Pair of Pimco closed-end funds suddenly blue-light specials

The recent bond market sell-off has left shares of two of Pacific Investment Management Co. LLC's closed-end funds trading at fire sale prices. Closed-end funds have a fixed number of shares outstanding. Therefore, when a fund is popular, the shares tend to trade at a premium to net asset value. When they are unpopular, they trade at a discount. With investor sentiment turning away from bond funds, which have seen six straight weeks of outflows, shares of the $282 million Pimco Income Strategy Fund (PFL) and the $587 million Pimco Income Strategy Fund II (PFN) are trading at their biggest discounts in three years. The drop in price could signal a good buying opportunity for income-hungry investors, writes Cara Esser, a closed-end fund analyst at Morningstar Inc. Shares of the Pimco Income Strategy Fund are trading at a 2.5% discount to the fund's net asset value and shares of Pimco Income Strategy Fund II are trading at a 2% discount. Over the past three years, the funds' shares have traded at premiums of 6.4% and 4%, respectively, according to Morningstar Inc. Both funds have a distribution rate of more than 9%. Bond guru Bill Gross was named as manager of the funds in mid-2009 and shortly thereafter, the funds' mandates were expanded to be more flexible. Since the funds adopted a go-anywhere approach in early 2010, their performance had been on a tear. The Pimco Income Strategy Funds had annualized three-year returns of around 16% as of July 8, according to Morningstar. The funds' closed-end peers had an average three-year annualized return of 12% over the same time. The average open-end fund had gained 7%. One of the reasons for the supersized performance is that Pimco is not afraid to use leverage to boost returns. Both funds currently have more than 20% leverage, which may scare off some investors, according to Morningstar. “Pimco's extensive use of leverage and derivatives in the past indicates a willingness to put capital at risk for potentially improved total return,” Ms. Esser wrote. “These funds are not for the faint of heart.”