PHT: Two Concerns, But Otherwise A Very Good Junk Bond Fund (NYSE:PHT)

The Pioneer High Income Fund, Inc. (NYSE:PHT) is a closed-end fund, or CEF, that income-focused investors can purchase in pursuit of their goals. As is frequently the case with closed-end bond funds, the Pioneer High Income Fund has a reasonably attractive yield. At least, its yield is very reasonable compared to the incredibly low bond yields that investors and savers have had to put up with over most of the 21st century. As of the time of writing, this fund yields 8.96%. Here is how that compares to some of its peers:

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As we can immediately see, the Pioneer High Income Fund is not the highest-yielding fund in the space. This is not necessarily a bad sign, as outsized yields in general tend to be a sign that the market believes that a fund is engaging in unsustainable activities. A common example for a closed-end fund would be the distribution of monies far exceeding the actual investment profits that are earned by the portfolio. A yield that is significantly lower than its peers does not necessarily mean that the fund is safer than other funds in the same category, though, so we should not look at yield alone. With that said, income-focused investors do frequently consider a fund’s yield as one factor in their analysis, and this one obviously does not look quite as good as its peers.

As regular readers can likely remember, we previously discussed the Pioneer High Income Fund in August 2023. The bond market environment at the time was very similar to the one that we have today as investors began to believe that the Federal Reserve was in no hurry to reduce rates and that it would keep them at levels far exceeding those of the “free money” era that dominated most of this century’s financial landscape. As such, bond prices were rapidly declining and bond yields rose. There was a period in late 2023 in which the opposite happened, and investors began to price in a significant degree of interest rate cuts in 2024. However, the market is no longer expecting much more than fifty basis points of interest rate cuts through December and the bond market has declined so far this year. As such, we can probably assume that the fund’s performance since the date of our prior discussion has been relatively flat. However, that has not been the case, as shares of the Pioneer High Income Fund have appreciated by 6.74% since that date:

As we can clearly see from the chart above, this fund’s share price has performed much better than either the Bloomberg U.S. Aggregate Bond Index (AGG) or the Bloomberg High Yield Very Liquid Index (JNK) that tracks junk bonds. Of the two indices, the junk bond index is a better benchmark for this fund, as the Pioneer High Income Fund also invests in high-yield bonds. The curious thing here is that the junk bond index has actually outperformed investment-grade corporate and sovereign issues over the intervening period. We would ordinarily expect junk bonds to decline more rapidly than investment-grade bonds during a period of time in which long-term interest rates are rising. For example, that is what happened back in 2022:

This is being driven by the yield premium that is demanded by investors for taking on the higher default risk of junk bonds being lower than it was back in August. In short, the yield of junk bonds is closer to that of investment-grade bonds than it was eight months ago. It is uncertain how long this will last, and it is a very real risk for anyone who buys the Pioneer High Income Fund today. After all, any expansion of the yield premium will cause the fund’s net asset value to decline unless all yields begin falling (which is unlikely in the near term due to comments made by Chairman Powell of the Federal Reserve earlier this week). That event would cause the fund’s share price to decline and hand losses to investors purchasing at today’s level.

As I have pointed out in various previous articles, the share price performance of a closed-end fund does not necessarily tell us how well investors in a given fund actually did. This is because funds such as the Pioneer High Income Fund distribute most or all of their investment profits to their shareholders. The basic business model is to keep the size of the portfolio relatively stable while giving the investors all the profits earned by said portfolio. This is the reason why these funds tend to have higher yields than just about anything else in the market. The distribution also provides a real return that results in the investors actually doing much better than the share price performance alone would suggest.

As such, we should take the fund’s distributions into account in any analysis of its performance. When we do that, we see that investors in the Pioneer High Income Fund have benefited from a 12.67% gain since the date that my previous article on this fund was published:

As we can see, the inclusion of the coupon payments and distributions paid out by both the Pioneer High Income Fund and both index funds was sufficient to offset the losses that investors suffered from the price decline of investment-grade bonds. This is nice, but obviously, no bond has come anywhere close to beating common stocks. That is the usual state of affairs, though, and as such we should not worry too much. After all, nobody invests in bonds because they expect to beat common stocks. Of course, in the short term, there could be some reasons to expect that bonds will outperform common stocks. In particular, some of the largest stocks in the S&P 500 Index (SP500) right now have somewhat stretched valuations that will take several decades for the companies in question to grow. Rising bond yields could make them more attractive than waiting for an extended period for a company’s profits to grow into its valuation.

As we can see from the charts above, the recent performance of the Pioneer High Income Fund has been good relative to its indices. This strong performance will almost certainly be attractive to investors, including those whose primary objectives revolve around the generation of income. However, past performance is no guarantee of future results, so let us take a look at this fund’s holdings and financial situation today in an attempt to determine where it will go from here.

About The Fund

The Pioneer closed-end funds are relatively unusual in that they do not have a dedicated website. This fund is no exception as the only thing that the fund sponsor provides is a website that shows all the funds in the family as well as provides some documentation for each respective fund. Fortunately, the fund’s fact sheet, which can be downloaded from that website provides a description of the fund’s strategy and objectives. Here is what the fact sheet states:

Pioneer High Income Fund, Inc. is a closed-end fund that invests for a high level of current income by investing in a portfolio of below-investment-grade bonds and convertible securities. It also seeks capital appreciation as a secondary objective.

The remainder of the description is simply a disclaimer outlining the various risks of investing in a junk bond fund. I suspect that most individuals who are reading this are well aware of the potential for default-related losses, market-driven declines, and similar risks, so I will not waste space copying the rest of the fund’s description. It can be freely viewed in the downloadable fact sheet in any case. The only real thing of importance that is mentioned in the disclaimer that could be relatively unusual or surprising is that the fund can invest up to half of its assets in illiquid securities that may be difficult to dispose of. As these securities are not traded on any exchange, it can be difficult to value them as well as to obtain an appropriate price given their characteristics and the issuing entity’s fundamentals. This could be a potential concern for potential investors as it results in the fund’s reported net asset value potentially being exposed to errors. After all, just because the fund’s managers or auditors say that an asset has a particular value does not mean that it could actually be sold at that price.

While the fund’s documentation states that it can have up to half of its assets invested into illiquid securities, the fact sheet does not state what percentage of its assets are currently invested in such securities. The only asset allocation that it provides is this:

The fund’s semi-annual report is similarly opaque. It repeats the fact sheet’s statement that up to half of its assets might be invested in these securities, but it does not outright state what percentage of total assets the fund currently has invested in such securities. Rather, the semi-annual report provides the following asset allocation:

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The foreign government bonds are obligations of the Russian Federation, which might attract some concern from American or European investors. After all, that country has been the target of economic sanctions for a while now. Those sanctions could, in fact, be causing this asset to be illiquid and basically force the fund to simply hold on to it. It is a tiny proportion of the fund’s total assets in any case, and as such, we probably do not need to worry about it.

There might be some eagle-eyed readers who notice that some of the asset allocation figures provided in the semi-annual report differ from the fact sheet’s statements. The semi-annual report provides a full accounting of all the assets that were held by the fund on September 30, 2023. The fact sheet provides a summary of its holdings on February 29, 2024. As such, the fact sheet is the more recent document and is therefore more authoritative in areas in which the two documents differ. However, the Pioneer High Income Fund only has a 24% annual turnover, so its assets will not be changing that often. As such, there could be a place for both information sources in determining what this fund currently holds in its portfolio.

The important takeaway, though, is that it does not appear that the fund is providing a concrete figure for the percentage of its portfolio that is currently invested in illiquid securities. As such, it is uncertain how accurate the fund’s reported net asset value actually is, as it might not be able to actually sell everything in its portfolio at the price that it claims in an emergency. This means that, as investors, we cannot be completely certain how appropriate the price that we pay for the fund’s shares is given its underlying assets. Any potential investor should keep this in mind when considering purchasing shares of the fund.

The asset allocation data that is provided in both the fund’s fact sheet and its semi-annual report state that the fund is primarily invested in high-yield corporate bonds, which are colloquially called “junk bonds.” These bonds are so named because they have a much higher risk of default than ordinary investment-grade bonds. As such, investors demand a much higher rate of interest than would be required from investment-grade corporate or sovereign bonds as compensation for the increased risk of default. Historically, this premium has ranged from 4% to 6% depending on the fear factor and general willingness of market participants to take on risk. This would ordinarily suggest that these bonds should decline along with investment-grade bonds to maintain that historical premium. However, interestingly, junk bonds have been outperforming government bonds year-to-date:

This chart shows the iShares 7-10 Year Treasury Bond ETF (IEF) against the junk bond SPDR over the year-to-date period:

This is very interesting as it suggests that so far this year, investors have been more willing to hold junk bonds than medium-term U.S. Treasury securities. Basically, the yield premium of junk bonds has been narrowing. Admittedly, this could also suggest a reduced willingness of investors to hold longer-dated bonds as the junk bond index has a 4.93-year average time to maturity, which is a bit less than the treasury bond fund. Short-term (1–3-year Treasuries) have held up better than junk bonds over the same period. However, take a look at the iShares 3-7 Year Treasury Bond ETF (IEI) over the year-to-date period:

Once again, we see that junk bonds are holding up better than U.S. Treasury securities of comparable time until maturity. This once again suggests that the yield premium is decreasing. It is possible that this is being caused by perceptions of U.S. Treasury safety right now, as QTR pointed out on the Fringe Finance Substack:

Now it is unfair to annualize this because there is some lumpiness in the monthly data; however, with 365 days in a year this implies a deficit of $3.65 Trillion/year. In the first Federal quarter that ended December 31, 2023, the deficit was $500 Billion implying a $2.0 Trillion annual deficit. Q2, which ended March 3, was just reported, and the deficit was $600 Billion. For the first half of fiscal 2024 the U.S. Federal Government recorded a $1.1 Trillion dollar deficit. Clearly, the current run rate is much higher.

Keep in mind that this is all with a relatively healthy economy and stock market. If the debt were to continue to grow at this rate, it would be comparable to a starting debt of $34 Trillion on December 31, 2023. It (a deficit run rate of $3.65T) would imply an annualized growth rate of 10.7% in the total debt burden. Annual debt growth of 10.7% compares very unfavorably to estimated GDP growth of 2.0-2.5%. GDP funds the interest payments on the debt and this is why the math is unrelenting. Something has to give. And by the way, the trend in this does not look good, the Biden Administration just proposed a spending budget of $7.3 Trillion for fiscal 2025, which represents a 13% increase in spending. Keep in mind that tax revenues in fiscal 2023 were only $4.4 Trillion. Where are they going to find the money?

Thus, it is possible that at least some portion of the apparent narrowing of the junk bond risk premium is being caused by investors re-evaluating their previous assumptions of U.S. Treasury debt as risk-free. If that debt is riskier than was previously believed, then it only makes sense that such re-evaluation would cause it to underperform junk bonds that have always been considered to be very risky assets. However, junk bonds still typically pay their coupons in U.S. dollars and many have an inherent link to the American economy. As such, there is a risk here that the risk premium compression will reverse and return to its historic levels. In such an event, anyone buying junk bonds, or a junk bond fund, today could suffer some price declines.

A look at the credit ratings of the securities in the fund’s portfolio shows that the risk of default-related losses should not be too bad:

An investment-grade security is anything rated BBB or higher, as well as cash-equivalent securities. As we can immediately see, that accounts for 15.17% of the fund’s total assets. This is obviously a minority, but it is still higher than many other junk bond funds possess. In particular, the fund’s cash position is much higher than most funds possess.

In the past, that would have been an unacceptable drag on a fund’s performance. Cash has actually outperformed most bonds so far this year because it has not declined, and money market funds are actually providing reasonable yields. However, we can still see that 76.15% of the fund’s assets are invested in speculative-grade securities. The percentage might be higher than this, as it seems likely that the 8.68% weighting to unrated securities also consists of speculative-grade securities. After all, pretty much any entity that is capable of getting an investment-grade credit rating will probably go through the time and expense to do so because that will save it a substantial amount of money on interest payments over time.

As such, we can assume that 84.83% of the fund’s assets are invested in junk debt. This is actually lower than we would expect from a junk bond fund, but it is certainly higher than a highly risk-averse investor might prefer.

However, we can see that 63.27% of the fund’s assets are invested in securities that carry either a BB or a B credit rating. These are the two highest possible ratings for speculative-grade debt. According to the official bond rating scale, entities that can issue bonds with these two ratings have sufficient financial strength to handle all of their existing debt and should be able to continue to do so even in the event of a short-term economic shock. Their balance sheets are not nearly as strong as an investment-grade entity, but the overall default risk should not really be too high. That could be a source of comfort when combined with the fact that the fund’s portfolio includes securities from 289 unique issuers. After all, the high number of issuers means that every single issuer only accounts for a small percentage of the portfolio, and thus a single default should not have a noticeable impact on the portfolio as a whole.

The biggest risk here is that many companies will default all at once, but that generally only happens when the economy is facing some sort of crisis. In such situations, most of us will have bigger things to worry about than some losses in a given bond fund in our portfolios. As such, we can see that we probably do not have to worry too much about losing money due to defaults. The biggest risk here is that junk bonds will decline in price due to either interest rates remaining high for an extended period or the currently compressed risk premium returning to average levels.

Leverage

As is the case with most closed-end funds, the Pioneer High Income Fund employs leverage as a method of boosting the effective yield that it receives from the assets in its portfolio. I explained how this works in my previous article on this fund:

In short, the fund is borrowing money and using that borrowed money to purchase junk bonds and similar assets. As long as the purchased assets have a higher yield than the interest rate that the fund has to pay on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. This fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this will usually be the case. However, it is important to note that this strategy is not as effective today with rates at 6% as it was three years ago when rates were essentially 0%. This is because the difference between the rate at which the fund can borrow and the yield on the purchased securities is much narrower than it once was.

As of the time of writing, the Pioneer High Income Fund has leveraged assets comprising 31.50% of its portfolio. This represents an improvement over the 32.07% leverage ratio that the fund had at the time of our previous discussion. However, neither ratio is especially bad, as I generally consider anything under a third of assets to represent a reasonable balance between the risks and the potential rewards of using leverage.

Here is how this fund’s leverage compares to that of its peers:

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(all figures from CEF Data.)

As we can clearly see, none of the funds that invest in junk bonds are particularly highly leveraged. At least, they are not anymore as a few of them did use fairly significant levels of leverage back when interest rates were at 0%, and buying bonds with substantial amounts of leverage was the only way to earn a reasonable yield from a junk bond portfolio. The Pioneer High Income Fund does have the highest leverage here, which would ordinarily suggest that the fund is taking on excessive amounts of risk relative to its peers. However, in truth, the difference between this fund’s leverage and that of its peers is not very great, so we can overlook it. Overall, it does appear that the Pioneer High Income Fund is striking a reasonable level of balance between the risk and the potential rewards of using leverage.

Distribution Analysis

As mentioned earlier in this article, the primary investment objective of the Pioneer High Income Fund is to provide its investors with a very high level of current income. This makes sense given the fund’s strategy of investing its assets in junk-rated bonds and similar assets because these securities deliver the bulk of their total returns in the form of direct payments to their investors. The fund collects the coupons that it receives from these securities and combines them with any trading profits that it manages to earn by exploiting the bond price movements that accompany changes in interest rates.

This fund then takes things a step further by borrowing money and using that money to purchase and receive coupon payments from more bonds than it could control simply by relying on its equity capital. Ultimately, the fund distributes all of this money to its shareholders, net of its own expenses. When we consider the fact that bond prices are currently reasonable for the first time in a generation, we can expect that this business model would provide the fund’s shares with a very attractive yield.

This is indeed the case, as the Pioneer High Income Fund pays a monthly distribution of $0.0550 per share ($0.66 per share annually), which gives it an 8.96% yield at the current share price. As we saw in the introduction to this article, this yield is slightly lower than that of many of the fund’s peers, but it is not entirely out of line with the sector. However, this fund has not been particularly consistent regarding its distributions over the years. In fact, the fund has both raised and lowered its distribution several times since its inception:

The recent trend, unfortunately, has been for the fund to cut its distribution, and it is currently much lower than the $0.1375 per share monthly distribution that the fund had a decade ago. The most recent distribution cut came last May, when the fund reduced its monthly distribution from $0.0575 per share to $0.0550 per share:

This is something that may turn out to be a turn-off for those investors who are seeking to earn a safe and consistent income from the assets in their portfolio. This is a group that includes many retirees as well as those individuals who are trying to supplement their salaries with some investment income in today’s inflationary environment. Speaking of an inflationary environment, a distribution reduction is the last thing that we really want to see because we need higher incomes to maintain a certain standard of living than we did only a few years ago. The fact that this fund has been cutting its distribution has the opposite effect.

However, as I have pointed out in the past, the fund’s distribution history is not necessarily the most important thing for an investor today. This is because anyone who purchases the fund’s shares today will receive the current distribution at the current yield. This person will not be adversely affected by events that occurred in the past. As such, we should take a look at the fund’s finances to see how well it can sustain its current distribution.

Unfortunately, we do not have a particularly recent document that we can consult for the purposes of our analysis. As of the time of writing, the most recent financial report for the Pioneer High Income Fund is the semi-annual report that corresponds to the six-month period that ended on September 30, 2023. As such, this report will include no information about the fund’s performance over the past seven months. This is disappointing, as there were several things that occurred during the intervening period, including both the epic bond market rally in the final two months of last year and the decline in bond prices that we have seen this year.

As the financial report ends before either of these events occurred, we have no way of knowing how well the fund performed in either of them. However, it does include at least part of the summer and autumn of 2023, which was a bear market for junk bonds. During that period, we generally saw rising yields and falling bond prices. That could have caused this fund to take some realized or unrealized losses. It is also more indicative of the quality of a fund’s management and how it performs during a challenging period than a bull market. After all, anyone can make money when the price of every asset in the market is rising.

For the six-month period that ended on September 30, 2023, the Pioneer High Income Fund received $13,875,751 in interest and $487,487 in dividends (net of foreign withholding taxes) from the assets in its portfolio. This gives the fund a total investment income of $14,363,238 for the period. The fund paid its expenses out of this amount, which left it with $9,689,018 available for shareholders.

This was, unfortunately, not sufficient to cover the $9,756,094 that the fund paid out in distributions during the period. However, it did manage to get very close to fully covering its distribution out of net investment income. We would ordinarily prefer that a fixed-income fund simply pay out its net investment income to the investors, so this is a good sign, although it would be preferable if its net investment income were slightly higher.

With that said, there are other methods through which a fund can obtain the money that it requires to cover its distributions to the shareholders. For example, it might be able to earn some money through the sale of bonds that go up in price when interest rates decline. These are realized capital gains and are therefore not included in net investment income for tax or accounting purposes. However, they clearly do represent money coming into a fund that can be paid out to the investors.

Fortunately, this fund managed to do okay here. It reported net realized losses of $6,956,242, but this was fully offset by $8,587,838 net unrealized gains. Overall, the fund’s net assets increased by $1,564,520 after accounting for all inflows and outflows in the period. As the fund’s net assets increased, it fully covered all of its payouts during the period.

This is probably sustainable going forward. As we can see, the fund came very close to fully covering its distributions solely out of net investment income. The fund actually cut its distribution part-way through the period, so we can assume that its distribution payouts are a bit lower now. Thus, assuming that the fund’s net investment income remained stable, it should be fully paying the smaller distribution solely with its net investment income. Bond coupons do not change over time, so it is probably the case that its net investment income is relatively stable. As such, everything is probably okay here.

Valuation

As of April 17, 2024 (the most recent date for which data is available as of the time of writing), the Pioneer High Income Fund has a net asset value of $8.06 per share, but the shares currently trade at $7.34 each. This gives the fund’s shares an 8.93% discount to net asset value at the current price. This is quite a bit more attractive than the 6.24% discount that the fund’s shares have had on average over the past month. Thus, the current price looks very good if you wish to add this fund to your portfolio.

Conclusion

Overall, the Pioneer High Income Fund looks like a pretty good junk bond fund. There are only two concerns that I have here, and one of them will apply to any junk bond fund right now. The concern that is unique to this fund is that it might have a significant percentage of its portfolio invested in illiquid securities that cannot be rapidly disposed of. As such, we do not know how accurate its stated net asset value actually is.

The second concern is that junk bonds might be overpriced because they have not declined in price as much as U.S. Treasury securities year-to-date. This could expose the Pioneer High Income Fund to losses if the market corrects and allows the junk bond risk premium to return to historic levels. Overall, though, Pioneer High Income Fund, Inc. could be a reasonable way to get an 8.96% yield today.