‘Hunkering Down’ To Weather The Storm With John Hancock’s Financial Opportunity Fund

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I have been a big fan of the John Hancock Financial Opportunity Fund (BTO) for many years, but its distribution yield, around 6%, never excited me all that much. But the fund, currently beaten-down in price but looking strong in terms of its portfolio and-cash generating ability, is still making the same distribution payment it always has. Except, now it represents a 10% distribution yield at its current price.

BTO, whose symbol used to stand for “Bank & Thrift Opportunities,” started out years ago investing in smaller regional banks and thrift institutions and eventually morphed into a fund specializing in major money center banks as well as regional institutions. It has a long history by closed-end fund standards, starting out in 1994, and its sponsor, John Hancock, has a terrific history and reputation. BTO has a total return average of almost 9% since inception and an impressive 10.9% for the past ten years.

I began to take a closer look at BTO recently as I searched for candidates for my “Hunker Down” portfolio. The goal was (and still is, since like many of my Income Factory portfolios, the “Hunker Down” model is a work in progress) to find funds that have a high likelihood of continuing to make distributions through “thick and thin” as we face the economic, medical, political and financial challenges of the next few months and 2021.

Based on reports I have seen (like this one and this one), it looks like most banks will not be cutting dividends and are well-capitalized and reserved to handle a serious recession. But you wouldn’t think so if you look at how BTO’s market price is down 42% from its pre-pandemic high, and its distribution yield has been driven up to 10.4% from around 6% earlier this year.

Meanwhile, the banks and other financial firms that BTO owns look like a pretty strong bunch, judging by the top ten holdings list:

Nine of the ten holdings (that together represent about a third of the whole portfolio) are banks, and not one of them has cut its dividend from its pre-pandemic level. Blackstone, a very strong non-bank financial group, typically has tended to move its dividend up and down to reflect its lumpier and less steady earnings flow. But analysts do not regard that as a sign of weakness, merely a different business model from banks that deliberately target a steadier financial growth profile.

These two factors – (1) that BTO’s price has dropped about one-third further than the stock price of its holdings, and (2) that its yield has jumped by 73% (from 6% to 10.4%), while the average yield of its holdings has only (?) jumped by 47% (from an average 2.8% to 4.1%) – suggest to me that the market has overcompensated in this case for the risks and unknowns in the banking and financial sector (which are real, of course) by taking it out on BTO.

If that is true, then BTO stands to bounce back further when the markets eventually return to something approaching normal. In the meantime, we are paid over 10% to wait for that to happen. Even if, for the first time in many years, BTO had to adjust its distribution downward, there is a fair amount of room to drop it before it reaches its previous 6% yield level.

A more conservative alternative

Investors looking for another way to “hunker down” that relies on the long-term strength and staying power of the major banks but doesn’t take the risk of indirectly owning their common stock may wish to consider some of the closed-end funds that focus on the preferred stock space. There are a number of CEF sponsors that specialize in preferred stocks and similar hybrid income classes (like convertibles, bank capital notes, etc.). They include:

  • Flaherty & Crumrine, whose entries in this category include, among others: F&C Total Return Fund (FLC) and F&C Preferred Income Opportunity Fund (PFO). I mention these two because they have lower premiums (although they are still both selling slightly above par, which reflects the fact the market has recognized how relatively safe these asset classes are at a time of widespread uncertainty). They pay distributions of 6.9% and 6.5%, respectively, and have had average total returns of 10.5% and 10.3% respectively for the past ten years.
  • Nuveen, whose preferred stock funds include the Nuveen Preferred & Income Opportunities Fund (JPC) and the Nuveen Preferred & Income Securities Fund (JPS), among others. These two have distributions of 6.9% and 7.5% and sell at discounts of -2.7% and -2.1%, respectively. Both have produced average total returns over 9% over the past ten years.
  • Investors may also wish to consider the John Hancock Premium Dividend Fund (PDT). It’s been around since 1989, with a ten-year average total return of 11.6%. It pays out 8.95% distributions with a price premium of 2.83%.

All of these are top-flight funds in the preferred stock arena. What I like about closed-end funds in the preferred asset class like these, especially right now, is:

  • The diversification and professional management, and the advantage of being in a closed-end fund vehicle that, through discounting (when available) and the cheap institutional leverage, can pay us 6-7% on an asset class whose “naked” or “natural” yield if held directly or in an open-end fund would only be about 5%.
  • The fact that they all focus mostly on preferred and other hybrid debt (holding company debt and other capital notes, convertible debt, etc.) issued by major banks, financial institutions and also major utilities. These are segments that are well-positioned in terms of capital and market position to survive and muddle through whatever challenges lie ahead of us.
  • In particular, the companies in these sectors – highly rated, major players in prominent industries, quintessential “blue chips” – even if they were to stumble temporarily and have to decrease their dividends, are highly unlikely to eliminate them entirely.
  • Hence the beauty of preferred stocks. A company cannot pay even one penny of common stock dividend unless it pays 100% of its preferred stock dividends. Even if a major bank or utility encounters business challenges, in the great majority of cases, I don’t think it would totally eliminate its common dividend unless its back were really against the wall. And as long as it pays any dividend at all to its common stockholders, my preferred stock payment is safe.

So, to summarize, I think BTO is an attractive opportunity at the current price and yield, and I plan to buy it myself and include it in some of our model portfolios. But if you want to avoid any common stock risk at all in the financial arena, while still collecting a reasonable distribution yield from some very well-established and professionally managed preferred stock funds, then you may wish to check out the John Hancock, Nuveen and Flaherty & Crumrine funds mentioned.

Thanks to all my members, followers and subscribers for your helpful suggestions, questions and comments. It was actually an Inside the Income Factory member’s question that caused me to explore the topics that led to the ideas in this article. I’ve often said that our dialogue is a two-way street, and it is.

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If you enjoy reading my articles and/or my book about the Income Factory®, but would like frequent real-time alerts to changes in the model portfolios or a more up-close-and-personal involvement with me and other members of the Income Factory community, then check out Inside the Income Factory.  It’s a boutique subscription service whose member/subscribers get to share their ideas and participate in the dialogue and decision-making that goes into creating our Income Factory model portfolios and our search for other investment opportunities. If you want to take your Income Factory investing up a notch, please click here to learn more.

Disclosure: I am/we are long BTO, JPS, FLC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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