One share per sector, or two?

[tjh290633]

Would the portfolio holder be happy with a farm bet of £100,000? I did not specify the size of his portfolio.

TJH

I thought that a farm bet of £100,000 meant that the size of the portfolio was also £100,000?

What do you mean by farm bet?

Adrian

Precisely that.

TJH

[moorfield]

That has nothing to do with the question that I put. Would the portfolio holder be happy with a farm bet of £100,000? I did not specify the size of his portfolio.

I would bet the farm on a single investment trust (CTY), certainly. But I suspect that wasn't quite the answer you were after.

[Gengulphus]

When people in the past have said "by having two holdings I reduce the chances of a company specific disaster" I have always muttered under my breath "yes and you halve the benefit of a company specific boost" such as a takeover or whatever.

To deal with a minor point first, "by having two holdings I reduce the chances of a company specific disaster" is plain wrong - as observed later in the thread, you double those chances. But I assume what they actually say is "by having two holdings I reduce the impact of a company specific disaster", and that's correct: you halve that impact. And yes, exactly the same applies if you substitute "boost" for "disaster".

But: exactly the same also applies if you substitute "sector" for "company" with appropriate consequential changes: "by having holdings in two sectors I halve the impact (and double the chances) of a sector specific disaster" and "by having holdings in two sectors I halve the impact (and double the chances) of a sector specific boost" are just as true. So if your argument implies that there's no point to diversifying into more than one company in a sector, then equally it implies that there's no point to diversifying into more than one sector... So why not just put your entire capital into the single share you think best?

Which is of course an absurd conclusion - but why is it absurd? Well, let's imagine someone thought that way in the spring of 2008. They might have thought that Lloyds was the best share around - and they'd have suffered a major disaster: even with Lloyds back to paying dividends and having a decent yield now, both capital and income would be a pretty small fraction of what they started with. Or they might have thought that Persimmon was the best share around - and they'd have experienced a major boost, with both capital and income several times what they started with. The first outcome is far worse and the second outcome far better than how a well-diversified HYP would have performed.

Equally, the owner of the well-diversified HYP might have chosen Lloyds, Persimmon, both or neither for it, and accordingly experienced either or both of those outcomes with one of its holdings - but the proportional impact of each on their entire HYP would only have been 1/15th as much (assuming a 15-share HYP). So capital and income of the HYP would have experienced a setback, a boost or both, but at nothing like either the "small fraction" or "several times" level...

What it all comes down to is: investing in a shares portfolio inevitably involves a gamble that one's own judgement about which are the right shares to be invested in will be good enough to achieve one's investment aims. One can't avoid making such a gamble (except by choosing something other than shares to be invested in, and that only replaces "the right shares" by "the right investments"), but one can decide how big to make the gamble. The totally-undiversified strategy of putting everything into a single share is a big gamble: get the share right and you win big, get it wrong and you lose big. A 15-share HYP is a smaller gamble, with both plausible wins and plausible losses considerably reduced in comparison.

Which is all stuff I think you basically 'get', given your later statement that "I think what I am saying is that diversification across 15 or so sectors and shares is enough in itself to mitigate the effects of single company problems without the need for also holding multiple shares per sector." But I think it's worth saying, partly because others might not, partly because it points out that the benefit of diversifying is that it reduces the variability of the outcomes (rather than improving the average outcome), and partly because it points out that the question of how much one wants to reduce that variability (and hence how much one wants to diversify) is an investor-specific question: the right answer for me is not necessarily the right answer for you!

That's partly for objective reasons, especially to do with what proportion of one's income comes from one's HYP and how badly that income is needed. Even a small chance of losing 25% of one's HYP's income is a fairly serious problem if one needs almost all of one's income and the HYP provides the vast majority of it, but much less serious if one has a good deal more income than one actually needs, if the HYP provides only a small proportion of one's income, or both.

But it's also partly for subjective reasons: whether rightly or wrongly, some people are more happy-go-lucky about such things. So even if I knew a good deal more about your financial circumstances than I do, I still wouldn't be able to tell you just how much diversification you want!

The above also provides some insight into the question of "doubling up" in sectors. A company in a new sector reduces the impact of both company-specific and sector-specific events (both disasters and boosts); a second company in an existing sector only significantly reduces the impact of company-specific events (*). So the second company in an existing sector does noticeably less to cut down the variability of outcomes than the company in a new sector. I.e. "doubling up" does improve diversification benefits, but by quite a bit less than a new sector does. Furthermore, if one goes into the maths of such things, the improvement tails off quite rapidly as the existing level of diversification rises (**). So essentially, I expect every HYPer to find a number of holdings at which they consider the benefits of further diversification to be negligible (and in particular, not worth the extra admin involved), and that number will be rather smaller with regard to "doubling up" than with regard to new sectors.

However, all of that is basically with regard to choosing a HYP bought with a lump sum or over quite a short period, during which market conditions don't change much. For HYPs built over longer periods, changing market conditions will mean that some sectors that did contain plausible HYP candidates no longer do (for instance, the financial sectors did contain quite a few of them in 2005, but by 2010 they contained few (if any!); the telecoms sector didn't contain any in 2000 but by 2005 it contained at least a couple). Which is good news for those with a taste for more diversification, as it means that with time, patience and not being too keen on selling off holdings that have lost their HYP qualifications (***), they can build up a more sector-diversified HYP than they could with a HYP bought over a shorter period.

The same sort of thing can happen for companies within sectors. A really big example of that is BP and Shell over 2009 and 2010: in 2009, they were fairly evenly-matched as HYP candidates, and a HYPer might very well have chosen BP out of the two; by mid-late 2010, BP had clearly completely lost its HYP credentials. So what was a HYPer who chose BP in 2009 to do if they've got more cash to invest in their HYP a year or two later? I can see four basic options:

1) Stick to only having one share per sector by deciding that means BP is their only choice in its sector, but is not an allowed HYP purchase, so they simply cannot invest any more in Oil & Gas Producers at all.

2) Stick to only having one share per sector by deciding that means BP is their only choice in its sector, decide that it's more important to continue investing in that sector than to only buy shares with HYP credentials, and so buy more BP despite it not being an allowed HYP purchase.

3) Stick to only having one share per sector by deciding that means they have no available HYP purchases in the sector unless they sell the BP holding, so sell it and use the extra cash plus the sale proceeds to buy Shell.

4) Decide that sticking to one share per sector isn't that important, so keep the BP holding and buy Shell with the extra cash.

What I know about those options is that they all have potential problems (and potential benefits) and that I've never managed to find an argument I find very convincing for one of them to be the 'right answer'. Instead, it is IMHO a matter on which each HYPer needs to use their own judgement - I can present them with some choices (as I have here), I can say what my own judgement is (FWIW, for my main HYP I usually favour option 4, but depending on my judgement about the company's recovery chances and my CGT circumstances at the time, I'll sometimes go for option 3 instead), but I cannot say with any certainty that my own judgement is the right one even for my own circumstances - let alone anyone else's!

Or to sum up this last section of my reply, if one builds up one's HYP over a significant length of time, sooner or later one is going to come across a situation where it simply isn't possible to adhere to all four of "invest in under-represented sectors in one's HYP as long as they contain a decent HYP candidate", "only buy shares that are decent HYP candidates", "don't sell voluntarily" and "only one share per sector". Your choice which you regard as the least important of those principles, but don't be surprised if some reckon it's "only one share per sector"!

(*) It will affect the impact of sector-specific events, increasing their impact in that sector and slightly reducing their impact in all other sectors. The overall effect might be in either direction, but is unlikely to reduce the impact all that significantly.

(**) On a total-return basis, various academic studies have shown that above around 10-15 shares, the further improvements that are possible exist but are pretty small. I think that if such studies were tried on a dividend-income basis instead, that number would be somewhat larger - that's essentially because it's more common for a share's dividend income to drop to zero than for its capital value to drop to zero (though fortunately also more reversible!). I'm by no means certain of it, though - but I'm uncertain enough that I personally prefer to play it safe and go for what might well be more diversification than I really need rather than risking having less than I need.

(***) Either through dividend cuts or through capital growth outstripping dividend growth.

Gengulphus

[evilbungle]

I would be the first to admit that I am not a great follower of the HYP arts as I let my feelings play too much of a factor in my decisions.

However for me, as I am in build mode so adding new funds as well as reinvesting, when I am topping up I make the choice then if I will top up that Sectors share or diversify. Classic example as Gengulphas also used to demonstrate is BP/Shell. I first invested in BP a few weeks before Deep Water Horizon and so was stuck with a Share I was not exactly happy to invest more in, therefore when topping up I bought Shell instead. My Shell holding in now double that of my BP holding and when I am again looking to top them up I will decide if I believe that Shell or BP currently have the best value for money (In my opinion - I am often wrong) this way I have diversified in some sectors (I currently have 3 banks) whilst in others (retail) no other share has ever seemed sufficiently secure enough to add instead.

I guess for me personally it depends on how many quality companies I see in a sector, at the specific time I am looking to invest. But as I said at the start I am not great at following the HYP rules so tend to be more relaxed with them.

[Gengulphus]

I thought that a farm bet of £100,000 meant that the size of the portfolio was also £100,000?

What do you mean by farm bet?

Precisely that.

Why exactly are "farm bets" in that sense at all relevant to discussions here, which are about HYPs as defined in this board's guidance?

"At its simplest, it will have at least 15 holdings, none of which should be from the same sector."

I can imagine a portfolio that is both a "farm bet" in that sense and a HYP within the spirit (though not the letter) of that guidance, but only in the case of a HYP being built up from scratch after the first purchase and before the second - e.g. GDHYP between July 2008 and October 2008 (last post in each thread). And it would be a very unusual HYP that made its first ever purchase with £100,000!

Gengulphus

[tjh290633]

I thought that a farm bet of £100,000 meant that the size of the portfolio was also £100,000?

What do you mean by farm bet?

Precisely that.

Why exactly are "farm bets" in that sense at all relevant to discussions here, which are about HYPs as defined in this board's guidance?

This cropped up in the discussion above about how many shares to have in a sector. It morphed into looking at an ivestor's attitude towards risk. This hinged on whether 15 should be the most you would ever need to have. See viewtopic.php?p=181106#p181106

I think it comes down to the amount invested. At, say, £20,000, duplication can be avoided with about 15 shares. At £200,000 it is a different matter and at £2 million, different again. What size of holding are you happy with? £1,000, £5,000, £20,000 or what? Can you sleep easily if you had a farm bet of £100,000?

In other words, do you or the OP begin to get worried if holdings get above a certain value? Would you be happy if you did a Jim Susan and put it all in a single share?

This is part of the argument for duplication within a sector, or non-duplication.

TJH

[Gengulphus]

Why exactly are "farm bets" in that sense at all relevant to discussions here, which are about HYPs as defined in this board's guidance?

This cropped up in the discussion above about how many shares to have in a sector. ...

Yes, I know what discussion "farm bets" cropped up in. What I'd like to know is why you consider "farm bets" relevant to that discussion?

I think it comes down to the amount invested. At, say, £20,000, duplication can be avoided with about 15 shares. At £200,000 it is a different matter and at £2 million, different again. What size of holding are you happy with? £1,000, £5,000, £20,000 or what? Can you sleep easily if you had a farm bet of £100,000?

So why is avoiding sector duplication with 15 equal-sized holdings any easier or more difficult with a total amount invested of £2m than with £200k or £20k? The holding sizes are different (£133,333 each to the nearest pound compared with £1,333 each) but neither involves "farm bets".

This is part of the argument for duplication within a sector, or non-duplication.

I can see absolute holding sizes (as opposed to their weightings within the overall portfolio) being part of that argument, though only really as a psychological and investor's-other-circumstances factor: a large absolute holding size may feel like too much to have at stake on a single company even if the overall portfolio size is much much larger and the holding only a small percentage of it. Though it is basically only those: apart from fixed (i.e. non-percentage) trading costs and liquidity issues, which should both be pretty small (negligible in the case of liquidity issues) for a decent-sized HYP, that 15-equal-sized holdings HYP of total value £2m behaves just like the one of value £20k with all monetary amounts multiplied up by 100. The psychological factor is that the £133,333 holdings feel a great deal larger than the £1,333 holdings - but replacing either is probably a bit more than a year's income from the HYP. The investor's-other-circumstances factors include that savings from their other income probably can't assist as much with replacing the holding: the £1,333 holding could probably be replaced within a few months or less even if it was done entirely from other income, the £133,333 holding would probably take quite a lot longer, especially if it was taxed income.

One other point is that the psychological and investor's-other-circumstances factors are ones that the investor will almost certainly have to overcome as their HYP gets larger, subject only to the fact that it won't continue getting larger forever. E.g. if one feels uncomfortable psychologically with holdings over £10k in value, that's easy enough to deal with when one has a £100k HYP: it can be a 15-share HYP and deviate a fair way from being equally-weighted without any one holding going over £10k in value (though some adjustment will probably be needed to deal with that discomfort, given enough time). If and when the portfolio value reaches £200k, a bare minimum of 20 holdings is needed to avoid that discomfort, and something more like 30 is probably needed to make it work reasonably smoothly without forever making small adjustments - quite workable numbers, though probably higher than some would want. If and when it reaches £500k, a bare minimum of 50 holdings will be needed to avoid discomfort, and more like 75 to do so reasonably smoothly - which is probably getting a bit impractical. If and when it reaches £1m, the numbers become 100 and about 150 holdings respectively, and I seriously doubt that's very practical! And it doesn't stop there... Sooner or later, one will be forced to overcome the psychological discomfort with £10k holdings and accept a larger limit, or stop the growth of the HYP, or die and thus make one's own psychology no longer relevant to it.

But "farm bets" being a factor in that argument??? The only relevance I can see is the rather obvious one that if it's a "farm bet", there is only one holding and so it's impossible for there to be any sector duplication...

Gengulphus

[tjh290633]

But "farm bets" being a factor in that argument??? The only relevance I can see is the rather obvious one that if it's a "farm bet", there is only one holding and so it's impossible for there to be any sector duplication...

Gengulphus

I thought that I had made it obvious that I was suggesting that an overlarge holding might worry the investor.

Perhaps I should explain my meaning in more simple terms.

TJH

[Gengulphus]

But "farm bets" being a factor in that argument??? The only relevance I can see is the rather obvious one that if it's a "farm bet", there is only one holding and so it's impossible for there to be any sector duplication...

I thought that I had made it obvious that I was suggesting that an overlarge holding might worry the investor.

Perhaps I should explain my meaning in more simple terms.

That's what I originally thought you meant!

But then AJC5001 asked you "I thought that a farm bet of £100,000 meant that the size of the portfolio was also £100,000? What do you mean by farm bet?" and you replied "Precisely that.", indicating that when you said "farm bet", you didn't just mean "overlarge holding" but "100%-of-portfolio holding".

The lesson is that no matter what term you use, if you use it with one meaning and then confirm a different meaning when asked what you meant, you create confusion!

Gengulphus

[evilbungle]

If and when it reaches £1m, the numbers become 100 and about 150 holdings respectively, and I seriously doubt that's very practical! And it doesn't stop there... Sooner or later, one will be forced to overcome the psychological discomfort with £10k holdings and accept a larger limit, or stop the growth of the HYP, or die and thus make one's own psychology no longer relevant to it.

I doubt I will ever have this problem - but it would be nice!

[pyad]

I can say from personal experience that with very large ports that started off much smaller and grew substantially over time, what happens is that you increase your individual sector or share comfort zone value, rather than increase the number of holdings just so as to reduce the average holding size to the earlier CZ level. There may be some increase in the number of sectors or shares but not in proportion to the growth of port value.

Thus if at some earlier stage you were comfortable with an average £10,000 per sector or share and the port later doubles in value you don't suddenly double the number of holdings. What happens is that your CZ doubles to £20,000 per sector or share and so on. Well that's how things panned out for me.

[Arborbridge]

But "farm bets" being a factor in that argument??? The only relevance I can see is the rather obvious one that if it's a "farm bet", there is only one holding and so it's impossible for there to be any sector duplication...

I thought that I had made it obvious that I was suggesting that an overlarge holding might worry the investor.

Perhaps I should explain my meaning in more simple terms.

That's what I originally thought you meant!

But then AJC5001 asked you "I thought that a farm bet of £100,000 meant that the size of the portfolio was also £100,000? What do you mean by farm bet?" and you replied "Precisely that.", indicating that when you said "farm bet", you didn't just mean "overlarge holding" but "100%-of-portfolio holding".

The lesson is that no matter what term you use, if you use it with one meaning and then confirm a different meaning when asked what you meant, you create confusion!

Gengulphus

Doesn't this all depend on how many farms one owns ?

[OZYU]

I can say from personal experience that with very large ports that started off much smaller and grew substantially over time, what happens is that you increase your individual sector or share comfort zone value, rather than increase the number of holdings just so as to reduce the average holding size to the earlier CZ level. There may be some increase in the number of sectors or shares but not in proportion to the growth of port value.

Thus if at some earlier stage you were comfortable with an average £10,000 per sector or share and the port later doubles in value you don't suddenly double the number of holdings. What happens is that your CZ doubles to £20,000 per sector or share and so on. Well that's how things panned out for me.

Fine, but it did not develop that way for us.

After quite a few years, in our HY portfolios, we became uncomfortable having holdings above a certain absolute amount, so we set such an amount and increase it from time to time with RPI. Different limits as our two HY portfolios have a different profile, one using collectives, the other not. This has led to a gradual increase in the number of holdings, some rebalancing, and as far as I can see by looking at our income units and divis per inc unit, no harm done at all. Both exceed the HYP1 equivalents (easy to model since your inc units would be a fixed number) comfortably over the past 30+ years for which I have exact records, and the past 18 years. Also our joint income stream has been substantially smoother than HYP1, a requisite imho for most retirees.

In fact we are reaching the stage at our advancing years where growing our income is not necessary any more, so in the last years or so, any re investment now ignores yield altogether(but not divi growth potential) while the rest churns out the divis. Looking at our other non-HY portfolios(hers, mine and ours), this will in due time increase TR even further if history repeats itself,which it so often does, eventually. Young investors take note, as TR does matter to you big time no matter what is said on this board, it is the ONLY thing which matters to you youngsters.


Doing your own thing one is comfortable with is best for any investor imho, after a few years experimenting anyway. I would be extremely uncomfortable with very unbalanced portfolios, even one seeking growth, but in particular one seeking to churn out income.

OZYU

[EssDeeAitch]

In answer to the OP question "One share per sector or two"?, this is an extract from Steven Bland's Dividend Letter which arrived today.

"Multiple Choice

BLND and LAND, as they stand on very close forecast yields, could form a paired property sector holding with no appreciable yield sacrifice. Remember if you go for this that the total investment in the sector has to be the same as if you purchased just one of the shares. The total is then split equally between them so as not overweight the sector at cost".

I wouldn't presume to say whats right/wrong or best/worst but and cannot quite understand what the fuss is about. One either prefers one or multiple stocks per sector. Cant see how either decision could be critisised.

[moorfield]

[Mod. - quoting Stephen Bland] The total is then split equally between them so as not overweight the sector at cost.

That's interesting. Why "at cost" and not "at value" if building over many years?

Moderator Message:
Clarification added. - Chris

[EssDeeAitch]

[Mod. - quoting Stephen Bland] The total is then split equally between them so as not overweight the sector at cost.

That's interesting. Why "at cost" and not "at value" if building over many years?

I assume that he refers to the initial cost of the multiple holding within said sector being equal to the cost of single holdings in other sectors so as to retain balance. Thereafter is another matter as share price movements will tweak the balance. But that's what I think, not what I know.

[88V8]

It's silly, it seems to me, that one should be inhibited by the cash value of a holding. After all, we're here for the income.

But when one views one's portfolio on the glowing screen, it's the value that jumps out.
So I do participate in this silliness; I rarely invest over £25k in a single share. And when I have a Carillion, which I did, I'm quite glad of that mental £25k ceiling.
And the £25k would rarely be a single purchase. This helps achieve a degree of pound cost averaging. I tend to creep up on things in perhaps two or three tranches, then at £25k, I stop. Or at a lower level if it's a second tier share, or a bit of a punt, or something in AIM.

That said, if the value thereafter increases above that level I'm not really bothered. Illogical, eh what?

Indeed, in some cases it has got considerably higher and I'm not bothered. I've even taken it deliberately above £25k in a roundabout fashion, buying Lloyds Prefs as well as the ords for example, and chipping in for rights issues & the like.
It's that initial bet where I limit myself.

This silliness, as I think of it, results in me having more holdings than I would like. On the other hand, I can sleep at night.
We all have farms, mentally speaking, it's just the acreage that differs.

V8

[tjh290633]

It's silly, it seems to me, that one should be inhibited by the cash value of a holding. After all, we're here for the income.

I thought that when I kept adding more Mapeley. The experience made me impose a limit on how much was invested in each holding.

TJH

[Gengulphus]

It's silly, it seems to me, that one should be inhibited by the cash value of a holding. After all, we're here for the income.

It's very reasonable to instead choose to be inhibited by the income weighting - i.e. the percentage of the portfolio's total income that is generated by the holding. In particular, it's very consistent with the primary income focus of HYPs, and the income weightings are affected by buys, sells and dividend raises/cuts rather than by buys, sells and share price fluctuations: that makes them much more stable in the short term and so a more comfortable basis on which to make decisions about a Long-Term Buy & Hold strategy.

Note that choosing to use income weightings actually produces tighter limits on the higher-yielding holdings than choosing to use current-value weightings, since for instance a 5%-yielder holding of a particular cash value will produce 1.25 times as much income of a 4%-yielder holding of the same cash value. So the 5%-yielder reaches any particular income limit at 1/1.25 = 80% of the cash value at which the 4%-yielder does.

Some will doubtless regard those tighter limits as a bad thing, since they'll result in somewhat lower portfolio income. E.g. an £18k portfolio containing just those two shares and placing the same cash value limit on them will have £9k in each and produce income of 5%*£9k + 4%*£9k = £810. If one instead places the same income limit on each, it will have £8k in the 5%-yielder and £10k in the 4%-yielder and produce income of 5%*£8k + 4%*£10k = £800. The same sort of thing happens quite generally for bigger portfolios and other holding yields - there is always a somewhat lower income from the equal-income-weighting portfolio than from the equal-capital-weighting portfolio (except in the special - and extremely unlikely! - case that all the holdings have precisely the same yield since that means that the two portfolios are identical).

Others will doubtless regard those tighter limits as a good thing, on the basis that higher yields indicate greater risk, and smaller holdings of the same share carry less risk to the overall portfolio. So having smaller holdings of the higher-yielding shares has those two effects on risk counteracting each other, and so tends to make the risks presented to the overall portfolio by the various holdings more equal. A sort of softer version of the "completely reject shares with too high a yield" filter. (Note I'm only saying that there are HYPers who use such a filter, which is very clear from what people have said on this board, not saying anything here whether it's sensible to do so - that's IMHO a contentious unnecessary distraction from what I'm saying.)

In short, I'm offering equal income weightings rather than equal capital-value weightings is an option to consider, and some arguments for and against them that people might want to take into account when considering them - not saying what decision I think people should come to at the end of considering them. That's for them to decide for themselves.

Gengulphus

[Raptor]

I started as a 1 per sector HYPer, even though I did play with the sectors as the "Support Services" covered a lot of industries and I started to think that there should only be ONE Telecomms. My move to multiples came with a "change in criteria". I still have a 10% per sector rule but dropped the 1 share per sector, reason was Lloyd came to the top of my top-up list but HSBC was paying a higher dividend. On combimimg telecom I had BT and VOD. Then I combined Utilities to get CNA and SSE. None of them break the 10% rule though.

So my feelings are that you should be looking at the dividend, if a share fits all your criteria then buy it. Yes you could have a problem if the sector tanks (Utilities are making me think again recently, we all know why) but the reverse could also happen and as long as the portfolio is diversified, you should be ok (famous last words).

Raptor.