RA - PDT: Worst Performing In Category Now Yields 11% Is It A Buy?

2023-10-23 11:50:26 ET

Summary

• John Hancock Premium Dividend Fund aims for high current income and capital growth, but has underperformed in the last decade.
• PDT focuses on dividend-paying securities, with utilities and financials making up a significant portion of its portfolio.
• PDT recently reduced its monthly payouts, causing investor disappointment, but still offers a high yield at its current price.
• We examine the setup for this fallen fund.

We recently looked at John Hancock Preferred Income Fund II ( HPF ) and calmly told you that the revered fund was a Sell. Thanks to its pricing distortions relative to its category, we felt that it was best you moved on to other alternatives. Let us talk about another fund with a very similar name, from the same family today. John Hancock Premium Dividend Fund ( PDT ) also "seeks to provide high current income, consistent with modest growth of capital." Here capital appreciation does not take a backseat, but might as well have, based on the total returns on NAV over the last decade.

Why Are We Looking At This One Today?

Well, we followed HPF and at the time we looked at all its brethren and were keeping an eye on them. We noticed that PDT had the proud distinction as of yesterday of being the worst performer year-to-date in the taxable income category on CEF Connect.

Not one of the worst, the worst. We must add here that this is a broad category that includes high yield CEFs, preferred CEFs, investment grade CEFs and even the unicorn known as Taxable Muni CEFs. This is stuff we write about on a regular basis and we have actually thoroughly covered Highland Opportunities and Income Fund ( HFRO ), Brookfield Real Assets Income Fund Inc. ( RA ) and Flaherty&Crumrine Preferred Income Fund ( PFD ), which made it to numbers two , three and four on this infamous list. So obviously something might be broken here for PDT. Alternatively, this could represent an opportunity and that is what we are exploring.

The Fund

The mandate for PDT under normal circumstances, is to invest at least 80% of its total assets on dividend paying securities, be it preferred or common. The aim is to target large-cap companies with good credit and strong fundamentals and higher than average dividend yields. The fund also has the leeway to invest in a host of other types of securities, including debt and preferred securities, primarily of investment grade. As at September 30, 2023, utilities formed close to 43% of the fund's portfolio, followed by financials at about 37%.

PDT held over 100 securities at the end of last month, with the top 10 issuers contributing about a third of the portfolio.

Like in HPF's case, this list too has a few familiar faces, most notably BP p.l.c. ( BP ) that has been a personal holding on and off over the years.

Unlike HPF, PDT's distribution cut is more recent. Effective June of this year, PDT reduced its monthly payouts from 9.75 cents to 8.25 cents. The income investor did a stealthy ninja exit in reaction to this event. The cut is fresh and investors are still nursing their feelings, so for now this fund remains in the gutter. We next look at the things you should consider in making your purchase decision.

1) What You Are Buying

The first thing to get here is that while PDT is lumped in with Nuveen "preferred" category, this fund is a blend. Common equity shares and preferred shares are almost split right down to center.

So you would expect this fund to have a slightly higher beta than preferred share CEF category. Of course with the S&P up for the year and preferred share ETFs down you would expect perhaps PDT to have done well.

2) Performance

PDT's poor performance year to date has been an outlier and we will get to reason for that a little further on. The fund has produced a solid, although exact comparatives are hard to benchmark this. The fund has done better than HPF, Reeves Utility Income Fund ( UTG ) and Cohen&Steers Infrastructure Fund Inc. ( UTF ). The latter two are good representatives of the utility heavy CEF category. Note performance is shown on NAV.

3) Price Vs NAV

PDT, thanks to the ninja income investors, is a bargain comparatively. The bulk of PDT's performance this year can be attributed to a widening discount to NAV. We started the year at a slight premium and now we are at a 12.16% discount.

Total return on NAV has not been too bad considering that utilities and financials have been taken to woodshed this year. The one year Z-score is decent and improves prospects for returns here.

Verdict

If you are looking for a CEF which goes across the preferred shares and common equity category, PDT fits the bill. The fund trades at a wide discount and that adds to its appeal. There are two reasons here that we are hesitant to add a buy. The first being that while the fund appears cheap, you can get even heavier discounted funds in both common equities and preferred categories. One example from each are shown below.

The second reason is that there is still a deal breaker in place. That deal breaker is the leverage.

At 42.13% leverage, the fund is far above our acceptable limits. We will also note that the expense ratio shown in the same screenshot, vastly understates the true expense ratio in real time today. The annual report capture is as of October 31, 2022 and interest rates have had a vertical climb since. The combination of leverage and interest rate sensitive assets make this a pass. Yes, there is that 11% "yield". If you believe that a fund that has generated 6.6% annually, primarily through ZIRP, can sustain a 10% yield on NAV (11% on price), we have a bridge to sell you.

We would consider this post a leverage reduction alongside at least a 15% discount to NAV. For now, we rate it as a hold.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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