Recently I suggested buying of closed-end funds, especially those at a high discount and with high yields.

One of the risks of buying these securities is the fun way the rules and bylaws for the funds take effect. For example, PFL, PIMCO’s Floating Rate Income Fund recently had a press release:

PFL “announced today that the Funds have postponed the payment of the previously declared dividends on the Funds’ common shares…

In accordance with the … Fund’s By-laws, each Fund is not permitted to pay or declare common share dividends unless that Fund’s [assets] have a minimum asset coverage of 200%… Due to current market conditions, the values of the Funds’ portfolio securities have declined, which has caused the Funds’ asset coverage ratios to fall below the 200% Level.”

Oh crap, right? Continuing with the press release:

“…the Funds’ ability to earn sufficient income to pay the previously declared dividends or declare the December dividends was not impacted by this decline in the asset coverage ratios or market conditions.”

The funds have the cash to pay the dividends, but they’re not allowed to do so due to their own rules!

Side note: I agree with this approach, but not everyone does.

And according to an earlier press release, the managers of the fund evaluated selling some of their assets to get back over the 200% ratio…

“To do so would require the Funds to sell a significant number of securities for cash. The Funds do not believe that this is in their best interest at this time. Market conditions continue to be extraordinarily volatile and the Funds believe that market prices do not reflect the fundamental value of securities.”

That’s great if you agree with the managers (I personally do), but sucks if you don’t agree with them, or were counting on the dividend.

Such are the risks of buying funds like this. I think those risks are well compensated for by the high yields and the discounts to NAV… but your mileage may vary.