HTD - HTD: Long-Term Winner Despite Latest Volatility

2023-04-18 16:31:50 ET

Summary

• What helped out HTD in terms of performance last year is what is making for weaker performance this year.
• Financials took a hit last month with the bank failures, primarily representing HTD's preferred and corporate bond allocations.
• At the same time, the larger utility sleeve of HTD has been weaker this year.

Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on April 4th, 2023

John Hancock Tax-Advantaged Dividend Income Fund ( HTD ) has been in a bit of a struggle in the last month or so due to bank failures and weaker utility performance. The fund is primarily invested in utility equity positions which have been weaker on a YTD basis for the fund. Additionally, the preferred and bond exposure the fund carries is primarily focused on financials - which was sent into a shock for March due to bank failures. Last year, the fund's utility exposure helped stave off deep declines we saw from many other asset classes, with HTD's declines being relatively limited.

All that being said, the fund's discount hadn't widened too significantly as the share price continued to hug its NAV quite closely, but more recently a slight discount has opened up. Longer-term, this fund had often provided deep discounts to allow investors to pick up a position or add to their position at attractive prices. At the same time, the latest declines should also be factored in.

A long-term investor could consider dollar-cost averaging into a position while we are at lower prices. A more patient investor could wait for a better discount to buy a larger position, which admittedly could happen if we see more volatility. However, even this latest volatility hasn't shaken the fund to any meaningful discount and having the second and third-largest bank collapses in U.S. history would generally be a big deal.

Since our last update , the fund has experienced declines due to the reasons mentioned above.

The Basics

• 1-Year Z-score: -0.78.
• Discount: -4.47%.
• Distribution Yield: 7.64%.
• Expense Ratio: 1.14%.
• Leverage: 35.07%.
• Managed Assets: $1.194 billion.
• Structure: Perpetual.

HTD's objective is to "provide a high level of after-tax total return from dividend income and capital appreciation." They highlight that the fund can be used for "tax-sensitive equity income." After all, even folks in retirement looking for fixed income should have some exposure to equities as well to maintain some diversification.

Their approach to investing is "typically investing at least 80% of assets in dividend-paying securities." With that, they will "typically emphasize preferred and common securities in the high dividend-paying utility sector."

The fund is pretty highly leveraged, but that often isn't too much of an issue for the more defensive positioning in the fund. Although noting the word "often" as the last month showed us that even defensive assets can become volatile with the right events.

The fund's expense ratio, when including the fairly heightened level of leverage, comes to 2.05% . As most leveraged CEFs have been experiencing, HTD sees higher leverage costs. The borrowings cost them 4.43% as of their last report, with rates heading higher since this also has increased. They pay based on one month LIBOR plus 0.625%.

However, as I noted in the last update, and that remains just as relevant now, they have hedged against these higher costs. This is through both utilizing interest rate swaps and shorting Treasury futures contracts. So, while the costs of the debt are rising, should the Fed continue to increase rates, the swap contracts and future contracts should see appreciation to offset the rising borrowing costs.

Performance - Discount Widens A Bit Recently

When looking at the YTD results for this fund, we can see that the fund had started to experience some of the upside with the broader market that kicked off at the beginning of the year. Most of the declines came in March when we saw the bank failures. Which was primarily driven by the allocation of the fund to the financial sector.

On top of the financial sector headaches, utilities weren't performing too much better on a YTD basis. The utility sector is the second worst-performing sector, only beating out the financial sector.

Over the longer term, the fund has been able to beat out its blended benchmarks. However, more recent results have shown that HTD has struggled a bit more. Also, note that these results aren't reflected through the end of March 2023 yet. That being said, the fund's benchmark results will also be impacted by the hits to the financial space as they incorporate preferred allocations, which makes sense.

HTD's declines were likely sharper in the last month - as we've seen with more recent results to the downside - due precisely to the leverage the fund utilizes. Of course, that also means that over the longer term, the fund's leverage also contributed to better results, too.

The fund is an attractive long-term play, in my opinion. However, why I still can't see it being a screaming buy despite what I believe will be a recovery in the financial space due to its valuation. As I said at the beginning, the fund has historically provided better opportunities in terms of buying this fund at a deeper discount. Over the last decade, the average discount was over 6%. At the same time, I could still see the case for adding cautiously here due to the hit from the financials and utilities.

In fact, if one expects a recession later this year, HTD could be a somewhat safer place to invest due to its defensive nature. Bearing in mind that if a recession sees more bank failures, we can expect heightened volatility to return, as we saw in March.

Distribution - Steady And Reasonable

When looking at a distribution for a CEF, investors tend to gravitate towards higher yields and/or how long a fund has continued to pay the same distribution out to investors.

However, that doesn't always tell us the whole story of if a distribution is being covered or not. A CEF can essentially pay out what it wants for as long as it wants and as long as the NAV stays positive.

With equity funds or hybrid funds such as HTD, they will regularly require capital gains to fund their distributions. As we touched on above, a fund's derivative contracts can be a source of those capital gains. Those capital gains can be achieved if they are successfully positioned, no matter what the broader market is doing.

Net investment income coverage for the fund in the prior fiscal year was 66.31%. That was a decline from 73.67% in the prior year. The 2021 fiscal year even had a $0.0208 special, making the total distributions paid slightly larger than the prior fiscal year. HTD paid another small special at the end of 2022, but that will be reflected in fiscal 2023 for the fund.

The decline in NII came precisely from the higher leverage expenses, as one would have probably guessed. Interest expense for this latest fiscal year was nearly $7.9 million from the $3.110 million in the prior year . A small decline in total investment income going from $56,943,731 to $56,867,232 would have also had an impact, albeit an incredibly small impact relative to the interest expenses rising.

Of course, during back-to-back weak years of performance, it can start to take its toll on a fund and its distribution. In the case of HTD, I still believe we are at a reasonable distribution rate for the fund despite what is starting to turn into a couple of years of weakness. Thanks to holding up significantly better last year, the fund's distribution yield comes to a fairly modest 7.64% with a NAV rate similarly at 7.57% due to a shallow discount.

The "tax-advantaged" portion of HTD's name refers to the qualified dividends that make up a large portion of the classification for the payout. Additionally, long-term capital gains make up a sizeable portion too. Of the total $1.6832 paid to investors in the prior year, $1.017784 was considered qualified dividends, with another $0.38219 considered LTCG. That left $0.283226 as ordinary income.

HTD's Portfolio

Overall, HTD's portfolio is comprised mostly of utilities at just over 56%. This is followed up by nearly 28% in financials, representing a lot of the preferred and bond allocation of the portfolio. Additionally, the fund has incorporated energy into the position, but the rest of the fund is pretty barren of diversification in terms of sector allocations. Thanks to the helpful way they provide the sector weightings, we can see that this has been fairly consistent over time for the most part.

The only change that could potentially be noteworthy but really isn't is that towards the end of 2018, the term for the telecommunication sector changed to communication services. That saw what would at first appear to be a change in the composition of HTD, but even at that, it doesn't represent a meaningful allocation to the fund.

When looking at the fund's top ten holdings, we see a representation of primarily utility companies. However, a couple of energy plays also make their way onto the top holdings list.

In particular, BP ( BP ) is the largest position in the fund. That's a bit of a change since our last update when it was The Williams Cos ( WMB ). WMB still represents a larger allocation to the fund though, and BP isn't necessarily new in the fund either. The allocation of BP has simply increased since that prior update. As we saw in the sector performance above on a YTD basis, the fund's energy exposure might not be down as far as utilities and financials, but it isn't in the green yet, either. With OPEC+ announcing cuts recently , that could be an area that gets further support going forward.

That being said, most of these names are all repeats but are simply different allocations due to normal market gyrations or small allocation changes. In the case of BP, the latest share count we can see is reflected in the N-PORT as of January 31, 2023. At that time, it reflects the same 845,450 share count as we can see back at the end of October 31, 2022. That tells us there's a good chance that the change reflected here was driven by market changes only. Bringing up the performance between the top ten clearly confirms this as well.

The fund's turnover is fairly low at just 11% in the prior fiscal year. The turnover has only gone as high as 24% in the last five years, and that occurred in fiscal 2018. So, it makes sense that we regularly see the same names appear in this fund from each quarterly update.

Conclusion

HTD's mixture helped it in the prior 2022 year, while most other investments struggled. However, more recently, what helped this fund last year is what isn't working this year. The utility sector was weaker on a YTD basis, and the financial sector was even weaker. HTD's exposure there is via preferred and fixed-income. That being said, despite this volatility, the fund's discount still hasn't widened out to a screaming buy level. A more patient investor could wait for a widening discount or feel comfortable continuing to hold. If one believes that financials can recover from here, as well as seeing utilities reverse their fortunes, then a lower price now still might make a tempting offer.

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