Analyzing Return of Capital in Managed Distribution Funds: Implications for Income Investors

The John Hancock Tax-Advantaged Dividend Income Fund (HTD) exemplifies the complexities of managed distribution funds, where return of capital (ROC) plays a pivotal role in sustaining high yields for income investors. As of August 2025, HTD’s monthly distribution of $0.1580 per share includes 74% net investment income and 26% ROC, reflecting a strategy to maintain payouts even when earnings fall short [1]. Over the fiscal year-to-date, the fund’s distributions have averaged 70% from income and 30% from capital gains and ROC [2]. While ROC provides a steady cash flow, its sustainability hinges on the fund’s financial health and market conditions.

The Mechanics of Return of Capital

ROC is not a taxable income stream but a return of the investor’s original capital. For HTD, this means that 26% of its August 2025 distribution effectively reduced shareholders’ cost bases by $0.0417 per share [3]. Over time, repeated ROC distributions amplify the tax liability upon sale, as the adjusted cost basis (ACB) shrinks, increasing the capital gain [4]. For example, an investor who purchased shares at $26.05 (NAV) and received $1.42 in ROC over a year would see their ACB drop to $24.63, resulting in a larger taxable gain if sold at $24.52 [5].

Sustainability Challenges

HTD’s ability to sustain its 7.67% annualized distribution rate (based on NAV) depends on its capacity to generate income and realize capital gains. The fund’s leverage of 31.22% and gross expense ratio of 4.44% pose risks, as higher costs and interest expenses could erode returns [6]. While the fund’s portfolio of tax-advantaged dividend stocks supports income generation, its reliance on ROC—used when distributions exceed net investment income—signals potential strain [7]. The fund’s 5.87% discount to NAV also raises questions about market confidence in its long-term performance [8].

Tax Implications for Investors

ROC distributions defer tax consequences until the sale of shares, offering short-term tax efficiency. However, this strategy carries hidden costs. If an investor sells HTD shares after years of ROC distributions, the accumulated ROC reduces the ACB, triggering a larger capital gain. For high-income earners, this gain could be taxed at 20% (long-term) or up to 37% (short-term), plus an additional 3.8% net investment income tax [9]. The 2025 tax thresholds for long-term gains (e.g., $48,350 for single filers) mean that even modest gains could push investors into higher brackets [10].

Conclusion

HTD’s managed distribution plan highlights the trade-offs between income stability and long-term sustainability. While ROC allows the fund to maintain its 8.31% yield (based on share price), investors must weigh the risks of eroding capital and future tax liabilities. For income-focused investors, HTD offers a compelling but nuanced proposition: high yields come with the caveat that part of the return is a return of invested capital, not profit. As with all managed distribution funds, understanding the composition of payouts and their tax implications is critical to aligning with investment goals.

Source:
[1] John Hancock HTD Declares $0.1580 Monthly Distribution [https://www.stocktitan.net/news/HTD/john-hancock-tax-advantaged-dividend-income-fund-notice-to-fy692fvxt41d.html]
[2] JHancock Tax-Advantaged Dividend Inc: HTD [https://www.cefconnect.com/fund/HTD]
[3] Return of Capital (ROC): What It Is, How It Works [https://www.investopedia.com/terms/r/returnofcapital.asp]
[4] Understanding Return of Capital Distributions in ETFs [https://blog.roundhillinvestments.com/roc-distributions-in-etfs]
[5] HTD Summary [https://www.schwab.wallst.com/Prospect/Research/etfs/summary.asp?symbol=htd]
[6] John Hancock Tax-Advantaged Dividend Income Fund [https://www.jhinvestments.com/resources/all-resources/fund-documents/investor-fact-sheets/john-hancock-tax-advantaged-dividend-income-fund-investor-fact-sheet]
[7] SOURCES OF DISTRIBUTION UNDER SECTION 19(a) [https://www.johnhancock.com/about-us/newsroom/news/john-hancock-investment-management/2025/07/john-hancock-tax-advantaged-dividend-income-fund-notice-to-shareholders---sources-of-distribution-under-section-19-a-.html]
[8] JHancock Tax-Advantaged Dividend Inc: HTD [https://www.cefconnect.com/fund/HTD]
[9] Topic no. 409, Capital Gains and Losses [https://www.irs.gov/taxtopics/tc409]
[10] 2025 Capital Gains Tax Rates [https://www.fidelity.com/learning-center/smart-money/capital-gains-tax-rates]