BTO - 11% Income You Can Bank On: BTO

2023-11-01 07:35:00 ET

Summary

• You need income you can bank on for your retirement.
• The financial services sector has a long storied history of providing strong returns.
• Earn 11% from a high-quality fund.

Co-authored by Treading Softly.

Have you ever wondered where the phrase "you can bank on it" comes from? It originates in popular usage within a 1970s TV show called Beretta. This is about a detective who lived in a run-down motel, had a pet cockatoo, and used to famously tell people that they could "take it to the bank" or they could "bank on it."

The concept of a bank being a financial institution gains its heritage farther back in history. The word bank and its oldest origins travel through French, Latin, and Germanic, to the concept of a bench. Something that is sturdy and reliable that you can rest on understanding that it'll be able to bear your weight. This makes sense. When you say to someone that they can bank on it, meaning that they can depend on it, that it's going to be reliable and occur as expected.

When it comes to the market, the only things that you can bank on are that you're going to live through a bear market and a bull market - probably more than once in your entire investing career. Yet, if you've lived through any of those situations, you've probably had a bank that you relied upon for your deposits and transactions. Financial institutions have existed for centuries, simply because people need a place to put their money, store it, and to be able to extract it for future use. If life was a casino, banks would be the house. They have ways of extracting value from their customers for their own profit time and time again. Yet, we all still continue to use them and rely upon them because we would not be able to operate in life without them - at least in the current making of our society.

So, when it comes to being a professional income investor and wanting strong, recurring income in my portfolio, I like to be able to have income that I can bank on.

Today, I want to talk about one opportunity to get income just like that.

Let's dive in!

Betting On The House

John Hancock Financial Opportunities Fund ( BTO ), yielding 11.1%, is a CEF (Closed-End Fund) that invests in banks. In early 2023, banks were reeling from the failure of Silicon Valley Bank and the following run and failure of Signature Bank and First Republic Bank. The number of failures wasn't unusual. What was unusual was the size of the banks that failed. Source .

There were also four bank failures in 2019, and nobody talked about them on a national news level because they were small. The fear in March was that the failures would become a "contagion" and spread throughout regional banks - it didn't. As we look at Q3 earnings reports, we see no reason to believe that bank failures are likely to pick back up on a national level.

Yet, even as we see many banks reporting higher NII (Net Investment Income), higher deposits, and good liquidity at Q3 earnings, many bank stocks remain at depressed valuations. With the 10-year Treasury (US10Y) touching 5% and fear of rising loan defaults, financials that are seen as "interest rate sensitive" are selling off.

Changes in interest rates can be challenging for banks as their assets and liabilities are both impacted by the changing values of debt. With the Fed hiking at the fastest pace in decades, the value of long-term U.S. Treasuries that banks often rely on for liquidity to protect deposits has plummeted.

This can create some pressure for banks, which need to ensure that they are maintaining sufficient liquidity so that when depositors demand their withdrawals, they can get them. On the other hand, higher interest rates provide great tailwinds for earnings because banks earn money by lending. Higher interest rates mean they can receive more when they lend.

The bottom line is that the pressure for banks is caused by the change in interest rates, not how high they are. Anyone who has lived in a climate where the weather changes can relate to how "cold" the first days of autumn feel and how "warm" the first days of spring feel, even though the measured temperature might be identical. This is because our bodies adjust, and we get used to temperatures, and our perception of "hot" or "cold" is driven by the change. Banks can "get used" to any interest rate level, but the change in interest rates isn't always easy.

This is especially true when banks have to deal with an "inverted" yield curve. The yield curve is inverted when short-maturity interest rates are higher than longer-dated maturities. This puts particular pressure on the strategy of borrowing short-term and lending long-term, which during "normal" times is one of the most profitable strategies for banks. Many bank liabilities are short-term, like demand deposits (think checking and saving accounts) and repo borrowings, while assets are often long-term. The yield curve has been significantly inverted over the past year, and that inversion is rapidly coming to an end.

We can see that a similar thing happened in 2000-2001:

Banks sold off as the yield curve inverted and then recovered. This cycle, banks have lagged in their recovery. Banks went on to dramatically outperform the equity markets in the following years as the economy tipped into recession.

This cycle, the recovery for banks has been slower. Undoubtedly, it was influenced by generally negative sentiment towards banks caused by the troubles in March. However, when we look at earnings, we can see that for most banks, earnings are, in fact, recovering as banks adapt to a higher interest rate world.

This is the kind of investment opportunity that we want to be on top of. Fundamentally, banks are improving, and the future outlook is positive, yet their price remains near multidecade lows. The old market words of wisdom, "buy low, sell high," is not an idea that should be followed blindly. The reason is that "low" prices can always go lower. Even when the price is low, it is important to make sure that the investment is fundamentally sound.

Banks are fundamentally sound. They have experienced some headwinds, and they have been tarred with negative sentiment fueled by the poor decisions of a handful of peers. This makes me happy to buy more BTO before sentiment shifts and the market realizes how strong the fundamentals are.

Conclusion

With John Hancock Financial Opportunities Fund, I'm able to enjoy strong income from a wide variety of banks operating within the United States. This fund not only holds regional banks that have a strong regional presence but also nationwide banks like Bank of America ( BAC ) and JPMorgan Chase ( JPM ). In the current environment, the larger the bank is, the better situated it is to benefit from the future. This is because the current interest rate environment and the cost of deposits are creating a situation of haves and have-nots. However, the management team of BTO has been exceptional at finding and discovering value within the banking sector for decades, and I fully expect that they will continue to be able to do so, providing me with strong income quarter after quarter.

Today, I can buy individual banks and try to pick the best ones out of hundreds that exist across the market, or I can use the fund with the management team that's been able to succeed in providing real value to their shareholders in the long run. While the market can be a turbulent sea with many different areas that get beaten and bashed, the banking sector has been one that has continued to provide value to its shareholders.

When it comes to retirement, you want to have income that you can bank on, and having a portfolio modeled using our unique Income Method can allow you to have a portfolio that enables your retirement to be as amazing as you want it to be. Your financial situation shouldn't be holding you back. It should be propelling you forward to a better, greater future.

That's the beauty of my Income Method. That's the beauty of income investing.

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