PDT: high return, but high expense ratio (NYSE: PDT)

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John Hancock Preferred Dividend Fund (New York Stock Exchange: PDT) is a closed-end equity mutual fund (“CEF”) that invests primarily in high-dividend stocks and bonds of utility, financial and energy companies. The fund invests in stocks and preferred shares primarily of these companies that have investment grade or investment grade debt securities. The fund has always paid monthly dividends over the past 28 years, and has generated a yield between 7 and 11% over the last 10 years. However, the price performance has always remained stable. Nevertheless, the fund has a positive total return over the long term.

High expense ratio plagues John Hancock’s dividend fund

PDT evaluates the performance of its portfolio against a benchmark composed of 70% of the eligible Bank of America Merrill Lynch Preferred Stock DRD index and 30% of the S&P 500 Utilities index. The fund was established as John Hancock Patriot Premium Dividend Fund II on December 21, 1989. It was launched and managed by John Hancock Investment Management LLC and is co-managed by John Hancock Asset Management. The fund seeks to generate strong income for its investors and has generated positive long-term total returns over the past 10 years.

PDT has an extremely high rate expense ratio by 1.82 percent. A likely reason could be its smaller asset base which stretches while investing in such a variety of assets. The fund also invests a very small proportion of funds in each of its selected stocks. His top 16 equity investments consist solely of 35 percent of the entire portfolio. In just three stocks, the fund has invested more than 3 percent. These stocks are NiSource Inc. (NI), The Williams Companies, Inc. (WMB) and NextEra Energy, Inc. (NEE). Research and management fees are also increasing due to the focus on stocks and preferred stocks of only companies that have high quality senior debt.

Additionally, asset selection and management in the utilities sector requires more expertise, as these stocks are not among the most popular stocks. Nearly half of its entire portfolio is invested in stocks and bonds belonging to the utility sector. This high spend rate technically generates an income of just over 5%, when the return is 7%. This could be one of the main reasons why investors avoid this stock, which is reflected in its poor price performance. Potato price growth has been negative over the past 3-5 years. Over the long term, it has managed to generate a positive price return, but this is exceptionally low.

A portfolio of utilities and financial stocks aimed at generating high yield

Almost 80 percent of PDT’s investments are in the utilities and finance sectors. Within utilities too, investments are split between electric utilities, gas suppliers and other multi-utility providers. In the financial sector, the fund invested in banking companies, capital market advisers and a few insurance companies. The fund invested half of its investments in equities, while the other half was invested in securities generating fixed income. Investments in corporate bonds financial giants, such as Citizens Financial Group, Inc. (CFG) and Bank of America Corporation (BAC), typically generate a return of over 6%, while its investments in government bonds have a yield of less than 3 percent.

Composition PDT

Membership (PDT website)

Source: Investor sheet | John Hancock Preferred Dividend Fund

The best thing about PDT’s stock portfolio is that 12 of its top 16 investments have generated double-digit returns over the past year. These companies are WMB, NI, Duke Energy Corporation (DUK), Dominion Energy, Inc. (D), OGE Energy Corp. (OGE), BP plc (BP), FirstEnergy Corp. (FE), Kinder Morgan, Inc. (KMI), Black Hills Corporation (BKH), Public Service Enterprise Group Incorporated (PEG), Spire Inc. (SR) and DTE Energy Company (DTP). However, unlike many other funds, only four stocks – WMB, OGE, BP and NI – were able to generate returns above 20%. In addition, the proportion of funds invested in a particular security is quite low. This implies that, although most stocks generate good returns, none of the stocks alone has the ability to pull up or down the performance of the fund.

Advantages and disadvantages of high yield funds

Investing legends like Benjamin Graham and John Bogle advocated buying stocks that pay high dividends. The same principle can be applied to CEFs, exchange-traded funds (“ETFs”) or any other fund. A CEF pays dividends out of its profits. Thus, funds paying higher dividends can be assumed to perform better. Investors can add stability to their portfolio by buying established funds with a history of regular and frequent high-yielding dividends. Dividends also provide a cushion in case the fund loses its market value and also creates an opportunity for the stock price to appreciate. This is the main reason for investing in high dividend stocks.

However, dividends are never guaranteed and are entirely dependent on general economic conditions as well as company performance. Historically, high yielding stocks have failed to become growth leaders. With few exceptions, high growth stocks generally do not pay high returns even if they have generated sufficient earnings and outperformed the market. Instead, these high-growth stocks invest more in capital expansion, research and development, human resource development, and mergers and acquisitions. In the case of high growth funds, they invest in acquiring more and better performing stocks in order to generate higher growth.

Investment thesis

The individual investments within the portfolio of the John Hancock Premium Dividend Fund have been able to generate steady growth in their values, and thus the fund has been able to generate a high return. The fund invests primarily in stocks and bonds of various types of utilities and financial companies. It invests a very small proportion of funds in a particular security and thus enjoys the advantage of diversification. However, its investment strategy involves a high expense ratio. An excessively high expense ratio eats away at the return offered to its investors, and the company has therefore failed to generate strong price growth. The fund could probably fall into the group of high yield funds unable to become a growth leader. While I don’t doubt PDT’s ability to generate high returns in the future, I don’t anticipate investors buying this fund in volume unless it is able to reduce its expense ratio.

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Sallie R. Loera