HYP investing as a yield trap

[Itsallaguess]

An HYP can and probably will have periodic falls in dividend income.

Long term records published by TJH showed a 40% drop in income following the Great Financial Crash.

Therefore you either need to:

a) accept that an HYP will result in variable payout
b) accept that if you have a fixed payout, there is a finite chance that you will run out of money
c) run a cash buffer to mitigate sequence of returns risk.

Agree with all of that, but I'm not sure about the 'either need to' in the above, as I think 'need to' would be more appropriate most of the time...

I think where the HYP strategy should get most credit, it's for the following -

1. It's a diversified income strategy, both in pure-numbers, regarding the minimum level of 15-companies (I would prefer a lot more than this personally...), and also in terms of looking to diversify across a large number of varied sectors.

2. It looks to take advantage of 'survivorship opportunities' by focussing on large-cap companies, which are hopefully likely to be able to recover from the inevitable 'strategic stumbles' that most companies will encounter over time.

3. It hopes to take advantage of the natural tendency for dividend-payouts to increase over time, which helps with an income-strategy that's looking to deliver inflation-proof payouts over long periods.

Totally agree with the cash-buffer side of things - I don't think I could possibly imagine trying to live on a dividend-related income-stream that didn't have some form of fluid cash, or cash-equivalent, backing up the strategy, and I think 2-years worth also feels about right too.

The above is countered, unfortunately, by the simple matter of the whole endeavour being both selected by the investor to start with, and then being consistently exposed to the whims of the market in a way that's simply 'highly visible' to the end-user, and I think this is often at the heart of many of the issues that HYP practitioners have, when they feel uncomfortable with the strategy.

It's that high-visibility that hurts when a slice of our HYP portfolio stumbles in dividend terms, and it's that high-visibility that pains us when our HYP components crash in capital terms too...

It's the high-visibility that makes us think that we need to keep track of all the myriad of investor-relations news coming out of our HYP investments, and which makes us squirm with indecisiveness if we're not seen to be 'doing something' with that information..... And we've got to 'do something' with it, otherwise what was the point of getting it....?

If there was a 'Wizard of Oz' curtain that we could pull over our HYP's once we've bought them, where from that point on all that we'd see would be the income coming into our bank-accounts, I think the vast majority of issues that people seem to have with the strategy would vanish overnight...

Luckily, those curtains exist already, but they're in the form of income Investment Trusts, rather than HYP's....

Buy some of those, as I have myself over the years, and that 'high visibility' simply disappears. I don't see the underlying companies struggling if and when they happen to, and I don't see when one of the IT components cuts it's dividend - it's all mopped up behind the scenes and is something I pay the IT manager to worry about.

I don't worry about dividend cuts affecting my income, because I know that the IT's have income-reserves for those periods where general market conditions affect large swathes of individual companies, and all I see is regular income and regular increases, on the whole, for very long periods of time.

Yes, there's a price to pay in terms of management-charges, but there's a price to pay for most of the things that we benefit from in life, and investment is no different, and I'm very happy to pay a price to have moved from a position of regular investor-angst, when I owned only my pure HYP for income, and to a position of relative-serenity now that I've moved away from such a company-specific approach for my income-strategy.

Some people don't need the curtain over their HYP's, and I think that's a great situation if it suits you, but I know enough about my own investment personality that it didn't suit me not to have a curtain - even if, as I know might well be the case, a comparison of underlying HYP investment performance might well have actually been on a par with most of the income-IT's that I own - it was simply that the 'high visibility' of the HYP components was what caused me the most angst, and that uncomfortable situation vanished completely when I started to hide them behind an IT-curtain....

Cheers,

Itsallaguess

[Dod101]

Following on from IAAG's ever sensible comments, I was away for three weeks in February and hardly looked at TLF and certainly made on contribution. I think it would be good for all of us (certainly including myself) if we did not look at these Boards every day. My contribution has certainly diminished because I now see no need to comment on every thread that interests me and this of course follows through to my portfolio.

Dod

[Charlottesquare]

The reason for my question is this. There are shares with high dividend yields, not because the Company is trading profitably enough, but because the Directors are essentially paying out the assets of the Company by way of dividends.

In point of fact dividends can only legally be paid out of profits or retained profits. Although I do appreciate that it is possible that the company could be paying out dividends when the cash could be better used to pay down debt for example.

Eventually the Company will run out of money, but it might take longer than the lifetime of the pension HYPer. So should an attempt be made to distinguish between the Companies that will retain their worth and Companies that won't?

One should always attempt to ascertain that the dividend being paid is sustainable going forward, as best one can anyway. With regards to a single share, if a company is paying what is considered a sustainable dividend, the capital value will be fine. But, because of the possible risks that an individual company may suspend or cancel dividend payments, or even go bust, appropriate diversification is essential.

If one is successful and the overall Portfolio Income continues, even increases, well into the future, then the capital value will be secure, over the long term. Of course, there will be ups and downs along the way, sometimes quite severe. HYP does not suggest one should ignore capital value, rather it simply aims for an increasing income which will, over time, result in a similar increase in capital.

I thought everyone understood that.


Ian

There is of course the issue that the holding company of a Group (the actual company paying the dividends) may have distributable reserves to cover the dividends but the Group, as a whole and when consolidated, may not.

The catch is that we of course look at Group balance sheets (that is what tends to be reported) but rarely look at holding company balance sheets.

Of course in a Group that does overall have reserves that are distributable dividends can often be paid up from subs to holdco to facilitate end dividends to the shareholders of said holdco, but you could get the position of a holdco having £1,000 of distributable reserves but the subs having
(£500) reserves, so whilst legally a £1,000 div can be paid by holdco if one looks at this on a Group basis it will result in the Group having negative distributable reserves of (£500.) post the dividend.

If say a sub has assets of £100 and liabilities of £600 with accordingly negative reserves of (£500), at the group level there is (£500) reflected but in the hodco it may carry the investment at nil, accordingly at holdco distributable level the (£500) gets ignored

Tends not to be a real issue with larger groups but care is sometimes needed further down the foodchain, the test re what may be distributed is legally made at the holdco company level not the group level.

[Dod101]

Returning to IAAG's comments, I now discover that I have 11 ITs out of a total holding of only 29 securities. It seems that without really intending to I too have moved in the direction of Investment Trusts. They just crept up on me.

Dod

[Itsallaguess]

Returning to IAAG's comments, I now discover that I have 11 ITs out of a total holding of only 29 securities. It seems that without really intending to I too have moved in the direction of Investment Trusts. They just crept up on me.

Out of interest Dod, what's your weighting between single-company holdings and IT's?

Mine's currently around 59% single-company holdings and 41% Investment Trusts, and I expect that I'll only ever see my IT weighting increase if anything, from this point forward.

I honestly cannot now remember the last time I directly invested new capital into a single-company holding....

Cheers,

Itsallaguess

[Raptor]

Returning to IAAG's comments, I now discover that I have 11 ITs out of a total holding of only 29 securities. It seems that without really intending to I too have moved in the direction of Investment Trusts. They just crept up on me.

Out of interest Dod, what's your weighting between single-company holdings and IT's?

Mine's currently around 59% single-company holdings and 41% Investment Trusts, and I expect that I'll only ever see my IT weighting increase if anything, from this point forward.

I honestly cannot now remember the last time I directly invested new capital into a single-company holding....

Cheers,

Itsallaguess

Last time I checked mine was 34% IT's and 66% Shares. 21 shares and 7 IT's make up the whole. That is about where I was trying to get to, but feel I am putting more into IT's now. When I have a median value on the latest (JETI) will probably look at an Technology flavoured IT.

Raptor.

[Dod101]

Out of interest Dod, what's your weighting between single-company holdings and IT's?

Mine's currently around 59% single-company holdings and 41% Investment Trusts, and I expect that I'll only ever see my IT weighting increase if anything, from this point forward.

My weighting is not dissimilar. I have 34% in ITs with the balance in single company shares. I had not really looked at this before. I have fairly recently added Smithson and HFEL which has taken the IT totals upwards because I subscribe very little new money so most has had to come from selling single company shares; in my case, SSE and Vodafone. Very similar to Raptor in fact, although in my case it is largely unplanned. I think part of the reason is because of the lack of attractive single company shares, the two I mention having been stalwarts for as long as I can remember but now, to me anyway, both quite unattractive.

Dod

[tjh290633]

An interesting conversation. I have 66% in my HYP, 9% in ITs for the grandchildren and 25% in OEICs, some of which is my wife's and some is mine of long standing.

TJH

[IanTHughes]

Out of interest Dod, what's your weighting between single-company holdings and IT's?

Mine's currently around 59% single-company holdings and 41% Investment Trusts, and I expect that I'll only ever see my IT weighting increase if anything, from this point forward.

My weighting is not dissimilar. I have 34% in ITs with the balance in single company shares. I had not really looked at this before. I have fairly recently added Smithson and HFEL which has taken the IT totals upwards because I subscribe very little new money so most has had to come from selling single company shares; in my case, SSE and Vodafone. Very similar to Raptor in fact, although in my case it is largely unplanned. I think part of the reason is because of the lack of attractive single company shares, the two I mention having been stalwarts for as long as I can remember but now, to me anyway, both quite unattractive.

What do you think Investment Trusts put your money into? Why single company shares of course! No doubt including SSE and Vodafone

Ian

[Dod101]

What do you think Investment Trusts put your money into? Why single company shares of course! No doubt including SSE and Vodafone

Last time I looked I did not see SSE or Vodafone in the holdings of HFEL or Murray International. They will almost certainly be held by Temple Bar, Murray Income and Edinburgh IT. But investment trusts usually hold up to 100 or more other shares as well so the effect of one or two shares which I do not like is very diluted, as of course you must know and know that I know, so why raise irrelevant questions?

Dod

[monabri]

I just had a quick look at the annual reports.

Murray Income: VOD = 2.6% : SSE =0.0%

Edinburgh Investment: VOD=0.0% : SSE =0.0%

Temple Bar : VOD=0.0% : SSE =0.0%

For someone who doesn't want to hold VOD/SSE, they seem to have more or less achieved that goal ( excusing a 2.6% holding in VOD which, as a part of a much larger portfolio, represents an insignificant holding).

In the words of Dave Lister ( Red Dwarf*) ....."Intended...played for and got!" ( with reference to a fluke shot in pool)


(* use Google)

[Arborbridge]

What do you think Investment Trusts put your money into? Why single company shares of course! No doubt including SSE and Vodafone

Last time I looked I did not see SSE or Vodafone in the holdings of HFEL or Murray International. They will almost certainly be held by Temple Bar, Murray Income and Edinburgh IT. But investment trusts usually hold up to 100 or more other shares as well so the effect of one or two shares which I do not like is very diluted, as of course you must know and know that I know, so why raise irrelevant questions?

Dod

I agree with the general thrust, but be a bit careful - last report, HFEL had 53 holdings, EDIN 53 and TMPL 49.

The big difference to me, is that when my single shares are wrapped in an IT, I cease to think about them too much, if at all One distinct advantage of going the IT route, especially when getting older.

[Dod101]

Thanks to Monabri and Arb for those helpful posts. I was doing just what Arb says, and not thinking about these trusts very much. If an Annual Report comes into me in hard copy form I read it more or less cover to cover, but when it is only available (without going to the trouble of asking for a hard copy) on a website, I tend not to read them unless I am looking for some particular item.

Anyway the comments have pretty well proved my point.

Actually if these managers of income trusts do not hold them, that is telling me something. They agree with me if nothing else!

Dod

[kempiejon]

Thinking about duplicated holdings, before I started HYPing I had several ISA years in an L&G FTSE100 tracker, it wasn't until a few years later when my HYP began to dwarf my tracker fund that it dawned on me my HYP was fishing in very much the same pool and my exposure to those largest holdings in the tracker (because of cap weighting) was even larger with my HYP included. I was unbalanced in things like the big oil and pharma and banks. I did swap my tracker into direct shares.

[Arborbridge]

Thanks to Monabri and Arb for those helpful posts. I was doing just what Arb says, and not thinking about these trusts very much. If an Annual Report comes into me in hard copy form I read it more or less cover to cover, but when it is only available (without going to the trouble of asking for a hard copy) on a website, I tend not to read them unless I am looking for some particular item.

Anyway the comments have pretty well proved my point.

Actually if these managers of income trusts do not hold them, that is telling me something. They agree with me if nothing else!

Dod

Yes, it's all very well things being available online, but there's nothing like something plonking on your doormat to remind you to take a look. On-line = out of sight, out of mind.

NB: you should note that buying TMPL you are also owning some of TESCO: 3.5% of portfolio - not to mention Morrisons, Marks and BT. So they don't entirely agree with you. Morrisons is listed as one of TMPLs biggest contributors in 2018 and HSBC on of its worst.

More seriously, it would seem very simple to "fish in the same pond" as these managers and perform better due to not having to pay fees. I haven't found it to be so simple, and my HYP does not perform as well as any of those mentioned in terms of TR, at any rate.

Arb.

[Charlottesquare]

What do you think Investment Trusts put your money into? Why single company shares of course! No doubt including SSE and Vodafone

Last time I looked I did not see SSE or Vodafone in the holdings of HFEL or Murray International. They will almost certainly be held by Temple Bar, Murray Income and Edinburgh IT. But investment trusts usually hold up to 100 or more other shares as well so the effect of one or two shares which I do not like is very diluted, as of course you must know and know that I know, so why raise irrelevant questions?

Dod

I agree with the general thrust, but be a bit careful - last report, HFEL had 53 holdings, EDIN 53 and TMPL 49.

The big difference to me, is that when my single shares are wrapped in an IT, I cease to think about them too much, if at all One distinct advantage of going the IT route, especially when getting older.

To a degree I agree that ITs take attention away from individual shares held but they may , more than individual shares, introduce macro economic factors to the thought process re investment decisions. I sit with circa 20% in individual shares and 80% in ITs (including Berkshire as a quasi IT) which are these days more chosen to get greater international exposure.

I now more look at sectors/marketswhere the ITs are positioned taking into account my views re exchange rates, my view re whether I like say Europe or prefer China, my view if emerging markets or smaller companies are where I want to be etc

Whilst ITs reduce the RNS reading, in my experience they bring more into focus different macro economic forecasting issues e.g. right now I am siting in a poor UK outcome re Brexit position with the bulk of my ITs (not all) not centered on sterling earning entities- in effect quasi Bad Brexit defensive.

[Arborbridge]

Dod might be interested to see what Alistair Mundy (TMPL) said about Centrica in his end of 2018 report:

"We also capitulated on Centrica (believing we had more straightforward and cheaper opportunities elsewhere)" I like the word "capitulated": that's how I would feel too, after hanging on for so long hoping the clouds would lift.

Interestingly, some of the cash liberated went into stocks such as BT and Tesco amongst others, which at the time seemed depressed in price - but unfortunately, as he points out, which became more depressed by the year end.

Can't we all empathise with that! Is this a professional falling into the frying-pan-to-fire trap? Something Pyadic HYPers avoid of course
Still, my TMPL holding has returned a not-too-bad XIRR of 9.61%, that's higher than my HYP*, although down from the 12%+ of recent years.

*though the crucial point is the TMPL's the yield wouldn't produce enough income for me to live, whereas my HYP does.

[Dod101]

I guess we had better not dwell on ITs here but I have read the Temple Bar report as I hold it in certificated form.

Dod

[Itsallaguess]

Whilst ITs reduce the RNS reading, in my experience they bring more into focus different macro economic forecasting issues

That's certainly not been my experience - I'm with the other posters here who have experienced a really quite 'Zen-like' approach once capital has moved from being in a relatively small number of single-company shares and into much more diversified collectives.

Cheers,

Itsallaguess

[Arborbridge]

I guess we had better not dwell on ITs here but I have read the Temple Bar report as I hold it in certificated form.

Dod

Well, I think a few mentions are safe enough. The board guidance does say ITs "can be considered". Indeed, people post here if they have a HYP with few naughty additions.



Arb.