John Hancock Preferred Income Fund III (HPS)
John Hancock Preferred Income Fund III concentrates on a single asset class: preferred stocks. These are hybrid securities—part stock, part bond—that pay a fixed or floating dividend and rank ahead of common equity if a company gets into trouble, but behind traditional debt holders. For income-seeking investors, preferred stocks offer higher yields than common stocks and (usually) higher yields than many bonds, with less volatility than common equity. The fund buys a diversified portfolio of preferred stocks from various issuers—banks, insurance companies, utilities, and industrial firms—and distributes most of the income to shareholders monthly.
The preferred-stock niche
John Hancock Preferred Income Fund III launched in 2007, just as the financial crisis was beginning. The fund manager, John Hancock Asset Management (part of the Canadian insurance and asset-management company Manulife), had identified an opportunity in preferred stocks. These securities were less well-known than bonds or common stocks, but they offered an interesting middle ground: much higher yields than common equity, less downside risk than common stocks, and a specific claim on company cash flows through their fixed or floating dividend.
The market for preferred stocks is real but smaller and less liquid than the bond or equity markets. That meant fewer investors competed for these securities, which sometimes meant they were mispriced—undervalued relative to the risks they carried. A fund manager with expertise and the ability to hold dozens or hundreds of preferred stocks could assemble a portfolio that offered genuine income with reasonable diversification and risk management.
What preferred stocks are and why a fund holds them
A preferred stock sits in the capital structure between common equity and bonds. If a company earns money, it first pays interest on its bonds. Then it pays the fixed or floating dividend on its preferred stock (if it can afford to do so without impairing capital). Only after that does anything flow to common-equity holders. If a company enters bankruptcy or is liquidated, bondholders get their claims paid first, preferred shareholders get what remains, and common shareholders get what is left over—usually nothing.
That priority creates stability. A preferred stock is less likely to be cut than a common dividend, because cutting it signals weakness. A preferred dividend is also less discretionary than a common dividend; it is almost a contractual obligation. In exchange, the preferred shareholder gives up the upside of common equity—the preference pays a fixed amount, not a growing amount. The holder of a preferred also takes on interest-rate risk: if rates rise, the value of the preferred falls because new preferreds can be issued at higher yields.
HPS holds preferreds from banks (JPMorgan, Bank of America, Citigroup), insurance companies (Berkshire, Loews, Reinsurance Group), utilities (Duke Energy, NextEra Energy), and industrial and financial firms. The fund’s portfolio typically comprises 50–150 holdings, with concentration varying based on where the manager finds value. Because preferreds have varying dividend yields, floating-rate versus fixed-rate structures, and different seniority levels within the capital structure, the manager’s job is to pick the ones offering the best risk-adjusted income.
The leverage question
Like many closed-end funds in the income space, HPS uses leverage—borrowing money at shorter-term rates and investing the proceeds in longer-yielding preferred stocks. When the yield on preferred stocks exceeds the cost of short-term borrowing, leverage amplifies the return for common shareholders. This turbocharges the monthly distribution.
In a benign environment with stable credit conditions and an upward-sloping yield curve, leverage works well. The fund earns more than it pays to borrow, and shareholders get a distribution that is higher than it would be without leverage. But leverage is a bet. If preferred-stock values fall sharply (as they did during the 2020 pandemic sell-off and again in 2023 as rates rose), or if short-term funding becomes expensive or unavailable (as in a credit crisis), leverage becomes a liability. Shareholders’ capital can be impaired quickly.
The fund’s leverage ratio has generally run between 30 and 45 percent, meaning the fund borrows roughly $0.35–0.45 for every dollar of shareholder capital. That is moderate leverage by closed-end-fund standards, but it is still a significant amplifier of both gains and losses.
Interest rates and the changing landscape
What is shifting in the preferred-stock market is the level and volatility of interest rates. For more than a decade after the financial crisis, rates stayed very low and stable. In that environment, preferred stocks paid 5–7 percent yields and did not move much in price. They were stable, income-generating, boring—exactly what an income investor wanted.
From late 2021 onward, the Federal Reserve raised rates sharply to fight inflation, pushing yields across the fixed-income market higher. Preferred stocks were repriced downward to reflect those higher rates—a preferred that used to yield 5 percent and was priced at $100 per share might now be priced at $92 to yield 6 percent. That repricing was painful for existing shareholders, though it also created new opportunity: new preferred stocks were being issued at higher yields, and existing ones trading at discounts became more attractive.
Simultaneously, the structure of the preferred market shifted. Floating-rate preferreds—where the dividend resets periodically based on short-term rates—became more common, as issuers sought to limit their exposure to rising rate risk. That is good for shareholders in a rising-rate environment, because the dividend on a floating preferred goes up when rates go up. But it also means the portfolio composition of a preferred-stock fund changes—the mix of fixed and floating preferred shifts, and the rate-sensitivity profile of the portfolio changes.
Credit risk and market risk
The fund faces two main categories of risk. Credit risk is the danger that an issuer cuts its dividend or becomes unable to pay. This happened to some preferreds during the financial crisis, when major financial institutions like Citigroup suspended their preferred dividends. It is less likely to happen in normal times, but it is always a possibility with preferred stocks.
Market risk is the risk that interest rates move against the fund, pushing down the value of all preferred stocks. This is the dominant risk. When the Fed raised rates in 2022–2023, HPS and similar preferred-stock funds declined sharply in net asset value, even though the credit quality of the underlying preferreds had not changed. An investor who bought HPS at a time when rates were low faced losses if forced to sell during a period of higher rates.
A third risk is leverage risk—that short-term funding becomes expensive or unavailable, forcing the fund to sell assets at bad prices or reduce leverage (which shrinks the distribution). This risk materialized briefly in March 2020 when preferred-stock values collapsed and credit markets froze.
How to research the fund
The fund’s monthly fact sheet (published on John Hancock’s website and available through EDGAR under SEC CIK 0001215913) shows the asset allocation—the mix of different issuers and types of preferreds. Look at how much of the portfolio is invested in floating-rate versus fixed-rate preferreds, as that tells you how much the fund will benefit or suffer if rates continue to move. Check the average yield of the holdings, which indicates the distribution potential.
Watch the fund’s discount or premium to net asset value. A wide discount suggests the market is skeptical of the fund’s future, possibly because investors fear leverage or expect rate declines that will hurt preferred values. A premium suggests confidence.
Most important, monitor the fund’s distribution details each month. The monthly distribution is broken down into yield on existing assets and return of capital. If return of capital is growing relative to actual yield from the portfolio, it signals the fund’s assets are not generating enough income to sustain the payout without principal erosion. Over time, that becomes unsustainable.