDI here because the underlying value of their assets should appreciate, and their ongoing investments over 2023 and 2024 should benefit shareholders in the future. They have been making investments at the top of the yield cycle, so at some point, that debt will become more desirable because it has the highest yield. As rates decline, institutional investors looking for yield, such a debt funds, will look to allocate capital toward newer debt, and as their face value increases, the yield will decrease to match the lower yields of future debt being issued. This should help shares of PDI appreciate.

While PDI has the potential to generate capital appreciation for its shareholders, it will likely remain an income standout for investors seeking to generate passive income. As the risk-free rate of return decreases, there will be capital looking to be reallocated to recreate the yields investors were getting from CDs, money markets, and bonds. PDI pays a monthly distribution with an annualized yield that exceeds 14%. Over the years, PDI has been able to increase distribution while paying special distributions. PDI has established a strong track record of rewarding shareholders with double-digit yields, and the trend could continue while shares start mounting a comeback.

Conclusion

There is a large segment of investors focused on generating passive income from their investments. PDI offers an indirect way to gain exposure to corporate debt instruments and produce a double-digit yield. I think the Fed has backed itself into a corner, and with unemployment increasing to 4%, they no longer have the luxury of sticking to the narrative of being data-dependent. Maximum employment is half of their mandate, and if the Fed remains too tight for too long, it is likely to cause a recession that is completely avoidable. If the Fed starts to cut rates in 2024, it will be bullish for PDI, as many of their underlying investments should appreciate in value. While I needed the capital for a different investment, I plan on rebuilding the position I had in the future. I am still a shareholder of PDI, and I am bullish on its future prospects as it can provide sizable amounts of income and capital appreciation.