PIMCO Dynamic Income Fund (NYSE:PDI) is a fixed income-oriented closed-end fund that is supplying a monthly dividend to passive income investors. The closed-end fund presently pays a 14% yield which makes the PDI obviously attractive to investors, particularly those that want to produce recurring income for retirement purposes.

The PIMCO Dynamic Income Fund is selling at a relatively high premium to net asset value, but the central bank is poised to slash short-term interest rates for the first time in 2024.

As we are approaching this crucial point in time, I anticipate that fixed income assets, which the PIMCO Dynamic Income Fund holds in its portfolio, to appreciate in value.

Thus, I think it is a good moment in time to change my classification for the PIMCO Dynamic Income Fund to ‘Buy’.

My Rating History

I modified my classification for the PIMCO Dynamic Income Fund from ‘Buy’ to Hold in January 2024 because the inflation flare-up at the start of the year made a fast decline in short-term interest rates improbable. This, in turn, delayed a crucial catalyst for the fixed income closed-end fund.

With inflation retreating lately, however, I think the central bank is anticipated to cut rates by 0.25% in December 2024 and take further action on rates in 2025. This should be a rerating catalyst for the underlying fixed income assets included in PIMCO Dynamic Income Fund’s portfolio.

Fund Position And Investment Strategy

The PIMCO Dynamic Income Fund is a fixed income-oriented closed-end fund with $5.3 billion in net assets. The fund’s primary objective is to produce recurring income from its portfolio of fixed income instruments such as mortgage-backed securities, corporate and sovereign bonds, investment-grade and high-yield credit investments as well as derivative instruments. The secondary objective of the PIMCO Dynamic Income Fund is to provide capital appreciation.

Non-Agency mortgage securities and high-yield credit investments were the two largest asset classes of the PIMCO Dynamic Income Fund as of May 31, 2024 with portfolio percentages of 24.6% and 25.1%.

The fund is primarily oriented towards fixed income investments in the U.S., but it may invest into other markets as well, particularly in emerging markets where the PDI has an opportunity to earn higher yields. As of May 31, 2024, 24% percent of the fund’s assets were invested outside of the U.S.

Attractive, Long-Term Returns For Passive Income Investors

A look at past performance can quickly reveal if investors are dealing with a stable investment option or with a one hit wonder. In the case of the PIMCO Dynamic Income Fund, the fund has returned an average annual return of 10.6% since inception (May 30, 2012).

The fund did particularly badly in 2022 because the central bank embarked on an aggressive rate-hiking cycle that year that lasted for about one and a half years. During this time, fixed income assets took a major beating as mortgage security and bond prices tend to move in opposite directions as interest rates.

In 2022, the PIMCO Dynamic Income Fund thus produced a negative annual return of 14.82%, but the closed-end fund has since recovered, partially because the central bank has avoided additional rate hikes and appears set to slash short-term interest rates in 2024.

The market expectation is for a 0.25% rate cut in December which could kick off the end of the present rate-cycle which in turn would probably profit the fund’s fixed income holdings. This is particularly true because inflation fell to 3.3% in May, which was the second consecutive quarter with easing price pressure.

PDI’s Premium Valuation

Contrary to my expectations, the PIMCO Dynamic Income Fund did not see a major decline in its net asset value premium since January. Presently, the PIMCO Dynamic Income Fund sells for a 13% premium to net asset value which, as of July 3, 2024, was $16.85. Closed-end fund tend to sell for either small discounts or premiums to net asset value and the PIMCO Dynamic Income Fund did both.

In the last year, the PDI sold between a 4% discount and a 15% premium to NAV, so the present valuation is situated at the higher end of this range.

Taking into account that the PIMCO Dynamic Income Fund could see its underlying portfolio of fixed income assets rerate higher as the central bank eyes rate cuts, I think we could potentially see a higher NAV premium towards the end of the year.

Why The Investment Thesis Might Not Meet My Expectations

If the central bank were to delay rate cuts yet again, the PIMCO Dynamic Income Fund would probably not benefit from a rerating of the underlying fixed income instruments and the high premium that the closed-end fund is selling at might disappear, inflicting potential capital losses on passive income investors.

Since we are approaching the date at which the central bank will kick off the interest-slashing cycle, I think that the risk/reward relationship has been enhanced.

A shortcoming of the PIMCO Dynamic Income Fund is that the fund does not raise the level of its distributions, meaning passive income investors are not benefiting from any dividend growth.

My Conclusion

In my view, the PIMCO Dynamic Income Fund as a compelling choice for passive income investors that want to lock in a high yield from a well-managed closed-end fund. This holds particularly true for passive income investors that rely on steady income, like those that are already in retirement.

The PIMCO Dynamic Income Fund has also become more of an attractive investment choice lately because the central bank is anticipated to lower short-term interest rates in the latter half of 2024 (expected for December 2024, to be more precise) which can be expected to benefit rate-dependent fixed income instruments like residential and commercial mortgage-backed securities as well as bonds across the yield universe.

Taking into account that inflation has also been receding for two straight months, I think a rerating catalyst for the PIMCO Dynamic Income Fund is potentially just around the corner. Buy.