HYP Strategy Reflection and Sticking with the Plan

[moorfield]

In a lot of these ruminations I think the P in HYP is lost.

I get where you're coming from MAD, but the interpretation of the P varies I think - some run a PHY (or should that be PHYS ?), others a HYP. Too often I read here of selling (and buying) decisions taken with little regard, commentary or measurement of how a portfolio is performing overall. Worth noting too that pyad always headlines (and frequently brags about) HYP1's overall income, rather than it's component income streams.

[Minesadouble]

In a lot of these ruminations I think the P in HYP is lost.

I get where you're coming from MAD, but the interpretation of the P varies I think - some run a PHY (or should that be PHYS ?), others a HYP. Too often I read here of selling (and buying) decisions taken with little regard, commentary or measurement of how a portfolio is performing overall. Worth noting too that pyad always headlines (and frequently brags about) HYP1's overall income, rather than it's component income streams.

Yes the aggregate or overall income stream is what’s important and to be frank that is the primary aim of the HYP strategy.
I do however understand it is dispiriting to see capital losses, I jettisoned Tesco, Carillion and Centrica to name but three and currently see red numbers against Greene King, SSE and Glaxo, but I try to focus on the overall HYP performance. I have 55 positions across my entire portfolio, I could find a new cause for concern everyday if I was that way inclined. I think it pays to be a bit more relaxed about this stuff. Just my view though.

MAD’

[BreakoutBoy1]

When you account for the ridiculous amount of extra risk HYP1 has run and continues to run compared to a FTSE 250 tracker, I don't find the results compelling. On a risk adjusted basis I think that result would make me less inclined to invest in a HYP.

[Gengulphus]

and to repeat , capital does matter , which probably rules out the strict HYP approach .

Yes, it's blinking obvious that capital does matter, as anyone whose portfolio contains Carillion can see. So obvious that I'm frankly amazed anyone thinks there's any question about it.

But I don't see that that obvious fact rules out the "strict HYP approach", at least for sensible, thought-out statements of HYP approaches (strict or otherwise). For example, take pyad's original two articles "Retirement Pays Dividends" and "Retirement Pays Dividends -- 2" stating his approach (which I think has to be considered the archetypal "strict HYP approach"!) and try to find anything that says that capital doesn't matter in them. The closest I can find is "Do not worry about the fluctuations in the underlying capital value of your shares that are certain to occur" in the first of them. But that paraphrases to "Don't pay attention to capital fluctuations" or at most "Don't pay attention to capital", which is not the same thing as "Capital doesn't matter". The world is full of things that matter, but aren't normally worth paying attention to (and a good thing too - if one had to continually pay attention to breathing, digesting one's food, keeping one's job, etc, one wouldn't have time for anything else, and going to sleep would be extremely risky!).

Furthermore, the first of those articles contains the statement "Having the capital available may be important at some future point if, for example, you have to go into a care home" and others that make it pretty clear that the approach treats capital as mattering.

In short, there are two myths here. "Capital doesn't matter" is one of them; the other is "HYP approaches involve a belief that capital doesn't matter", which is a myth even if one restricts one's attention to "strict" ones (whatever that means exactly - I've never seen a clear consensus about exactly what distinguishes "strict" from "non-strict" HYP approaches). It's only if one somehow believes both that the first of them is a myth and that the second isn't that your "probably rules out" statement follows.

And I'll take the opportunity to point out a third, often unstated myth, which is that HYP approaches are suitable for everyone. They're not, and the second of the articles points out some cases of people for whom they're unsuitable when it says "This is not for those who will lose sleep if the portfolio plunges in value. It is for those who can ignore the fluctuations in capital value and accept that there is a risk that the income will not, in fact, rise."

I do accept that some HYP proponents sometimes put forward those myths, and that they need to be debunked when they are put forward. But only when they are put forward: debunking a myth in contexts where no-one else has put it forward is what is otherwise known as a straw man argument!

Gengulphus

[Gengulphus]

I think this is in part why there is often a difference of perspective. There seem to be a number of people (like myself) who have started their HYP recently and seen some pretty horrific capital destruction. When this gets raised the response from those who started their HYP's long ago is something like "focus on the income". I suspect that it is psychologically much easier to do that if you are sitting on a portfolio that has already grown significantly through past capital growth and dividend reinvestment. It may be irrational, but maybe it is easier to see capital created for you by the strategy taken away than to lose hard earned cash only recently invested. It is also all too easy to do the mental maths on a share 30% down since purchase with a 6% yield and work out how long it will take before you are back to breakeven, which I guess is the non-scientific version of ******* point above.

Bear in mind that "horrific capital destruction" is not a special feature that has only arisen recently, and indeed what has arisen recently is not especially "horrific" by historical standards. For example, taking the normal version of the FTSE 350 Higher Yield index as a proxy for HYP capital performance, it's fallen by about 1/10th recently; for comparison, it fell about by about a third between the springs of 2002 and 2003, by over a half between the autumn of 2007 and the spring of 2009, and by about a quarter between the springs of 2015 and 2016. (All figures approximate because I've eyeballed them from a long-term chart.)

That doesn't of course mean that individual HYPs (let alone individual HYP shares!) haven't suffered greater capital destruction: ones that have been unfortunately chosen (*) will have suffered greater capital destruction. Nor does it necessarily mean that the performances of individual HYPs can be expected to average out at precisely the FTSE 350 Higher Yield index performance, since the index's selection criteria probably don't reflect those of individual HYPs all that well: I would only expect the index's performance to be a very rough guide to the expected HYP performance.

So the difference in perspective between more recent and less recent HYPers that you mention isn't really a matter of whether one has experienced "horrific capital destruction". Rather, it is a matter of experience, IMHO most importantly about how HYPs recover from massive capital destruction. At least in my experience (about 15 years' worth with my main HYP, plus a couple more before that with a much smaller tentative "experimental" one to assess how well the strategy suited me), it quite simply isn't just by the dividends accumulating to bring one back to breakeven, not even on a whole-portfolio level (let alone an individual-holding level). Rather, it's by the combination of that and massive value creation as share prices recover: looking at the total return version of the FTSE 350 High Yield index to get their combined effect, recovery from the 2002-2003, 2007-2009 and 2015-2016 falls mentioned above took about 1.5, 3.5 and 0.5 years respectively, which are nothing like the lengths of time that your mental-maths calculation suggests!

That is of course a whole-portfolio calculation, and I don't expect the same to apply at an individual-holding level. RBS is for example nowhere near recovering from its falls about 10 years ago, and Carillion is never going to recover from its recent falls. There definitely is an argument for selling holdings that have fallen and are going to take a very long time to recover or never recover - if you can determine with reasonable accuracy which they are among the holdings that have fallen. But that again brings in the issue of experience: it's a task that my experience tells me is a lot harder than I originally thought

Anyway, the point is that thought experiments like your mental-maths calculation always need sanity-checking against reality. Find some sort of real-world observation that can be done reasonably quickly and can at least roughly confirm or contradict the conclusion of the thought experiment. If you can't find one, don't place any reliance on or credence in the thought experiment's results until you can sanity-check them against reality - and preferably stop doing the thought experiment at all until then as well, because it's remarkably difficult to avoid placing credence in a habitual thought pattern...

(*) Whether by bad luck or misjudgement. It doesn't matter which from the point of view of what the HYPer has experienced, which is what the point I am making here is about, only from the point of view of what lessons it's possible to learn from the experience.

Gengulphus

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