UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number: 811-23211
PIMCO Flexible Credit Income Fund
(Exact name of registrant as specified in charter)
1633 Broadway, New York, NY 10019
(Address of principal executive offices)
Trent W. Walker
Treasurer (Principal Financial & Accounting Officer)
650 Newport Center Drive
Newport Beach, CA 92660
(Name and address of agent for service)
Copies to:
David C. Sullivan
Ropes & Gray LLP
Prudential Tower
800 Boylston Street
Boston, MA 02199
Registrant’s telephone number, including area code: (844) 312-2113
Date of fiscal year end: June 30
Date of reporting period: June 30, 2018
Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget (“OMB”) control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. § 3507.
| Item 1. | Reports to Shareholders. |
The following is a copy of the report transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act of 1940, as amended (the “1940 Act”) (17 CFR 270.30e-1).
PIMCO Interval Funds
Annual Report
June 30, 2018
PIMCO Flexible Credit Income Fund | PFLEX
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Letter from the Chairman of the Board & President
Dear Shareholder,
Following is the PIMCO Flexible Credit Income Fund‘s Annual Report, which covers the 12-month reporting period ended June 30, 2018. On the subsequent pages you will find specific details regarding investment results and a discussion of factors that most affected performance over the reporting period.
For the 12-month reporting period ended June 30, 2018
The U.S. economy continued to expand during the reporting period. Looking back, U.S. gross domestic product (GDP) expanded at a revised annual pace of 2.8% and 2.3% during the third and fourth quarters of 2017, respectively. First-quarter 2018 GDP then moderated to a revised annual pace of 2.2%. The Commerce Department’s initial reading — released after the reporting period had ended — showed that second-quarter 2018 GDP grew at an annual pace of 4.1%.
The Federal Reserve (Fed) continued to normalize monetary policy during the reporting period. After raising interest rates in March and June 2017, the Fed again raised rates in December, moving the federal funds rate up to a range between 1.25% and 1.50%. And, in October 2017, the Fed started to reduce its balance sheet. At its March 2018 meeting, the Fed again increased rates to a range between 1.50% and 1.75%. Finally, at its meeting that concluded on June 13, 2018, the Fed raised rates to a range between 1.75% and 2.00%.
Economic activity outside the U.S. initially accelerated during the reporting period, but then moderated somewhat as the reporting period progressed. Against this backdrop, the European Central Bank (ECB) and Bank of Japan largely maintained their highly accommodative monetary policies. Other central banks took a more hawkish stance. In November 2017, the Bank of England instituted its first rate hike since 2007, and the Bank of Canada raised rates twice during the reporting period. Meanwhile, in June 2018, the ECB indicated that it plans to end its quantitative easing program by the end of the year, but it did not expect to raise interest rates “at least through the summer of 2019.”
The U.S. Treasury yield curve flattened during the reporting period, as short-term rates moved up more than their longer-term counterparts. The increase in rates at the short end of the yield curve was mostly due to Fed interest rate hikes. The yield on the benchmark 10-year U.S. Treasury note was 2.85% at the end of the reporting period, up from 2.31% on June 30, 2017. U.S. Treasuries, as measured by the Bloomberg Barclays U.S. Treasury Index, returned -0.65% over the 12 months ended June 30, 2018. Meanwhile, the Bloomberg Barclays U.S. Aggregate Bond Index, a widely used index of U.S. investment grade bonds, returned -0.40% over the period. Riskier fixed income asset classes, including high yield corporate bonds and emerging market debt, generated mixed results versus the broad U.S. market. The ICE BofAML U.S. High Yield Index gained 2.53% over the reporting period, whereas emerging market external debt, as represented by the JPMorgan Emerging Markets Bond Index (EMBI) Global, returned -2.45% over the reporting period. Emerging market local bonds, as represented by the JPMorgan Government Bond Index-Emerging Markets Global Diversified Index (Unhedged), returned -2.33% over the period.
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Global equities generally rose over the first seven months of the period. This rally was driven by a number of factors, including improving global growth, corporate profits that often exceeded expectations and, in the U.S., optimism surrounding the passage of a tax reform bill in December 2017. In the U.S., a portion of those gains were given back in February and March 2018. This was partially due to concerns over less accommodative central bank policies and fears of a trade war. However, U.S. equities then rallied over the last three months of the reporting period. All told, U.S. equities, as represented by the S&P 500 Index, returned 14.37% during the reporting period. Emerging market equities, as measured by the MSCI Emerging Markets Index, returned 8.20% over the period, whereas global equities, as represented by the MSCI World Index, returned 11.09%. Elsewhere, Japanese equities, as represented by the Nikkei 225 Index (in JPY), returned 13.45% over the reporting period and European equities, as represented by the MSCI Europe Index (in EUR), returned 2.85%.
Commodity prices fluctuated but generally moved higher during the 12 months ended June 30, 2018. When the reporting period began, crude oil was approximately $46 a barrel. By the end of the period, it was roughly $74 a barrel. This ascent was driven in part by planned and observed production cuts by OPEC and the collapse in Venezuelan oil production, as well as global growth maintaining demand. Elsewhere, gold and copper prices moved modestly higher over the reporting period.
Finally, during the reporting period, there were periods of volatility in the foreign exchange markets, due in part to signs of improving global growth, decoupling central bank policies, and a number of geopolitical events. The U.S. dollar generally weakened against other major currencies over the reporting period. For example, the U.S. dollar returned -2.26%, -1.40% and -1.45% versus the euro, British pound and Japanese yen, respectively, during the 12 months ended June 30, 2018.
Thank you for the assets you have placed with us. We deeply value your trust, and will continue to work diligently to meet your broad investment needs. For any questions regarding your PIMCO Interval Fund investments, please contact your financial adviser, or call the Funds’ shareholder servicing agent at (844) 312-2113. We also invite you to visit our website at pimco.com to learn more about our global viewpoints.
Sincerely,
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| Hans W. Kertess | Peter G. Strelow | |
| Chairman of the Board of Trustees | President | |
Past performance is no guarantee of future results.
| ANNUAL REPORT | JUNE 30, 2018 | 3 |
Important Information About the Fund
We believe that bond funds have an important role to play in a well-diversified investment portfolio. It is important to note, however, that in an environment where interest rates may trend upward, rising rates would negatively impact the performance of most bond funds, and fixed-income securities and other instruments held by the Fund are likely to decrease in value. A wide variety of factors can cause interest rates to rise (e.g., central bank monetary policies, inflation rates, general economic conditions). In addition, changes in interest rates can be sudden and unpredictable, and there is no guarantee that Fund management will anticipate such movement accurately. The Fund may lose money as a result of movement in interest rates.
As of the date of this report, interest rates in the U.S. and many parts of the world, including certain European countries, are at or near historically low levels. As such, bond funds may currently face an increased exposure to the risks associated with a rising interest rate environment. This is especially true as the Fed ended its quantitative easing program in October 2014 and has begun, and may continue, to raise interest rates. To the extent the Federal Reserve Board continues to raise interest rates, there is a risk that rates across the financial system may rise. Further, while bond markets have steadily grown over the past three decades, dealer inventories of corporate bonds are near historic lows in relation to market size. As a result, there has been a significant reduction in the ability of dealers to “make markets.” Bond funds and individual bonds with a longer duration (a measure used to determine the sensitivity of a security’s price to changes in interest rates) tend to be more sensitive to changes in interest rates, usually making them more volatile than securities or funds with shorter durations. In addition, in the current low interest rate environment, the net asset value (“NAV”) of the Fund’s common shares may be particularly sensitive to changes in interest rates or the perception that there will be a change in interest rates. All of the factors mentioned above, individually or collectively, could lead to increased volatility and/or lower liquidity in the fixed income markets or negatively impact the Fund’s performance or cause the Fund to incur losses.
The use of derivatives may subject the Fund to greater volatility than investments in traditional securities. The Fund may use derivative instruments for hedging purposes or as part of an investment strategy. Use of these instruments may involve certain costs and risks such as liquidity risk, interest rate risk, market risk, call risk, credit risk, leverage risk, management risk and the risk that the Fund may not be able to close out a position when it would be most advantageous to do so. Changes in regulation relating to the Fund’s use of derivatives and related instruments could potentially limit or impact the Fund’s ability to invest in derivatives, limit the Fund’s ability to employ certain strategies that use derivatives and/or adversely affect the value or performance of derivatives and the Fund. Certain derivative transactions may have a leveraging effect on the Fund. For example, a small investment in a derivative instrument may have a significant impact on the Fund’s exposure to interest rates, currency exchange rates or other investments. As a result, a relatively small price movement in an asset, instrument or component of the index underlying a derivative instrument may cause an immediate and substantial loss or gain, which translates into heightened volatility in the Fund’s net asset value NAV. The Fund may engage in such transactions regardless of whether the Fund owns the asset, instrument or components of the index underlying the derivative instrument. The Fund may invest a significant portion of its assets in these types of instruments. If it does, the Fund’s investment exposure could far exceed the value of its portfolio securities and its investment performance could be primarily dependent upon securities it does not own.
The Fund’s use of leverage creates the opportunity for increased income for the Fund’s common shareholders, but also creates special risks. Leverage is a speculative technique that may expose the
| 4 | PIMCO INTERVAL FUNDS |
Fund to greater risk and increased costs. If shorter-term interest rates rise relative to the rate of return on the Fund’s portfolio, the interest and other costs of leverage to the Fund could exceed the rate of return on the debt obligations and other investments held by the Fund, thereby reducing return to the Fund’s common shareholders. In addition, fees and expenses of any form of leverage used by the Fund will be borne entirely by its common shareholders (and not by preferred shareholders, if any) and will reduce the investment return of the Fund’s common shares.
There can be no assurance that the Fund’s use of leverage will result in a higher yield on its common shares, and it may result in losses. Leverage creates several major types of risks for the Fund’s common shareholders, including: (1) the likelihood of greater volatility of the net asset value of the Fund’s common shares, and of the investment return to the Fund’s common shareholders, than a comparable portfolio without leverage; (2) the possibility either that the Fund’s common share dividends will fall if the interest and other costs of leverage rise, or that dividends paid on the Fund’s common shares will fluctuate because such costs vary over time; and (3) the effects of leverage in a declining market or a rising interest rate environment, as leverage is likely to cause a greater decline in the net asset value of the Fund’s common shares than if the Fund were not leveraged and may result in a greater decline in the net asset value of the Fund’s common shares.
The Fund’s investments in and exposure to foreign securities involve special risks. For example, the value of these investments may decline in response to unfavorable political and legal developments, unreliable or untimely information or economic and financial instability. Foreign securities may experience more rapid and extreme changes in value than investments in securities of U.S. issuers. The securities markets of certain foreign countries are relatively small, with a limited number of companies representing a small number of industries. Issuers of foreign securities are usually not subject to the same degree of regulation as U.S. issuers. Reporting, accounting, auditing and custody standards of foreign countries differ, in some cases significantly, from U.S. standards. Also, nationalization, expropriation or other confiscation, currency blockage, political changes or diplomatic developments could adversely affect the Fund’s investments in foreign securities. In the event of nationalization, expropriation or other confiscation, the Fund could lose its entire investment in foreign securities. Investing in foreign (non-U.S.) securities may entail risk due to foreign (non-U.S.) economic and political developments; this risk may be increased when investing in emerging markets. For example, if the Fund invests in emerging market debt, it may face increased exposure to interest rate, liquidity, volatility, and redemption risk due to the specific economic, political, geographical, or legal background of the foreign (non-U.S.) issuer.
The geographical classification of foreign (non-U.S.) securities in this report are classified by the country of incorporation of a holding. In certain instances, a security’s country of incorporation may be different from its country of economic exposure. The United States presidential administration’s enforcement of tariffs on goods from other countries, with a focus on China, has contributed to international trade tensions and may impact portfolio securities.
Investments in loans (including whole loans) are generally subject to risks similar to those of investments in other types of debt obligations, including, among others, credit risk, interest rate risk, variable and floating rate securities risk, and, as applicable, risks associated with mortgage-related securities. In addition, in many cases loans are subject to the risks associated with below-investment grade securities. In the case of a loan participation or assignment, the Fund generally has no right to enforce compliance with the terms of the loan agreement with the borrower. As a result, the Fund
| ANNUAL REPORT | JUNE 30, 2018 | 5 |
Important Information About the Fund (Cont.)
may be subject to the credit risk of both the borrower and the lender that is selling the loan agreement. In the event of the insolvency of the lender selling a loan participation, the Fund may be treated as a general creditor of the lender and may not benefit from any set-off between the lender and the borrower. The Fund may be subject to heightened or additional risks and potential liabilities and costs by investing in mezzanine and other subordinated loans, including those arising under bankruptcy, fraudulent conveyance, equitable subordination, lender liability, environmental and other laws and regulations, and risks and costs associated with debt servicing and taking foreclosure actions associated with the loans.
Mortgage-related and other asset-backed securities represent interests in “pools” of mortgages or other assets such as consumer loans or receivables held in trust and often involve risks that are different from or possibly more acute than risks associated with other types of debt instruments. Generally, rising interest rates tend to extend the duration of fixed rate mortgage-related securities, making them more sensitive to changes in interest rates. As a result, in a period of rising interest rates, if the Fund holds mortgage-related securities, it may exhibit additional volatility since individual mortgage holders are less likely to exercise prepayment options, thereby putting additional downward pressure on the value of these securities and potentially causing the Fund to lose money. This is known as extension risk. Mortgage-backed securities can be highly sensitive to rising interest rates, such that even small movements can cause an investing Fund to lose value. Mortgage-backed securities, and in particular those not backed by a government guarantee, are subject to credit risk. In addition, adjustable and fixed rate mortgage-related securities are subject to prepayment risk. When interest rates decline, borrowers may pay off their mortgages sooner than expected. This can reduce the returns of the Fund because the Fund may have to reinvest that money at the lower prevailing interest rates. The Fund’s investments in other asset-backed securities are subject to risks similar to those associated with mortgage-related securities, as well as additional risks associated with the nature of the assets and the servicing of those assets. Payment of principal and interest on asset-backed securities may be largely dependent upon the cash flows generated by the assets backing the securities, and asset-backed securities may not have the benefit of any security interest in the related assets. Additionally, investments in subordinate mortgage-backed and other asset-backed securities will be subject to risks arising from delinquencies and foreclosures, thereby exposing the Fund’s investment portfolio to potential losses. Subordinate securities of mortgage-backed and other asset-backed securities are also subject to greater credit risk than those mortgage-backed or other asset-backed securities that are more highly rated.
The Fund may also invest in the residual or equity tranches of mortgage-related and other asset-backed instruments, which may be referred to as subordinate mortgage-backed or asset-backed instruments and interest-only mortgage-backed or asset-backed instruments. Subordinate mortgage-backed or asset-backed instruments are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes a large percentage of delinquent loans, there is a risk that interest payment on subordinate mortgage-backed or asset-backed instruments will not be fully paid. There are multiple tranches of mortgage-backed and asset-backed instruments, offering investors various maturity and credit risk characteristics. Tranches are categorized as senior, mezzanine, and subordinated/equity or “first loss,” according to their degree of risk. The most senior tranche of a mortgage-backed or asset-backed instrument has the greatest collateralization and pays the lowest interest rate. If there are defaults or the collateral otherwise underperforms, scheduled payments to senior tranches take precedence over those of mezzanine tranches, and scheduled
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payments to mezzanine tranches take precedence over those to subordinated/equity tranches. Lower tranches represent lower degrees of credit quality and pay higher interest rates intended to compensate for the attendant risks. The return on the lower tranches is especially sensitive to the rate of defaults in the collateral pool. The lowest tranche (i.e., the “equity” or “residual” tranche) specifically receives the residual interest payments (i.e., money that is left over after the higher tranches have been paid and expenses of the issuing entities have been paid) rather than a fixed interest rate. The Fund expects that investments in subordinate mortgage-backed and other asset-backed instruments will be subject to risks arising from delinquencies and foreclosures, thereby exposing its investment portfolio to potential losses. Subordinate securities of mortgage-backed and other asset-backed instruments are also subject to greater credit risk than those mortgage-backed or other asset-backed securities that are more highly rated.
The risk of investing in collateralized loan obligations (“CLOs”), include prepayment risk, credit risk, liquidity risk, market risk, structural risk, legal risk and interest rate risk. CLOs may carry additional risks, including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the collateral may decline in value or default; (iii) the possibility that the investments in CLOs are subordinate to other classes or tranches thereof; and (iv) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results.
High-yield bonds (commonly referred to as “junk bonds”) typically have a lower credit rating than other bonds. Lower-rated bonds generally involve a greater risk to principal than higher-rated bonds. Further, markets for lower-rated bonds are typically less liquid than for higher-rated bonds, and public information is usually less abundant in markets for lower-rated bonds. Thus, high yield investments increase the chance that the Fund will lose money. PIMCO does not rely solely on credit ratings, and develops its own analysis of issuer credit quality. The Fund may purchase unrated securities (which are not rated by a rating agency) if PIMCO determines that the security is of comparable quality to a rated security that the Fund may purchase. Unrated securities may be less liquid than comparable rated securities and involve the risk that PIMCO may not accurately evaluate the security’s comparative credit quality, which could result in the Fund’s portfolio having a higher level of credit and/or high yield risk than PIMCO has estimated or desires for the Fund, and could negatively impact the Fund’s performance and/or returns. The Fund may invest a substantial portion of its assets in unrated securities and therefore may be particularly subject to the associated risks. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher-quality debt obligations. To the extent that the Fund invests in high yield and/or unrated securities, the Fund’s success in achieving its investment objectives may depend more heavily on the portfolio manager’s creditworthiness analysis than if the Fund invested exclusively in higher-quality and rated securities. The Fund may hold defaulted securities that may involve special considerations including bankruptcy proceedings, other regulatory and legal restrictions affecting the Fund’s ability to trade, and the availability of prices from independent pricing services or dealer quotations. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest other payments. Defaulted securities are often illiquid and may not be actively traded. Sales of securities in bankrupt companies at an acceptable price may be difficult and differences compared to the value of the securities used by the Fund could be material. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
| ANNUAL REPORT | JUNE 30, 2018 | 7 |
Important Information About the Fund (Cont.)
Contingent convertible securities (“CoCos”) are a form of hybrid debt security issued primarily by non-U.S. issuers, which have loss absorption mechanisms built into their terms. CoCos have no stated maturity, have fully discretionary coupons and are typically issued in the form of subordinated debt instruments. CoCos generally either convert into equity of the issuer or have their principal written down upon the occurrence of certain triggering events (“triggers”) linked to regulatory capital thresholds or regulatory actions relating to the issuer’s continued viability. As a result, an investment by the Fund in CoCos is subject to the risk that interest payments will be cancelled by the issuer or a regulatory authority, the risk of ranking junior to other creditors in the event of a liquidation or other bankruptcy-related event as a result of holding subordinated debt, the risk of the Fund’s investment becoming further subordinated as a result of conversion from debt to equity , the risk that the principal amount due can be written down to a lesser amount, and the general risks applicable to fixed income investments, including interest rate risk, credit risk, market risk and liquidity risk, any of which could result in losses to the Fund. In certain scenarios, investors in CoCos may suffer a loss of capital ahead of equity holders or when equity holders do not. There is no guarantee that the Fund will receive a return of principal on CoCos. Any indication that an automatic write-down or conversion event may occur can be expected to have an adverse effect on the market price of CoCos. CoCos are often rated below investment grade and are subject to the risks of high yield securities. Because CoCos are issued primarily by financial institutions, CoCos may present substantially increased risks at times of financial turmoil, which could affect financial institutions more than companies in other sectors and industries. Further, the value of an investment in CoCos is unpredictable and will be influenced by many factors and risks, including interest rate risk, credit risk, market risk and liquidity risk. An investment by the Fund in CoCos may result in losses to the Fund.
Variable and floating rate securities generally are less sensitive to interest rate changes but may decline in value if their interest rates do not rise as much, or as quickly, as interest rates in general. Conversely, floating rate securities will not generally increase in value if interest rates decline. Inverse floating rate securities may decrease in value if interest rates increase. Inverse floating rate securities may also exhibit greater price volatility than a fixed rate obligation with similar credit quality. When the Fund holds variable or floating rate securities, a decrease (or, in the case of inverse floating rate securities, an increase) in market interest rates will adversely affect the income received from such securities and the NAV of the Fund’s shares.
The global economic crisis brought several small countries in Europe to the brink of default and many other economies into recession and weakened the banking and financial sectors of many European countries. For example, the governments of Greece, Spain, Portugal, and the Republic of Ireland have all experienced large public budget deficits, the effects of which are still yet unknown and may slow the overall recovery of the European economies from the global economic crisis. In addition, due to large public deficits, some European countries may be dependent on assistance from other European governments and institutions or other central banks or supranational agencies such as the International Monetary Fund. Assistance may be dependent on a country’s implementation of reforms or reaching a certain level of performance. Failure to reach those objectives or an insufficient level of assistance could result in a deep economic downturn which could significantly affect the value of the Fund’s European investments. It is possible that one or more Economic and Monetary Union of the European Union member countries could abandon the euro and return to a national currency and/or that the euro will cease to exist as a single currency in its current form. The exit of any country out of the euro may have an extremely destabilizing effect on other eurozone countries
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and their economies and a negative effect on the global economy as a whole. Such an exit by one country may also increase the possibility that additional countries may exit the euro should they face similar financial difficulties. In June 2016, the United Kingdom approved a referendum to leave the European Union. Significant uncertainty remains in the market regarding the ramifications of that development, and the range and potential implications of possible political, regulatory, economic and market outcomes are difficult to predict.
The Fund may make investments in debt instruments and other securities directly or through one or more direct or indirect fully owned subsidiaries formed by the Fund (each, a “Subsidiary”). Each Subsidiary may invest, for example, in whole loans or in shares, certificates, notes or other securities representing the right to receive principal and interest payments due on fractions of whole loans or pools of whole loans, or any other security or other instrument that the Fund may hold directly. References herein to the Fund include references to a Subsidiary in respect of the Fund’s investment exposure. The allocation of the Fund’s portfolio in a Subsidiary will vary over time and might not always include all of the different types of investments described herein. By investing through its Subsidiaries, the Fund is exposed to the risks associated with the Subsidiaries’ investments. The Subsidiaries are not registered as investment companies under the 1940 Act and are not subject to all of the investor protections of the 1940 Act, although each Subsidiary is managed pursuant to the compliance policies and procedures of the Fund applicable to it. Changes in the laws of the United States and/or the jurisdiction in which a Subsidiary is organized could result in the inability of the Fund and/or the Subsidiary to operate as described in this report and could adversely affect the Fund.
The Fund may acquire residential mortgage loans and unsecured consumer loans through a Subsidiary. Subsidiaries directly holding a beneficial interest in loans will be formed as domestic common law or statutory trusts with a federally chartered bank serving as trustee. Each such Subsidiary will hold the beneficial interests of loans and the federally chartered bank acting as trustee will hold legal title to the loans for the benefit of the Subsidiary and/or the trust’s beneficial owners (i.e., the Fund or its direct or indirect fully-owned subsidiary). State licensing laws typically exempt federally chartered banks from their licensing requirements, and federally chartered banks may also benefit from federal preemption of state laws, including any licensing requirements. The use of common law or statutory trusts with a federally chartered bank serving as trustee is intended to address any state licensing requirements that may be applicable to purchasers or holders of loans, including state licensing requirements related to foreclosure. The Fund believes that such direct or indirect fully-owned Subsidiaries will not be treated as associations or publicly traded partnerships taxable as corporations for U.S. federal income tax purposes, and that therefore, the Subsidiaries will not be subject to U.S. federal income tax at the subsidiary level. Investments in residential mortgage loans or unsecured consumer loans through entities that are not so treated can potentially be limited by the Fund’s intention to qualify as a regulated investment company, and limit the Fund’s ability to qualify as such.
If the Fund or its Subsidiary trust is required to be licensed in any particular jurisdiction in order to acquire, hold, dispose or foreclose loans, obtaining the required license may not be viable (because, for example, it is not possible or practical) and the Fund or its Subsidiary may be unable to restructure its holdings to address the licensing requirement. In that case, the Fund or its Subsidiary may be forced to cease activities involving the affected loans, or may be forced to sell such loans. If a state regulator or court were to determine that the Fund or its Subsidiary acquired, held or foreclosed a loan without a required state license, the Fund or its Subsidiary could be subject to penalties or other sanctions, prohibited or restricted in its ability to enforce its rights under the loan, or subject to litigation risk or other losses or damages.
| ANNUAL REPORT | JUNE 30, 2018 | 9 |
Important Information About the Fund (Cont.)
As the use of technology has become more prevalent in the course of business, the Fund has become potentially more susceptible to operational and information security risks resulting from breaches in cyber security. A breach in cyber security refers to both intentional and unintentional cyber events that may, among other things, cause the Fund to lose proprietary information, suffer data corruption and/or destruction or lose operational capacity, result in the unauthorized release or other misuse of confidential information, or otherwise disrupt normal business operations. Cyber security breaches may involve unauthorized access to the Fund’s digital information systems (e.g., through “hacking” or malicious software coding), but may also result from outside attacks such as denial-of-service attacks (i.e., efforts to make network services unavailable to intended users). In addition, cyber security breaches involving the Fund’s third party service providers (including but not limited to advisers, sub-advisers, administrators, transfer agents, custodians, distributors and other third parties), trading counterparties or issuers in which the Fund invests can also subject the Fund to many of the same risks associated with direct cyber security breaches. Moreover, cyber security breaches involving trading counterparties or issuers in which the Fund invests could adversely impact such counterparties or issuers and cause the Fund’s investment to lose value.
Cyber security failures or breaches may result in financial losses to the Fund and its shareholders. These failures or breaches may also result in disruptions to business operations, potentially resulting in financial losses; interference with the Fund’s ability to calculate its net asset value, process shareholder transactions or otherwise transact business with shareholders; impediments to trading; violations of applicable privacy and other laws; regulatory fines; penalties; reputational damage; reimbursement or other compensation costs; additional compliance and cyber security risk management costs and other adverse consequences. In addition, substantial costs may be incurred in order to prevent any cyber incidents in the future.
Like with operational risk in general, the Fund has established business continuity plans and risk management systems designed to reduce the risks associated with cyber security. However, there are inherent limitations in these plans and systems, including that certain risks may not have been identified, in large part because different or unknown threats may emerge in the future. As such, there is no guarantee that such efforts will succeed, especially because the Fund does not directly control the cyber security systems of issuers in which the Fund may invest, trading counterparties or third party service providers to the Fund. There is also a risk that cyber security breaches may not be detected. The Fund and its shareholders could be negatively impacted as a result.
The Fund may invest in securities and instruments that are economically tied to Russia. Investments in Russia are subject to various risks such as political, economic, legal, market and currency risks. The risks include uncertain political and economic policies, short-term market volatility, poor accounting standards, corruption and crime, an inadequate regulatory system, and unpredictable taxation. Investments in Russia are particularly subject to the risk that economic sanctions may be imposed by the United States and/or other countries. Such sanctions — which may impact companies in many sectors, including energy, financial services and defense, among others — may negatively impact the Fund’s performance and/or ability to achieve their investment objectives. The Russian securities market is characterized by limited volume of trading, resulting in difficulty in obtaining accurate prices. The Russian securities market, as compared to U.S. markets, has significant price volatility, less liquidity, a smaller market capitalization and a smaller number of traded securities. There may be little publicly available information about issuers. Settlement, clearing and registration of securities transactions are subject to risks because of registration systems that may not be subject to effective
| 10 | PIMCO INTERVAL FUNDS |
government supervision. This may result in significant delays or problems in registering the transfer of securities. Russian securities laws may not recognize foreign nominee accounts held with a custodian bank, and therefore the custodian may be considered the ultimate owner of securities they hold for their clients. Ownership of securities issued by Russian companies is recorded by companies themselves and by registrars instead of through a central registration system. It is possible that the ownership rights of the Fund could be lost through fraud or negligence. While applicable Russian regulations impose liability on registrars for losses resulting from their errors, it may be difficult for the Fund to enforce any rights it may have against the registrar or issuer of the securities in the event of loss of share registration. Adverse currency exchange rates are a risk and there may be a lack of available currency hedging instruments. Investments in Russia may be subject to the risk of nationalization or expropriation of assets. Oil, natural gas, metals, and timber account for a significant portion of Russia’s exports, leaving the country vulnerable to swings in world prices.
The Fund may be subject to various risks, including, but not limited to, the following: asset allocation risk, credit risk, stressed securities risk, distressed and defaulted securities risk, corporate bond risk, contingent convertible securities risk, high yield risk, market risk, issuer risk, liquidity risk, equity securities and related market risk, mortgage-related and other asset-backed securities risk, extension risk, prepayment risk, privately issued mortgage-related securities risk, mortgage market/ subprime risk, foreign (non-U.S.) investment risk, emerging markets risk, currency risk, redenomination risk, non-diversification risk, management risk, municipal bond risk, inflation-indexed security risk, senior debt risk, loans, participations and assignments risk, reinvestment risk, real estate risk, U.S. Government securities risk, foreign (non-U.S.) government securities risk, valuation risk, segregation and cover risk, focused investment risk, credit default swaps risk, event-linked securities risk, counterparty risk, preferred securities risk, confidential information access risk, other investment companies risk, private placements risk, inflation/deflation risk, regulatory risk, tax risk, recent economic conditions risk, market disruptions and geopolitical risk, potential conflicts of interest involving allocation of investment opportunities, repurchase agreements risk, securities lending risk, zero-coupon bond and payment-in-kind securities risk, portfolio turnover risk, smaller company risk, short sale risk and convertible securities risk. A description of certain of these risks is available in the Notes to Financial Statements of this Report.
On the Fund Summary page in this Shareholder Report, the Average Annual Total Return table measures performance assuming that all dividend and capital gain distributions were reinvested. Returns do not reflect the deduction of taxes that a shareholder would pay on (i) Fund distributions or (ii) the repurchase of Fund shares. Total return for a period of more than one year represents the average annual total return. Performance shown is net of fees and expenses.
The following table discloses the commencement of operations and diversification status of the Fund:
| Fund Name | Commencement of Operations |
Diversification Status |
||||||||||
| PIMCO Flexible Credit Income Fund |
02/22/17 | Non-Diversified | ||||||||||
An investment in the Fund is not a deposit of a bank and is not guaranteed or insured by the Federal Deposit Insurance Corporation or any other government agency. It is possible to lose money on investments in the Fund.
| ANNUAL REPORT | JUNE 30, 2018 | 11 |
Important Information About the Fund (Cont.)
The Trustees are responsible generally for overseeing the management of the Fund. The Trustees authorize the Fund to enter into service agreements with the Investment Manager and other service providers in order to provide, and in some cases authorize service providers to procure through other parties, necessary or desirable services on behalf of the Fund. Shareholders are not parties to or third-party beneficiaries of such service agreements. Neither the Fund’s original or any subsequent prospectus or Statement of Additional Information (SAI), any press release or shareholder report, any contracts filed as exhibits to the Fund’s registration statement, nor any other communications, disclosure documents or regulatory filings from or on behalf of the Fund creates a contract between or among any shareholders of the Fund, on the one hand, and the Fund, a service provider to the Fund, and/or the Trustees or officers of the Fund, on the other hand.
The Trustees (or the Fund and its officers, service providers or other delegates acting under authority of the Trustees) may amend its most recent or use a new prospectus or SAI with respect to the Fund, adopt and disclose new or amended policies and other changes in press releases and shareholder reports and/or amend, file and/or issue any other communications, disclosure documents or regulatory filings, and may amend or enter into any contracts to which the Fund is a party, and interpret the investment objective(s), policies, restrictions and contractual provisions applicable to the Fund, without shareholder input or approval, except in circumstances in which shareholder approval is specifically required by law (such as changes to fundamental investment policies) or where a shareholder approval requirement was specifically disclosed in the Fund’s prospectus, SAI or shareholder report and is otherwise still in effect.
PIMCO has adopted written proxy voting policies and procedures (“Proxy Policy”) as required by Rule 206(4)-6 under the Investment Advisers Act of 1940. The Proxy Policy has been adopted by the Fund as the policies and procedures that PIMCO will use when voting proxies on behalf of the Fund. A description of the policies and procedures that PIMCO uses to vote proxies relating to portfolio securities of the Fund, and information about how the Fund voted proxies relating to portfolio securities held during the most recent twelve-month period ended June 30, are available without charge, upon request, by calling the Fund at (844) 312-2113, on the Fund’s website at www.pimco.com, and on the Securities and Exchange Commission’s (“SEC”) website at http://www.sec.gov.
The Fund files a complete schedule of its portfolio holdings with the SEC for the first and third quarters of its fiscal year on Form N-Q. A copy of the Fund’s Form N-Q is available on the SEC’s website at http://www.sec.gov and may be reviewed and copied at the SEC’s Public Reference Room in Washington, D.C., and is available without charge, upon request by calling the Fund at (844) 312-2113 and on the Fund’s website at www.pimco.com. Information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.
The SEC adopted a rule that generally allows funds to deliver shareholder reports to investors by providing access to such reports online free of charge and by mailing a notice that the report is electronically available. Pursuant to the rule, investors may still elect to receive a complete shareholder report in the mail. PIMCO is evaluating how to make the electronic delivery option available to shareholders in the future.
| 12 | PIMCO INTERVAL FUNDS |
[THIS PAGE INTENTIONALLY LEFT BLANK]
| ANNUAL REPORT | JUNE 30, 2018 | 13 |
| PIMCO Flexible Credit Income Fund | Institutional Class - PFLEX |
| Allocation Breakdown as of 06/30/2018†§ | ||||
| Corporate Bonds & Notes | 33.1% | |||
| Non-Agency Mortgage-Backed Securities | 27.5% | |||
| Asset-Backed Securities | 22.2% | |||
| Loan Participations and Assignments | 7.8% | |||
| U.S. Government Agencies | 3.5% | |||
| Short-Term Instruments | 3.2% | |||
| Sovereign Issues | 1.9% | |||
| Other | 0.8% | |||
| † | % of Investments, at value. |
| § | Allocation Breakdown and % of investments exclude securities sold short and financial derivative instruments, if any. |
| Average Annual Total Return for the period ended June 30, 2018 | ||||||||
| 1 Year | Commencement of Operations (02/22/17) |
|||||||
| PIMCO Flexible Credit Income Fund Institutional Class | 6.98% | 8.50% | ||||||
All Fund returns are net of fees and expenses.
Performance quoted represents past performance. Past performance is not a guarantee or a reliable indicator of future results. Current performance may be lower or higher than performance shown. Investment return and the principal value of an investment will fluctuate. Shares may be worth more or less than original cost when repurchased by the fund. Returns shown do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the repurchase of fund shares. Performance current to the most recent month-end is available at www.pimco.com or via (844) 312-2113.
The Fund’s total annual operating expense ratio in effect as of period end, was 2.60% for Institutional Class shares. Details regarding any changes to the Fund’s operating expenses, subsequent to period end, can be found in the Fund’s current prospectus, as supplemented. As of June 30, 2018, the Fund’s Total Effective Leverage(1) was 32%.
| (1) | Represents total effective leverage outstanding, as a percentage of total managed assets. Total effective leverage consists of preferred shares, reverse repurchase agreements and other borrowings, credit default swap notional and floating rate notes issued in tender option bond transactions, as applicable (collectively “Total Effective Leverage”). The Fund may engage in other transactions not included in Total Effective Leverage disclosed above that may give rise to a form of leverage, including certain derivative transactions. For the purpose of calculating Total Effective Leverage outstanding as a percentage of total managed assets, total managed assets refer to total assets (including assets attributable to Total Effective Leverage that may be outstanding) minus accrued liabilities (other than liabilities representing Total Effective Leverage). |
| 14 | PIMCO INTERVAL FUNDS |
| PIMCO Flexible Credit Income Fund | Institutional Class - PFLEX |
Investment Objective and Strategy Overview
PIMCO Flexible Credit Income Fund seeks to provide attractive risk-adjusted returns and current income. The Fund seeks to achieve its investment objectives by investing, under normal circumstances, at least 80% of its net assets (plus any borrowings for investment purposes) in a portfolio of debt instruments of varying maturities. The Fund utilizes a flexible asset allocation strategy across a wide array of global credit sectors, including corporate, mortgage, consumer, emerging market and municipal credit markets, and utilizing a flexible asset allocation strategy among multiple public and private credit sectors in the global credit markets, including corporate debt (including, among other things, fixed-, variable- and floating-rate bonds, loans, convertible and contingent convertible securities and stressed, distressed and defaulted debt securities issued by U.S. or foreign (non-U.S.) corporations or other business entities, including emerging market issuers), mortgage-related and other consumer-related instruments, collateralized debt obligations, including, without limitation, collateralized loan obligations, government and sovereign debt, municipal bonds and other fixed-, variable- and floating-rate income-producing securities of U.S. and foreign issuers, including emerging market issuers. Please refer to the Fund’s current prospectus for more information regarding the Fund’s strategy.
Fund Insights
The following affected performance during the reporting period:
| » | Exposure to residential mortgage-backed securities contributed to performance. |
| » | Exposure to commercial mortgage-backed securities was positive for performance. |
| » | Exposure to high yield corporate credit was positive for performance. |
| » | Exposure to bank capital contributed to performance. |
| » | Exposure to asset-backed securities was positive for performance. |
| » | Exposure to collateralized debt obligations and collateralized loan obligations added to performance. |
| » | Interest rate swap positioning was negative for performance, as interest rates rose, and the yield curve flattened. |
| ANNUAL REPORT | JUNE 30, 2018 | 15 |
Financial Highlights PIMCO Flexible Credit Income Fund (Consolidated)
| Investment Operations | Less Distributions(b) | ||||||||||||||||||||||||||||||||||||||||||||
| Selected Per Share Data for the Year or Period Ended^: |
Net Asset Value Beginning of Year or Period |
Net Investment Income (Loss)(a) |
Net Realized/ Unrealized Gain (Loss) |
Total | From Net Investment Income |
From Net Realized Capital Gains |
Tax Basis Return of Capital |
Total | |||||||||||||||||||||||||||||||||||||
| Institutional Class |
|||||||||||||||||||||||||||||||||||||||||||||
| 06/30/2018 |
$ | 10.32 | $ | 0.71 | $ | 0.00 | $ | 0.71 | $ | (0.75 | ) | $ | 0.00 | $ | 0.00 | $ | (0.75 | ) | |||||||||||||||||||||||||||
| 02/22/2017 - 06/30/2017 |
10.00 | 0.19 | 0.25 | 0.44 | (0.12 | ) | 0.00 | 0.00 | (0.12 | ) | |||||||||||||||||||||||||||||||||||
| ^ | A zero balance may reflect actual amounts rounding to less than $0.01 or 0.01%. |
| * | Annualized |
| (a) | Per share amounts based on average number of shares outstanding during the year or period. |
| (b) | The tax characterization of distributions is determined in accordance with Federal income tax regulations. See Note 2, Distributions—Common Shares, in the Notes to Financial Statements for more information. |
| (c) | Interest expense primarily relates to participation in borrowing and financing transactions. See Note 5, Borrowings and Other Financing Transactions, in the Notes to Financial Statements for more information. |
| 16 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
| Ratios/Supplemental Data | |||||||||||||||||||||||||||||||||||||||||||
| Ratios to Average Net Assets | |||||||||||||||||||||||||||||||||||||||||||
| Net Asset Value End of Year or Period |
Total Return |
Net Assets End of Year or Period (000s) |
Expenses(c) | Expenses Excluding Waivers(c) |
Expenses Excluding Interest Expense(c) |
Expenses Excluding Interest Expense and Waivers(c) |
Net Investment Income (Loss) |
Portfolio Turnover Rate | |||||||||||||||||||||||||||||||||||
| $ | 10.28 | 6.98 | % | $ | 538,772 | 3.09 | % | 3.11 | % | 1.98 | % | 2.00 | % | 6.84 | % | 14 | % | ||||||||||||||||||||||||||
| |
10.32 |
4.36 | 68,995 | 1.44 | * | 5.70 | * | 1.39 | * | 5.65 | * | 5.24 | * | 11 | |||||||||||||||||||||||||||||
| ANNUAL REPORT | JUNE 30, 2018 | 17 |
Consolidated Statement of Assets and Liabilities PIMCO Flexible Credit Income Fund
June 30, 2018
| (Amounts in thousands, except per share amounts) | ||||
| Assets: |
||||
| Investments, at value |
||||
| Investments in securities* |
$ | 803,268 | ||
| Financial Derivative Instruments |
||||
| Exchange-traded or centrally cleared |
98 | |||
| Over the counter |
1,684 | |||
| Cash |
1 | |||
| Deposits with counterparty |
5,142 | |||
| Foreign currency, at value |
2,154 | |||
| Receivable for investments sold |
2,152 | |||
| Receivable for Fund shares sold |
3,006 | |||
| Interest and/or dividends receivable |
7,323 | |||
| Total Assets |
824,828 | |||
| Liabilities: |
||||
| Borrowings & Other Financing Transactions |
||||
| Payable for reverse repurchase agreements |
$ | 238,335 | ||
| Financial Derivative Instruments |
||||
| Exchange-traded or centrally cleared |
133 | |||
| Over the counter |
1,066 | |||
| Payable for investments purchased |
28,457 | |||
| Payable for unfunded loan commitments |
9,447 | |||
| Deposits from counterparty |
943 | |||
| Distributions payable |
6,816 | |||
| Accrued management fees |
842 | |||
| Accrued reimbursement to PIMCO |
17 | |||
| Total Liabilities |
286,056 | |||
| Net Assets |
$ | 538,772 | ||
| Net Assets Consist of: |
||||
| Shares: |
||||
| Par value ($0.00001 per share) |
$ | 1 | ||
| Paid in capital in excess of par |
547,288 | |||
| Undistributed (overdistributed) net investment income |
6,663 | |||
| Accumulated undistributed net realized gain (loss) |
(2,798 | ) | ||
| Net unrealized appreciation (depreciation) |
(12,382 | ) | ||
| Net Assets |
$ | 538,772 | ||
| Cost of investments in securities |
$ | 814,750 | ||
| Cost of foreign currency held |
$ | 2,147 | ||
| Cost or premiums of financial derivative instruments, net |
$ | (1,460 | ) | |
| Net Assets: |
||||
| Institutional Class |
$ | 538,772 | ||
| Common Shares Outstanding: |
||||
| Institutional Class |
52,427 | |||
| Net Asset Value Per Common Share Outstanding: |
||||
| Institutional Class |
$ | 10.28 | ||
| * Includes repurchase agreements of: |
$ | 22,598 | ||
| 18 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
Consolidated Statement of Operations PIMCO Flexible Credit Income Fund
| Year Ended June 30, 2018 | ||||
| (Amounts in thousands†) | ||||
| Investment Income: |
||||
| Interest |
$ | 27,847 | ||
| Dividends |
405 | |||
| Total Income |
28,252 | |||
| Expenses: |
||||
| Management fees |
5,411 | |||
| Trustee fees and related expenses |
46 | |||
| Interest expense |
3,139 | |||
| Miscellaneous expense |
228 | |||
| Total Expenses |
8,824 | |||
| Waiver and/or Reimbursement by PIMCO |
(46 | ) | ||
| Net Expenses |
8,778 | |||
| Net Investment Income (Loss) |
19,474 | |||
| Net Realized Gain (Loss): |
||||
| Investments in securities |
1,002 | |||
| Exchange-traded or centrally cleared financial derivative instruments |
767 | |||
| Over the counter financial derivative instruments |
3,530 | |||
| Short sales |
(1 | ) | ||
| Foreign currency |
(538 | ) | ||
| Net Realized Gain (Loss) |
4,760 | |||
| Net Change in Unrealized Appreciation (Depreciation): |
||||
| Investments in securities |
(12,232 | ) | ||
| Exchange-traded or centrally cleared financial derivative instruments |
(1,910 | ) | ||
| Over the counter financial derivative instruments |
643 | |||
| Foreign currency assets and liabilities |
505 | |||
| Net Change in Unrealized Appreciation (Depreciation) |
(12,994 | ) | ||
| Net Increase (Decrease) in Net Assets Resulting from Operations |
$ | 11,240 | ||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| ANNUAL REPORT | JUNE 30, 2018 | 19 |
Consolidated Statements of Changes in Net Assets PIMCO Flexible Credit Income Fund
| (Amounts in thousands†) | Year Ended June 30, 2018 |
Period from February 22, 2017 - |
||||||
| Increase (Decrease) in Net Assets from: |
||||||||
| Operations: |
||||||||
| Net investment income (loss) |
$ | 19,474 | $ | 463 | ||||
| Net realized gain (loss) |
4,760 | (48 | ) | |||||
| Net change in unrealized appreciation (depreciation) |
(12,994 | ) | 612 | |||||
| Net Increase (Decrease) in Net Assets Resulting |
11,240 | 1,027 | ||||||
| Distributions to Common Shareholders: |
||||||||
| From net investment income |
||||||||
| Institutional Class |
(20,347 | ) | (437 | ) | ||||
| Total Distributions to Common Shareholders(a) |
(20,347 | ) | (437 | ) | ||||
| Common Share Transactions: |
||||||||
| Receipts for shares sold |
485,488 | 68,313 | ||||||
| Issued as reinvestment of distributions |
3,671 | 92 | ||||||
| Cost of shares repurchased |
(10,275 | ) | 0 | |||||
| Net increase (decrease) resulting from common share transactions** |
478,884 | 68,405 | ||||||
| Total Increase (Decrease) in Net Assets |
469,777 | 68,995 | ||||||
| Net Assets: |
||||||||
| Beginning of period |
68,995 | 0 | ||||||
| End of period* |
$ | 538,772 | $ | 68,995 | ||||
| *Including undistributed (overdistributed) net investment income of: |
$ | 6,663 | $ | 1 | ||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| ** | See Note 13, Common Shares Offering, in the Notes to Financial Statements. |
| (a) | The tax characterization of distributions is determined in accordance with Federal income tax regulations. See Note 2, Distributions—Common Shares, in the Notes to Financial Statements for more information. |
| 20 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
Consolidated Statement of Cash Flows PIMCO Flexible Credit Income Fund
| Year Ended June 30, 2018
(Amounts in thousands†) |
||||
| Cash Flows Provided by (Used for) Operating Activities: |
||||
| Net increase (decrease) in net assets resulting from operations |
$ | 11,240 | ||
| Adjustments to Reconcile Net Increase (Decrease) in Net Assets from Operations to Net Cash Provided by (Used for) Operating Activities: |
||||
| Purchases of long-term securities |
(785,331 | ) | ||
| Proceeds from sales of long-term securities |
89,189 | |||
| (Purchases) Proceeds from sales of short-term portfolio investments, net |
(36,442 | ) | ||
| (Increase) decrease in deposits with counterparty |
(4,238 | ) | ||
| (Increase) decrease in receivable for investments sold |
(2,140 | ) | ||
| (Increase) decrease in interest and/or dividends receivable |
(6,435 | ) | ||
| Proceeds from (Payments on) exchange-traded or centrally cleared financial derivative instruments |
(1,128 | ) | ||
| Proceeds from (Payments on) over the counter financial derivative instruments |
3,328 | |||
| Increase (decrease) in reimbursement receivable from PIMCO |
24 | |||
| Increase (decrease) in payable for investments purchased |
23,915 | |||
| Increase (decrease) in payable for unfunded loan commitments |
9,447 | |||
| Increase (decrease) in deposits from counterparty |
943 | |||
| Increase (decrease) in accrued management fees |
774 | |||
| Proceeds from (Payments on) short sales transactions, net |
(1 | ) | ||
| Proceeds from (Payments on) foreign currency transactions |
(616 | ) | ||
| Increase (decrease) in other liabilities |
(9 | ) | ||
| Net Realized (Gain) Loss |
||||
| Investments in securities |
(1,002 | ) | ||
| Exchange-traded or centrally cleared financial derivative instruments |
(767 | ) | ||
| Over the counter financial derivative instruments |
(3,530 | ) | ||
| Short sales |
1 | |||
| Foreign currency |
538 | |||
| Net Change in Unrealized (Appreciation) Depreciation |
||||
| Investments in securities |
12,232 | |||
| Exchange-traded or centrally cleared financial derivative instruments |
1,910 | |||
| Over the counter financial derivative instruments |
(643 | ) | ||
| Foreign currency assets and liabilities |
(505 | ) | ||
| Non Cash Payment in Kind |
(32 | ) | ||
| Net amortization (accretion) on investments |
(2,289 | ) | ||
| Net Cash Provided by (Used for) Operating Activities |
(691,567 | ) | ||
| Cash Flows Received from (Used for) Financing Activities: |
||||
| Proceeds from shares sold |
483,242 | |||
| Payments on shares repurchased |
(10,275 | ) | ||
| Cash distributions paid* |
(10,205 | ) | ||
| Proceeds from reverse repurchase agreements |
847,819 | |||
| Payments on reverse repurchase agreements |
(617,863 | ) | ||
| Net Cash Received from (Used for) Financing Activities |
692,718 | |||
| Net Increase (Decrease) in Cash and Foreign Currency |
1,151 | |||
| Cash and Foreign Currency: |
||||
| Beginning of year |
1,004 | |||
| End of year |
$ | 2,155 | ||
| * Reinvestment of distributions |
$ | 3,671 | ||
| Supplemental Disclosure of Cash Flow Information: |
||||
| Interest expense paid during the year |
$ | 2,229 | ||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
A Statement of Cash Flows is presented when the Fund has a significant amount of borrowing during the year, based on the average total borrowing outstanding in relation to total assets or when substantially all of the Fund’s investments are not classified as Level 1 or 2 in the fair value hierarchy.
| ANNUAL REPORT | JUNE 30, 2018 | 21 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund
(Amounts in thousands*, except number of shares, contracts and units, if any)
| 22 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 23 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
| 24 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 25 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
| 26 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 27 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
| 28 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 29 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
NOTES TO CONSOLIDATED SCHEDULE OF INVESTMENTS:
| * | A zero balance may reflect actual amounts rounding to less than one thousand. |
| † | All or a portion of this security is owned by PFLEXLS I LLC, which is a 100% owned subsidiary of the Fund. |
| ^ | Security is in default. |
| « | Security valued using significant unobservable inputs (Level 3). |
| ∎ | All or a portion of this amount represent unfunded loan commitments. The interest rate for the unfunded portion will be determined at the time of funding. See Note 4, Securities and Other Investments, in the Notes to Financial Statements for more information regarding unfunded loan commitments. |
| ~ | Variable or Floating rate security. Rate shown is the rate in effect as of period end. Certain variable rate securities are not based on a published reference rate and spread, rather are determined by the issuer or agent and are based on current market conditions. Reference rate is as of reset date, which may vary by security. These securities may not indicate a reference rate and/or spread in their description. |
| · | Rate shown is the rate in effect as of period end. The rate may be based on a fixed rate, a capped rate or a floor rate and may convert to a variable or floating rate in the future. These securities do not indicate a reference rate and spread in their description. |
| × | Coupon represents a rate which changes periodically based on a predetermined schedule. Rate shown is the rate in effect as of period end. |
| (a) | Interest only security. |
| (b) | Principal only security. |
| (c) | When-issued security. |
| (d) | Payment in-kind security. |
| (e) | Security is not accruing income as of the date of this report. |
| (f) | Security did not produce income within the last twelve months. |
| (g) | Coupon represents a weighted average yield to maturity. |
| (h) | Zero coupon security. |
| (i) | Coupon represents a yield to maturity. |
| (j) | Perpetual maturity; date shown, if applicable, represents next contractual call date. |
| (k) | Contingent convertible security. |
| 30 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
(l) RESTRICTED SECURITIES:
| Issuer Description | Coupon | Maturity Date |
Acquisition Date | Cost | Market Value |
Market Value as Percentage of Net Assets |
||||||||||||||||||
| Preylock Reitman Santa Cruz Mezz LLC † |
7.546% | 11/09/2022 | 04/09/2018 | $ | 7,900 | $ | 7,914 | 1.47% | ||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||
BORROWINGS AND OTHER FINANCING TRANSACTIONS
(m) REPURCHASE AGREEMENTS:
| Counterparty | Lending Rate |
Settlement Date |
Maturity Date |
Principal Amount |
Collateralized By | Collateral (Received) |
Repurchase Agreements, at Value |
Repurchase Agreement Proceeds to be Received(1) |
||||||||||||||||||||||
| FICC |
1.500 | % | 06/29/2018 | 07/02/2018 | $ | 2,498 | U.S. Treasury Notes 2.125% due 08/15/2021 | $ | (2,551 | ) | $ | 2,498 | $ | 2,498 | ||||||||||||||||
| GSC |
2.270 | 06/29/2018 | 07/02/2018 | 20,100 | Freddie Mac 4.500% due 10/01/2045 | (20,743 | ) | 20,100 | 20,104 | |||||||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Total Repurchase Agreements |
|
$ | (23,294 | ) | $ | 22,598 | $ | 22,602 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||||||||
REVERSE REPURCHASE AGREEMENTS:
| Counterparty | Borrowing Rate(2) |
Settlement Date |
Maturity Date |
Amount Borrowed(2) |
Payable for Reverse Repurchase Agreements |
|||||||||||||||||
| BCY |
0.950 | % | 06/18/2018 | TBD | (3) | $ | (5,453 | ) | $ | (5,455 | ) | |||||||||||
| 3.339 | 04/11/2018 | 07/11/2018 | (4,869 | ) | (4,906 | ) | ||||||||||||||||
| 3.343 | 05/14/2018 | 08/14/2018 | (4,037 | ) | (4,055 | ) | ||||||||||||||||
| 3.362 | 04/26/2018 | 07/26/2018 | (4,990 | ) | (5,021 | ) | ||||||||||||||||
| 3.363 | 05/02/2018 | 08/02/2018 | (14,964 | ) | (15,049 | ) | ||||||||||||||||
| BPS |
3.332 | 06/22/2018 | 09/24/2018 | (8,127 | ) | (8,135 | ) | |||||||||||||||
| BRC |
(1.000 | ) | 06/07/2018 | 07/09/2018 | EUR | (735 | ) | (858 | ) | |||||||||||||
| 2.000 | 06/18/2018 | TBD | (3) | $ | (6,734 | ) | (6,739 | ) | ||||||||||||||
| 2.700 | 05/09/2018 | 08/09/2018 | (913 | ) | (913 | ) | ||||||||||||||||
| GSC |
3.073 | 06/14/2018 | 07/13/2018 | (5,329 | ) | (5,337 | ) | |||||||||||||||
| JPS |
3.463 | 05/08/2018 | 08/08/2018 | (11,113 | ) | (11,172 | ) | |||||||||||||||
| MSB |
3.763 | 02/05/2018 | 02/05/2019 | (1,040 | ) | (1,045 | ) | |||||||||||||||
| NOM |
2.730 | 06/04/2018 | 08/06/2018 | (2,810 | ) | (2,816 | ) | |||||||||||||||
| 2.750 | 06/18/2018 | 07/02/2018 | (1,002 | ) | (1,003 | ) | ||||||||||||||||
| 2.750 | 06/18/2018 | 07/18/2018 | (16,305 | ) | (16,322 | ) | ||||||||||||||||
| 2.850 | 05/21/2018 | 08/21/2018 | (2,624 | ) | (2,633 | ) | ||||||||||||||||
| RBC |
3.280 | 02/12/2018 | 08/13/2018 | (3,658 | ) | (3,705 | ) | |||||||||||||||
| 3.280 | 05/18/2018 | 08/13/2018 | (158 | ) | (160 | ) | ||||||||||||||||
| 3.450 | 03/12/2018 | 09/12/2018 | (839 | ) | (848 | ) | ||||||||||||||||
| RTA |
2.778 | 03/06/2018 | 09/06/2018 | (2,191 | ) | (2,211 | ) | |||||||||||||||
| 3.712 | 05/01/2018 | 11/01/2018 | (2,469 | ) | (2,485 | ) | ||||||||||||||||
| 4.059 | 10/31/2017 | TBD | (3) | (2,345 | ) | (2,358 | ) | |||||||||||||||
| SAL |
3.404 | 05/03/2018 | 11/05/2018 | (952 | ) | (957 | ) | |||||||||||||||
| SBI |
3.404 | 05/03/2018 | 11/05/2018 | (9,273 | ) | (9,326 | ) | |||||||||||||||
| SGY |
3.459 | 04/27/2018 | 10/29/2018 | (6,136 | ) | (6,175 | ) | |||||||||||||||
| SOG |
2.630 | 04/12/2018 | 07/12/2018 | (5,848 | ) | (5,883 | ) | |||||||||||||||
| 2.690 | 04/20/2018 | 07/20/2018 | (3,743 | ) | (3,763 | ) | ||||||||||||||||
| 2.690 | 04/24/2018 | 07/24/2018 | (1,035 | ) | (1,040 | ) | ||||||||||||||||
| 2.700 | 04/25/2018 | 07/25/2018 | (4,931 | ) | (4,956 | ) | ||||||||||||||||
| 2.750 | 05/08/2018 | 08/08/2018 | (2,453 | ) | (2,463 | ) | ||||||||||||||||
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 31 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
| Counterparty | Borrowing Rate(2) |
Settlement Date |
Maturity Date |
Amount Borrowed(2) |
Payable for Reverse Repurchase Agreements |
|||||||||||||||||
| 2.790 | % | 06/04/2018 | 09/04/2018 | $ | (2,197 | ) | $ | (2,202 | ) | |||||||||||||
| 2.820 | 06/14/2018 | 09/14/2018 | (1,126 | ) | (1,128 | ) | ||||||||||||||||
| 2.820 | 06/26/2018 | 09/26/2018 | (5,298 | ) | (5,301 | ) | ||||||||||||||||
| 3.256 | 02/28/2018 | 08/28/2018 | (3,187 | ) | (3,223 | ) | ||||||||||||||||
| 3.283 | 06/20/2018 | 09/12/2018 | (3,024 | ) | (3,027 | ) | ||||||||||||||||
| UBS |
0.100 | 06/11/2018 | 07/11/2018 | EUR | (1,153 | ) | (1,346 | ) | ||||||||||||||
| 0.950 | 06/08/2018 | 07/09/2018 | GBP | (2,010 | ) | (2,655 | ) | |||||||||||||||
| 0.950 | 06/14/2018 | 07/16/2018 | (3,936 | ) | (5,197 | ) | ||||||||||||||||
| 0.950 | 06/18/2018 | 07/18/2018 | (8,431 | ) | (11,132 | ) | ||||||||||||||||
| 1.000 | 05/30/2018 | 07/05/2018 | (1,192 | ) | (1,574 | ) | ||||||||||||||||
| 1.050 | 06/25/2018 | 08/02/2018 | (810 | ) | (1,069 | ) | ||||||||||||||||
| 1.100 | 05/02/2018 | 08/02/2018 | (2,698 | ) | (3,567 | ) | ||||||||||||||||
| 1.100 | 05/14/2018 | 08/02/2018 | (1,035 | ) | (1,368 | ) | ||||||||||||||||
| 1.150 | 05/02/2018 | 08/02/2018 | (1,720 | ) | (2,274 | ) | ||||||||||||||||
| 2.780 | 06/12/2018 | 09/12/2018 | $ | (5,855 | ) | (5,864 | ) | |||||||||||||||
| 2.860 | 05/31/2018 | 08/31/2018 | (3,430 | ) | (3,439 | ) | ||||||||||||||||
| 2.860 | 06/01/2018 | 08/31/2018 | (2,365 | ) | (2,371 | ) | ||||||||||||||||
| 2.880 | 04/09/2018 | 07/09/2018 | (1,816 | ) | (1,828 | ) | ||||||||||||||||
| 2.910 | 04/25/2018 | 07/24/2018 | (1,463 | ) | (1,471 | ) | ||||||||||||||||
| 2.910 | 05/01/2018 | 08/01/2018 | (3,853 | ) | (3,872 | ) | ||||||||||||||||
| 2.960 | 04/25/2018 | 07/24/2018 | (643 | ) | (647 | ) | ||||||||||||||||
| 3.000 | 05/02/2018 | 08/02/2018 | (3,149 | ) | (3,165 | ) | ||||||||||||||||
| 3.010 | 04/25/2018 | 07/24/2018 | (5,525 | ) | (5,556 | ) | ||||||||||||||||
| 3.010 | 05/31/2018 | 08/31/2018 | (684 | ) | (686 | ) | ||||||||||||||||
| 3.010 | 06/01/2018 | 08/31/2018 | (2,163 | ) | (2,169 | ) | ||||||||||||||||
| 3.350 | 05/09/2018 | 08/09/2018 | (16,329 | ) | (16,411 | ) | ||||||||||||||||
| 3.360 | 05/01/2018 | 08/01/2018 | (7,958 | ) | (8,004 | ) | ||||||||||||||||
|
|
|
|||||||||||||||||||||
| Total Reverse Repurchase Agreements |
|
$ | (238,335 | ) | ||||||||||||||||||
|
|
|
|||||||||||||||||||||
BORROWINGS AND OTHER FINANCING TRANSACTIONS SUMMARY
The following is a summary by counterparty of the market value of Borrowings and Other Financing Transactions and collateral pledged/(received) as of June 30, 2018:
| Counterparty | Repurchase Agreement Proceeds to be Received(1) |
Payable for Reverse Repurchase Agreements |
Payable for Sale-Buyback Transactions |
Total Borrowings and Other Financing Transactions |
Collateral Pledged/ (Received) |
Net Exposure(4) |
||||||||||||||||||
| Global/Master Repurchase Agreement |
| |||||||||||||||||||||||
| BCY |
$ | 0 | $ | (34,486 | ) | $ | 0 | $ | (34,486 | ) | $ | 48,361 | $ | 13,875 | ||||||||||
| BPS |
0 | (8,135 | ) | 0 | (8,135 | ) | 9,915 | 1,780 | ||||||||||||||||
| BRC |
0 | (8,510 | ) | 0 | (8,510 | ) | 9,259 | 749 | ||||||||||||||||
| FICC |
2,498 | 0 | 0 | 2,498 | (2,551 | ) | (53 | ) | ||||||||||||||||
| GSC |
20,104 | (5,337 | ) | 0 | 14,767 | (14,309 | ) | 458 | ||||||||||||||||
| JPS |
0 | (11,172 | ) | 0 | (11,172 | ) | 13,887 | 2,715 | ||||||||||||||||
| MSB |
0 | (1,045 | ) | 0 | (1,045 | ) | 1,493 | 448 | ||||||||||||||||
| NOM |
0 | (22,774 | ) | 0 | (22,774 | ) | 24,406 | 1,632 | ||||||||||||||||
| RBC |
0 | (4,713 | ) | 0 | (4,713 | ) | 5,710 | 997 | ||||||||||||||||
| RTA |
0 | (7,054 | ) | 0 | (7,054 | ) | 9,166 | 2,112 | ||||||||||||||||
| SBI |
0 | (10,283 | ) | 0 | (10,283 | ) | 13,346 | 3,063 | ||||||||||||||||
| SOG |
0 | (39,161 | ) | 0 | (39,161 | ) | 44,905 | 5,744 | ||||||||||||||||
| UBS |
0 | (85,665 | ) | 0 | (85,665 | ) | 104,387 | 18,722 | ||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||
| Total Borrowings and Other Financing Transactions(5) |
$ | 22,602 | $ | (238,335 | ) | $ | 0 | |||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||
| 32 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
CERTAIN TRANSFERS ACCOUNTED FOR AS SECURED BORROWINGS
Remaining Contractual Maturity of the Agreements
| Overnight and Continuous |
Up to 30 days | 31-90 days | Greater Than 90 days | Total | ||||||||||||||||
| Reverse Repurchase Agreements |
| |||||||||||||||||||
| Corporate Bonds & Notes |
$ | 0 | $ | (65,231 | ) | $ | (49,510 | ) | $ | (12,195 | ) | $ | (126,936 | ) | ||||||
| U.S. Government Agencies |
0 | (4,906 | ) | (10,272 | ) | 0 | (15,178 | ) | ||||||||||||
| Non-Agency Mortgage-Backed Securities |
0 | (5,021 | ) | (51,868 | ) | (18,731 | ) | (75,620 | ) | |||||||||||
| Asset-Backed Securities |
0 | (5,337 | ) | (11,649 | ) | (3,615 | ) | (20,601 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total Borrowings |
$ | 0 | $ | (80,495 | ) | $ | (123,299 | ) | $ | (34,541 | ) | $ | (238,335 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Payable for reverse repurchase agreements and sale-buyback financing transactions |
|
$ | (238,335 | ) | ||||||||||||||||
|
|
|
|||||||||||||||||||
| (n) | Securities with an aggregate market value of $291,269 have been pledged as collateral under the terms of the above master agreements as of June 30, 2018. |
| (1) | Includes accrued interest. |
| (2) | The average amount of borrowings outstanding during the period ended June 30, 2018 was $(129,304) at a weighted average interest rate of 2.368%. Average borrowings may include sale-buyback transactions and reverse repurchase agreements, if held during the period. |
| (3) | Open maturity reverse repurchase agreement. |
| (4) | Net Exposure represents the net receivable/(payable) that would be due from/to the counterparty in the event of default. Exposure from borrowings and other financing transactions can only be netted across transactions governed under the same master agreement with the same legal entity. The Fund and Subsidiary are recognized as two separate legal entities. As such, exposure cannot be netted. See Note 8, Master Netting Arrangements, in the Notes to Financial Statements for more information regarding master netting arrangements. |
| (5) | The Subsidiary did not have Borrowings or Other Financing Transactions as of period end. |
(o) FINANCIAL DERIVATIVE INSTRUMENTS: EXCHANGE-TRADED OR CENTRALLY CLEARED
SWAP AGREEMENTS:
CREDIT DEFAULT SWAPS ON CORPORATE ISSUES - SELL PROTECTION(1)
| Fixed |
Payment |
Maturity |
Implied Credit Spread at June 30, 2018(2) |
Notional |
Premiums |
Unrealized |
Market |
Variation Margin | ||||||||||||||||||||||||||||||
| Reference Entity | Asset | Liability | ||||||||||||||||||||||||||||||||||||
| Ally Financial, Inc. |
5.000% |
Quarterly | 06/20/2022 | 1.065 | % | $ 1,770 | $ | 230 | $ | 32 | $ | 262 | $ | 1 | $ | 0 | ||||||||||||||||||||||
| Ally Financial, Inc. |
5.000 |
Quarterly | 12/20/2022 | 1.312 | 285 | 49 | (5 | ) | 44 | 0 | (1 | ) | ||||||||||||||||||||||||||
| Frontier Communications Corp. |
5.000 |
Quarterly | 06/20/2020 | 8.963 | 1,600 | (59 | ) | (47 | ) | (106 | ) | 0 | (4 | ) | ||||||||||||||||||||||||
| Navient Corp. |
5.000 |
Quarterly | 06/20/2022 | 2.296 | 1,900 | 155 | 34 | 189 | 0 | (2 | ) | |||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||
| $ | 375 | $ | 14 | $ | 389 | $ | 1 | $ | (7 | ) | ||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 33 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
INTEREST RATE SWAPS
| Pay/ Receive Rate |
Floating Rate |
Fixed |
Payment |
Maturity |
Notional |
Premiums |
Unrealized |
Market |
Variation Margin | |||||||||||||||||||||||||||||||
| Asset | Liability | |||||||||||||||||||||||||||||||||||||||
| Pay(4) | 3-Month USD-LIBOR |
1.250 | % | Semi-Annual | 06/21/2022 | $ | 48,100 | $ | (1,542 | ) | $ | (1,437 | ) | $ | (2,979 | ) | $ | 0 | $ | (23 | ) | |||||||||||||||||||
| Pay(4) | 3-Month USD-LIBOR |
2.250 | Semi-Annual | 12/20/2022 | 21,100 | 97 | (670 | ) | (573 | ) | 0 | (11 | ) | |||||||||||||||||||||||||||
| Pay(4) | 3-Month USD-LIBOR |
1.500 | Semi-Annual | 06/21/2027 | 11,500 | (834 | ) | (496 | ) | (1,330 | ) | 0 | (11 | ) | ||||||||||||||||||||||||||
| Pay(4) | 3-Month USD-LIBOR |
2.500 | Semi-Annual | 12/20/2027 | 2,500 | 40 | (129 | ) | (89 | ) | 0 | (2 | ) | |||||||||||||||||||||||||||
| Pay(4) | 3-Month USD-LIBOR |
2.250 | Semi-Annual | 06/20/2028 | 68,000 | (4,057 | ) | (191 | ) | (4,248 | ) | 0 | (71 | ) | ||||||||||||||||||||||||||
| Receive(4) | 3-Month USD-LIBOR |
2.500 | Semi-Annual | 06/20/2048 | 55,200 | 4,192 | 1,290 | 5,482 | 89 | 0 | ||||||||||||||||||||||||||||||
| Receive | 6-Month EUR-EURIBOR |
1.250 | Annual | 09/19/2028 | EUR | 4,400 | (62 | ) | (101 | ) | (163 | ) | 0 | (7 | ) | |||||||||||||||||||||||||
| Receive | 6-Month EUR-EURIBOR |
1.250 | Annual | 12/19/2028 | 900 | (15 | ) | (13 | ) | (28 | ) | 0 | (1 | ) | ||||||||||||||||||||||||||
| Receive | 6-Month GBP-LIBOR |
1.500 | Semi-Annual | 09/19/2028 | GBP | 5,790 | 133 | (96 | ) | 37 | 8 | 0 | ||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
| $ | (2,048 | ) | $ | (1,843 | ) | $ | (3,891 | ) | $ | 97 | $ | (126 | ) | |||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
| Total Swap Agreements |
$ | (1,673 | ) | $ | (1,829 | ) | $ | (3,502 | ) | $ | 98 | $ | (133 | ) | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||
| FINANCIAL DERIVATIVE INSTRUMENTS: EXCHANGE-TRADED OR CENTRALLY CLEARED SUMMARY
The following is a summary of the market value and variation margin of Exchange-Traded or Centrally Cleared Financial derivative instruments as of June 30, 2018:
|
| Financial Derivative Assets | Financial Derivative Liabilities | |||||||||||||||||||||||||||||||||||||||||||
| Market Value | Variation Margin Asset |
Market Value | Variation Margin Liability |
|||||||||||||||||||||||||||||||||||||||||
| Purchased Options |
Futures | Swap Agreements |
Total | Written Options |
Futures | Swap Agreements |
Total | |||||||||||||||||||||||||||||||||||||
| Total Exchange-Traded or Centrally Cleared(5) |
$ | 0 | $ | 0 | $ | 98 | $ | 98 | $ | 0 | $ | 0 | $ | (133 | ) | $ | (133 | ) | ||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||||
Cash of $5,142 has been pledged as collateral for exchange-traded and centrally cleared financial derivative instruments as of June 30, 2018.
| (1) | If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation or underlying securities comprising the referenced index or (ii) pay a net settlement amount in the form of cash, securities or other deliverable obligations equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced index. |
| (2) | Implied credit spreads, represented in absolute terms, utilized in determining the market value of credit default swap agreements on corporate or sovereign issues as of period end serve as indicators of the current status of the payment/performance risk and represent the likelihood or risk of default for the credit derivative. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may include upfront payments required to be made to enter into the agreement. Wider credit spreads represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. |
| (3) | The maximum potential amount the Fund could be required to pay as a seller of credit protection or receive as a buyer of credit protection if a credit event occurs as defined under the terms of that particular swap agreement. |
| 34 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| (4) | This instrument has a forward starting effective date. See Note 2, Securities Transactions and Investment Income, in the Notes to Financial Statements for further information. |
| (5) | The Subsidiary did not have Exchange-Traded or Centrally Cleared financial derivative instruments as of period end. |
(p) FINANCIAL DERIVATIVE INSTRUMENTS: OVER THE COUNTER
FORWARD FOREIGN CURRENCY CONTRACTS:
| Settlement |
Currency to |
Currency to |
Unrealized Appreciation/ (Depreciation) |
|||||||||||||||||||||||||
| Counterparty | Asset | Liability | ||||||||||||||||||||||||||
| BOA |
07/2018 | ARS | 16,784 | $ | 580 | $ | 1 | $ | (1 | ) | ||||||||||||||||||
| 07/2018 | $ | 654 | ARS | 16,784 | 0 | (74 | ) | |||||||||||||||||||||
| BPS |
07/2018 | ARS | 16,548 | $ | 603 | 31 | 0 | |||||||||||||||||||||
| 07/2018 | EUR | 23,492 | 27,247 | 0 | (187 | ) | ||||||||||||||||||||||
| 07/2018 | PEN | 1,940 | 593 | 2 | 0 | |||||||||||||||||||||||
| 07/2018 | $ | 1,168 | ARS | 33,095 | 1 | (31 | ) | |||||||||||||||||||||
| 07/2018 | 32,117 | EUR | 27,604 | 119 | 0 | |||||||||||||||||||||||
| 07/2018 | 593 | PEN | 1,940 | 0 | (2 | ) | ||||||||||||||||||||||
| 08/2018 | EUR | 27,604 | $ | 32,189 | 0 | (117 | ) | |||||||||||||||||||||
| 09/2018 | $ | 591 | PEN | 1,940 | 0 | (2 | ) | |||||||||||||||||||||
| BRC |
07/2018 | GBP | 2,783 | $ | 3,679 | 7 | 0 | |||||||||||||||||||||
| 07/2018 | RUB | 123,412 | 1,963 | 0 | (1 | ) | ||||||||||||||||||||||
| 07/2018 | $ | 63,364 | GBP | 48,445 | 581 | (9 | ) | |||||||||||||||||||||
| 08/2018 | GBP | 48,040 | $ | 62,907 | 0 | (580 | ) | |||||||||||||||||||||
| 08/2018 | $ | 1,954 | RUB | 123,412 | 1 | 0 | ||||||||||||||||||||||
| 09/2018 | ARS | 82,332 | $ | 2,964 | 349 | 0 | ||||||||||||||||||||||
| CBK |
07/2018 | EUR | 1,066 | 1,255 | 10 | 0 | ||||||||||||||||||||||
| 07/2018 | GBP | 42,179 | 55,882 | 217 | 0 | |||||||||||||||||||||||
| 07/2018 | $ | 1,765 | RUB | 112,390 | 23 | 0 | ||||||||||||||||||||||
| 10/2018 | 57 | ARS | 1,720 | 0 | (4 | ) | ||||||||||||||||||||||
| GLM |
07/2018 | EUR | 3,046 | $ | 3,554 | 16 | (19 | ) | ||||||||||||||||||||
| 07/2018 | GBP | 3,850 | 5,184 | 102 | 0 | |||||||||||||||||||||||
| 07/2018 | $ | 695 | GBP | 521 | 0 | (7 | ) | |||||||||||||||||||||
| 07/2018 | 177 | RUB | 11,022 | 0 | (1 | ) | ||||||||||||||||||||||
| 08/2018 | 813 | EUR | 697 | 2 | 0 | |||||||||||||||||||||||
| 08/2018 | 883 | RUB | 55,664 | 0 | (2 | ) | ||||||||||||||||||||||
| RYL |
07/2018 | GBP | 154 | $ | 205 | 1 | 0 | |||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
| Total Forward Foreign Currency Contracts |
|
$ | 1,463 | $ | (1,037 | ) | ||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||
SWAP AGREEMENTS:
CREDIT DEFAULT SWAPS ON CORPORATE AND SOVEREIGN ISSUES - SELL PROTECTION(1)
| Counterparty |
Reference Entity |
Fixed |
Payment |
Maturity |
Implied Credit Spread at June 30, 2018(2) |
Notional |
Premiums |
Unrealized |
Swap Agreements, at Value |
|||||||||||||||||||||||||||||
| Asset | Liability | |||||||||||||||||||||||||||||||||||||
| BRC | Ukraine Government International Bond |
5.000 | % | Quarterly | 12/20/2022 | 3.874 | % | $ | 3,100 | $ | 190 | $ | (50 | ) | $ | 140 | $ | 0 | ||||||||||||||||||||
| GST | Petrobras Global Finance BV |
1.000 | Quarterly | 06/20/2022 | 3.002 | 400 | (37 | ) | 8 | 0 | (29 | ) | ||||||||||||||||||||||||||
| Springleaf Finance Corp. |
5.000 | Quarterly | 06/20/2022 | 2.090 | 750 | 60 | 21 | 81 | 0 | |||||||||||||||||||||||||||||
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| $ | 213 | $ | (21 | ) | $ | 221 | $ | (29 | ) | |||||||||||||||||||||||||||||
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| Total Swap Agreements |
$ | 213 | $ | (21 | ) | $ | 221 | $ | (29 | ) | ||||||||||||||||||||||||||||
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| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 35 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
FINANCIAL DERIVATIVE INSTRUMENTS: OVER THE COUNTER SUMMARY
The following is a summary by counterparty of the market value of OTC financial derivative instruments and collateral (received) as of June 30, 2018:
| Financial Derivative Assets | Financial Derivative Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||
| Counterparty | Forward Foreign Currency Contracts |
Purchased Options |
Swap Agreements |
Total Over the Counter |
Forward Foreign Currency Contracts |
Written Options |
Swap Agreements |
Total Over the Counter |
Net Market |
Collateral (Received) |
Net Exposure(4) |
|||||||||||||||||||||||||||||||||||||
| BOA |
$ | 1 | $ | 0 | $ | 0 | $ | 1 | $ | (75 | ) | $ | 0 | $ | 0 | $ | (75 | ) | $ | (74 | ) | $ | 0 | $ (74 | ) | |||||||||||||||||||||||
| BPS |
153 | 0 | 0 | 153 | (339 | ) | 0 | 0 | (339 | ) | (186 | ) | 0 | (186 | ) | |||||||||||||||||||||||||||||||||
| BRC |
938 | 0 | 140 | 1,078 | (590 | ) | 0 | 0 | (590 | ) | 488 | (480 | ) | 8 | ||||||||||||||||||||||||||||||||||
| CBK |
250 | 0 | 0 | 250 | (4 | ) | 0 | 0 | (4 | ) | 246 | (460 | ) | (214 | ) | |||||||||||||||||||||||||||||||||
| GLM |
120 | 0 | 0 | 120 | (29 | ) | 0 | 0 | (29 | ) | 91 | 0 | 91 | |||||||||||||||||||||||||||||||||||
| GST |
0 | 0 | 81 | 81 | 0 | 0 | (29 | ) | (29 | ) | 52 | 0 | 52 | |||||||||||||||||||||||||||||||||||
| RYL |
1 | 0 | 0 | 1 | 0 | 0 | 0 | 0 | 1 | 0 | 1 | |||||||||||||||||||||||||||||||||||||
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| Total Over the Counter(5) |
$ | 1,463 | $ | 0 | $ | 221 | $ | 1,684 | $ | (1,037 | ) | $ | 0 | $ | (29 | ) | $ | (1,066 | ) | |||||||||||||||||||||||||||||
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| (1) | If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation or underlying securities comprising the referenced index or (ii) pay a net settlement amount in the form of cash, securities or other deliverable obligations equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced index. |
| (2) | Implied credit spreads, represented in absolute terms, utilized in determining the market value of credit default swap agreements on corporate or sovereign issues as of period end serve as indicators of the current status of the payment/performance risk and represent the likelihood or risk of default for the credit derivative. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may include upfront payments required to be made to enter into the agreement. Wider credit spreads represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. |
| (3) | The maximum potential amount the Fund could be required to pay as a seller of credit protection or receive as a buyer of credit protection if a credit event occurs as defined under the terms of that particular swap agreement. |
| (4) | Net Exposure represents the net receivable/(payable) that would be due from/to the counterparty in the event of default. Exposure from OTC derivatives can only be netted across transactions governed under the same master agreement with the same legal entity. The Fund and Subsidiary are recognized as two separate legal entities. As such, exposure cannot be netted. See Note 7, Principal Risks, in the Notes to Financial Statements for more information regarding master netting agreements. |
| (5) | The Subsidiary did not have Over the Counter Financial Derivative Instruments as of period end. |
FAIR VALUE OF FINANCIAL DERIVATIVE INSTRUMENTS
The following is a summary of the fair valuation of the Fund’s derivative instruments categorized by risk exposure. See Note 7, Principal Risks, in the Notes to Financial Statements on risks of the Fund.
Fair Values of Financial Derivative Instruments on the Consolidated Statement of Assets and Liabilities as of June 30, 2018:
| Derivatives not accounted for as hedging instruments | ||||||||||||||||||||||||
| Commodity Contracts |
Credit Contracts |
Equity Contracts |
Foreign Exchange Contracts |
Interest Rate Contracts |
Total | |||||||||||||||||||
| Financial Derivative Instruments - Assets |
||||||||||||||||||||||||
| Exchange-traded or centrally cleared |
||||||||||||||||||||||||
| Swap Agreements |
$ | 0 | $ | 1 | $ | 0 | $ | 0 | $ | 97 | $ | 98 | ||||||||||||
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| Over the counter |
||||||||||||||||||||||||
| Forward Foreign Currency Contracts |
$ | 0 | $ | 0 | $ | 0 | $ | 1,463 | $ | 0 | $ | 1,463 | ||||||||||||
| Swap Agreements |
0 | 0 | 221 | 0 | 0 | 221 | ||||||||||||||||||
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| $ | 0 | $ | 0 | $ | 221 | $ | 1,463 | $ | 0 | $ | 1,684 | |||||||||||||
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| $ | 0 | $ | 1 | $ | 221 | $ | 1,463 | $ | 97 | $ | 1,782 | |||||||||||||
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| 36 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
| Derivatives not accounted for as hedging instruments | ||||||||||||||||||||||||
| Commodity Contracts |
Credit Contracts |
Equity Contracts |
Foreign Exchange Contracts |
Interest Rate Contracts |
Total | |||||||||||||||||||
| Financial Derivative Instruments - Liabilities |
| |||||||||||||||||||||||
| Exchange-traded or centrally cleared |
||||||||||||||||||||||||
| Swap Agreements |
$ | 0 | $ | 7 | $ | 0 | $ | 0 | $ | 126 | $ | 133 | ||||||||||||
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| Over the counter |
||||||||||||||||||||||||
| Forward Foreign Currency Contracts |
$ | 0 | $ | 0 | $ | 0 | $ | 1,037 | $ | 0 | $ | 1,037 | ||||||||||||
| Swap Agreements |
0 | 0 | 29 | 0 | 0 | 29 | ||||||||||||||||||
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| $ | 0 | $ | 0 | $ | 29 | $ | 1,037 | $ | 0 | $ | 1,066 | |||||||||||||
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| $ | 0 | $ | 7 | $ | 29 | $ | 1,037 | $ | 126 | $ | 1,199 | |||||||||||||
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The effect of Financial Derivative Instruments on the Consolidated Statement of Operations for the period ended June 30, 2018:
| Derivatives not accounted for as hedging instruments |
||||||||||||||||||||||||
| Commodity Contracts |
Credit Contracts |
Equity Contracts |
Foreign Exchange Contracts |
Interest Rate Contracts |
Total | |||||||||||||||||||
| Net Realized Gain on Financial Derivative Instruments |
| |||||||||||||||||||||||
| Exchange-traded or centrally cleared |
||||||||||||||||||||||||
| Swap Agreements |
$ | 0 | $ | 257 | $ | 0 | $ | 0 | $ | 510 | $ | 767 | ||||||||||||
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| Over the counter |
||||||||||||||||||||||||
| Forward Foreign Currency Contracts |
$ | 0 | $ | 0 | $ | 0 | $ | 3,421 | $ | 0 | $ | 3,421 | ||||||||||||
| Swap Agreements |
0 | 109 | 0 | 0 | 0 | 109 | ||||||||||||||||||
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| $ | 0 | $ | 109 | $ | 0 | $ | 3,421 | $ | 0 | $ | 3,530 | |||||||||||||
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| $ | 0 | $ | 366 | $ | 0 | $ | 3,421 | $ | 510 | $ | 4,297 | |||||||||||||
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| Net Change in Unrealized Appreciation (Depreciation) on Financial Derivative Instruments |
| |||||||||||||||||||||||
| Exchange-traded or centrally cleared |
||||||||||||||||||||||||
| Swap Agreements |
$ | 0 | $ | 1 | $ | 0 | $ | 0 | $ | (1,911 | ) | $ | (1,910 | ) | ||||||||||
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| Over the counter |
||||||||||||||||||||||||
| Forward Foreign Currency Contracts |
$ | 0 | $ | 0 | $ | 0 | $ | 671 | $ | 0 | $ | 671 | ||||||||||||
| Swap Agreements |
0 | (28 | ) | 0 | 0 | 0 | (28 | ) | ||||||||||||||||
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| $ | 0 | $ | (28 | ) | $ | 0 | $ | 671 | $ | 0 | $ | 643 | ||||||||||||
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| $ | 0 | $ | (27 | ) | $ | 0 | $ | 671 | $ | (1,911 | ) | $ | (1,267 | ) | ||||||||||
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FAIR VALUE MEASUREMENTS
The following is a summary of the fair valuations according to the inputs used as of June 30, 2018 in valuing the Fund’s assets and liabilities:
| Category and Subcategory | Level 1 | Level 2 | Level 3 | Fair Value at |
||||||||||||
| Investments in Securities, at Value |
||||||||||||||||
| Loan Participations and Assignments |
$ | 100 | $ | 48,427 | $ | 13,888 | $ | 62,415 | ||||||||
| Corporate Bonds & Notes |
||||||||||||||||
| Banking & Finance |
0 | 118,850 | 0 | 118,850 | ||||||||||||
| Industrials |
0 | 119,787 | 9,621 | 129,408 | ||||||||||||
| Utilities |
0 | 14,853 | 0 | 14,853 | ||||||||||||
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 37 |
Consolidated Schedule of Investments PIMCO Flexible Credit Income Fund (Cont.)
| Category and Subcategory | Level 1 | Level 2 | Level 3 | Fair Value at |
||||||||||||
| Convertible Bonds & Notes |
||||||||||||||||
| Industrials |
$ | 0 | $ | 1,663 | $ | 0 | $ | 1,663 | ||||||||
| Municipal Bonds & Notes |
||||||||||||||||
| Illinois |
0 | 15 | 0 | 15 | ||||||||||||
| Texas |
0 | 199 | 0 | 199 | ||||||||||||
| West Virginia |
0 | 144 | 0 | 144 | ||||||||||||
| U.S. Government Agencies |
0 | 27,937 | 0 | 27,937 | ||||||||||||
| Non-Agency Mortgage-Backed Securities |
0 | 218,503 | 94 | 218,597 | ||||||||||||
| Asset-Backed Securities |
0 | 143,710 | 32,435 | 176,145 | ||||||||||||
| Sovereign Issues |
0 | 15,007 | 0 | 15,007 | ||||||||||||
| Common Stocks |
||||||||||||||||
| Consumer Discretionary |
2,154 | 0 | 0 | 2,154 | ||||||||||||
| Energy |
2,101 | 0 | 0 | 2,101 | ||||||||||||
| Utilities |
0 | 0 | 8,661 | 8,661 | ||||||||||||
| Corporate Bonds & Notes |
0 | 0 | 0 | 0 | ||||||||||||
| Short-Term Instruments |
| |||||||||||||||
| Repurchase Agreements |
0 | 22,598 | 0 | 22,598 | ||||||||||||
| Short-Term Notes |
0 | 200 | 0 | 200 | ||||||||||||
| Argentina Treasury Bills |
0 | 843 | 0 | 843 | ||||||||||||
| U.S. Treasury Bills |
0 | 1,478 | 0 | 1,478 | ||||||||||||
| Total Investments |
$ | 4,355 | $ | 734,214 | $ | 64,699 | $ | 803,268 | ||||||||
| Financial Derivative Instruments - Assets |
| |||||||||||||||
| Exchange-traded or centrally cleared |
0 | 98 | 0 | 98 | ||||||||||||
| Over the counter |
0 | 1,684 | 0 | 1,684 | ||||||||||||
| $ | 0 | $ | 1,782 | $ | 0 | $ | 1,782 | |||||||||
| Financial Derivative Instruments - Liabilities |
| |||||||||||||||
| Exchange-traded or centrally cleared |
0 | (133 | ) | 0 | (133 | ) | ||||||||||
| Over the counter |
0 | (1,066 | ) | 0 | (1,066 | ) | ||||||||||
| $ | 0 | $ | (1,199 | ) | $ | 0 | $ | (1,199 | ) | |||||||
| Total Financial Derivative Instruments |
$ | 0 | $ | 583 | $ | 0 | $ | 583 | ||||||||
| Totals |
$ | 4,355 | $ | 734,797 | $ | 64,699 | $ | 803,851 | ||||||||
There were no significant transfers among Levels 1 and 2 during the period ended June 30, 2018.
The following is a reconciliation of the fair valuations using significant unobservable inputs (Level 3) for the Fund during the period ended June 30, 2018:
| Category and Subcategory | Beginning Balance at 06/30/2017 |
Net Purchases |
Net Sales |
Accrued Discounts/ (Premiums) |
Realized Gain/ (Loss) |
Net Change in Unrealized Appreciation/ (Depreciation)(1) |
Transfers into Level 3 |
Transfers Level 3 |
Ending 06/30/2018 |
Net Change in Unrealized |
||||||||||||||||||||||||||||||
| Investments in Securities, at Value |
|
|||||||||||||||||||||||||||||||||||||||
| Loan Participations and Assignments |
$ | 0 | $ | 9,621 | $ | (438 | ) | $ | (1 | ) | $ | 29 | $ | 128 | $ | 4,549 | $ | 0 | $ | 13,888 | $ | 128 | ||||||||||||||||||
| Corporate Bonds & Notes |
| |||||||||||||||||||||||||||||||||||||||
| Industrials |
209 | 16,911 | (50 | ) | 11 | 1 | (336 | ) | 0 | (7,125 | ) | 9,621 | (239 | ) | ||||||||||||||||||||||||||
| Non-Agency Mortgage-Backed Securities |
109 | 0 | (23 | ) | 0 | 3 | 5 | 0 | 0 | 94 | 5 | |||||||||||||||||||||||||||||
| Asset-Backed Securities |
2,709 | 30,738 | (33 | ) | 122 | 13 | (1,114 | ) | 0 | 0 | 32,435 | (1,113 | ) | |||||||||||||||||||||||||||
| Common Stocks |
| |||||||||||||||||||||||||||||||||||||||
| Utilities |
0 | 8,661 | 0 | 0 | 0 | 0 | 0 | 0 | 8,661 | 0 | ||||||||||||||||||||||||||||||
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| Totals |
$ | 3,027 | $ | 65,931 | $ | (544 | ) | $ | 132 | $ | 46 | $ | (1,317 | ) | $ | 4,549 | $ | (7,125 | ) | $ | 64,699 | $ | (1,219 | ) | ||||||||||||||||
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|||||||||||||||||||||
| 38 | PIMCO INTERVAL FUNDS | See Accompanying Notes |
June 30, 2018
The following is a summary of significant unobservable inputs used in the fair valuations of assets and liabilities categorized within Level 3 of the fair value hierarchy:
| Category and Subcategory | Ending Balance at 06/30/2018 |
Valuation Technique |
Unobservable Inputs |
Input Value(s) (% Unless Noted Otherwise) | ||||||||||||
| Investments in Securities, at Value |
| |||||||||||||||
| Loan Participations and Assignments |
$ | 9,916 | Third Party Vendor |
Broker Quote |
102.000-105.000 | |||||||||||
| 3,972 | Proxy Pricing |
Base Price |
99.250 | |||||||||||||
| Corporate Bonds & Notes Industrials |
9,621 | Reference Instrument |
Yield |
10.153 | ||||||||||||
| Non-Agency Mortgage-Backed Securities |
94 | Third Party Vendor |
Broker Quote |
88.470 | ||||||||||||
| Asset-Backed Securities |
32,435 | Proxy Pricing |
Base Price |
46.070-140,500.000 | ||||||||||||
| Common Stocks |
||||||||||||||||
| Utilities |
8,661 | Indicative Market Quotation |
Broker Quote |
$ | 35.500 | |||||||||||
|
|
|
|||||||||||||||
| Total |
$ | 64,699 | ||||||||||||||
|
|
|
|||||||||||||||
| (1) | Any difference between Net Change in Unrealized Appreciation/(Depreciation) and Net Change in Unrealized Appreciation/(Depreciation) on Investments Held at June 30, 2018 may be due to an investment no longer held or categorized as Level 3 at period end. |
| See Accompanying Notes | ANNUAL REPORT | JUNE 30, 2018 | 39 |
1. ORGANIZATION
PIMCO Flexible Credit Income Fund (the “Fund”) is organized as a closed-end management investment company registered under the Investment Company Act of 1940, as amended, and the rules and regulations thereunder (the “Act”). The Fund was organized as a Massachusetts business trust on October 25, 2016. The Fund is a closed-end management investment company that continuously offers its shares (“Common Shares”) and is operated as an “interval fund”. The Fund currently offers one class of Common Shares: Institutional Class. Pacific Investment Management Company LLC (“PIMCO” or the “Manager”) serves as the Fund’s investment manager.
The Fund is an “interval fund” and, in order to provide liquidity to shareholders, the Fund, subject to applicable law, conducts quarterly repurchase offers of the Fund’s outstanding common shares at net asset value (“NAV”), subject to approval of the Board. In all cases such repurchases will be for at least 5% and not more than 25% of its outstanding common shares at NAV, pursuant to Rule 23c-3 under the Act. The Fund currently expects to conduct quarterly repurchase offers for 5% of its outstanding common shares under ordinary circumstances. The Fund believes that these repurchase offers are generally beneficial to the Fund’s shareholders, and repurchases generally will be funded from available cash or sales of portfolio securities. However, repurchase offers and the need to fund repurchase obligations may affect the ability of the Fund to be fully invested or force the Fund to maintain a higher percentage of its assets in liquid investments, which may harm the Fund’s investment performance. Moreover, diminution in the size of the Fund through repurchases may result in untimely sales of portfolio securities (with associated imputed transaction costs, which may be significant), may limit the ability of the Fund to participate in new investment opportunities or to achieve its investment objective and will tend to increase the Fund’s expense ratio per common share for remaining shareholders. The Fund may accumulate cash by holding back (i.e., not reinvesting) payments received in connection with the Fund’s investments. The Fund believes that payments received in connection with the Fund’s investments will generate sufficient cash to meet the maximum potential amount of the Fund’s repurchase obligations. If at any time cash and other liquid assets held by the Fund are not sufficient to meet the Fund’s repurchase obligations, the Fund intends, if necessary, to sell investments. If, as expected, the Fund employs investment leverage, repurchases of common shares would compound the adverse effects of leverage in a declining market. In addition, if the Fund borrows to finance repurchases, interest on that borrowing will negatively affect common shareholders who do not tender their common shares by increasing the Fund’s expenses and reducing any net investment income.
If a repurchase offer is oversubscribed, the Board of Trustees of the Fund may determine to increase the amount repurchased by up to 2% of the Fund’s outstanding shares as of the date of the Repurchase Request Deadline (as defined in the Fund’s prospectus). In the event that the Board of Trustees of the Fund determines not to repurchase more than the repurchase offer amount, or if shareholders tender more than the repurchase offer amount plus 2% of the Fund’s outstanding shares as of the date of the Repurchase Request Deadline, the Fund will repurchase the common shares tendered on a pro rata basis, and shareholders will have to wait until the next repurchase offer to make another repurchase request. As a result, shareholders may be unable to liquidate all or a given percentage of their investment in the Fund during a particular repurchase offer. Some shareholders, in anticipation of proration, may tender more common shares than they wish to have repurchased in a particular quarter, thereby increasing the likelihood that proration will occur. A
| 40 | PIMCO INTERVAL FUNDS |
June 30, 2018
shareholder may be subject to market and other risks, and the NAV of common shares tendered in a repurchase offer may decline between the Repurchase Request Deadline and the date on which the NAV for tendered common shares is determined. In addition, the repurchase of common shares by the Fund may be a taxable event to shareholders.
During the fiscal year ended June 30, 2018, the Fund engaged in repurchase offers as follows:
| Repurchase Request Deadline | Repurchase Offer Amount (as a percentage of outstanding shares) |
Number of Shares Repurchased |
Percentage of Outstanding Shares Tendered |
|||||||||||||
| May 8, 2018 |
5% | 832,622.743 | 1.83% | |||||||||||||
| February 8, 2018 |
5% | 136,874.308 | 0.40% | |||||||||||||
| November 9, 2017 |
5% | 4,170.190 | 0.02% | |||||||||||||
| August 9, 2017 |
5% | 8,642.316 | 0.09% | |||||||||||||
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Fund is treated as an investment company under the reporting requirements of U.S. GAAP. The functional and reporting currency for the Funds is the U.S. dollar. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates.
(a) Securities Transactions and Investment Income Securities transactions are recorded as of the trade date for financial reporting purposes. Realized gains (losses) from securities sold are recorded on the identified cost basis. Securities purchased or sold on a when-issued or delayed-delivery basis may be settled beyond a standard settlement period for the security after the trade date. Dividend income is recorded on the ex-dividend date, except certain dividends from foreign securities where the ex-dividend date may have passed, which are recorded as soon as the Fund is informed of the ex-dividend date. Interest income, adjusted for the accretion of discounts and amortization of premiums, is recorded on the accrual basis from settlement date, with the exception of securities with a forward starting effective date, where interest income is recorded on the accrual basis from effective date. For convertible securities, premiums attributable to the conversion feature are not amortized. Estimated tax liabilities on certain foreign securities are recorded on an accrual basis and are reflected as components of interest income or net change in unrealized appreciation (depreciation) on investments on the Consolidated Statement of Operations, as appropriate. Tax liabilities realized as a result of such security sales are reflected as a component of net realized gain (loss) on investments on the Consolidated Statement of Operations. Paydown gains (losses) on mortgage-related and other asset-backed securities, if any, are recorded as components of interest income on the Consolidated Statement of Operations. Income or short-term capital gain distributions received from registered investment companies, if any, are recorded as dividend income. Long-term capital gain distributions received from registered investment companies, if any, are recorded as realized gains.
| ANNUAL REPORT | JUNE 30, 2018 | 41 |
Notes to Financial Statements (Cont.)
Debt obligations may be placed on non-accrual status and related interest income may be reduced by ceasing current accruals and writing off interest receivable when the collection of all or a portion of interest has become doubtful based on consistently applied procedures. A debt obligation is removed from non-accrual status when the issuer resumes interest payments or when collectability of interest is probable.
(b) Cash and Foreign Currency The market values of foreign securities, currency holdings and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the current exchange rates each business day. Purchases and sales of securities and income and expense items denominated in foreign currencies, if any, are translated into U.S. dollars at the exchange rate in effect on the transaction date. The Fund does not separately report the effects of changes in foreign exchange rates from changes in market prices on securities held. Such changes are included in net realized gain (loss) and net change in unrealized appreciation (depreciation) from investments on the Consolidated Statement of Operations. The Fund may invest in foreign currency-denominated securities and may engage in foreign currency transactions either on a spot (cash) basis at the rate prevailing in the currency exchange market at the time or through a forward foreign currency contract. Realized foreign exchange gains (losses) arising from sales of spot foreign currencies, currency gains (losses) realized between the trade and settlement dates on securities transactions and the difference between the recorded amounts of dividends, interest, and foreign withholding taxes and the U.S. dollar equivalent of the amounts actually received or paid are included in net realized gain (loss) on foreign currency transactions on the Consolidated Statement of Operations. Net unrealized foreign exchange gains (losses) arising from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period are included in net change in unrealized appreciation (depreciation) on foreign currency assets and liabilities on the Consolidated Statement of Operations.
(c) Distributions — Common Shares Distributions from net investment income, if any, are declared daily and distributed to shareholders quarterly. Net realized capital gains earned by the Fund, if any, will be distributed no less frequently than once each year.
Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from U.S. GAAP. Differences between tax regulations and U.S. GAAP may cause timing differences between income and capital gain recognition. Further, the character of investment income and capital gains may be different for certain transactions under the two methods of accounting. As a result, income distributions and capital gain distributions declared during a fiscal period may differ significantly from the net investment income (loss) and realized gains (losses) reported on the Fund’s annual financial statements presented under U.S. GAAP.
If the Fund estimates that a portion of its distribution may be comprised of amounts from sources other than net investment income, in accordance with its policies and good accounting practices, the Fund will notify shareholders of the estimated composition of such distribution through a Section 19 Notice. For these purposes, the Fund estimates the source or sources from which a distribution is paid, to the close of the period as of which it is paid, in reference to its internal accounting records and related accounting practices. If, based on such accounting records and practices, it is estimated that a particular distribution does not include capital gains or paid-in surplus or other capital sources, a Section 19 Notice generally would not be issued. It is important to note that differences exist between the Fund’s daily internal accounting records and practices, the Fund’s financial statements
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presented in accordance with U.S. GAAP, and recordkeeping practices under income tax regulations. For instance, the Fund’s internal accounting records and practices may take into account, among other factors, tax-related characteristics of certain sources of distributions that differ from treatment under U.S. GAAP. Examples of such differences may include, among others, the treatment of paydowns on mortgage-backed securities purchased at a discount and periodic payments under interest rate swap contracts. Accordingly, among other consequences, it is possible that the Fund may not issue a Section 19 Notice in situations where the Fund’s financial statements prepared later and in accordance with U.S. GAAP and/or the final tax character of those distributions might later report that the sources of those distributions included capital gains and/or a return of capital. Please visit www.pimco.com for the most recent Section 19 Notice, if applicable, for additional information regarding the estimated composition of distributions. Final determination of a distribution’s tax character will be reported on Form 1099 DIV sent to shareholders for the calendar year.
Distributions classified as a tax basis return of capital, if any, are reflected on the Consolidated Statement of Changes in Net Assets and have been recorded to paid in capital. In addition, other amounts have been reclassified between undistributed (overdistributed) net investment income (loss), accumulated undistributed (overdistributed) net realized gain (loss) and/or paid in capital to more appropriately conform U.S. GAAP to tax characterizations of distributions.
(d) New Accounting Pronouncements In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15 which amends Accounting Standards Codification (“ASC”) 230 to clarify guidance on the classification of certain cash receipts and cash payments in the Statement of Cash Flows. The ASU is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Fund has adopted the ASU. The implementation of the ASU did not have an impact on the Fund’s financial statements.
In October 2016, the U.S. Securities and Exchange Commission (“SEC”) adopted new rules and forms, and amendments to certain current rules and forms, to modernize reporting and disclosure of information by registered investment companies. The amendments to Regulation S-X require standardized, enhanced disclosure about derivatives in investment company financial statements, and also change the rules governing the form and content of such financial statements. The compliance date for these amendments was August 1, 2017. Compliance is based on reporting period-end date. Management has adopted these amendments and the changes are incorporated in the financial statements.
In November 2016, the FASB issued ASU 2016-18 which amends ASC 230 to provide guidance on the classification and presentation of changes in restricted cash and restricted cash equivalents on the Statement of Cash Flows. The ASU is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Fund has adopted the ASU. The implementation of the ASU did not have an impact on the Fund’s financial statements.
In March 2017, the FASB issued ASU 2017-08 which provides guidance related to the amortization period for certain purchased callable debt securities held at a premium. The ASU is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. The Fund has adopted the ASU. The implementation of the ASU did not have an impact on the Fund’s financial statements.
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Notes to Financial Statements (Cont.)
3. INVESTMENT VALUATION AND FAIR VALUE MEASUREMENTS
(a) Investment Valuation Policies The NAV of the Fund’s shares is determined by dividing the total value of portfolio investments and other assets attributable to that Fund less any liabilities by the total number of shares outstanding of the Fund.
On each day that the New York Stock Exchange (“NYSE”) is open, Fund shares are ordinarily valued as of the close of regular trading (“NYSE Close”). Information that becomes known to the Fund or its agents after the time as of which NAV has been calculated on a particular day will not generally be used to retroactively adjust the price of a security or the NAV determined earlier that day. The Fund reserves the right to change the time as of which its NAV is calculated if the Fund closes earlier, or as permitted by the SEC.
For purposes of calculating a NAV, portfolio securities and other assets for which market quotes are readily available are valued at market value. Market value is generally determined on the basis of official closing prices or the last reported sales prices, or if no sales are reported, based on quotes obtained from established market makers or prices (including evaluated prices) supplied by the Fund’s approved pricing services, quotation reporting systems and other third-party sources (together, “Pricing Services”). The Fund will normally use pricing data for domestic equity securities received shortly after the NYSE Close and does not normally take into account trading, clearances or settlements that take place after the NYSE Close. If market value pricing is used, a foreign (non-U.S.) equity security traded on a foreign exchange or on more than one exchange is typically valued using pricing information from the exchange considered by PIMCO to be the primary exchange. A foreign (non-U.S.) equity security will be valued as of the close of trading on the foreign exchange, or the NYSE Close, if the NYSE Close occurs before the end of trading on the foreign exchange. Domestic and foreign (non-U.S.) fixed income securities, non-exchange traded derivatives, and equity options are normally valued on the basis of quotes obtained from brokers and dealers or Pricing Services using data reflecting the earlier closing of the principal markets for those securities. Prices obtained from Pricing Services may be based on, among other things, information provided by market makers or estimates of market values obtained from yield data relating to investments or securities with similar characteristics. Certain fixed income securities purchased on a delayed-delivery basis are marked to market daily until settlement at the forward settlement date. Exchange-traded options, except equity options, futures and options on futures are valued at the settlement price determined by the relevant exchange. Swap agreements are valued on the basis of bid quotes obtained from brokers and dealers or market-based prices supplied by Pricing Services. The Fund’s investments in open-end management investment companies, other than exchange-traded funds (“ETFs”), are valued at the NAVs of such investments.
If a foreign (non-U.S.) equity security’s value has materially changed after the close of the security’s primary exchange or principal market but before the NYSE Close, the security may be valued at fair value based on procedures established and approved by the Board of Trustees of the Trust (the “Board”). Foreign (non-U.S.) equity securities that do not trade when the NYSE is open are also valued at fair value. With respect to foreign (non-U.S.) equity securities, the Fund may determine the fair value of investments based on information provided by Pricing Services and other third-party vendors, which may recommend fair value or adjustments with reference to other securities, indices or assets. In considering whether fair valuation is required and in determining fair values, the Fund may, among other things, consider significant events (which may be considered to include changes in
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the value of U.S. securities or securities indices) that occur after the close of the relevant market and before the NYSE Close. The Fund may utilize modeling tools provided by third-party vendors to determine fair values of non-U.S. securities. For these purposes, any movement in the applicable reference index or instrument (“zero trigger”) relating to the non-U.S security being fair valued between the earlier close of the applicable foreign market and the NYSE Close may be deemed to be a significant event, prompting the application of the pricing model (effectively resulting in daily fair valuations). Foreign exchanges may permit trading in foreign (non-U.S.) equity securities on days when the Fund is not open for business, which may result in the Fund’s portfolio investments being affected when shareholders are unable to buy or sell shares.
Senior secured floating rate loans for which an active secondary market exists to a reliable degree will be valued at the mean of the last available bid/ask prices in the market for such loans, as provided by a Pricing Service. Senior secured floating rate loans for which an active secondary market does not exist to a reliable degree will be valued at fair value, which is intended to approximate market value. In valuing a senior secured floating rate loan at fair value, the factors considered may include, but are not limited to, the following: (a) the creditworthiness of the borrower and any intermediate participants, (b) the terms of the loan, (c) recent prices in the market for similar loans, if any, and (d) recent prices in the market for instruments of similar quality, rate, period until next interest rate reset and maturity.
Investments valued in currencies other than the U.S. dollar are converted to the U.S. dollar using exchange rates obtained from Pricing Services. As a result, the value of such investments and, in turn, the NAV of the Fund’s shares may be affected by changes in the value of currencies in relation to the U.S. dollar. The value of investments traded in markets outside the United States or denominated in currencies other than the U.S. dollar may be affected significantly on a day that the Fund is not open for business. As a result, to the extent that the Fund holds foreign (non-U.S.) investments, the value of those investments may change at times when shareholders are unable to buy or sell shares and the value of such investments will be reflected in the Fund’s next calculated NAV.
Investments for which market quotes or market based valuations are not readily available are valued at fair value as determined in good faith by the Board or persons acting at their direction. The Board has adopted methods for valuing securities and other assets in circumstances where market quotes are not readily available, and has delegated to PIMCO the responsibility for applying the fair valuation methods. In the event that market quotes or market based valuations are not readily available, and the security or asset cannot be valued pursuant to a Board approved valuation method, the value of the security or asset will be determined in good faith by the Valuation Oversight Committee of the Board (“Valuation Oversight Committee”), generally based on recommendations provided by the Manager. Market quotes are considered not readily available in circumstances where there is an absence of current or reliable market-based data (e.g., trade information, bid/ask information, indicative market quotations (“Broker Quotes”), Pricing Services’ prices), including where events occur after the close of the relevant market, but prior to the NYSE Close, that materially affect the values of the Fund’s securities or assets. In addition, market quotes are considered not readily available when, due to extraordinary circumstances, the exchanges or markets on which the securities trade do not open for trading for the entire day and no other market prices are available. The Board has delegated to the Manager the responsibility for monitoring significant events that may materially affect the values of the Fund’s securities or assets and for determining whether the value of the applicable securities or assets should be reevaluated in light of such significant events.
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Notes to Financial Statements (Cont.)
When the Fund uses fair valuation to determine the value of a portfolio security or other asset for purposes of calculating its NAV, such investments will not be priced on the basis of quotes from the primary market in which they are traded, but rather may be priced by another method that the Board or persons acting at their direction believe reflects fair value. Fair valuation may require subjective determinations about the value of a security. While the Fund’s policy is intended to result in a calculation of the Fund’s NAV that fairly reflects security values as of the time of pricing, the Fund cannot ensure that fair values determined by the Board or persons acting at their direction would accurately reflect the price that the Fund could obtain for a security if it were to dispose of that security as of the time of pricing (for instance, in a forced or distressed sale). The prices used by the Fund may differ from the value that would be realized if the securities were sold.
(b) Fair Value Hierarchy U.S. GAAP describes fair value as the price that the Fund would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date. It establishes a fair value hierarchy that prioritizes inputs to valuation methods and requires disclosure of the fair value hierarchy, separately for each major category of assets and liabilities, that segregates fair value measurements into levels (Level 1, 2, or 3). The inputs or methodology used for valuing securities are not necessarily an indication of the risks associated with investing in those securities. Levels 1, 2, and 3 of the fair value hierarchy are defined as follows:
| ∎ | Level 1 — Quoted prices in active markets or exchanges for identical assets and liabilities. |
| ∎ | Level 2 — Significant other observable inputs, which may include, but are not limited to, quoted prices for similar assets or liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates) or other market corroborated inputs. |
| ∎ | Level 3 — Significant unobservable inputs based on the best information available in the circumstances, to the extent observable inputs are not available, which may include assumptions made by the Board or persons acting at their direction that are used in determining the fair value of investments. |
Assets or liabilities categorized as Level 2 or 3 as of period end have been transferred between Levels 2 and 3 since the prior period due to changes in the method utilized in valuing the investments. Transfers from Level 2 to Level 3 are a result of a change, in the normal course of business, from the use of methods used by Pricing Services (Level 2) to the use of a Broker Quote or valuation technique which utilizes significant unobservable inputs due to an absence of current or reliable market-based data (Level 3). Transfers from Level 3 to Level 2 are a result of the availability of current and reliable market-based data provided by Pricing Services or other valuation techniques which utilize significant observable inputs. In accordance with the requirements of U.S. GAAP, the amounts of transfers between Levels 1 and 2 and transfers into and out of Level 3, if material, are disclosed in the Notes to Consolidated Schedule of Investments for the Fund.
For fair valuations using significant unobservable inputs, U.S. GAAP requires a reconciliation of the beginning to ending balances for reported fair values that presents changes attributable to realized gain (loss), unrealized appreciation (depreciation), purchases and sales, accrued discounts (premiums), and transfers into and out of the Level 3 category during the period. The end of period
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value is used for the transfers between Levels of the Fund’s assets and liabilities. Additionally, U.S. GAAP requires quantitative information regarding the significant unobservable inputs used in the determination of fair value of assets or liabilities categorized as Level 3 in the fair value hierarchy. In accordance with the requirements of U.S. GAAP, a fair value hierarchy, and if material, a Level 3 reconciliation and details of significant unobservable inputs, have been included in the Notes to Consolidated Schedule of Investments for the Fund.
(c) Valuation Techniques and the Fair Value Hierarchy
Level 1 and Level 2 trading assets and trading liabilities, at fair value The valuation methods (or “techniques”) and significant inputs used in determining the fair values of portfolio securities or other assets and liabilities categorized as Level 1 and Level 2 of the fair value hierarchy are as follows:
Fixed income securities including corporate, convertible and municipal bonds and notes, U.S. government agencies, U.S. treasury obligations, sovereign issues, bank loans, convertible preferred securities and non-U.S. bonds are normally valued on the basis of quotes obtained from brokers and dealers or Pricing Services that use broker-dealer quotations, reported trades or valuation estimates from their internal pricing models. The Pricing Services’ internal models use inputs that are observable such as issuer details, interest rates, yield curves, prepayment speeds, credit risks/spreads, default rates and quoted prices for similar assets. Securities that use similar valuation techniques and inputs as described above are categorized as Level 2 of the fair value hierarchy.
Fixed income securities purchased on a delayed-delivery basis or as a repurchase commitment in a sale-buyback transaction are marked to market daily until settlement at the forward settlement date and are categorized as Level 2 of the fair value hierarchy.
Mortgage-related and asset-backed securities are usually issued as separate tranches, or classes, of securities within each deal. These securities are also normally valued by Pricing Services that use broker-dealer quotations, reported trades or valuation estimates from their internal pricing models. The pricing models for these securities usually consider tranche-level attributes, current market data, estimated cash flows and market-based yield spreads for each tranche, and incorporate deal collateral performance, as available. Mortgage-related and asset-backed securities that use similar valuation techniques and inputs as described above are categorized as Level 2 of the fair value hierarchy.
Valuation adjustments may be applied to certain securities that are solely traded on a foreign exchange to account for the market movement between the close of the foreign market and the NYSE Close. These securities are valued using Pricing Services that consider the correlation of the trading patterns of the foreign security to the intraday trading in the U.S. markets for investments. Securities using these valuation adjustments are categorized as Level 2 of the fair value hierarchy. Preferred securities and other equities traded on inactive markets or valued by reference to similar instruments are also categorized as Level 2 of the fair value hierarchy.
Equity exchange-traded options and over the counter financial derivative instruments, such as forward foreign currency contracts and options contracts derive their value from underlying asset prices, indices, reference rates, and other inputs or a combination of these factors. These contracts are normally valued on the basis of quotes obtained from a quotation reporting system, established market makers or Pricing Services (normally determined as of the NYSE Close). Depending on the
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Notes to Financial Statements (Cont.)
product and the terms of the transaction, financial derivative instruments can be valued by Pricing Services using a series of techniques, including simulation pricing models. The pricing models use inputs that are observed from actively quoted markets such as quoted prices, issuer details, indices, bid/ask spreads, interest rates, implied volatilities, yield curves, dividends and exchange rates. Financial derivative instruments that use similar valuation techniques and inputs as described above are categorized as Level 2 of the fair value hierarchy.
Centrally cleared swaps and over the counter swaps derive their value from underlying asset prices, indices, reference rates, and other inputs or a combination of these factors. They are valued using a broker-dealer bid quotation or on market-based prices provided by Pricing Services (normally determined as of the NYSE close). Centrally cleared swaps and over the counter swaps can be valued by Pricing Services using a series of techniques, including simulation pricing models. The pricing models may use inputs that are observed from actively quoted markets such as the overnight index swap rate (“OIS”), London Interbank Offered Rate (“LIBOR”) forward rate, interest rates, yield curves and credit spreads. These securities are categorized as Level 2 of the fair value hierarchy.
Level 3 trading assets and trading liabilities, at fair value When a fair valuation method is applied by PIMCO that uses significant unobservable inputs, investments will be priced by a method that the Board or persons acting at their direction believe reflects fair value and are categorized as Level 3 of the fair value hierarchy. The valuation techniques and significant inputs used in determining the fair values of portfolio assets and liabilities categorized as Level 3 of the fair value hierarchy are as follows:
Proxy pricing procedures set the base price of a fixed income security and subsequently adjust the price proportionally to market value changes of a pre-determined security deemed to be comparable in duration, generally a U.S. Treasury or sovereign note based on country of issuance. The base price may be a broker-dealer quote, transaction price, or an internal value as derived by analysis of market data. The base price of the security may be reset on a periodic basis based on the availability of market data and procedures approved by the Valuation Oversight Committee. Significant changes in the unobservable inputs of the proxy pricing process (the base price) would result in direct and proportional changes in the fair value of the security. These securities are categorized as Level 3 of the fair value hierarchy.
If third-party evaluated vendor pricing is not available or not deemed to be indicative of fair value, the Adviser may elect to obtain Broker Quotes directly from the broker-dealer or passed through from a third-party vendor. In the event that fair value is based upon a single sourced Broker Quote, these securities are categorized as Level 3 of the fair value hierarchy. Broker Quotes are typically received from established market participants. Although independently received, the Adviser does not have the transparency to view the underlying inputs which support the market quotation. Significant changes in the Broker Quote would have direct and proportional changes in the fair value of the security.
Reference instrument valuation estimates fair value by utilizing the correlation of the security to one or more broad-based securities, market indices, and/or other financial instruments, whose pricing information is readily available. Unobservable inputs may include those used in algorithm formulas based on percentage change in the reference instruments and/or weights of each reference instrument. Significant changes in the unobservable inputs would result in direct and proportional changes in the fair value of the security. These securities are categorized as Level 3 of the fair value hierarchy.
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Short-term debt instruments (such as commercial paper) having a remaining maturity of 60 days or less may be valued at amortized cost, so long as the amortized cost value of such short-term debt instruments is approximately the same as the fair value of the instrument as determined without the use of amortized cost valuation. These securities are categorized as Level 2 or Level 3 of the fair value hierarchy depending on the source of the base price.
4. SECURITIES AND OTHER INVESTMENTS
(a) Investments in Securities
The Fund may utilize the investments and strategies described below to the extent permitted by the Fund’s investment policies.
Loan Participations and Assignments are direct debt instruments which are interests in amounts owed to lenders or lending syndicates by corporate, governmental, or other borrowers. The Fund’s investments in loans may be in the form of direct investments, participations in loans or assignments of all or a portion of loans from third parties or exposure to investments in loans through investments in a mutual fund or other pooled investment vehicle. A loan is often administered by a bank or other financial institution (the “agent”) that acts as agent for all holders. The agent administers the terms of the loan, as specified in the loan agreement. The Fund may invest in multiple series or tranches of a loan, which may have varying terms and carry different associated risks. The Fund generally has no right to enforce compliance with the terms of the loan agreement with the borrower. As a result, the Fund may be subject to the credit risk of both the borrower and the agent that is selling the loan agreement.
In the event of the insolvency of the agent selling a participation, the Fund may be treated as a general creditor of the agent and may not benefit from any set-off between the agent and the borrower. When the Fund purchases assignments from agents it acquires direct rights against the borrowers of the loans. These loans may include participations in bridge loans, which are loans taken out by borrowers for a short period (typically less than one year) pending arrangement of more permanent financing through, for example, the issuance of bonds, frequently high yield bonds issued for the purpose of acquisitions.
Investments in loans are generally subject to risks similar to those of investments in other types of debt obligations, including, among others, credit risk, interest rate risk, variable and floating rate securities risk, and risks associated with mortgage-related securities. In addition, in many cases loans are subject to the risks associated with below-investment grade securities. The Fund may be subject to heightened or additional risks and potential liabilities and costs by investing in mezzanine and other subordinated loans, including those arising under bankruptcy, fraudulent conveyance, equitable subordination, environmental and other laws and regulations, and risks and costs associated with debt servicing and taking foreclosure actions associated with the loans.
Additionally, because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered “securities” for purposes of the anti-fraud provisions under the federal securities laws and, as a result, as a purchaser of these instruments, the Fund may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, the Fund may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in
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Notes to Financial Statements (Cont.)
possession of such information, the Fund may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for the Fund to do so. Alternatively, the Fund may choose not to receive material nonpublic information about an issuer of such loans, with the result that the Fund may have less information about such issuers than other investors who transact in such assets.
The types of loans and related investments in which the Fund may invest include, among others, senior loans, subordinated loans (including second lien loans, B-Notes and mezzanine loans), whole loans, commercial real estate and other commercial loans and structured loans. The Fund may acquire direct interests in loans through primary loan distributions and/or in private transactions. In the case of subordinated loans, there may be significant indebtedness ranking ahead of the borrower’s obligation to the holder of such a loan, including in the event of the borrower’s insolvency. Mezzanine loans are typically secured by a pledge of an equity interest in the mortgage borrower that owns the real estate rather than an interest in a mortgage.
Investments in loans may include unfunded loan commitments, which are contractual obligations for future funding. Unfunded loan commitments may include revolving credit facilities, which may obligate the Fund to supply additional cash to the borrower on demand. Unfunded loan commitments represent a future obligation in full, even though a percentage of the committed amount may not be utilized by the borrower. When investing in a loan participation, the Fund has the right to receive payments of principal, interest and any fees to which it is entitled only from the agent selling the loan agreement and only upon receipt of payments by the agent from the borrower. Because investing in unfunded loan commitments creates a future obligation for the Fund to provide funding to a borrower upon demand in exchange for a fee, the Fund will segregate or earmark liquid assets with the Fund’s custodian in amounts sufficient to satisfy any such future obligations. The Fund may receive a commitment fee based on the undrawn portion of the underlying line of credit portion of a loan. In certain circumstances, the Fund may receive a penalty fee upon the prepayment of a loan by a borrower. Fees earned or paid are recorded as a component of interest income or interest expense, respectively, on the Consolidated Statement of Operations. Unfunded loan commitments are reflected as a liability on the Consolidated Statements of Assets and Liabilities.
Mortgage-Related and Other Asset-Backed Securities directly or indirectly represent a participation in, or are secured by and payable from, loans on real property. Mortgage-related securities are created from pools of residential or commercial mortgage loans, including mortgage loans made by savings and loan institutions, mortgage bankers, commercial banks and others. These securities typically provide a monthly payment which consists of both principal and interest. Interest may be determined by fixed or adjustable rates. In times of declining interest rates, there is a greater likelihood that the Fund’s higher yielding securities will be pre-paid with the Fund being unable to reinvest the proceeds in an investment with as great a yield. The rate of prepayments on underlying mortgages will affect the price and volatility of a mortgage-related security, and may have the effect of shortening or extending the effective duration of the security relative to what was anticipated at the time of purchase. Interest-only and principal-only securities are especially sensitive to interest rate changes, which can affect not only their prices but can also change the income flows and repayment assumptions about those investments. The timely payment of principal and interest of certain mortgage-related securities is guaranteed with the full faith and credit of the U.S. Government. Pools created and guaranteed by non-governmental issuers, including government-
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sponsored corporations, may be supported by various forms of insurance or guarantees, but there can be no assurance that private insurers or guarantors can meet their obligations under the insurance policies or guarantee arrangements. Many of the risks of investing in mortgage-related securities secured by commercial mortgage loans (“CMBS”) reflect the effects of local and other economic conditions on real estate markets, the ability of tenants to make lease payments, and the ability of a property to attract and retain tenants. These securities may be less liquid and may exhibit greater price volatility than other types of mortgage-related or other asset-backed securities. Other asset-backed securities are created from many types of assets, including without limitation, auto loans, credit card receivables, home equity loans, and student loans. The Fund may invest in any level of the capital structure of an issuer of mortgage-backed or asset-backed securities, including the equity or “first loss” tranche.
Collateralized Debt Obligations (“CDOs”) include Collateralized Bond Obligations (“CBOs”), Collateralized Loan Obligations (“CLOs”) and other similarly structured securities. CBOs and CLOs are types of asset-backed securities. A CBO is a trust which is typically backed by a diversified pool of high risk, below investment grade fixed income securities. A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and foreign senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans. For both CBOs and CLOs, the cash flows from the trust are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the “equity” tranche which bears the bulk of defaults from the bonds or loans in the trust and serves to protect the other, more senior tranches from default in all but the most severe circumstances. Since it is partially protected from defaults, a senior tranche from a CBO trust or CLO trust typically has higher ratings and lower yields than the underlying securities, and can be rated investment grade. Despite the protection from the equity tranche, CBO or CLO tranches can experience substantial losses due to actual defaults, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults and aversion to CBO or CLO securities as a class. The risks of an investment in a CDO depend largely on the type of the collateral securities and the class of the CDO in which the Fund invests. CDOs carry additional risks including, but not limited to, (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments, (ii) the collateral may decline in value or default, (iii) the Fund may invest in CDOs that are subordinate to other classes, and (iv) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results.
Collateralized Mortgage Obligations (“CMOs”) are debt obligations of a legal entity that are collateralized by whole mortgage loans or private mortgage bonds and divided into classes. CMOs are structured into multiple classes, often referred to as “tranches”, with each class bearing a different stated maturity and entitled to a different schedule for payments of principal and interest, including prepayments. CMOs may be less liquid and may exhibit greater price volatility than other types of mortgage-related or asset-backed securities.
As CMOs have evolved, some classes of CMO bonds have become more common. For example, the Fund may invest in parallel-pay and planned amortization class (“PAC”) CMOs and multi-class pass-through certificates. Parallel-pay CMOs and multi-class pass-through certificates are structured to provide payments of principal on each payment date to more than one class. These simultaneous
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Notes to Financial Statements (Cont.)
payments are taken into account in calculating the stated maturity date or final distribution date of each class, which, as with other CMO and multi-class pass-through structures, must be retired by its stated maturity date or final distribution date but may be retired earlier. PACs generally require payments of a specified amount of principal on each payment date. PACs are parallel-pay CMOs with the required principal amount on such securities having the highest priority after interest has been paid to all classes. Any CMO or multi-class pass-through structure that includes PAC securities must also have support tranches — known as support bonds, companion bonds or non-PAC bonds — which lend or absorb principal cash flows to allow the PAC securities to maintain their stated maturities and final distribution dates within a range of actual prepayment experience. These support tranches are subject to a higher level of maturity risk compared to other mortgage-related securities, and usually provide a higher yield to compensate investors. If principal cash flows are received in amounts outside a pre-determined range such that the support bonds cannot lend or absorb sufficient cash flows to the PAC securities as intended, the PAC securities are subject to heightened maturity risk. The Fund may invest in various tranches of CMO bonds, including support bonds and equity or “first loss” tranches (see “Collateralized Debt Obligations” above).
Payment In-Kind Securities (“PIKs”) may give the issuer the option at each interest payment date of making interest payments in either cash and/or additional debt securities. Those additional debt securities usually have the same terms, including maturity dates and interest rates, and associated risks as the original bonds. The daily market quotations of the original bonds may include the accrued interest (referred to as a dirty price) and require a pro rata adjustment from the unrealized appreciation (depreciation) on investments to interest receivable on the Consolidated Statement of Assets and Liabilities.
Stripped Mortgage-Backed Securities (“SMBS”) are derivative multi-class mortgage securities. SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. An SMBS will have one class that will receive all of the interest (the interest-only or “IO” class), while the other class will receive the entire principal (the principal-only or “PO” class). IOs and POs can be extremely volatile in response to changes in interest rates. As interest rates rise and fall, the value of IOs tends to move in the same direction as interest rates. POs perform best when prepayments on the underlying mortgages rise since this increases the rate at which the principal is returned and the yield to maturity on the PO. When payments on mortgages underlying a PO are slower than anticipated, the life of the PO is lengthened and the yield to maturity is reduced. The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Fund’s yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated prepayments of principal, the Funds may fail to recoup some or all of its initial investment in these securities even if the security is in one of the highest rating categories.
Payments received for IOs are included in interest income on the Consolidated Statement of Operations. Because no principal will be received at the maturity of an IO, adjustments are made to the cost of the security on a monthly basis until maturity. These adjustments are included in interest income on the Consolidated Statement of Operations. Payments received for POs are treated as reductions to the cost and par value of the securities.
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Restricted Investments are subject to legal or contractual restrictions on resale and may generally be sold privately, but may be required to be registered or exempted from such registration before being sold to the public. Private placement securities are generally considered to be restricted except for those securities traded between qualified institutional investors under the provisions of Rule 144A of the Securities Act of 1933. Disposal of restricted investments may involve time-consuming negotiations and expenses, and prompt sale at an acceptable price may be difficult to achieve. Restricted investments held by the Fund at June 30, 2018 are disclosed in the Notes to Consolidated Schedule of Investments.
Securities Issued by U.S. Government Agencies or Government-Sponsored Enterprises are obligations of and, in certain cases, guaranteed by, the U.S. Government, its agencies or instrumentalities. Some U.S. Government securities, such as Treasury bills, notes and bonds, and securities guaranteed by the Government National Mortgage Association (“GNMA” or “Ginnie Mae”), are supported by the full faith and credit of the U.S. Government; others, such as those of the Federal Home Loan Banks, are supported by the right of the issuer to borrow from the U.S. Department of the Treasury (the “U.S. Treasury”); and others, such as those of the Federal National Mortgage Association (“FNMA” or “Fannie Mae”), are supported by the discretionary authority of the U.S. Government to purchase the agency’s obligations. U.S. Government securities may include zero coupon securities. Zero coupon securities do not distribute interest on a current basis and tend to be subject to a greater risk than interest-paying securities.
Government-related guarantors (i.e., not backed by the full faith and credit of the U.S. Government) include FNMA and the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”). FNMA is a government-sponsored corporation. FNMA purchases conventional (i.e., not insured or guaranteed by any government agency) residential mortgages from a list of approved seller/servicers which include state and federally chartered savings and loan associations, mutual savings banks, commercial banks and credit unions and mortgage bankers. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA, but are not backed by the full faith and credit of the U.S. Government. FHLMC issues Participation Certificates (“PCs”), which are pass-through securities, each representing an undivided interest in a pool of residential mortgages. FHLMC guarantees the timely payment of interest and ultimate collection of principal, but PCs are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agency’s obligations.
When-Issued Transactions are purchases or sales made on a when-issued basis. These transactions are made conditionally because a security, although authorized, has not yet been issued in the market. Transactions to purchase or sell securities on a when-issued basis involve a commitment by the Fund to purchase or sell these securities for a predetermined price or yield, with payment and delivery taking place beyond the customary settlement period. The Fund may sell when-issued securities before they are delivered, which may result in a realized gain (loss).
5. BORROWINGS AND OTHER FINANCING TRANSACTIONS
The Fund may enter into the borrowings and other financing transactions described below to the extent permitted by the Fund’s investment policies.
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Notes to Financial Statements (Cont.)
The following disclosures contain information on the Fund’s ability to lend or borrow cash or securities to the extent permitted under the Act, which may be viewed as borrowing or financing transactions by the Fund. The location of these instruments in the Fund’s financial statements is described below. For a detailed description of credit and counterparty risks that can be associated with borrowings and other financing transactions; please see Note 7, Principal Risks.
(a) Repurchase Agreements Under the terms of a typical repurchase agreement, the Fund purchases an underlying debt obligation (collateral) subject to an obligation of the seller to repurchase, and the Fund to resell, the obligation at an agreed-upon price and time. In an open maturity repurchase agreement, there is no pre-determined repurchase date and the agreement can be terminated by the Fund or counterparty at any time. The underlying securities for all repurchase agreements are held by the Fund’s custodian or designated subcustodians under tri-party repurchase agreements and in certain instances will remain in custody with the counterparty. The market value of the collateral must be equal to or exceed the total amount of the repurchase obligations, including interest. Repurchase agreements, if any, including accrued interest, are included on the Consolidated Statement of Assets and Liabilities. Interest earned is recorded as a component of interest income on the Consolidated Statement of Operations. In periods of increased demand for collateral, the Fund may pay a fee for the receipt of collateral, which may result in interest expense to the Fund.
(b) Reverse Repurchase Agreements In a reverse repurchase agreement, the Fund delivers a security in exchange for cash to a financial institution, the counterparty, with a simultaneous agreement to repurchase the same or substantially the same security at an agreed upon price and date. In an open maturity reverse repurchase agreement, there is no pre-determined repurchase date and the agreement can be terminated by the Fund or counterparty at any time. The Fund is entitled to receive principal and interest payments, if any, made on the security delivered to the counterparty during the term of the agreement. Cash received in exchange for securities delivered plus accrued interest payments to be made by the Fund to counterparties are reflected as a liability on the Consolidated Statement of Assets and Liabilities. Interest payments made by the Fund to counterparties are recorded as a component of interest expense on the Consolidated Statement of Operations. In periods of increased demand for the security, the Fund may receive a fee for use of the security by the counterparty, which may result in interest income to the Fund. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, the Fund’s use of the proceeds of the agreement may be restricted pending a determination by the other party, or its trustee or receiver, whether to enforce the Fund’s obligation to repurchase the securities. Reverse repurchase agreements involve leverage risk and also the risk that the market value of the securities to be repurchased may decline below the repurchase price; please see Note 7, Principal Risks.
(c) Short Sales Short sales are transactions in which the Fund sells a security that it may not own. The Fund may make short sales of securities to (i) offset potential declines in long positions in similar securities, (ii) to increase the flexibility of the Fund, (iii) for investment return, (iv) as part of a risk arbitrage strategy, and (v) as part of its overall portfolio management strategies involving the use of derivative instruments. When the Fund engages in a short sale, it may borrow the security sold short and deliver it to the counterparty. The Fund will ordinarily have to pay a fee or premium to borrow a security and be obligated to repay the lender of the security any dividend or interest that accrues on the security during the period of the loan. Securities sold in short sale transactions and the dividend
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or interest payable on such securities, if any, are reflected as payable for short sales on the Consolidated Statement of Assets and Liabilities. Short sales expose the Fund to the risk that it will be required to cover its short position at a time when the security or other asset has appreciated in value, thus resulting in losses to the Fund. A short sale is “against the box” if the Fund holds in its portfolio or has the right to acquire the security sold short, or securities identical to the security sold short, at no additional cost. The Fund will be subject to additional risks to the extent that it engages in short sales that are not “against the box.” The Fund’s loss on a short sale could theoretically be unlimited in cases where the Fund is unable, for whatever reason, to close out its short position.
6. FINANCIAL DERIVATIVE INSTRUMENTS
The Fund may enter into the financial derivative instruments described below to the extent permitted by the Fund’s investment policies.
The following disclosures contain information on how and why the Fund uses financial derivative instruments, and how financial derivative instruments affect the Fund’s financial position, results of operations and cash flows. The location and fair value amounts of these instruments on the Consolidated Statement of Assets and Liabilities and the net realized gain (loss) and net change in unrealized appreciation (depreciation) on the Consolidated Statement of Operations, each categorized by type of financial derivative contract and related risk exposure, are included in a table in the Notes to Consolidated Schedule of Investments. The financial derivative instruments outstanding as of period end and the amounts of net realized gain (loss) and net change in unrealized appreciation (depreciation) on financial derivative instruments during the period, as disclosed in the Notes to Consolidated Schedule of Investments, serve as indicators of the volume of financial derivative activity for the Fund.
(a) Forward Foreign Currency Contracts may be engaged, in connection with settling planned purchases or sales of securities, to hedge the currency exposure associated with some or all of the Fund’s securities or as part of an investment strategy. A forward foreign currency contract is an agreement between two parties to buy and sell a currency at a set price on a future date. The market value of a forward foreign currency contract fluctuates with changes in foreign currency exchange rates. Forward foreign currency contracts are marked to market daily, and the change in value is recorded by the Fund as an unrealized gain (loss). Realized gains (losses) are equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed and are recorded upon delivery or receipt of the currency. The contractual obligations of a buyer or seller of a forward foreign currency contract may generally be satisfied by taking or making physical delivery of the underlying currency, establishing an opposite position in the contract and recognizing the profit or loss on both positions simultaneously on the delivery date or, in some instances, paying a cash settlement before the designated date of delivery. These contracts may involve market risk in excess of the unrealized gain (loss) reflected on the Consolidated Statement of Assets and Liabilities. Although forwards may be intended to minimize the risk of loss due to a decline in the value of the hedged currencies, at the same time, they tend to limit any potential gain which might result should the value of such currencies increase. In addition, the Fund could be exposed to risk if the counterparties are unable to meet the terms of the contracts or if the value of the currency changes unfavorably to the U.S. dollar. To mitigate such risk, cash or securities may be exchanged as collateral pursuant to the terms of the underlying contracts.
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Notes to Financial Statements (Cont.)
(b) Swap Agreements are bilaterally negotiated agreements between the Fund and a counterparty to exchange or swap investment cash flows, assets, foreign currencies or market-linked returns at specified, future intervals. Swap agreements may be privately negotiated in the over the counter market (“OTC swaps”) or may be cleared through a third party, known as a central counterparty or derivatives clearing organization (“Centrally Cleared Swaps”). The Fund may enter into asset, credit default, cross-currency, interest rate, total return, variance and other forms of swap agreements to manage its exposure to credit, currency, interest rate, commodity, equity and inflation risk. In connection with these agreements, securities or cash may be identified as collateral or margin in accordance with the terms of the respective swap agreements to provide assets of value and recourse in the event of default or bankruptcy/insolvency.
Centrally Cleared Swaps are marked to market daily based upon valuations as determined from the underlying contract or in accordance with the requirements of the central counterparty or derivatives clearing organization. Changes in market value, if any, are reflected as a component of net change in unrealized appreciation (depreciation) on the Consolidated Statement of Operations. Daily changes in valuation of centrally cleared swaps, if any, are recorded as variation margin on the Consolidated Statement of Assets and Liabilities. Centrally Cleared and OTC swap payments received or paid at the beginning of the measurement period are included on the Consolidated Statement of Assets and Liabilities and represent premiums paid or received upon entering into the swap agreement to compensate for differences between the stated terms of the swap agreement and prevailing market conditions (credit spreads, currency exchange rates, interest rates, and other relevant factors). Upfront premiums received (paid) are initially recorded as liabilities (assets) and subsequently marked to market to reflect the current value of the swap. These upfront premiums are recorded as realized gain (loss) on the Consolidated Statement of Operations upon termination or maturity of the swap. A liquidation payment received or made at the termination of the swap is recorded as realized gain (loss) on the Consolidated Statement of Operations. Net periodic payments received or paid by the Fund are included as part of realized gain (loss) on the Consolidated Statement of Operations.
For purposes of a Fund’s investment policy adopted pursuant to Rule 35d-1 under the 1940 Act, the Fund will count derivative instruments at market value. For purposes of applying the Fund’s other investment policies and restrictions, swap agreements, like other derivative instruments, may be valued by the Fund at market value, notional value or full exposure value or any combination of the foregoing (e.g., notional value for purposes of calculating the numerator and market value for purposes of calculating the denominator for compliance with a particular policy or restriction). See Note 6 — Asset Segregation below. In the case of a credit default swap, in applying certain of the Fund’s investment policies and restrictions, the Fund will value the credit default swap at its notional value or its full exposure value (i.e., the sum of the notional amount for the contract plus the market value), but may value the credit default swap at market value for purposes of applying certain of the Fund’s other investment policies and restrictions. For example, the Fund may value credit default swaps at full exposure value for purposes of the Fund’s credit quality guidelines (if any) because such value in general better reflects the Fund’s actual economic exposure during the term of the credit default swap agreement. As a result, the Fund may, at times, have notional exposure to an asset class (before netting) that is greater or lesser than the stated limit or restriction noted in the Fund’s prospectus. In this context, both the notional amount and the market value may be positive or negative depending on whether the Fund is selling or buying protection through the credit default
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swap. The manner in which certain securities or other instruments are valued by the Fund for purposes of applying investment policies and restrictions may differ from the manner in which those investments are valued by other types of investors.
Entering into swap agreements involves, to varying degrees, elements of interest, credit, market and documentation risk in excess of the amounts recognized on the Consolidated Statement of Assets and Liabilities. Such risks involve the possibility that there will be no liquid market for these agreements, that the counterparty to the agreements may default on its obligation to perform or disagree as to the meaning of contractual terms in the agreements and that there may be unfavorable changes in interest rates or the values of the asset upon which the swap is based.
The Fund’s maximum risk of loss from counterparty credit risk is the discounted net value of the cash flows to be received from the counterparty over the contract’s remaining life, to the extent that amount is positive. The risk may be mitigated by having a master netting arrangement between the Fund and the counterparty and by the posting of collateral to the Fund to cover the Fund’s exposure to the counterparty.
Credit Default Swap Agreements on corporate, loan, sovereign, U.S. municipal or U.S. Treasury issues are entered into to provide a measure of protection against defaults of the issuers (i.e., to reduce risk where the Fund owns or has exposure to the referenced obligation) or to take an active long or short position with respect to the likelihood of a particular issuer’s default. Credit default swap agreements involve one party making a stream of payments (referred to as the buyer of protection) to another party (the seller of protection) in exchange for the right to receive a specified return in the event that the referenced entity, obligation or index, as specified in the swap agreement, undergoes a certain credit event. As a seller of protection on credit default swap agreements, the Fund will generally receive from the buyer of protection a fixed rate of income throughout the term of the swap provided that there is no credit event. As the seller, the Fund would effectively add leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap.
If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation, other deliverable obligations or underlying securities comprising the referenced index or (ii) pay a net settlement amount in the form of cash or securities equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced index. If the Fund is a buyer of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) receive from the seller of protection an amount equal to the notional amount of the swap and deliver the referenced obligation, other deliverable obligations or underlying securities comprising the referenced index or (ii) receive a net settlement amount in the form of cash or securities equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced index. Recovery values are estimated by market makers considering either industry standard recovery rates or entity specific factors and considerations until a credit event occurs. If a credit event has occurred, the recovery value is determined by a facilitated auction whereby a minimum number of allowable broker bids, together with a specified valuation method, are used to calculate the settlement value. The ability to
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Notes to Financial Statements (Cont.)
deliver other obligations may result in a cheapest-to-deliver option (the buyer of protection’s right to choose the deliverable obligation with the lowest value following a credit event).
Credit default swap agreements on corporate or sovereign issues involve one party making a stream of payments to another party in exchange for the right to receive a specified return in the event of a default or other credit event. If a credit event occurs and cash settlement is not elected, a variety of other deliverable obligations may be delivered in lieu of the specific referenced obligation. The ability to deliver other obligations may result in a cheapest-to-deliver option (the buyer of protection’s right to choose the deliverable obligation with the lowest value following a credit event).
Implied credit spreads, represented in absolute terms, utilized in determining the market value of credit default swap agreements on corporate, loan, sovereign, U.S. municipal or U.S. Treasury issues as of period end, if any, are disclosed in the Notes to Consolidated Schedule of Investments. They serve as an indicator of the current status of payment/performance risk and represent the likelihood or risk of default for the reference entity. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may include upfront payments required to be made to enter into the agreement. Wider credit spreads represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. For credit default swap agreements on asset-backed securities and credit indices, the quoted market prices and resulting values serve as the indicator of the current status of the payment/performance risk. Increasing market values, in absolute terms when compared to the notional amount of the swap, represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement.
The maximum potential amount of future payments (undiscounted) that the Fund as a seller of protection could be required to make under a credit default swap agreement equals the notional amount of the agreement. Notional amounts of each individual credit default swap agreement outstanding as of period end for which the Fund is the seller of protection are disclosed in the Notes to Consolidated Schedule of Investments. These potential amounts would be partially offset by any recovery values of the respective referenced obligations, upfront payments received upon entering into the agreement, or net amounts received from the settlement of buy protection credit default swap agreements entered into by the Fund for the same referenced entity or entities.
Interest Rate Swap Agreements may be entered into to help hedge against interest rate risk exposure and to maintain the Fund’s ability to generate income at prevailing market rates. The value of the fixed rate bonds that the Fund holds may decrease if interest rates rise. To help hedge against this risk and to maintain its ability to generate income at prevailing market rates, the Fund may enter into interest rate swap agreements. Interest rate swap agreements involve the exchange by the Fund with another party for their respective commitment to pay or receive interest on the notional amount of principal. Certain forms of interest rate swap agreements may include: (i) interest rate caps, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or “cap”, (ii) interest rate floors, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates fall below a specified rate, or “floor”, (iii) interest rate collars, under which a party sells a cap and purchases a floor or vice versa in an attempt to protect itself against interest rate movements exceeding given
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minimum or maximum levels, (iv) callable interest rate swaps, under which the buyer pays an upfront fee in consideration for the right to early terminate the swap transaction in whole, at zero cost and at a predetermined date and time prior to the maturity date, (v) spreadlocks, which allow the interest rate swap users to lock in the forward differential (or spread) between the interest rate swap rate and a specified benchmark, or (vi) basis swaps, under which two parties can exchange variable interest rates based on different segments of money markets.
Asset Segregation Certain transactions described above can be viewed as constituting a form of borrowing or financing transaction by the Fund. In such event, the Fund will cover its commitment under such transactions by segregating or “earmarking” assets in accordance with procedures adopted by the Board, in which case such transactions will not be considered “senior securities” by the Fund. With respect to forwards and futures contracts and interest rate swaps that are contractually required to cash settle (i.e., where physical delivery of the underlying reference asset is not permitted or physical settlement is not otherwise involved), the Fund is permitted to segregate or earmark liquid assets equal to the Fund’s daily mark-to-market net obligation under the derivative instrument, if any, rather than the derivative’s full notional value, but will segregate full notional value, as applicable, with respect to other derivative instruments (including written credit default swaps, written total return swaps and written options) that contractually require or permit physical delivery of securities or other underlying assets. By segregating or earmarking liquid assets equal to only its net mark-to-market obligation under forwards and futures contracts and interest rate swaps that are required to cash settle, the Fund will have the ability to employ leverage to a greater extent than if the Fund were to segregate or earmark liquid assets equal to the full notional value of such derivatives.
7. PRINCIPAL RISKS
In the normal course of business, the Fund trades financial instruments and enters into financial transactions where risk of potential loss exists due to such things as changes in the market (market risk) or failure or inability of the other party to a transaction to perform (credit and counterparty risk). See below for a detailed description of select principal risks. For a more comprehensive list of potential risks the Fund may be subject to, please see the Important Information About the Fund.
Market Risks The Fund’s investments in financial derivative instruments and other financial instruments expose the Fund to various risks such as, but not limited to, interest rate, foreign (non-U.S.) currency, equity and commodity risks.
Interest rate risk is the risk that fixed income securities and other instruments held by the Fund will decline in value because of changes in interest rates. As nominal interest rates rise, the value of certain fixed income securities held by the Fund is likely to decrease. A nominal interest rate can be described as the sum of a real interest rate and an expected inflation rate. Interest rate changes can be sudden and unpredictable, and the Fund may lose money if these changes are not anticipated by the Fund’s management. Variable rate securities may decline in value if their interest rates do not rise as much, or as quickly, as interest rates in general. The Fund may not be able to hedge against changes in interest rates or may choose not to do so for cost or other reasons. In addition, any hedges may not work as intended.
Fixed income securities with longer durations tend to be more sensitive to changes in interest rates, usually making them more volatile than securities with shorter durations. Duration is a measure used
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Notes to Financial Statements (Cont.)
to determine the sensitivity of a security’s price to changes in interest rates that incorporates a security’s yield, coupon, final maturity and call features, among other characteristics. Duration is useful primarily as a measure of the sensitivity of a fixed income security’s market price to interest rate (i.e. yield) movements. All other things remaining equal, for each one percentage point increase in interest rates, the value of a portfolio of fixed income investments would generally be expected to decline by one percent for every year of the portfolio’s average duration above zero. For example, the value of a portfolio of fixed income securities with an average duration of three years would generally be expected to decline by approximately 3% if interest rates rose by one percentage point. Convexity is an additional measure used to understand a security’s interest rate sensitivity. Convexity measures the rate of change of duration in response to changes in interest rates and may be positive or negative Securities with negative convexity may experience greater losses during periods of rising interest rates, and accordingly a Fund holding such securities may be subject to a greater risk of losses in periods of rising interest rates.
A wide variety of factors can cause interest rates to rise (e.g., central bank monetary policies, inflation rates, general economic conditions, etc.). This risk may be particularly acute in the current market environment because market interest rates are currently near historically low levels. The Fund currently faces a heightened level of interest rate risk, especially since the Federal Reserve Board has ended its quantitative easing program and has begun, and may continue, to raise interest rates. To the extent the Federal Reserve Board continues to raise interest rates, there is a risk that rates across the financial system may rise. During periods of very low or negative interest rates, the Fund may be unable to maintain positive returns. Changing interest rates, including rates that fall below zero, may have unpredictable effects on markets, may result in heightened market volatility and may detract from Fund performance to the extent the Fund is exposed to such interest rates. Rising interest rates may result in a decline in value of the Fund’s fixed-income investments and in periods of volatility. Further, while U.S. bond markets have steadily grown over the past three decades, dealer “market making” ability has remained relatively stagnant. As a result, dealer inventories of certain types of bonds and similar instruments, which provide a core indication of the ability of financial intermediaries to “make markets,” are at or near historic lows in relation to market size. Because market makers provide stability to a market through their intermediary services, the significant reduction in dealer inventories could potentially lead to decreased liquidity and increased volatility in the fixed income markets. Such issues may be exacerbated during periods of economic uncertainty. All of these factors, collectively and/or individually, could cause the Fund to lose value.
Foreign (non-U.S.) securities in this report are classified by the country of incorporation of a holding. In certain instances, a security’s country of incorporation may be different from its country of economic exposure. If the Fund invests directly in foreign (non-U.S.) currencies or in securities that trade in, and receive revenues in, foreign (non-U.S.) currencies, or in financial derivatives that provide exposure to foreign (non-U.S.) currencies, it will be subject to the risk that those currencies will decline in value relative to the base currency of the Fund, or, in the case of hedging positions, that the Fund’s base currency will decline in value relative to the currency being hedged. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including changes in interest rates, intervention (or the failure to intervene) by U.S. or foreign governments, central banks or supranational entities such as the International Monetary Fund, or by the imposition of currency controls or other political developments in the United States or abroad. As a result, the Fund’s investments in foreign currency denominated securities may reduce the Fund’s returns.
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The market values of the Fund’s investments may decline due to general market conditions which are not specifically related to a particular company or issuer, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. Equity securities and equity related investments generally have greater market price volatility than fixed income securities, although under certain market conditions fixed income securities may have comparable or greater price volatility. Credit ratings downgrades may also negatively affect securities held by the Fund. Even when markets perform well, there is no assurance that the investments held by the Fund will increase in value along with the broader market. In addition, market risk includes the risk that geopolitical events will disrupt the economy on a national or global level.
To the extent the Fund has a policy to limit the net amount owed to or to be received from a single counterparty under existing swap agreements, such limitation only applies to counterparties to over the counter swaps and does not apply to centrally cleared swaps where the counterparty is a central counterparty or derivatives clearing organization.
Credit and Counterparty Risks The Fund will be exposed to credit risk to parties with whom it trades and will also bear the risk of settlement default. The Fund seeks to minimize concentrations of credit risk by undertaking transactions with a large number of counterparties on recognized and reputable exchanges, where applicable. Over the counter (“OTC”) derivative transactions are subject to the risk that a counterparty to the transaction will not fulfill its contractual obligations to the other party, as many of the protections afforded to centrally cleared derivative transactions might not be available for OTC derivative transactions. For derivatives traded on an exchange or through a central counterparty, credit risk resides with the Fund’s clearing broker, or the clearinghouse itself, rather than with a counterparty in an OTC derivative transaction. The Fund could lose money if the issuer or guarantor of a fixed income security, or the counterparty to a financial derivatives contract, repurchase agreement or a loan of portfolio securities, is unable or unwilling to make timely principal and/or interest payments, or to otherwise honor its obligations. Securities are subject to varying degrees of credit risk, which are often reflected in credit ratings.
Similar to credit risk, the Fund may be exposed to counterparty risk, or the risk that an institution or other entity with which the Fund has unsettled or open transactions will default. PIMCO, as the Manager, seeks to minimize counterparty risks to the Fund through a number of ways. Prior to entering into transactions with a new counterparty, the PIMCO Counterparty Risk Committee conducts an extensive credit review of such counterparty and must approve the use of such counterparty. Furthermore, pursuant to the terms of the underlying contract, to the extent that unpaid amounts owed to the Fund exceed a predetermined threshold, such counterparty is required to advance collateral to the Fund in the form of cash or securities equal in value to the unpaid amount owed to the Fund. The Fund may invest such collateral in securities or other instruments and will typically pay interest to the counterparty on the collateral received. If the unpaid amount owed to the Fund subsequently decreases, the Fund would be required to return to the counterparty all or a portion of the collateral previously advanced. PIMCO’s attempts to minimize counterparty risk may, however, be unsuccessful.
All transactions in listed securities are settled/paid for upon delivery using approved counterparties. The risk of default is considered minimal, as delivery of securities sold is only made once the Fund
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Notes to Financial Statements (Cont.)
has received payment. Payment is made on a purchase once the securities have been delivered by the counterparty. The trade will fail if either party fails to meet its obligation.
8. MASTER NETTING ARRANGEMENTS
The Fund may be subject to various netting arrangements (“Master Agreements”) with select counterparties. Master Agreements govern the terms of certain transactions, and are intended to reduce the counterparty risk associated with relevant transactions by specifying credit protection mechanisms and providing standardization that is intended to improve legal certainty. Each type of Master Agreement governs certain types of transactions. Different types of transactions may be traded out of different legal entities or affiliates of a particular organization, resulting in the need for multiple agreements with a single counterparty. As the Master Agreements are specific to unique operations of different asset types, they allow the Fund to close out and net its total exposure to a counterparty in the event of a default with respect to all the transactions governed under a single Master Agreement with a counterparty. For financial reporting purposes the Consolidated Statement of Assets and Liabilities generally present derivative assets and liabilities on a gross basis, which reflects the full risks and exposures prior to netting.
Master Agreements can also help limit counterparty risk by specifying collateral posting arrangements at pre-arranged exposure levels. Under most Master Agreements, collateral is routinely transferred if the total net exposure to certain transactions (net of existing collateral already in place) governed under the relevant Master Agreement with a counterparty in a given account exceeds a specified threshold, which typically ranges from zero to $250,000 depending on the counterparty and the type of Master Agreement. United States Treasury Bills and U.S. dollar cash are generally the preferred forms of collateral, although other forms of AAA rated paper or sovereign securities may be used depending on the terms outlined in the applicable Master Agreement. Securities and cash pledged as collateral are reflected as assets on the Consolidated Statement of Assets and Liabilities as either a component of Investments at value (securities) or Deposits with counterparty. Cash collateral received is not typically held in a segregated account and as such is reflected as a liability on the Consolidated Statement of Assets and Liabilities as Deposits from counterparty. The market value of any securities received as collateral is not reflected as a component of NAV. The Fund’s overall exposure to counterparty risk can change substantially within a short period, as it is affected by each transaction subject to the relevant Master Agreement.
Master Repurchase Agreements and Global Master Repurchase Agreements (individually and collectively “Master Repo Agreements”) govern repurchase, reverse repurchase, and sale-buyback transactions between the Fund and select counterparties. Master Repo Agreements maintain provisions for, among other things, initiation, income payments, events of default, and maintenance of collateral. The market value of transactions under the Master Repo Agreement, collateral pledged or received, and the net exposure by counterparty as of period end are disclosed in the Notes to Consolidated Schedule of Investments.
Master Securities Forward Transaction Agreements (“Master Forward Agreements”) govern certain forward settling transactions, such as TBA securities, delayed-delivery or sale-buyback transactions by and between the Fund and select counterparties. The Master Forward Agreements maintain provisions for, among other things, transaction initiation and confirmation, payment and transfer,
| 62 | PIMCO INTERVAL FUNDS |
June 30, 2018
events of default, termination, and maintenance of collateral. The market value of forward settling transactions, collateral pledged or received, and the net exposure by counterparty as of period end is disclosed in the Notes to Consolidated Schedule of Investments.
Customer Account Agreements and related addenda govern cleared derivatives transactions such as futures, options on futures, and cleared OTC derivatives. Such transactions require posting of initial margin as determined by each relevant clearing agency which is segregated in an account at a futures commission merchant (“FCM”) registered with the Commodity Futures Trading Commission (“CFTC”). In the United States, counterparty risk may be reduced as creditors of an FCM cannot have a claim to Fund assets in the segregated account. Portability of exposure reduces risk to the Fund. Variation margin, or changes in market value, are exchanged daily, but may not be netted between futures and cleared OTC derivatives unless the parties have agreed to a separate arrangement in respect of portfolio margining. The market value or accumulated unrealized appreciation (depreciation), initial margin posted, and any unsettled variation margin as of period end are disclosed in the Notes to Consolidated Schedule of Investments.
International Swaps and Derivatives Association, Inc. Master Agreements and Credit Support Annexes (“ISDA Master Agreements”) govern bilateral OTC derivative transactions entered into by the Fund with select counterparties. ISDA Master Agreements maintain provisions for general obligations, representations, agreements, collateral posting and events of default or termination. Events of termination include conditions that may entitle counterparties to elect to terminate early and cause settlement of all outstanding transactions under the applicable ISDA Master Agreement. Any election to terminate early could be material to the financial statements. In limited circumstances, the ISDA Master Agreement may contain additional provisions that add counterparty protection beyond coverage of existing daily exposure if the counterparty has a decline in credit quality below a predefined level. These amounts, if any, may be segregated with a third-party custodian. The market value of OTC financial derivative instruments, collateral received or pledged, and net exposure by counterparty as of period end are disclosed in the Notes to Consolidated Schedule of Investments.
9. FEES AND EXPENSES
(a) Management Fee Pursuant to the Investment Management Agreement with PIMCO (the “Agreement”), and subject to the supervision of the Board, PIMCO is responsible for providing the Fund investment guidance and policy direction in connection with the management of the Fund, including oral and written research, analysis, advice, and statistical and economic data and information. In addition, pursuant to the Agreement and subject to the general supervision of the Board, PIMCO, at its expense, provides or causes to be furnished most other supervisory and administrative services the Fund requires, including but not limited to, expenses of most third-party service providers (e.g., audit, custodial, legal, transfer agency, printing) and other expenses, such as those associated with insurance, proxy solicitations and mailings for shareholder meetings, New York Stock Exchange listing and related fees, tax services, valuation services and other services the Fund requires for its daily operations.
| ANNUAL REPORT | JUNE 30, 2018 | 63 |
Notes to Financial Statements (Cont.)
Pursuant to the Agreement, PIMCO receives an annual fee, payable monthly, at the annual rate shown in the table below:
| Annual Rate(1) |
||||||||
| Institutional Class |
1.30% | |||||||
| (1) | Management fees calculated based on the Fund’s average daily “total managed assets”. Total managed assets includes total assets of the Fund (including assets attributable to any reverse repurchase agreements, dollar rolls, borrowings and preferred shares that may be outstanding, if any) minus accrued liabilities (other than liabilities representing reverse repurchase agreements, dollar rolls and borrowings). |
(b) Fund Expenses The Fund bears other expenses, which may vary and affect the total level of expenses paid by shareholders, such as (i) salaries and other compensation or expenses, including travel expenses, of any of the Fund’s executive officers and employees, if any, who are not officers, directors, shareholders, members, partners or employees of PIMCO or its subsidiaries or affiliates; (ii) taxes and governmental fees, if any, levied against the Fund; (iii) brokerage fees and commissions, and other portfolio transaction expenses incurred by or for the Fund (including, without limitation, fees and expenses of outside legal counsel or third-party consultants retained in connection with reviewing, negotiating and structuring specialized loan and other investments made by the Fund, and any costs associated with originating loans, asset securitizations, alternative lending-related strategies and so-called “broken-deal costs” (e.g., fees, costs, expenses and liabilities, including, for example, due diligence-related fees, costs, expenses and liabilities, with respect to unconsummated investments)); (iv) expenses of the Fund’s securities lending (if any), including any securities lending agent fees, as governed by a separate securities lending agreement; (v) costs, including interest expenses, of borrowing money or engaging in other types of leverage financing including, without limitation, through the use by the Fund of reverse repurchase agreements, dollar rolls, bank borrowings, credit facilities and tender option bonds; (vi) costs, including dividend and/or interest expenses and other costs (including, without limitation, offering and related legal costs, fees to brokers, fees to auction agents, fees to transfer agents, fees to ratings agencies and fees to auditors associated with satisfying ratings agency requirements for preferred shares or other securities issued by the Fund and other related requirements in the Fund’s organizational documents) associated with the Fund’s issuance, offering, redemption and maintenance of preferred shares, commercial paper or other senior securities (such as the use of reverse repurchase agreements, dollar rolls, bank borrowings, credit facilities and tender option bonds) for the purpose of incurring leverage; (vii) fees and expenses of any underlying funds or other pooled vehicles in which the Fund invests; (viii) dividend and interest expenses on short positions taken by the Fund; (ix) fees and expenses, including travel expenses, and fees and expenses of legal counsel retained for their benefit, of Trustees who are not officers, employees, partners, shareholders or members of PIMCO or its subsidiaries or affiliates; (x) extraordinary expenses, including extraordinary legal expenses, as may arise, including, without limitation, expenses incurred in connection with litigation, proceedings, other claims, and the legal obligations of the Fund to indemnify its Trustees, officers, employees, shareholders, distributors, and agents with respect thereto; (xi) fees and expenses, including legal, printing and mailing, solicitation and other fees and expenses associated with and incident to shareholder meetings and proxy solicitations involving contested elections of Trustees, shareholder proposals or other non-routine matters that are not initiated or proposed by Fund management; (xii) organizational and offering expenses of the Fund, including registration (including share registration fees), legal, marketing, printing, accounting and other expenses, associated with organizing the Fund in its state of jurisdiction and in connection with the initial registration of the Fund under the Act and the initial registration of its
| 64 | PIMCO INTERVAL FUNDS |
June 30, 2018
shares under the Securities Act of 1933 (i.e., through the effectiveness of the Fund’s initial registration statement on Form N-2) and fees and expenses associated with seeking, applying for and obtaining formal exemptive, no-action and/or other relief from the SEC in connection with the issuance of multiple share classes; (xiii) except as otherwise specified herein as an expense of PIMCO, any expenses allocated or allocable to a specific class of shares, including sub-transfer agency expenses paid pursuant to a Rule 12b-1 or similar plan adopted by the Board of Trustees of the Fund for a particular share class; and (xiv) expenses of the Fund which are capitalized in accordance with U.S. GAAP.
Each of the Trustees of the Fund who is not an “interested person” under Section 2(a)(19) of the Act, (the “Independent Trustees”) also serves as a trustee of a number of other closed-end funds for which PIMCO serves as investment manager (the “PIMCO Closed-End Funds”), as well as the Fund and PIMCO Flexible Municipal Income Fund (the “PIMCO Interval Funds”), and PIMCO Managed Accounts Trust, an open-end management investment company with multiple series for which PIMCO serves as investment adviser and administrator (“PMAT” and, together with the PIMCO Interval Funds and the PIMCO Closed-End Funds, the “PIMCO-Managed Funds”). In addition, each of the Independent Trustees also serves as a trustee of certain investment companies (together, the “Allianz-Managed Funds”), for which Allianz Global Investors U.S. LLC (“AllianzGI U.S.”), an affiliate of PIMCO, serves as investment manager.
Each Independent Trustee currently receives annual compensation of $225,000 for his or her service on the Boards of the PIMCO-Managed Funds, payable quarterly. The Independent Chairman of the Boards receives an additional $75,000 per year, payable quarterly. The Audit Oversight Committee Chairman receives an additional $50,000 annually, payable quarterly. Trustees are also reimbursed for meeting-related expenses.
Each Trustee’s compensation for his or her service as a Trustee on the Boards of the PIMCO-Managed Funds and other costs in connection with joint meetings of such Funds are allocated among the PIMCO-Managed Funds, as applicable, on the basis of fixed percentages among PMAT, the PIMCO Interval Funds and the PIMCO Closed-End Funds. Trustee compensation and other costs will then be further allocated pro rata among the individual PIMCO-Managed Funds within each grouping based on each such PIMCO-Managed Fund’s relative net assets.
(c) Expense Limitation PIMCO has contractually agreed, through November 1, 2019, to waive its management fee, or reimburse the Fund, to the extent that organizational expenses and pro rata Trustees’ fees exceed 0.07% of the Fund’s net assets attributable to Common Shares, (the “Expense Limit”). Under an expense limitation agreement, which, following an intial two year period from the effective date, renews annually for a full year unless terminated by PIMCO upon at least 30 days’ notice prior to the end of the contract term, PIMCO is entitled to reimbursement by the Fund of any portion of the management fee reduced as set forth above (the “Reimbursement Amount”) during the previous thirty-six months, provided that such amount paid to PIMCO will not (1) together with any recoupment of organizational expenses and pro rata trustee fees or management fees exceed 0.07% of average net assets; (2) exceed the total Reimbursement Amount; or (3) include any amounts previously reimbursed to PIMCO. For the period ended June 30, 2018, the remaining recoverable amounts to PIMCO are disclosed in the table below (in thousands†):
| Expiring within | ||||||||||||||||||
| 12 months | 13-24 months | 25-36 months | Total | |||||||||||||||
| $ | 0 | $ | 838 | $ | 46 | $ | 884 | |||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| ANNUAL REPORT | JUNE 30, 2018 | 65 |
Notes to Financial Statements (Cont.)
(d) Distribution Contract PIMCO Investments LLC (the “Distributor”) serves as the principal underwriter in the continuous public offering of the Fund’s shares pursuant to a distribution contract (“Distribution Contract”) with the Fund, which is subject to annual approval by the Board. The Distributor is a wholly-owned subsidiary of PIMCO and an indirect subsidiary of Allianz Asset Management. The Distributor does not receive compensation from the Fund for services as distributor of the Common Shares (although the Distributor may receive compensation under the Distribution Contract with respect to future share classes of the Fund).
10. RELATED PARTY TRANSACTIONS
The Manager is a related party. Fees payable to this party are disclosed in Note 9, Fees and Expenses, and the accrued related party fee amounts are disclosed on the Consolidated Statement of Assets and Liabilities.
The Fund is permitted to purchase or sell securities from or to certain related affiliated funds under specified conditions outlined in procedures adopted by the Board. The procedures have been designed to ensure that any purchase or sale of securities by the Fund from or to another fund or portfolio that are, or could be, considered an affiliate, or an affiliate of an affiliate, by virtue of having a common investment adviser (or affiliated investment advisers), common Trustees and/or common officers complies with Rule 17a-7 under the Act. Further, as defined under the procedures, each transaction is effected at the current market price. During the period ended June 30, 2018, the Fund engaged in purchases and sales of securities pursuant to Rule 17a-7 under the Act (amounts in thousands†):
| Purchases | Sales | |||||
| $ | 59,290 | $ | 7,019 | |||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
11. GUARANTEES AND INDEMNIFICATIONS
Under the Fund’s organizational documents, each Trustee and officer is indemnified, to the extent permitted by the Act, against certain liabilities that may arise out of performance of their duties to the Fund. Additionally, in the normal course of business, the Fund enters into contracts that contain a variety of indemnification clauses. The Fund’s maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. However, the Fund has not had prior claims or losses pursuant to these contracts.
12. PURCHASES AND SALES OF SECURITIES
The length of time the Fund has held a particular security is not generally a consideration in investment decisions. A change in the securities held by the Fund is known as “portfolio turnover.” The Fund may engage in frequent and active trading of portfolio securities to achieve its investment objective, particularly during periods of volatile market movements. High portfolio turnover may involve correspondingly greater transaction costs to the Fund, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestments in other securities. Such sales may also result in realization of taxable capital gains, including short-term capital gains (which are generally taxed at ordinary income tax rates). The transaction costs and tax effects associated with portfolio turnover may adversely affect the Fund’s performance. The portfolio turnover rates are reported in the Financial Highlights.
| 66 | PIMCO INTERVAL FUNDS |
June 30, 2018
Purchases and sales of securities (excluding short-term investments) for the period ended June 30, 2018, were as follows (amounts in thousands†):
| U.S. Government/Agency | All Other | |||||||||||||
| Purchases | Sales | Purchases | Sales | |||||||||||
| $ | 27,594 | $ | 32 | $ | 757,120 | $ | 58,416 | |||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
13. COMMON SHARES OFFERING
The Fund has authorized an unlimited number of Common Shares at a par value of $0.00001 per share.
Changes in common shares of beneficial interest were as follows (shares and amounts in thousands†):
| Year Ended June 30, 2018 |
Period from February 22, 2017 - June 30, 2017 |
|||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||
| Receipts for shares sold |
||||||||||||||||||||
| Institutional Class |
46,369 | $ | 485,488 | 6,677 | $ | 68,313 | ||||||||||||||
| Issued as reinvestment of distributions |
||||||||||||||||||||
| Institutional Class |
354 | 3,671 | 9 | 92 | ||||||||||||||||
| Cost of shares repurchased |
||||||||||||||||||||
| Institutional Class |
(982 | ) | (10,275 | ) | 0 | 0 | ||||||||||||||
| Net increase (decrease) resulting from Fund share transactions |
45,741 | $ | 478,884 | 6,686 | $ | 68,405 | ||||||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
14. BASIS FOR CONSOLIDATION
PFLEXLS I LLC, CLM 13648 LLC and MLM 13648 LLC (each a “Subsidiary” and, collectively, the “Subsidiaries”), each a Delaware limited liability company, were formed as wholly owned subsidiaries acting as investment vehicles for the PIMCO Flexible Credit Income Fund (the “Fund”) in order to effect certain investments for the Fund consistent with the Fund’s investment objectives and policies in effect from time to time. PFLEXLS I LLC was formed on December 1, 2017, CLM 13648 LLC was formed on March 29, 2018 and MLM 13648 LLC was formed on April 3, 2018. PIMCO Flexible Credit Income Fund’s investment portfolio has been consolidated and includes the portfolio holdings of PIMCO Flexible Credit Income Fund and the Subsidiaries. Accordingly, the consolidated financial statements include the accounts of the Fund and the Subsidiaries. All inter-company transactions and balances have been eliminated. This structure was established so that certain loans could be held by a separate legal entity from the Fund. See the table below for details regarding the structure, incorporation and relationship as of the period end of the Subsidiaries (amounts in thousands†).
| PFLEXLS I LLC | CLM 13648 LLC | MLM 13648 LLC | ||||||||||||
| Date of Inception |
01/09/2018 | 04/30/2018 | 04/30/2018 | |||||||||||
| Consolidated Fund Net Assets |
$ | 538,753 | $ | 538,753 | $ | 538,753 | ||||||||
| Subsidiary % of Fund Net Assets |
1.5% | 0.0% | 0.0% | |||||||||||
| Subsidiary Financial Statement Information |
||||||||||||||
| Total assets |
$ | 7,952 | $ | 1 | $ | 1 | ||||||||
| Total liabilities |
0 | 0 | 0 | |||||||||||
| ANNUAL REPORT | JUNE 30, 2018 | 67 |
Notes to Financial Statements (Cont.)
| PFLEXLS I LLC | CLM 13648 LLC | MLM 13648 LLC | ||||||||||||||
| Net assets |
$ | 7,952 | $ | 1 | $ | 1 | ||||||||||
| Total income |
278 | 0 | 0 | |||||||||||||
| Net investment income (loss) |
277 | 0 | 0 | |||||||||||||
| Net realized gain (loss) |
0 | 0 | 0 | |||||||||||||
| Net change in unrealized appreciation (depreciation) |
14 | 0 | 0 | |||||||||||||
| Increase (decrease) in net assets resulting from operations |
$ | 291 | $ | 0 | $ | 0 | ||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
15. REGULATORY AND LITIGATION MATTERS
The Fund is not named as a defendant in any material litigation or arbitration proceedings and is not aware of any material litigation or claim pending or threatened against it.
The foregoing speaks only as of the date of this report.
16. FEDERAL INCOME TAX MATTERS
The Fund intends to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code (the “Code”) and distribute all of its taxable income and net realized gains, if applicable, to shareholders. Accordingly, no provision for Federal income taxes has been made.
The Fund may be subject to local withholding taxes, including those imposed on realized capital gains. Any applicable foreign capital gains tax is accrued daily based upon net unrealized gains, and may be payable following the sale of any applicable investments.
In accordance with U.S. GAAP, the Manager has reviewed the Fund’s tax positions for all open tax years. As of June 30, 2018, the Fund has recorded no liability for net unrecognized tax benefits relating to uncertain income tax positions it has taken or expects to take in future tax returns.
The Fund files U.S. federal, state, and local tax returns as required. The Fund’s tax returns are subject to examination by relevant tax authorities until expiration of the applicable statute of limitations, which is generally three years after the filing of the tax return but which can be extended to six years in certain circumstances. Tax returns for open years have incorporated no uncertain tax positions that require a provision for income taxes.
As of June 30, 2018, the components of distributable taxable earnings are as follows (amounts in thousands†):
| Undistributed Ordinary Income(1) |
Undistributed Long-Term Capital Gains |
Net Tax Basis Unrealized Appreciation/ (Depreciation)(2) |
Other Book-to-Tax Accounting Differences(3) |
Accumulated Capital Losses(4) |
Qualified Late-Year Loss Deferral - Capital(5) |
Qualified Late-Year Loss Deferral - Ordinary(6) |
||||||||||||||||||||||||||
| PIMCO Flexible Credit Income Fund | $ | 13,987 | $ | 0 | $ | (12,363 | ) | $ | (6,816 | ) | $ | (3,325 | ) | $ | 0 | $ | 0 | |||||||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| (1) | Includes undistributed short-term capital gains, if any. |
| 68 | PIMCO INTERVAL FUNDS |
June 30, 2018
| (2) | Adjusted for open wash sale loss deferrals and the accelerated recognition of unrealized gain or loss on certain forward contracts for federal income tax purposes. Also adjusted for differences between book and tax realized and unrealized gain (loss) on swap contracts, Passive Foreign Investment Companies (PFICs), partnership adjustments, convertible preferred securities, and straddle loss deferrals. |
| (3) | Represents differences in income tax regulations and financial accounting principles generally accepted in the United States of America, mainly for distributions payable at fiscal year-end. |
| (4) | Capital losses available to offset future net capital gains expire in varying amounts as shown below. |
| (5) | Capital losses realized during the period November 1, 2017 through June 30, 2018 which the Fund elected to defer to the following taxable year pursuant to income tax regulations. |
| (6) | Specified losses realized during the period November 1, 2017 through June 30, 2018 and Ordinary losses realized during the period January 1, 2018 through June 30, 2018, which the Funds elected to defer to the following taxable year pursuant to income tax regulations. |
Under the Regulated Investment Company Modernization Act of 2010, a fund is permitted to carry forward any new capital losses for an unlimited period. Additionally, such capital losses that are carried forward will retain their character as either short-term or long-term capital losses rather than being considered all short-term under previous law. As of June 30, 2018, the Fund had the following post-effective capital losses with no expiration (amounts in thousands†):
| Short-Term | Long-Term | |||||||||||
| PIMCO Flexible Credit Income Fund |
$ | 3,325 | $ | 0 | ||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
As of June 30, 2018, the aggregate cost and the net unrealized appreciation/(depreciation) of investments for federal income tax purposes are as follows (amounts in thousands†):
| Federal Tax Cost |
Unrealized Appreciation |
Unrealized (Depreciation) |
Net Unrealized Appreciation/ (Depreciation)(7) |
|||||||||||||||||
| PIMCO Flexible Credit Income Fund |
$ | 813,270 | $ | 13,089 | $ | (25,975 | ) | $ | (12,886 | ) | ||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| (7) | Primary differences, if any, between book and tax net unrealized appreciation/(depreciation) on investments are attributable to open wash sale loss deferrals, unrealized gain or loss on certain forward contracts, realized and unrealized gain (loss) on swap contracts, Passive Foreign Investment Companies (PFICs), partnership adjustments, convertible preferred securities, and straddle loss deferrals. |
For the fiscal years ended June 30, 2018 and June 30, 2017, respectively, the Fund made the following tax basis distributions (amounts in thousands†):
| June 30, 2018 | June 30, 2017 | |||||||||||||||||||||||||||||||
| Ordinary Income Distributions(8) |
Long-Term Capital Gain Distributions |
Return of Capital(9) |
Ordinary Income Distributions(8) |
Long-Term Capital Gain Distributions |
Return of Capital(9) |
|||||||||||||||||||||||||||
| PIMCO Flexible Credit Income Fund |
$ | 20,347 | $ | 0 | $ | 0 | $ | 437 | $ | 0 | $ | 0 | ||||||||||||||||||||
| † | A zero balance may reflect actual amounts rounding to less than one thousand. |
| (8) | Includes short-term capital gains distributed, if any. |
| (9) | A portion of the distributions made represents a tax return of capital. Return of capital distributions have been reclassified from undistributed net investment income to paid-in capital to more appropriately conform financial accounting to tax accounting. |
| ANNUAL REPORT | JUNE 30, 2018 | 69 |
Report of Independent Registered Public Accounting Firm
To the Board of Trustees and Shareholders of PIMCO Flexible Credit Income Fund
Opinion on the Financial Statements
We have audited the accompanying consolidated statement of assets and liabilities, including the consolidated schedule of investments, of PIMCO Flexible Credit Income Fund and its subsidiaries (the “Fund”) as of June 30, 2018, the related consolidated statements of operations and cash flows for the year ended June 30, 2018 and the consolidated statement of changes in net assets and the financial highlights for the year ended June 30, 2018 and for the period February 22, 2017 (commencement of operations) through June 30, 2017, including the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Fund as of June 30, 2018, the results of their operations and their cash flows for the year ended June 30, 2018, and the changes in their net assets and the financial highlights for the year ended June 30, 2018 and for the period February 22, 2017 (commencement of operations) through June 30, 2017 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our procedures included confirmation of securities owned as of June 30, 2018 by correspondence with the custodian and brokers; when replies were not received from brokers, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Kansas City, Missouri
August 24, 2018
We have served as the auditor of one or more investment companies in PIMCO Interval Funds since 2016.
| 70 | PIMCO INTERVAL FUNDS |
Glossary: (abbreviations that may be used in the preceding statements)
(Unaudited)
| Counterparty Abbreviations: | ||||||
| BCY | Barclays Capital, Inc. |
MSB | Morgan Stanley Bank, N.A | |||
| BOA | Bank of America N.A. |
NOM | Nomura Securities International Inc. | |||
| BPS | BNP Paribas S.A. |
RBC | Royal Bank of Canada | |||
| BRC | Barclays Bank PLC |
RTA | Bank of New York Mellon Corp. | |||
| CBK | Citibank N.A. |
RYL | Royal Bank of Scotland Group PLC | |||
| FICC | Fixed Income Clearing Corporation |
SAL | Citigroup Global Markets, Inc. | |||
| GLM | Goldman Sachs Bank USA |
SBI | Citigroup Global Markets Ltd. | |||
| GSC | Goldman Sachs & Co. |
SGY | Societe Generale, New York | |||
| GST | Goldman Sachs International |
SOG | Societe Generale | |||
| JPS | JP Morgan Securities, Inc. |
UBS | UBS Securities LLC | |||
| Currency Abbreviations: | ||||||
| ARS | Argentine Peso |
PEN | Peruvian New Sol | |||
| EUR | Euro |
RUB | Russian Ruble | |||
| GBP | British Pound |
USD (or $) | United States Dollar | |||
| Exchange Abbreviations: | ||||||
| OTC | Over the Counter |
|||||
| Index/Spread Abbreviations: | ||||||
| 12MTA | 12 Month Treasury Average |
LIBOR01M | 1 Month USD-LIBOR | |||
| BADLARPP | Argentina Badlar Floating Rate Notes |
LIBOR03M | 3 Month USD-LIBOR | |||
| BP0003M | 3 Month GBP-LIBOR |
US0001M | 1 Month USD Swap Rate | |||
| EUR003M | 3 Month EUR Swap Rate |
US0003M | 3 Month USD Swap Rate | |||
| EUR006M | 6 Month EUR Swap Rate |
|||||
| Other Abbreviations: | ||||||
| ABS | Asset-Backed Security |
LIBOR | London Interbank Offered Rate | |||
| BABs | Build America Bonds |
PIK | Payment-in-Kind | |||
| CDO | Collateralized Debt Obligation |
TBA | To-Be-Announced | |||
| CLO | Collateralized Loan Obligation |
TBD | To-Be-Determined | |||
| DAC | Designated Activity Company |
TBD% | Interest rate to be determined when | |||
| EURIBOR | Euro Interbank Offered Rate |
loan settles | ||||
| ANNUAL REPORT | JUNE 30, 2018 | 71 |
(Unaudited)
Pursuant to the Fund’s dividend reinvestment plan (the “Plan”), all common shareholders will have all dividends, including any capital gain dividends, reinvested automatically in additional Common Shares by DST Systems, Inc., as agent for the Common Shareholders (the “Plan Agent”), unless the shareholder elects to receive cash. An election to receive cash may be revoked or reinstated at the option of the shareholder. In the case of record shareholders such as banks, brokers or other nominees that hold common shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of Common Shares certified from time to time by the record shareholder as representing the total amount registered in such shareholder’s name and held for the account of beneficial owners who are to participate in the Plan. Shareholders whose shares are held in the name of a bank, broker or nominee should contact the bank, broker or nominee for details. Such shareholders may not be able to transfer their shares to another bank or broker and continue to participate in the Plan.
Common Shares received under the Plan will be issued to you at their NAV on the ex-dividend date; there is no sales or other charge for reinvestment. You are free to withdraw from the Plan and elect to receive cash at any time by giving written notice to the Plan Agent or by contacting your broker or dealer, who will inform the Fund. Your request must be received by the Fund at least ten days prior to the payment date of the distribution to be effective for that dividend or capital gain distribution.
The Plan Agent provides written confirmation of all transactions in the shareholder accounts in the Plan, including information you may need for tax records. Any proxy you receive will include all Common Shares you have received under the Plan.
Automatically reinvested dividends and distributions are taxed in the same manner as cash dividends and distributions. See “Tax Matters.”
The Fund and the Plan Agent reserve the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. Additional information about the Plan may be obtained from the Plan Agent.
| 72 | PIMCO INTERVAL FUNDS |
(Unaudited)
The chart below identifies Trustees and Officers of the Fund. Unless otherwise indicated, the address of all persons below is c/o Pacific Investment Management Company LLC, 1633 Broadway, New York, New York 10019.
Trustees
| Name and Year of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served* |
Principal Occupation(s) During the Past 5 Years |
Number of Portfolios in Fund Complex Overseen by Trustee |
Other Directorships Held by Trustee During the Past 5 Years | |||||
| Independent Trustees | ||||||||||
| Hans W. Kertess 1939 |
Chairman of the Board, Trustee |
Since 2016. | President, H. Kertess & Co., a financial advisory company; and Senior Adviser (formerly Managing Director), Royal Bank of Canada Capital Markets (since 2004). | 93 | None | |||||
| Deborah A. DeCotis 1952 |
Trustee | Since 2016. | Advisory Director, Morgan Stanley & Co., Inc. (since 1996); Member, Circle Financial Group (since 2009); and Member, Council on Foreign Relations (since 2013); Trustee, Smith College (since 2017); and Director, Watford Re (since 2017). Formerly, Co-Chair Special Projects Committee, Memorial Sloan Kettering (2005-2015); Trustee, Stanford University (2010-2015); Principal, LaLoop LLC, a retail accessories company (1999-2014); Director, Helena Rubenstein Foundation (1997-2010); and Director, Armor Holdings (2002-2010). | 93 | None | |||||
| Bradford K. Gallagher 1944 |
Trustee | Since 2016. | Retired. Founder, Spyglass Investments LLC, a private investment vehicle (since 2001). Formerly, Chairman and Trustee, The Common Fund (2005-2014); Partner, New Technology Ventures Capital Management LLC, a venture capital fund (2011-2013); Chairman and Trustee, Atlantic Maritime Heritage Foundation (2007-2012); and Founder, President and CEO, Cypress Holding Company and Cypress Tree Investment Management Company (1995-2001). | 93 | Formerly, Chairman and Trustee of Grail Advisors ETF Trust (2009-2010) and Trustee of Nicholas- Applegate Institutional Funds (2007-2010). | |||||
| James A. Jacobson 1945 |
Trustee | Since 2016. | Retired. Trustee (since 2002) and Chairman of Investment Committee (since 2007), Ronald McDonald House of New York; and Trustee, New Jersey City University (since 2014). Formerly, Vice Chairman and Managing Director, Spear, Leeds & Kellogg Specialists, LLC, a specialist firm on the New York Stock Exchange (2003-2008). | 93 | Formerly, Trustee, Alpine Mutual Funds Complex consisting of 18 funds. | |||||
| ANNUAL REPORT | JUNE 30, 2018 | 73 |
Management of the Fund (Cont.)
| Name and Year of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served* |
Principal Occupation(s) During the Past 5 Years |
Number of Portfolios in Fund Complex Overseen by Trustee |
Other Directorships Held by Trustee During the Past 5 Years | |||||
| William B. Ogden, IV 1945 |
Trustee | Since 2016. | Retired. Formerly, Asset Management Industry Consultant; and Managing Director, Investment Banking Division of Citigroup Global Markets Inc. | 93 | None | |||||
| Alan Rappaport 1953 |
Trustee | Since 2016. | Advisory Director (formerly Vice Chairman), Roundtable Investment Partners (since 2009); Adjunct Professor, New York University Stern School of Business (since 2011); Lecturer, Stanford University Graduate School of Business (since 2013); and Director, Victory Capital Holdings, Inc., an asset management firm (since 2013). Formerly, Member of Board of Overseers, NYU Langone Medical Center (2015-2016); Trustee, American Museum of Natural History (2005-2015); Trustee, NYU Langone Medical Center (2007-2015); Vice Chairman (formerly Chairman and President), U.S. Trust (formerly Private Bank of Bank of America, the predecessor entity of U.S. Trust) (2001-2008). | 93 | None | |||||
| Interested Trustees | ||||||||||
| Craig A. Dawson** 1968 |
Trustee | Since 2016. | Managing Director and Head of PIMCO Europe, Middle East and Africa (since 2016). Director of a number of PIMCO’s Europeans investment vehicles and affiliates (since 2008). Formerly, Head of Strategic Business Management, PIMCO (2014-2016), head of PIMCO’s Munich office and head of European product management for PIMCO. | 27 | None | |||||
| John C. Maney*** 1959 |
Trustee | Since 2016. | Managing Director of Allianz Asset Management of America L.P. (since January 2005) and a member of the Management Board and Chief Operating Officer of Allianz Asset Management of America L.P. (since November 2006). Formerly, Member of the Management Board of Allianz Global Investors Fund Management LLC (2007-2014) and Managing Director of Allianz Global Investors Fund Management LLC (2011-2014). | 27 | None | |||||
| * | Under the Fund’s Amended and Restated Agreement and Declaration of Trust, a Trustee serves until his or her retirement, resignation or replacement. |
| ** | Mr. Dawson is an “interested person” of the Fund, as defined in Section 2(a)(19) of the Act, due to his affiliation with PIMCO and its affiliates. Mr. Dawson’s address is 11 Baker Street London, W1U 3AH GBR. |
| *** | Mr. Maney is an “interested person” of the Fund, as defined in Section 2(a)(19) of the Act, due to his affiliation with Allianz Asset Management of America L.P. and its affiliates. Mr. Maney’s address is 680 Newport Center Drive, Suite 250, Newport Beach, CA 92660. |
| 74 | PIMCO INTERVAL FUNDS |
(Unaudited)
Officers
| Name, Address and Year of Birth |
Position(s) Held with Fund |
Term of Office of Time Served+ |
Principal Occupation(s) During the Past 5 Years | |||
| Peter G. Strelow1 1970 |
President | Since inception. | Managing Director and Co-Chief Operating Officer, PIMCO. President, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Chief Administrative Officer, PIMCO. | |||
| Keisha Audain-Pressley 1975 |
Chief Compliance Officer | Since January 2018 | Senior Vice President and Deputy Chief Compliance Officer, PIMCO. Chief Compliance Officer, PIMCO-Managed Funds. | |||
| Joshua D. Ratner 1976 |
Vice President, Secretary and Chief Legal Officer | Since inception. | Executive Vice President and Deputy General Counsel, PIMCO. Chief Legal Officer, PIMCO Investments LLC. Vice President, Secretary and Chief Legal Officer, PIMCO-Managed Funds. Vice President - Senior Counsel, Secretary, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Ryan Leshaw1 1980 |
Assistant Secretary | Since inception. | Senior Vice President and Senior Counsel, PIMCO. Assistant Secretary, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Associate, Willkie Farr & Gallagher LLP. | |||
| Wu-Kwan Kit1 1981 |
Assistant Secretary | Since March 2017 | Vice President and Counsel, PIMCO. Assistant Secretary, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Assistant General Counsel, VanEck. | |||
| Stacie D. Anctil1 1969 |
Vice President | Since inception. | Executive Vice President, PIMCO. Vice President, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Eric D. Johnson1 1970 |
Vice President | Since inception. | Executive Vice President, PIMCO. Vice President, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Bijal Parikh1 1978 |
Vice President | Since March 2017 | Senior Vice President, PIMCO. Vice President, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust and PIMCO Equity Series. | |||
| William G. Galipeau1 1974 |
Vice President | Since December 2017 | Executive Vice President, PIMCO. Vice President, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Trent W. Walker1 1974 |
Treasurer | Since December 2017 | Executive Vice President, PIMCO. Assistant Treasurer, PIMCO-Managed Funds. Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Erik C. Brown1 1967 |
Assistant Treasurer | Since inception. | Executive Vice President, PIMCO. Assistant Treasurer, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Colleen Miller 1980 |
Assistant Treasurer | Since March 2017 | Senior Vice President, PIMCO. Assistant Treasurer, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Vice President Cohen & Steers Capital Management. |
| ANNUAL REPORT | JUNE 30, 2018 | 75 |
Management of the Fund (Cont.)
(Unaudited)
| Name, Address and Year of Birth |
Position(s) Held with Fund |
Term of Office of Time Served+ |
Principal Occupation(s) During the Past 5 Years | |||
| Christopher M. Morin1 1980 |
Assistant Treasurer | Since inception. | Senior Vice President, PIMCO. Assistant Treasurer, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. | |||
| Jason J. Nagler 1982 |
Assistant Treasurer | Since inception. | Vice President, PIMCO. Assistant Treasurer, PIMCO-Managed Funds, PIMCO Funds, PIMCO Variable Insurance Trust, PIMCO ETF Trust, PIMCO Equity Series and PIMCO Equity Series VIT. Formerly, Head of Mutual Fund Reporting, GMO, and Assistant Treasurer, GMO Trust and GMO Series Trust Funds. |
| 1 | The address of these officers is Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, California 92660. |
| 76 | PIMCO INTERVAL FUNDS |
Approval of Investment Management Agreement
(Unaudited)
At an in-person meeting held on June 14, 2018 (the “Approval Meeting”), the Board of Trustees of the Fund (the “Board”), including the Trustees who are not interested persons (as that term is defined in the Investment Company Act of 1940) of the Fund or PIMCO (the “Independent Trustees”), formally considered and unanimously approved the continuation of the Investment Management Agreement between the Fund and PIMCO (the “Investment Management Agreement”) and the Distribution Contract between the Fund and PIMCO Investments LLC (“PI”) (the “Distribution Contract” and, together with the Investment Management Agreement, the “Agreements”) and the Distribution and Servicing Plan for Class A shares of the Fund (the “Class A Plan”), each for an additional one-year period commencing on August 1, 2018. Prior to the Approval Meeting, the Contracts Committee (the “Committee”) of the Board held an in-person meeting on June 14, 2018 (the “Committee Meeting”) and formally considered and recommended to the Board the continuation of the Agreements and Class A Plan. Prior to the Approval Meeting, on May 11, 2018, the Chair and another member of the Committee participated in a conference call with members of management and PIMCO personnel and counsel to the Independent Trustees (“Independent Counsel”) to discuss the process for the Board’s review of the Agreements and Class A Plan and to consider certain information relating to the Fund, including, among other information, information relating to PIMCO’s profitability with respect to the Agreements, comparative fees and expenses and Fund performance. On May 16, 2018, PIMCO and PI provided materials to the Committee for its consideration of the Agreements in response to a request from Independent Counsel (the “Manager Request Letter”), as well as other materials and information PIMCO and PI believed was useful in evaluating the continuation of the Agreements and Class A Plan.
On May 23, 2018, the Committee held a meeting via conference call (collectively with the May 11, 2018 conference call, Committee Meeting and the Approval Meeting, the “Contract Renewal Meetings”), at which the members of the Committee, all of whom are Independent Trustees, considered the materials and information provided by PIMCO and PI bearing on the continuation of the Agreements. The Committee also received and reviewed a memorandum from counsel to the Fund regarding the Trustees’ responsibilities in evaluating the Agreements, which they discussed with Independent Counsel.
Following the presentation at the Committee Meeting, the Independent Trustees met separately in executive session with Independent Counsel to review and discuss all relevant information, including, but not limited to, information provided in response to the Manager Request Letter and information presented and discussed at the prior Contract Renewal Meetings.
In connection with their deliberations regarding the proposed continuation of the Agreements and Class A Plan for the Fund, the Trustees, including the Independent Trustees, considered such information and factors as they believed, in light of the legal advice furnished to them and their own business judgment, to be relevant. The Trustees also considered the nature, quality and extent of the various investment management, administrative, distribution, and other services performed by PIMCO and PI under the Agreements.
It was noted that, in connection with their Contract Renewal Meetings and review of the Agreements and Class A Plan, the Trustees relied upon materials provided by PIMCO and PI which included, among other items: (i) information provided by Broadridge Financial Solutions, Inc./Lipper Inc. (“Lipper”), an independent third party, on the total return investment performance (based on net
| ANNUAL REPORT | JUNE 30, 2018 | 77 |
Approval of Investment Management Agreement (Cont.)
asset value of the Fund’s Institutional Class Common Shares) of the Fund for various time periods, presented through comparisons to the investment performance of a group of funds identified by Lipper with investment classifications/objectives comparable to those of the Fund (its “Lipper Performance Universe”), (ii) information provided by Lipper on the Fund’s management fees and other expenses under the Investment Management Agreement and the management fees and other expenses of a smaller sample of comparable funds identified by Lipper (its “Lipper Expense Group”) as well as of a larger sample of comparable funds identified by Lipper (its “Lipper Expense Universe”), (iii) information regarding the investment performance and fees for other funds and accounts managed by PIMCO with similar investment strategies to those of the Fund, (v) the estimated profitability to PIMCO with respect to the Fund for the period between the Fund’s inception on February 22, 2017 and December 31, 2017, (vi) descriptions of various functions performed by PIMCO for the Fund, such as portfolio management, compliance monitoring and portfolio trading practices, (vii) information regarding PIMCO’s compliance policies applicable to the Funds, (viii) information regarding the Fund’s use of leverage, (ix) information regarding any economies of scale reached in the operation of the Fund, (x) summaries assigning a quadrant placement to the Fund based on an average of certain measures of performance and fees/expenses versus Lipper peer group medians (the “Fund Scoring Summaries”), (xi) a fact card for the Fund that included summary information regarding the Fund, (xii) information regarding the comparative yield of the Fund, (xiii) information regarding the risk-adjusted returns of the Fund, (xiv) possible “fall-out” benefits to PIMCO from its relationship with the Fund, (xv) information regarding the overall organization of PIMCO, including information regarding senior management, portfolio managers and other personnel providing investment management, administrative, compliance and other services to the Fund; (xvi) information regarding sub-accounting arrangements for the Portfolios; (xvii) comparative information regarding fees that will be payable by Class A shares of PFLEX under the Class A Plan; and (xviii) PI’s Compliance Manual, organizational structure and personnel information.
The Trustees’ conclusions as to the continuation of the Agreements were based on a comprehensive consideration of all information provided to the Trustees and were not the result of any single factor. Some of the factors that figured particularly in the Trustees’ deliberations are described below, although individual Trustees may have evaluated the information presented differently from one another, attributing different weights to various factors.
As part of their review of the Investment Management Agreement, the Trustees examined PIMCO’s abilities to provide high-quality investment management and other services to the Fund. Among other information, the Trustees considered the investment philosophy and research and decision-making processes of PIMCO; the experience of key advisory personnel of PIMCO responsible for portfolio management of the Funds; the ability of PIMCO to attract and retain capable personnel; and the capabilities of the senior management and staff of PIMCO. In addition, the Trustees reviewed the quality of PIMCO’s services with respect to regulatory compliance and compliance with the investment policies of the Fund; the nature and quality of the supervisory and administrative services PIMCO is responsible for providing to the Fund; and conditions that might affect PIMCO’s and PI’s ability to provide high-quality services to the Fund in the future under the Agreements, including PIMCO’s and PI’s financial condition and operational stability. Based on the foregoing, the Trustees concluded that PIMCO’s investment process, research capabilities and philosophy are well suited to the Fund given its investment objectives and policies, and that PIMCO and PI would be able to continue to meet any reasonably foreseeable obligations under the Agreements.
| 78 | PIMCO INTERVAL FUNDS |
(Unaudited)
In assessing the reasonableness of the Fund’s fees under the Investment Management Agreement, the Trustees considered, among other information, the Fund’s management fee and its total expense ratio as a percentage of average net assets attributable to common shares and as a percentage of average managed assets (including assets attributable to common shares and leverage outstanding combined), and the management fee and total expense ratios of the Lipper Expense Group and Lipper Expense Universe for the Fund. In each case, the total expense ratio information was provided both inclusive and exclusive of interest and borrowing expenses. The comparative fees/expenses reviewed by the Trustees are discussed below. The fee and expense results discussed below were prepared and provided by Lipper and were not independently verified by the Trustees.
The Trustees specifically took note of how the Fund compared to its Lipper peers as to performance, management fee expense and total expense ratio. The Trustees noted that, while the Fund is not currently charged a separate administration fee (recognizing that its management fees include a component for administrative services under the unitary fee arrangement), it was not clear in all cases whether the peer funds in the Lipper categories were separately charged such a fee by their investment managers, so that the total expense ratio, as opposed to any individual expense component, represented the most relevant comparison. The Trustees also considered that the total expense ratio seems to provide a more apt comparison than management fee expense because the Fund’s unitary fee arrangement covers other supervisory and administrative services required by the Fund that are typically paid for or incurred by peer closed-end funds and closed-end interval funds directly in addition to a fund’s management fee (such fees and expenses, “Operating Expenses”) as discussed below. It was noted that the total expense ratio comparisons reflect the effect of expense waivers/reimbursements, if any. The Trustees considered total expense ratio comparisons both including and excluding interest and borrowing expenses. The Trustees noted that only closed-end interval funds and leveraged closed-end funds were considered for inclusion in the Lipper Expense Groups and Lipper Expense Universes presented for comparison with the Fund.
The Trustees noted that the contractual management fee rate for the Fund under its unitary fee arrangement was above the median contractual management fees of the other funds in its Lipper Expense Group, calculated both on average net assets and on average managed assets. The Trustees took into account that the Fund’s unitary fee arrangement covers substantially all of the Fund’s Operating Expenses and therefore would tend to be higher than the contractual management fee rates of other funds in its Lipper Expense Group, which generally do not have a unitary fee structure and bear Operating Expenses directly and in addition to the management fee. The Trustees determined that a review of the Fund’s total expense ratio with the total expense ratios of peer funds would generally provide more meaningful comparisons than considering contractual management fee rates in isolation.
In this regard, the Trustees noted PIMCO’s view that the unitary fee arrangement has benefited and will continue to benefit the Fund’s common shareholders because it provides a management fee expense structure (including Operating Expenses) that is essentially fixed for the duration of the contractual period as a percentage of managed assets (including assets attributable to any preferred shares and certain other forms of leverage), as applicable, making it more predictable under ordinary circumstances in comparison to other fee and expense structures, under which Operating Expenses (including certain third-party fees and expenses) could vary significantly over time. The Trustees also considered that the unitary fee arrangement generally insulates the Fund and common shareholders
| ANNUAL REPORT | JUNE 30, 2018 | 79 |
Approval of Investment Management Agreement (Cont.)
from increases in applicable third-party and certain other expenses because PIMCO, rather than the Fund, would bear the risk of such increases (though the Trustees also noted that PIMCO would benefit from any reductions in such expenses).
Comparative performance results for the Fund reviewed by the Trustees are discussed below. The comparative performance information was prepared and provided by Lipper and was not independently verified by the Trustees. Due to the passage of time, these performance results may differ from the performance results for more recent periods. With respect to the Fund, the Trustees reviewed, among other information, comparative information showing performance of the Fund against the Lipper Performance Universes for the period from the Fund’s inception on February 22, 2017 until December 31, 2017. The Trustees also reviewed the Fund Scoring Summaries prepared by PIMCO at the Independent Trustees’ request comparing the Fund’s fees/expenses against those of its Lipper Expense Universe and performance against that of its Lipper Performance Universe, by identifying a quadrant designation based on the Fund’s fees/expenses versus performance. The Fund Scoring Summaries were based on net assets, one showing total expenses inclusive of interest and borrowing expenses and the other showing total expenses exclusive of interest and borrowing expenses. In addition, the Trustees also reviewed a fact card for the Fund that included summary information regarding the Fund, including investment objective and strategy, portfolio managers, assets under management, outstanding leverage, net asset value performance comparisons, comparative fee and expense information and information regarding PIMCO’s estimated profitability.
In addition, it was noted that the Trustees considered matters bearing on the Fund and its advisory arrangement at their meetings throughout the year, including a review of performance data at each regular meeting.
Among other information, the Trustees took into account the following comparative information regarding the Fund. With respect to the Fund’s common share total return performance (based on net asset value) relative to its Lipper Performance Universe, consisting of 32 funds, the Trustees noted that the Fund had first quintile performance for the period from the Fund’s inception on February 22, 2017 until December 31, 2017.
The Trustees noted that the Lipper Expense Group for the Fund consisted of a total of ten funds, including the Fund. The Trustees also noted that the average net assets of the common shares of the funds in the Lipper Expense Group ranged from $56.0 million to $308.8 million, and that four of the funds in the group were larger in asset size than the Fund. The Trustees noted that the Lipper Expense Universe for the Fund consisted of a total of 34 funds, including the Fund. The Trustees noted that the Fund’s total expense ratio (including interest and borrowing expenses) calculated on both average managed assets and average net assets was above the median total expense ratio (including interest and borrowing expenses) of the funds in its Lipper Expense Group and Lipper Expense Universe. The Trustees noted that the Fund’s total expense ratio (excluding interest and borrowing expenses) calculated on both average managed assets and average net assets was above the median total expense ratio (excluding interest and borrowing expenses) of the funds in its Lipper Expense Group and Lipper Expense Universe.
The Trustees also took into account that the Fund pays management fees on assets attributable to types of leverage that it uses (such as reverse repurchase agreements) under the Investment
| 80 | PIMCO INTERVAL FUNDS |
(Unaudited)
Management Agreement (because the Fund’s fees are calculated based on total managed assets (including assets attributable to any reverse repurchase agreements, dollar rolls, borrowings and preferred shares that may be outstanding) minus accrued liabilities (other than liabilities representing reverse repurchase agreements, dollar rolls and borrowings). In this regard, the Trustees took into account that PIMCO has a financial incentive for the Fund to utilize reverse repurchase agreements, borrowings, preferred shares, and/or certain other forms of leverage on which management fees would be paid, which may create a conflict of interest between PIMCO, on one hand, and the Fund’s common shareholders, on the other. Therefore, the Trustees noted that the total fees paid by the Fund to PIMCO under the Fund’s unitary fee arrangement would therefore vary more with increases and decreases in applicable leverage incurred by the Fund than under a non-unitary fee arrangement, all other things being equal. The Trustees considered information provided by PIMCO and related presentations as to why the Fund’s use of leverage continues to be appropriate and in the best interests of the respective Fund under current market conditions. The Trustees also considered PIMCO’s representation that it will use leverage for the Fund solely as it determines to be in the best interests of the Fund from an investment perspective and without regard to the level of compensation PIMCO receives.
The Trustees also considered estimated profitability analyses provided by PIMCO, which included, among other information, (i) PIMCO’s estimated pre- and post-distribution operating margin for the Fund for the period between the Fund’s inception on February 22, 2017 and December 31, 2017 (the “Estimated Margins”); (ii) a comparison of the Estimated Margins to the estimated “year one” pro forma profitability margins presented to the Board in connection with the Fund’s organizational meeting; and (iii) an overview of PIMCO’s fee rate with respect to the Fund, compared to PIMCO’s average fee rates with respect to its other clients, including PIMCO-managed listed closed-end funds, PIMCO-advised separate accounts, open-end funds, hedge funds and private equity funds. The Trustees also took into account explanations from PIMCO regarding how certain corporate and shared expenses were allocated among the Fund and other funds and accounts managed by PIMCO for purposes of developing profitability estimates. Based on the profitability analyses provided by PIMCO, the Trustees determined, taking into account the various assumptions made, that such profitability did not appear to be excessive.
The Trustees also took into account the entrepreneurial and business risk PIMCO has undertaken as investment manager and sponsor of the Fund.
The Trustees also took into account that the Fund does not currently have any breakpoints in its management fee. The Trustees noted that PIMCO shares the benefits of potential economies of scale with the Funds and their shareholders in a number of ways, including investing in portfolio and trade operations management, firm technology, middle and back office support, legal and compliance, and fund administration logistics; senior management supervision and governance of those services; and the enhancement of services provided to the Funds in return for fees paid. The Trustees also considered that the unitary fee arrangement provides inherent economies of scale because the Fund maintains a competitive fixed unitary fee even if the Fund’s assets decline and/or operating costs rise. The Trustees further considered that, in contrast, breakpoints are a proxy for charging higher fees on lower asset levels and that when a fund’s assets decline, breakpoints may reverse, which causes expense ratios to increase. The Trustees also considered that, unlike the Fund’s unitary fee arrangement, funds with “pass through” administrative fee structures may experience increased
| ANNUAL REPORT | JUNE 30, 2018 | 81 |
Approval of Investment Management Agreement (Cont.)
expense ratios when fixed dollar fees are charged against declining fund assets. The Trustees also considered that the unitary fee arrangement protects shareholders from a rise in Operating Expenses that may result from, including, among other things, PIMCO’s investments in various business enhancements and infrastructure. The Trustees noted that PIMCO has made extensive investments in these areas.
Additionally, the Trustees considered so-called “fall-out benefits” to PIMCO, such as reputational value derived from serving as investment manager to the Fund and research, statistical and quotation services PIMCO may receive from broker-dealers executing the Fund’s portfolio transactions on an agency basis.
With respect to the Distribution Contract, the Trustees noted that PI does not receive compensation from the Fund for services as distributor of the Fund’s Institutional Class Common Shares, but that PI may receive compensation from the Fund in respect of future share classes with different pricing structures, including share classes with sales loads, distribution fees and/or service fees. In this regard, the Trustees noted that it had authorized the issuance Class A common shares that would be subject to such fees and make payments to PI pursuant to the Class A Plan, which had been adopted in accordance with Rule 12b-1 (as if the Fund were an open-end fund), but that the new share class was not yet being offered by the Fund. The Trustees also considered comparative information regarding fees that would be payable by Class A shares of PFLEX under the Class A Plan.
After reviewing these and other factors described herein, the Trustees concluded, with respect to the Fund, within the context of their overall conclusions regarding the Agreements and the Class A Plan and based on the information provided and related representations made by management, that they were satisfied with PIMCO’s responses and efforts relating to the investment performance of the Fund. The Trustees also concluded that the fees payable under the Investment Management Agreement represent reasonable compensation in light of the nature, extent and quality of services provided by PIMCO. Based on their evaluation of factors that they deemed to be material, including those factors described above, the Trustees, including the Independent Trustees, unanimously concluded that the continuation of the Agreements and the Class A Plan was in the interests of the Fund and its shareholders, and should be approved.
| 82 | PIMCO INTERVAL FUNDS |
(Unaudited)
(Unaudited)
The Fund2,3 considers customer privacy to be a fundamental aspect of their relationships with shareholders and is committed to maintaining the confidentiality, integrity and security of their current, prospective and former shareholders’ non-public personal information. The Fund has developed policies that are designed to protect this confidentiality, while allowing shareholder needs to be served.
Obtaining Personal Information
In the course of providing shareholders with products and services, the Fund and certain service providers to the Fund, such as the Fund’s investment adviser or sub-adviser (“Adviser”), may obtain non-public personal information about shareholders, which may come from sources such as account applications and other forms, from other written, electronic or verbal correspondence, from shareholder transactions, from a shareholder’s brokerage or financial advisory firm, financial advisor or consultant, and/or from information captured on applicable websites.
Respecting Your Privacy
As a matter of policy, the Fund does not disclose any non-public personal information provided by shareholders or gathered by the Fund to non-affiliated third parties, except as required or permitted by law or as necessary for such third parties to perform their agreements with respect to the Fund. As is common in the industry, non-affiliated companies may from time to time be used to provide certain services, such as preparing and mailing prospectuses, reports, account statements and other information, conducting research on shareholder satisfaction and gathering shareholder proxies. The Fund or its affiliates may also retain non-affiliated companies to market the Fund’s shares or products which use the Fund’s shares and enter into joint marketing arrangements with them and other companies. These companies may have access to a shareholder’s personal and account information, but are permitted to use this information solely to provide the specific service or as otherwise permitted by law. In most cases, the shareholders will be clients of a third party, but the Fund may also provide a shareholder’s personal and account information to the shareholder’s respective brokerage or financial advisory firm and/or financial advisor or consultant.
Sharing Information with Third Parties
The Fund reserves the right to disclose or report personal or account information to non-affiliated third parties in limited circumstances where the Fund believes in good faith that disclosure is required under law, to cooperate with regulators or law enforcement authorities, to protect their rights or property, or upon reasonable request by any fund advised by PIMCO in which a shareholder has invested. In addition, the Fund may disclose information about a shareholder or a shareholder’s accounts to a non-affiliated third party at the shareholder’s request or with the consent of the shareholder.
Sharing Information with Affiliates
The Fund may share shareholder information with their affiliates in connection with servicing shareholders’ accounts, and subject to applicable law may provide shareholders with information about products and services that the Fund or its Adviser, distributor or their affiliates (“Service Affiliates”) believe may be of interest to such shareholders. The information that the Fund may share may include, for example, a shareholder’s participation in the Fund or in other investment programs sponsored by a Service Affiliate, a shareholder’s ownership of certain types of accounts (such as IRAs), information about the Fund’s experiences or transactions with a shareholder, information captured on applicable websites, or other data about a shareholder’s accounts, subject to applicable
| ANNUAL REPORT | JUNE 30, 2018 | 83 |
(Unaudited)
law. The Fund’s Service Affiliates, in turn, are not permitted to share shareholder information with non-affiliated entities, except as required or permitted by law.
Procedures to Safeguard Private Information
The Fund takes seriously the obligation to safeguard shareholder non-public personal information. In addition to this policy, the Fund has implemented procedures that are designed to restrict access to a shareholder’s non-public personal information to internal personnel who need to know that information to perform their jobs, such as servicing shareholder accounts or notifying shareholders of new products or services. Physical, electronic and procedural safeguards are in place to guard a shareholder’s non-public personal information.
Information Collected from Websites
Websites maintained by the Fund or its service providers may use a variety of technologies to collect information that help the Fund and its service providers understand how the website is used. Information collected from your web browser (including small files stored on your device that are commonly referred to as “cookies”) allow the websites to recognize your web browser and help to personalize and improve your user experience and enhance navigation of the website. In addition, the Fund or its Service Affiliates may use third parties to place advertisements for the Fund on other websites, including banner advertisements. Such third parties may collect anonymous information through the use of cookies or action tags (such as web beacons). The information these third parties collect is generally limited to technical and web navigation information, such as your IP address, web pages visited and browser type, and does not include personally identifiable information such as name, address, phone number or email address. If you are a registered user of the Fund’s website, the Fund or their service providers or third party firms engaged by the Fund or their service providers may collect or share information submitted by you, which may include personally identifiable information. This information can be useful to the Fund when assessing and offering services and website features. You can change your cookie preferences by changing the setting on your web browser to delete or reject cookies. If you delete or reject cookies, some website pages may not function properly. The Fund does not look for web browser “do not track” requests.
Changes to the Privacy Policy
From time to time, the Fund may update or revise this privacy policy. If there are changes to the terms of this privacy policy, documents containing the revised policy on the relevant website will be updated.
1 Amended as of March 23, 2017.
2 PIMCO Investments LLC (“PI”) serves as the Fund’s distributor. This Privacy Policy applies to the activities of PI to the extent that PI regularly effects or engages in transactions with or for a Fund shareholder who is the record owner of such shares. For purposes of this Privacy Policy, references to “the Fund” shall include PI when acting in this capacity.
3 When distributing this Policy, the Fund may combine the distribution with any similar distribution of its investment adviser’s privacy policy. The distributed, combined policy may be written in the first person (i.e., by using “we” instead of “the Fund”).
| 84 | PIMCO INTERVAL FUNDS |
General Information
Investment Manager
Pacific Investment Management Company LLC
1633 Broadway
New York, NY 10019
Distributor
PIMCO Investments LLC
1633 Broadway
New York, NY 10019
Custodian
State Street Bank and Trust Company
801 Pennsylvania Avenue
Kansas City, MO 64105
Transfer Agent, Dividend Paying Agent and Registrar
DST Asset Manager Solutions, Inc.
430 W. 7th Street, STE 219993
Kansas City, MO 64105-1407
Legal Counsel
Ropes & Gray LLP
Prudential Tower
800 Boylston Street
Boston, MA 02199
Independent Registered Public Accounting Firm
PricewaterhouseCoopers LLP
1100 Walnut Street, Suite 1300
Kansas City, MO 64106
This report is submitted for the general information of the shareholders of the Fund listed on the report cover.
PIF3001AR_063018
| Item 2. | Code of Ethics. |
As of the end of the period covered by this report, the Registrant has adopted a code of ethics (the “Code”) that applies to the Registrant’s principal executive officer and principal financial & accounting officer. The Registrant did not grant any waivers, including implicit waivers, from any provisions of the Code to the principal executive officer or principal financial & accounting officer during the period covered by this report.
A copy of the Code is included as an exhibit to this report.
| Item 3. | Audit Committee Financial Expert. |
(a) The Board of Trustees has determined that James A. Jacobson, who serves on the Board’s Audit Oversight Committee, qualifies as an “audit committee financial expert” as such term is defined in the instructions to this Item 3. The Board has also determined that Mr. Jacobson is “independent” as such term is interpreted under this Item 3.
| Item 4. | Principal Accountant Fees and Services. |
| (a) | Fiscal Year Ended | Audit Fees | ||
| June 30, 2018 | $ 93,584 | |||
| June 30, 2017 | $ 40,715 | |||
| (b) | Fiscal Year Ended | Audit-Related Fees(1) | ||
| June 30, 2018 | $ — | |||
| June 30, 2017 | $ — | |||
| (c) | Fiscal Year Ended | Tax Fees(1) | ||
| June 30, 2018 | $ — | |||
| June 30, 2017 | $ — | |||
| (d) | Fiscal Year Ended | All Other Fees(1) | ||
| June 30, 2018 | $ — | |||
| June 30, 2017 | $ — | |||
“Audit Fees” represents fees billed for each of the last two fiscal years for professional services rendered for the audit and review of the Registrant’s annual financial statements for those fiscal years or services that are normally provided by the accountant in connection with statutory or regulatory filings or engagements for those fiscal years.
“Audit-Related Fees” represents fees billed for each of the last two fiscal years for assurance and related services that are reasonably related to the performance of the audit or review of the Registrant’s financial statements, but not reported under “Audit Fees” above, and that include accounting consultations, agreed-upon procedure reports, attestation reports and comfort letters for those fiscal years.
“Tax Fees” represents fees billed for each of the last two fiscal years for professional services related to tax compliance, tax advice and tax planning, including services relating to the filing or amendment of federal, state or local income tax returns, regulated investment company qualification reviews, and tax distribution and analysis reviews.
“All Other Fees” represents fees, if any, billed for other products and services rendered by the principal accountant to the Registrant other than those reported above under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” for the last two fiscal years.
(1) There were no “Audit-Related Fees”, “Tax Fees” and “All Other Fees” for the last two fiscal years.
| (e) | Pre-approval policies and procedures |
(1) The Registrant’s Audit Oversight Committee has adopted pre-approval policies and procedures (the “Procedures”) to govern the Audit Oversight Committee’s pre-approval of (i) all audit services and permissible non-audit services to be provided to the Registrant by its independent accountant, and (ii) all permissible non-audit services to be provided by such independent accountant to the Registrant’s investment adviser and to any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the Registrant (collectively, the “Service Affiliates”) if the services provided directly relate to the Registrant’s operations and financial reporting. In accordance with the Procedures, the Audit Oversight Committee is responsible for the engagement of the independent accountant to certify the Registrant’s financial statements for each fiscal year. With respect to the pre-approval of non-audit services provided to the Registrant and its Service Affiliates, the Procedures provide that the Audit Oversight Committee may annually pre-approve a list of types or categories of non-audit services that may be provided to the Registrant or its Service Affiliates, or the Audit Oversight Committee may pre-approve such services on a project-by-project basis as they arise. Unless a type of service has received general pre-approval, it will require specific pre-approval by the Audit Oversight Committee if it is to be provided by the independent accountant. The Procedures also permit the Audit Oversight Committee to delegate authority to one or more of its members to pre-approve any proposed non-audit services that have not been previously pre-approved by the Audit Oversight Committee, subject to the ratification by the full Audit Oversight Committee no later than its next scheduled meeting.
(2) With respect to the services described in paragraphs (b) through (d) of this Item 4, no amount was approved by the Audit Oversight Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
| f) | Not applicable. |
| g) |
| Aggregate Non-Audit Fees Billed to Entity | ||||||||
| Entity | June 30, 2018 | June 30, 2017 | ||||||
| PIMCO Flexible Credit Income Fund |
$ | — | $ | — | ||||
| Pacific Investment Management Company LLC (“PIMCO”)
|
|
$7,397,858
|
|
|
8,531,028
|
| ||
|
|
|
|
|
|||||
| Total |
$ | 7,397,858 | $ | 8,531,028 | ||||
|
|
|
|
|
|||||
| h) | The Registrant’s Audit Oversight Committee has considered whether the provision of non-audit services that were rendered to the Registrant’s investment adviser, and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the Registrant which were not pre-approved (not requiring pre-approval) is compatible with maintaining the principal accountant’s independence. |
| Item 5. | Audit Committee of Listed Registrants. |
Not applicable.
| Item 6. | Schedule of Investments. |
The Schedule of Investments is included as part of the report to shareholders under Item 1.
| Item 7. | Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. |
Policy Statement: The proxy voting policy is intended to foster PIMCO’s compliance with its fiduciary obligations and applicable law; the policy applies to any voting or consent rights with respect to securities held in accounts over which PIMCO has discretionary voting authority. The Policy is designed in a manner reasonably expected to ensure that voting and consent rights are exercised in the best interests of PIMCO’s clients.
Overview: PIMCO has adopted a written proxy1 voting policy (“Proxy Policy”) as required by Rule 206(4)-6 under the Advisers Act. As a general matter, when PIMCO has proxy voting authority, PIMCO has a fiduciary obligation to monitor corporate
events and to take appropriate action on client proxies that come to its attention. Each proxy is voted on a case-by-case basis, taking into account relevant facts and circumstances. When considering client proxies, PIMCO may determine not to vote a proxy in limited circumstances.
Equity Securities2: PIMCO has retained an Industry Service Provider (“ISP”) to provide research and voting recommendations for proxies relating to equity securities in accordance with the ISP’s guidelines. By following the guidelines of an independent third party, PIMCO seeks to mitigate potential conflicts of interest PIMCO may have with respect to proxies covered by the ISP. PIMCO will follow the recommendations of the ISP unless: (i) the ISP does not provide a voting recommendation; or (ii) a PM decides to override the ISP’s voting recommendation. In either such case as described above, the Legal and Compliance department will review the proxy to determine whether a material conflict of interest, or the appearance of one, exists.
Fixed Income Securities: Fixed income securities can be processed as proxy ballots or corporate action-consents3 at the discretion of the issuer/ custodian. When processed as proxy ballots, the ISP generally does not provide a voting recommendation and their role is limited to election processing and recordkeeping. When processed as corporate action-consents, the Legal and Compliance department will review all election forms to determine whether a conflict of interest, or the appearance of one, exists with respect to the PM’s consent election. PIMCO’s Credit Research and Portfolio Management Groups are responsible for issuing recommendations on how to vote proxy ballots and corporation action-consents with respect to fixed income securities.
Resolution of potential conflicts of interest: The Proxy Policy permits PIMCO to seek to resolve material conflicts of interest by pursuing any one of several courses of action. With respect to material conflicts of interest between PIMCO and a client account, the Proxy Policy permits PIMCO to either: (i) convene a working group to assess and resolve the conflict (the “Proxy Working Group”); or (ii) vote in accordance with protocols previously established by the Proxy Policy, the Proxy Working Group and/or other relevant procedures approved by PIMCO’s Legal and Compliance department with respect to specific types of conflicts.
PIMCO will supervise and periodically review its proxy voting activities and the implementation of the Proxy Policy. PIMCO’s Proxy Policy, and information about how PIMCO voted a client’s proxies, is available upon request.
Sub-Adviser Engagement: As an investment manager, PIMCO may exercise its discretion to engage a Sub-Adviser to provide portfolio management services to certain funds. Consistent with its management responsibilities, the Sub-Adviser will assume the authority for voting proxies on behalf of PIMCO for these funds. Sub-Advisers may utilize third parties to perform certain services related to their portfolio management responsibilities. As a fiduciary, PIMCO will maintain oversight of the investment management responsibilities performed by the Sub-Adviser and contracted third parties.
1 Proxies generally describe corporate action-consent rights (relative to fixed income securities) and proxy voting ballots (relative to fixed income or equity securities) as determined by the issuer or custodian.
2 The term “equity securities” means common and preferred stock, including common and preferred shares issued by investment companies; it does not include debt securities convertible into equity securities.
3 Voting or consent rights shall not include matters which are primarily decisions to buy or sell investments, such as tender offers, exchange offers, conversions, put options, redemptions, and Dutch auctions.
| Item 8. | Portfolio Managers of Closed-End Management Investment Companies. |
(a)(1)
As of August 28, 2018 the following individuals have primary responsibility for the day-to-day management of the PIMCO Flexible Credit Income Fund (the “Fund”):
Daniel J. Ivascyn
Mr. Ivascyn has been the lead portfolio manager of the Fund since its inception in February 2017. Mr. Ivascyn is Group Chief Investment Officer and a managing director in the Newport Beach office. Prior to joining PIMCO in 1998, he worked at Bear Stearns in the asset-backed securities group, as well as T. Rowe Price and Fidelity Investments
Alfred T. Murata
Mr. Murata has been a portfolio manager of the Fund since its inception in February 2017. Mr. Murata is a managing director in the Newport Beach office and a portfolio manager on the mortgage credit team. Prior to joining PIMCO in 2001, he researched and implemented exotic equity and interest rate derivatives at Nikko Financial Technologies.
Mark R. Kiesel
Mr. Kiesel has been a portfolio manager of the Fund since its inception February 2017. Mr. Kiesel is CIO Global Credit and a managing director in the Newport Beach office. He is a member of the PIMCO Investment Committee, a generalist portfolio manager and the global head of corporate bond portfolio management. He has served as a portfolio manager, head of equity derivatives and as a senior Credit Analyst since joining PIMCO in 1996.
Marc P. Seidner
Mr. Seidner has been a portfolio manager of the Fund since its inception February 2017. Mr. Seidner is CIO Non-traditional Strategies, a managing director and head of portfolio management in the New York office. He is also a generalist portfolio manager and a member of the Investment Committee. He rejoined PIMCO in November 2014 after serving as head of fixed income at GMO LLC, and previously he was a PIMCO managing director, generalist portfolio manager and member of the Investment Committee until January 2014.
Christian Stracke
Mr. Kiesel has been a portfolio manager of the Fund since its inception February 2017. Mr. Stracke is a managing director in the Newport Beach office, global head of the credit research group, and co-head of PIMCO’s BRAVO opportunistic private strategies complex. Mr. Stracke is also a senior portfolio manager across PIMCO’s suite of private credit strategies, investing across mortgage, real estate, specialty financials, corporate special situations, and performing private corporate credit. In addition to his portfolio management responsibilities, he sits on the firm’s Executive Committee.
Eve Tournier
Ms. Tournier has been a portfolio manager of the Fund since its inception February 2017. Ms. Tournier is a managing director in the London office and head of pan-European credit portfolio management. She is the lead portfolio manager for the firm’s global multi-sector credit strategies as well as dedicated European credit and European income-oriented portfolios, and she is also a member of the European portfolio committee.
(a)(2)
The following summarizes information regarding each of the accounts, excluding the Fund, managed by the Portfolio Managers as of June 30, 2018, including accounts managed by a team, committee, or other group that includes a Portfolio Manager. Unless mentioned otherwise, the advisory fee charged for managing each of the accounts listed below is not based on performance.
|
Registered Investment Companies
|
Other Pooled Investment Vehicles
|
Other Accounts
| ||||||||||
|
PM
|
#
|
AUM($million)
|
#
|
AUM($million)
|
#
|
AUM($million)
| ||||||
|
Daniel J. Ivascyn
|
18
|
$139,370.13
|
10*
|
$68,995.57
|
177**
|
$10,083.17
| ||||||
|
Mark R. Kiesel
|
21
|
$138,396.25
|
66***
|
$72,524.19
|
125****
|
$66,057.07
| ||||||
|
Alfred T. Murata
|
20
|
$138,437.04
|
10
|
$29,058.45
|
11
|
$1,534.68
| ||||||
|
Marc P. Seidner
|
5
|
$4,651.97
|
11*****
|
$4,836.97
|
58******
|
$9,352.20
| ||||||
|
Christian Stracke
|
2
|
$1,012.35
|
2
|
$426.70
|
1
|
$173.02
| ||||||
|
Eve Tournier
|
3
|
$6,716.41
|
24*******
|
$21,757.09
|
23********
|
$4,286.36
| ||||||
* Of these Other Pooled Investment Vehicles, 1 account totaling $0.00 in assets pays an advisory fee that is based in part on the performance of the accounts.
**Of these Other Accounts, 1 account totaling $235.61 million in assets pays an advisory fee that is based in part on the performance of the accounts.
*** Of these Other Pooled Investment Vehicles, 12 accounts totaling $11,153.05 million in assets pay an advisory fee that is based in part on the performance of the accounts.
****Of these Other Accounts, 13 accounts totaling $4,316.42 million in assets pay an advisory fee that is based in part on the performance of the accounts.
***** Of these Other Pooled Investment Vehicles, 1 account totaling $232.63 million in assets pays an advisory fee that is based in part on the performance of the accounts
******Of these Other Accounts, 7 accounts totaling $1,943.07 million in assets pay an advisory fee that is based in part on the performance of the accounts.
******* Of these Other Pooled Investment Vehicles, 3 accounts totaling $783.87 million in assets pay an advisory fee that is based in part on the performance of the accounts.
********Of these Other Accounts, 1 account totaling $49.79 million in assets pays an advisory fee that is based in part on the performance of the accounts.
From time to time, potential and actual conflicts of interest may arise between a portfolio manager’s management of the investments of the Fund, on the one hand, and the management of other accounts, on the other. Potential and actual conflicts of interest may also arise as a result of PIMCO’s other business activities and PIMCO’s possession of material non-public information about an issuer. Other accounts managed by a portfolio manager might have similar investment objectives or strategies as the Fund, track the same index as the Fund or otherwise hold, purchase, or sell securities that are eligible to be held, purchased or sold by the Fund. The other accounts might also have different investment objectives or strategies than the Fund. Potential and actual conflicts of interest may also arise as a result of PIMCO serving as investment adviser to accounts that invest in the Fund. In this case, such conflicts of interest could in theory give rise to incentives for PIMCO to, among other things, vote proxies of the Fund in a manner beneficial to the investing account but detrimental to the Fund. Conversely, PIMCO’s duties to the Fund, as well as regulatory or other limitations applicable to the Fund, may affect the courses of action available to PIMCO-advised accounts (including certain funds) that invest in the Fund in a manner that is detrimental to such investing accounts. In addition, regulatory restrictions, actual or potential conflicts of interest or other considerations may cause PIMCO to restrict or prohibit participation in certain investments.
Because PIMCO is affiliated with Allianz, a large multi-national financial institution, conflicts similar to those described below may occur between the Fund and other accounts managed by PIMCO and PIMCO’s affiliates or accounts managed by those affiliates. Those affiliates (or their clients), which generally operate autonomously from PIMCO, may take actions that are adverse to the Fund or other accounts managed by PIMCO. In many cases, PIMCO will not be in a position to mitigate those actions or address those conflicts, which could adversely affect the performance of the Fund or other accounts managed by PIMCO.
Knowledge and Timing of Fund Trades. A potential conflict of interest may arise as a result of the portfolio manager’s day-to-day management of the Fund. Because of their positions with the Fund, the portfolio managers know the size, timing and possible market impact of the Fund’s trades. It is theoretically possible that the portfolio managers could use this information to the advantage of other accounts they manage and to the possible detriment of the Fund.
Investment Opportunities. A potential conflict of interest may arise as a result of the portfolio manager’s management of a number of accounts with varying investment guidelines. Often, an investment opportunity may be suitable for both the Fund and other accounts managed by the portfolio manager, but may not be available in sufficient quantities for both the Fund and the other accounts to participate fully. In addition, regulatory issues applicable to PIMCO or the Fund or other accounts may result in the Fund not receiving securities that may otherwise be appropriate for it. Similarly, there may be limited opportunity to sell an investment held by the Fund and another account. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities on a fair and equitable basis over time.
Under PIMCO’s allocation procedures, investment opportunities are allocated among various investment strategies based on individual account investment guidelines and PIMCO’s investment outlook. PIMCO has also adopted additional procedures to complement the general trade allocation policy that are designed to address potential conflicts of interest due to the side-by-side management of the Fund and certain pooled investment vehicles, including investment opportunity allocation issues.
Conflicts potentially limiting the Fund’s investment opportunities may also arise when the Fund and other PIMCO clients invest in different parts of an issuer’s capital structure, such as when the Fund owns senior debt obligations of an issuer and other clients own junior tranches of the same issuer. In such circumstances, decisions over whether to trigger an event of default, over the terms of any workout, or how to exit an investment may result in conflicts of interest. In order to minimize such conflicts, a portfolio manager may avoid certain investment opportunities that would potentially give rise to conflicts with other PIMCO clients or PIMCO may enact internal procedures designed to minimize such conflicts, which could have the effect of limiting the Fund’s investment opportunities. Additionally, if PIMCO acquires material non-public confidential information in connection with its business activities for other clients, a portfolio manager may be restricted from purchasing securities or selling securities for the Fund. Moreover, the Fund or other accounts managed by PIMCO may invest in a transaction in which one or more other funds or accounts managed by PIMCO are expected to participate, or already have made or will seek to make, an investment. Such funds or accounts may have conflicting interests and objectives in connection with such investments, including, for example and without limitation, with respect to views on the operations or activities of the issuer involved, the targeted returns from the investment, and the timeframe for, and method of, exiting the investment. Additionally, a fund or other account managed by PIMCO may take an investment position or action that may be different from, or inconsistent with, an investment position or action taken by another fund or other account managed by PIMCO having similar or differing investment objectives. These positions and actions may adversely impact the Fund. For example, the Fund may buy a security and another fund or other account managed by PIMCO may establish a short position in that same security or in another security issued by the same issuer. The subsequent short sale may result in a decrease in the price of the security that the first fund holds. When making investment decisions where a conflict of interest may arise, PIMCO will endeavor to act in a fair and equitable manner as between the Fund and other clients; however, in certain instances the resolution of the conflict may result in PIMCO acting on behalf of another client in a manner that may not be in the best interest, or may be opposed to the best interest, of the Fund.
Performance Fees. A portfolio manager may advise certain accounts with respect to which the advisory fee is based entirely or partially on performance. Performance fee arrangements may create a conflict of interest for the portfolio manager in that the portfolio manager may have an incentive to allocate the investment opportunities that he or she believes might be the most profitable to such other accounts instead of allocating them to the Fund. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities between the Fund and certain pooled investment vehicles on a fair and equitable basis over time.
(a)(3)
As of June 30, 2018 the following explains the compensation structure of the individuals who have primary responsibility for day-to-day portfolio management of the Fund:
Portfolio Manager Compensation
PIMCO’s approach to compensation seeks to provide professionals with a Total Compensation Plan and process that is driven by PIMCO’s mission and values. Key Principles on Compensation Philosophy include:
| ● | PIMCO’s pay practices are designed to attract and retain high performers; |
| ● | PIMCO’s pay philosophy embraces a corporate culture of rewarding strong performance, a strong work ethic, and meritocracy; |
| ● | PIMCO’s goal is to ensure key professionals are aligned to PIMCO’s long-term success through equity participation; and |
| ● | PIMCO’s “Discern and Differentiate” discipline guides total compensation levels. |
The Total Compensation Plan consists of three components. The compensation program for portfolio managers is designed to align with clients’ interests, emphasizing each portfolio manager’s ability to generate long-term investment success for PIMCO’s clients. A portfolio manager’s compensation is not based solely on the performance of the Fund or any other account managed by that portfolio manager:
Base Salary – Base salary is determined based on core job responsibilities, positions/levels and market factors. Base salary levels are reviewed annually, when there is a significant change in job responsibilities or position, or a significant change in market levels.
Performance Bonus – Performance bonuses are designed to reward risk-adjusted performance and contributions to PIMCO’s broader investment process. The compensation process is not formulaic and the following non-exhaustive list of qualitative and quantitative criteria are considered when determining the total compensation for portfolio managers:
| ● | Performance measured over a variety of longer- and shorter-term periods, including 5-year, 4-year, 3-year, 2-year and 1-year dollar-weighted and account-weighted, pre-tax total and risk-adjusted investment performance as judged against the applicable benchmarks (which may include internal investment performance-related benchmarks) for each account managed by a portfolio manager (including the Fund) and relative to applicable industry peer groups; greatest emphasis is placed on 5-year and 3-year performance, followed by 1-year performance; |
| ● | Consistency of investment performance across portfolios of similar mandate and guidelines, rewarding low dispersion and consistency of outperformance; |
| ● | Appropriate risk positioning and risk management mindset which includes consistency with PIMCO’s investment philosophy, the Investment Committee’s positioning guidance, absence of defaults, and appropriate alignment with client objectives; |
| ● | Contributions to mentoring, coaching and/or supervising members of team; |
| ● | Collaboration, idea generation, and contribution of investment ideas in the context of PIMCO’s investment process, Investment Committee meetings, and day-to-day management of portfolios; |
| ● | With much lesser importance than the aforementioned factors: amount and nature of assets managed by the portfolio manager, contributions to asset retention, and client satisfaction. |
PIMCO’s partnership culture further rewards strong long term risk adjusted returns with promotion decisions almost entirely tied to long term contributions to the investment process. 10-year performance can also be considered, though not explicitly as part of the compensation process.
Deferred Compensation – Long Term Incentive Plan (“LTIP”) and/or M Options are awarded to key professionals. Employees who reach a total compensation threshold are delivered their annual compensation in a mix of cash and/or deferred compensation. PIMCO incorporates a progressive allocation of deferred compensation as a percentage of total compensation, which is in line with market practices.
| ● | The LTIP provides participants with deferred cash awards that appreciate or depreciate based on PIMCO’s operating earnings over a rolling three-year period. The plan provides a link between longer term company performance and participant pay, further motivating participants to make a long term commitment to PIMCO’s success. |
| ● | The M Unit program provides mid-to-senior level employees with the potential to acquire an equity stake in PIMCO over their careers and to better align employee incentives with the Firm’s long-term results. In the program, options are awarded and vest over a number of years and may convert into PIMCO equity which shares in the profit distributions of the Firm. M Units are non-voting common equity of PIMCO and provide a mechanism for individuals to build a significant equity stake in PIMCO over time. |
Eligibility to participate in LTIP and the M Unit program is contingent upon continued employment at PIMCO and all other applicable eligibility requirements.
Profit Sharing Plan. Portfolio managers who are Managing Directors of PIMCO receive compensation from a non-qualified profit sharing plan consisting of a portion of PIMCO’s net profits. Portfolio managers who are Managing Directors receive an amount determined by the Compensation Committee, based upon an individual’s overall contribution to the firm.
(a)(4)
The following summarizes the dollar range of securities of the Fund the Portfolio Managers beneficially owned as of June 30, 2018:
| Portfolio Manager | Dollar Range of Equity Securities of the Fund Owned as of June 30, 2018 | |
|
Daniel J. Ivascyn |
None | |
|
Mark R. Kiesel |
None | |
|
Alfred T. Murata |
$10,001 - $50,000 | |
|
Marc P. Seidner |
None | |
|
Christian Stracke |
None | |
| Eve Tournier |
$100,001-$500,000 |
| Item 9. | Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers. |
None.
| Item 10. | Submission of Matters to a Vote of Security Holders. |
There have been no material changes to the procedures by which shareholders may recommend nominees to the Fund’s Board of Trustees since the Fund last provided disclosure in response to this item.
| Item 11. | Controls and Procedures. |
| (a) | The principal executive officer and principal financial & accounting officer have concluded as of a date within 90 days of the filing date of this report, based on their evaluation of the Registrant’s disclosure controls and procedures (as defined in Rule 30a-3(c) under the 1940 Act), that the design of such procedures is effective to provide reasonable assurance that material information required to be disclosed by the Registrant on Form N-CSR is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. |
| (b) | There were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d))) that occurred during the last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting. |
| Item 12. | Disclosure of Securities Lending Activities for Closed-End Management Investment Companies. |
None.
| Item 13. | Exhibits. |
| (a)(1) | Exhibit 99.CODE— Code of Ethics pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. |
| (a)(2) | Exhibit 99.CERT—Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| (a)(3) | None. |
| (a)(4) | There was no change in the registrant’s independent public accountant for the period covered by this report |
| (b) | Exhibit 99.906CERT—Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| PIMCO Flexible Credit Income Fund | ||
| By: | /s/ Peter G. Strelow
| |
| Peter G. Strelow | ||
| President (Principal Executive Officer) | ||
| Date: | August 28, 2018 | |
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| By: | /s/ Peter G. Strelow
| |
| Peter G. Strelow | ||
| President (Principal Executive Officer) | ||
| Date: | August 28, 2018 | |
| By: | /s/ Trent W. Walker
| |
| Trent W. Walker | ||
| Treasurer (Principal Financial & Accounting Officer) | ||
| Date: | August 28, 2018 | |