HPS: Valuation Has Become More Attractive (Rating Upgrade)

John Hancock Preferred Income Fund III (HPS) has been upgraded to a "buy" rating, driven by its current attractive valuation—trading at a reduced 1.1% premium to NAV after a 9.8% share price decline over the past year. Despite a 1.5% total return loss over 12 months and ongoing pressure from elevated interest rates affecting its operating spread and high leverage, the fund offers a 9.1% dividend yield. The upgrade anticipates that potential future interest rate cuts will improve HPS's performance, positioning it as an appealing income-focused opportunity for investors willing to accumulate shares in anticipation of a market turnaround.

Analysis

The John Hancock Preferred Income Fund III (HPS) has been upgraded to a buy rating, predicated on a valuation opportunity created by recent market pressures. The fund's share price has declined 9.8% over the last twelve months, resulting in a negative 1.5% total return and compressing its premium to NAV from a three-year average of 4.6% to just 1.1%. This valuation shift is the central pillar of the revised outlook. HPS operates as a leveraged income vehicle, offering a 9.1% dividend yield primarily through a portfolio of preferred securities (54.85%) and corporate bonds (41.56%), with heavy concentration in the financial sector at 61.5% of its $724M in assets. However, significant risks persist, primarily driven by the high interest rate environment. The fund's aggressive leverage of 37.72% amplifies risks and compresses its net investment income spread, contributing to a steady decline in its NAV per share from $18.33 in 2021 to $14.51 in mid-2025. Furthermore, the portfolio carries substantial credit risk, with 37.76% of its holdings rated below investment grade, exposing it to a potential increase in defaults, which S&P Global forecasts could rise to 3.5% by March 2026 in a pessimistic scenario. The sustainability of the dividend, while currently covered by net investment income, is therefore contingent on an eventual easing of monetary policy, as prolonged high rates could force a distribution cut.

Key Decisions for Investors

• Income-focused investors with a higher risk tolerance could consider accumulating HPS at its current suppressed valuation, viewing the 9.1% yield as compensation for waiting for a more favorable interest rate environment.
• Closely monitor key metrics such as the fund's leverage costs, trends in its NAV, and credit default rate forecasts, as a sustained period of elevated rates could jeopardize the dividend and erode the investment thesis.
• Investors should recognize HPS is a vehicle for income, not capital appreciation, and may be best held in a tax-advantaged account to mitigate the higher tax liability associated with its ordinary income distributions.