HYP investing as a yield trap

[daveh]

Prefinvestor was commenting on the practical board that SLA had done poorly with the dividends not really compensating for the poor capital performance. Prefinvestor went on to say in a separate post:

Well I am new to these boards (more used to ii) so apologies if my post here is any way off topic. I did mention HYP in passing, but only in passing…..

I had not encountered HYP before reading these boards, high yield investing yes (I do that myself) but HYP as an investing strategy aimed at non-sophisticated investors ?. Sounds like a possibly problematic combination to me. Investing in single stocks with high yields has the high probability of investing in dividend traps, resulting in good income (for a while) but also capital losses (as in the case of SLA covered in my earlier post). Repeated execution of such a strategy could be severely damaging to your capital and if the dividends are then cancelled or cut that could be very bad news indeed for your capital and hence your income.

Personally I feel that any investment strategy that I would call successful has to aim for capital growth (or at the very least capital preservation) as well as generating a useful income. But then I fully admit I am not fully versed in HYP and maybe it has elements designed to address these issues.

ATB

Pref

and I replied:

I am aiming for a future income, buying it now and reinvesting that income in buying more income until the day I need said income. I generally follow PYADs HYP philosophy with the addition of some high yield ETFs for foreign shares. I've generally done little or no trading* (I've top sliced SEGRO as it grew to be too high a % of the portfolio for my liking). I'm happy with the performance of my HYP viewtopic.php?f=56&t=15487

I started unitising from 31/09/03 at £1.00 per unit. Accumulation units have grown to £3.02 and income units to £1.48 and the income is 16.9p and 8.5p per unit respectively as of end of Dec 2018. I was not a sophisticated investor when I started and doubt if I am now. The start to the year has been pretty good - up 9% so far, which just about balance s the loses in the last 3 months of last year and the income is coming in as expected, slightly ahead of last year. I can't comment on others, but repeated execution of the strategy hasn't been severely damaging to income or capital for myself and there are a number of others on here who have also done reasonably well using variations of the HYP strategy, of course we could be self selecting for those who have done well and those who have done badly don't post.

* bar a fair bit of bed and ISAing in the last 2-3 years to get my un sheltered dividends below the dividend allowance.

As its almost certainly off topic on Practical I've started a thread here as Prefinvestor wanted to discuss the idea further.

[Alaric]

But then I fully admit I am not fully versed in HYP and maybe it has elements designed to address these issues.

In my view it's somewhat weak on that front, other than dismissing some shares as having a dividend yield too high to be true. The mantra that capital values don't matter is unhelpful. After all if you bought a Bond paying 10%, you would be concerned that it was priced on the basis that it might default on either the income or the capital or both.

With shares then I think there should be a concern that if you invest for a dividend yield of 6% and you receive this, that if the share price declines by 6% or more, you haven't made any return. You would be better off with a share which paid a 2% dividend yield, but consistently increased it by 4% a year. To maintain a 2% yield, the price is likely to go up by 4% a year. Unilever and Diago are shares which approximately fit this profile and there was something of a row on the HYP board about whether they could be discussed there.

[Arborbridge]

But then I fully admit I am not fully versed in HYP and maybe it has elements designed to address these issues.

In my view it's somewhat weak on that front, other than dismissing some shares as having a dividend yield too high to be true. The mantra that capital values don't matter is unhelpful. After all if you bought a Bond paying 10%, you would be concerned that it was priced on the basis that it might default on either the income or the capital or both.

With shares then I think there should be a concern that if you invest for a dividend yield of 6% and you receive this, that if the share price declines by 6% or more, you haven't made any return. You would be better off with a share which paid a 2% dividend yield, but consistently increased it by 4% a year. To maintain a 2% yield, the price is likely to go up by 4% a year. Unilever and Diago are shares which approximately fit this profile and there was something of a row on the HYP board about whether they could be discussed there.

The mantra that capital values don't matter is unhelpful. AFAIK, there is no such mantra. It seems to be something that gets repeated endlessly, often by people who are not entirely sympathetic towards HYP. Point me to any essay in which the originator of HYP, Stephen Bland, wrote that exactly, and I might believe it.
It only takes a moment to realise that the capital value does matter, and Stephen Bland was not stupid: he would have realised it too! If capital tends towards zero, dividends will collapse - therefore capital matters.

What is true is that HYP is an income strategy, and that if dividends grow, then so will capital over the long term. This is quite different to the distorted mirror held up by non-HYPers to mock HYPers.

As a HYPer myself, I can also tell you that I am sanguine about the value of my capital, provided it stays intact or preferably grows (note this is different from saying it does not matter). That's because I am interested in that capital as seed corn for producing my pension income, not in its capital value from one moment to the next. If it drops by 5%, that is not of particular interest when my income flow has stayed the same or increased - as it did last year - since I have no intention of selling that capital to realise its value. That is probably the view from which the "capital doesn't matter" idea was hatched and then grew out of context and misapplied by naysayers.


Arb.

[Alaric]

Point me to any essay in which the originator of HYP, Stephen Bland, wrote that exactly, and I might believe it.

I don't think it matters whether it's in the sacred texts or not, it's the impression that's generally given. All that talk about "Doris" for example.

What is true is that HYP is an income strategy, and that if dividends grow, then so will capital over the long term.

That isn't true for those Companies which maintain or increase dividend payouts where profits have not increased. They are doing this by paying out capital or in some cases by borrowing to pay dividends. Eventually, as with Carillion and others, they run out of money. Hence the term "yield trap".

[Arborbridge]

To illustrate my point, here is a chart of forecast income and capital values. Income is forecast to keep on rising slowly, though the value of capital gyrates. Eventually, unless there is a complete system failure of the capitalist world (always a risk) the capital will eventually re-align. Of course, there is always a risk of a failure which blights one generation's life chances.....



Arb.

[Dod101]

What is true is that HYP is an income strategy, and that if dividends grow, then so will capital over the long term. This is quite different to the distorted mirror held up by non-HYPers to mock HYPers.

That was my reason for getting into an income strategy in the first place. However, all too often we have seen income doing well and yet the capital value simply has not followed and sometimes has fallen away. The tobaccos are a good current example of this, what I have called 'dearly bought income'. The question is of course whether the drop in value is permanent or whether the capital value will return to earlier levels and over what period. I judge the tobaccos to be OK and the dividends secure. (Time will tell and in fact in two days time we will have the 2018 results from BAT)

I do not think there was ever a mantra that said capital does not matter. Rather, I think it was that capital is less important than securing a good, secure and rising income. To some extent it depends at what stage of the investing cycle you are in. If you are drawing an income from your HYP (fundamentally the whole point of it) capital is certainly less important than if you are in what some call the 'building' phase. After all in the building phase you are surely looking for total return.

I subscribe to the idea that one should not be chasing income and have said in the past that I tend not to look at any share that yields much more than say 50% above the FTSE100, around 6.5% or so today. If a share consistently is yielding 8 or 9% I look very carefully at it and will often sell. I have recently done so with Vodafone because I think the market is telling us that it has no confidence in the sustainability of the dividend. I prefer to get out earlier than to wait until the cut comes because often the cut will be accompanied by a drop in the capital value.

I have never held SLA, not because of its performance as such but because I have never liked Martin Gilbert who I think is a wheeler or dealer, and quite a good one but taking on Standard Life is something else. The culture of the two entities is very different, and it seems that investors have lost faith in Aberdeen as a fund manager and of course although Standard Life has always been a fund manager it had the mindset of a major life insurer and from that followed fund management rather than the other way round. SLA is currently yielding over 10% and is a yield trap par excellence in my book.

So yes I think that HYP investing can be a yield trap but as always with investing we must always be on our guard.

Dod

[Arborbridge]

Point me to any essay in which the originator of HYP, Stephen Bland, wrote that exactly, and I might believe it.

I don't think it matters whether it's in the sacred texts or not, it's the impression that's generally given. All that talk about "Doris" for example.

What is true is that HYP is an income strategy, and that if dividends grow, then so will capital over the long term.

That isn't true for those Companies which maintain or increase dividend payouts where profits have not increased. They are doing this by paying out capital or in some cases by borrowing to pay dividends. Eventually, as with Carillion and others, they run out of money. Hence the term "yield trap".

It really does matter, because that is the basis of the HYP system - Bland's writings. The "impression" is only another way of saying that later there were various misquotes or statements taken out of context and without the careful qualifying remarks which were used in the original. Chinese whispers are hardly the basis for sensible discussion on whether HYP says "capital doesn't matter". Like company accounts, one should always go back to the original. And you mention "Doris" - that is meaningless. Doris was sitting on several million pounds, we are told, and was used to show that one could generate a healthy income for life without bothering too much about the details. That was the point of Doris, who I'm sure would have been quite distraught at the thought of her capital reducing to zero, as any later HYPer would be. So don't drag up a probably fictional character out of context to illustrate a point she never made, as far as we know.

The second point is certainly valid, but HYP looks for sustainable income, not unicorns, and it is also a portfolio system. Both of those are vital to its success, but both you have chosen to ignore in the point you've made.

Finally, I think it is really important to get the basis right. That is to say, because various people have misquoted HYPers as saying "capital doesn't matter" that does not remotely suggest that HYPers themselves believe that, or that the original article ever said that. In other words, it's a man of straw argument: making an argument which sound a bit
like the original (but isn't) and which is self-evidently stupid, in order to prove that the original is untrue.

Arb.

Unfortunately, as interesting as this may be, I really have to get some work done today - so I will note engage further for a while. Hopefully, some others will join in, meanwhile.

[Arborbridge]

Just popped back to say I generally agree with Dod's post. A word of caution in this discussion - we must not mix up "yield" and "income". I've been concentrating on capital as related to the later, not yield, since the point under discussion in my post was the falsehood thrown out that HYPers say "capital doesn't matter".


Arb,

[moorfield]

I subscribe to the idea that one should not be chasing income and have said in the past that I tend not to look at any share that yields much more than say 50% above the FTSE100, around 6.5% or so today. If a share consistently is yielding 8 or 9% I look very carefully at it and will often sell.

Agree with you Dod, I've mentioned elsewhere I now use 2 * CTY.L yield as that ceiling, above which I don't buy (that's ~9% today, ruling out top ups of CNA, VOD in my portfolio) and I am minded to start using it as a sell signal too.

Since we're on HYSS, and given the name of the poster referred to on the OP, I think it's reasonable to suggest that preference shares (and particularly the cumulative ones) might offer more sustainable, albeit fixed, dividends at those higher yields. RE.B is one I hold, current yield 9.3% (priced slightly below par), I'd rather have that income than CNA at 9.6%.

[kempiejon]

I'll have to disagree with moorfield and dod here, and it's a point I have made before, a high yield per se would not exclude a share from being shortlisted as a potential for my HYP. I rank FTSE100 shares by yield and check down the list excluding those that don't show a history of increasing dividends, have poor cover, increasing debt, gearing and any statements from the company regarding its dividend policy for the future. With over 30 shares in my HYP diversification or concentration of income or capital invested is less relevant these days but I'd not overweight an industry, sector or individual share.

Often high yielding shares are ones to avoid from my other metrics but just because the yield is above or below a multiple of the FTSE100 average yield isn't enough to make my decision. To use the examples both VOD and Centrica fail my tests so moorfield and I come to the same conclusion using different routes. I'd consider both the tobacco shares suitable and they yield around 7%.

[moorfield]

To use the examples both VOD and Centrica fail my tests so moorfield and I come to the same conclusion using different routes.

Maybe my test took much less time and effort than yours ...

[Alaric]

RE.B is one I hold, current yield 9.3% (priced slightly below par), I'd rather have that income than CNA at 9.6%.

I had to look that one up.

R.E.A.Holdings 9% Pref

I was still little the wiser, so dug further

It's a highly specialist Company

http://www.rea.co.uk/business/overview

The REA group is principally engaged in the cultivation of oil palms in the province of East Kalimantan in Indonesia and in the production of crude palm oil (CPO) and crude palm kernel oil (CPKO).

In addition, the group holds an investment in a stone deposit located close to the agricultural operations and holds three coal mining concessions.

I think it's valid though, that if as an investor you are looking for something like a 4% income on your capital, increasing at 2%, then balancing up Prefs and Bonds giving a 6% to 9% return but no capital growth with shares giving a dividend yield of 1% to 2% but with dividends increasing at 4% to 5% could well be a plausible approach.

Where shares have a dividend yield of 9%, you are in the territory where the market at least has limited faith in the sustainability of the dividend or the future share price or prospects of the Company.

CNA is Centrica of course. Being one of the successor businesses from the British Gas privatisation, you wonder whether it is still widely held by private investors.

[IanTHughes]

I subscribe to the idea that one should not be chasing income and have said in the past that I tend not to look at any share that yields much more than say 50% above the FTSE100, around 6.5% or so today. If a share consistently is yielding 8 or 9% I look very carefully at it and will often sell. I have recently done so with Vodafone because I think the market is telling us that it has no confidence in the sustainability of the dividend. I prefer to get out earlier than to wait until the cut comes because often the cut will be accompanied by a drop in the capital value.

So, you sell out at a higher yield than you buy. How is that protecting your capital?

Ian

[Arborbridge]

Since we're on HYSS, and given the name of the poster referred to on the OP, I think it's reasonable to suggest that preference shares (and particularly the cumulative ones) might offer more sustainable, albeit fixed, dividends at those higher yields. RE.B is one I hold, current yield 9.3% (priced slightly below par), I'd rather have that income than CNA at 9.6%.

If that's REA, please don't touch it. I had an IT with 5% in this company and they are destroying Orangutan habit to cultivate palm oil - I found it very distressing to have inadvertently been dragged into possibly killing off an endangered species.

I hope you will give some weight to this enthical side.

Arb.

[Alaric]

So, you sell out at a higher yield than you buy. How is that protecting your capital?

If you switch from a share yielding 9% to a share yielding 5%, you are reducing your dividend income. In terms of capital protection, you are removing the risk that the 9% share price might collapse. In other words, you use high yield as a "sell" indicator.

If you intend to buy and hold, buying into the higher quality dividend yield could make sense. So you choose the 5% yield rather than the 9% one.

50% above the FTSE 100 is an ad hoc rule of course, but it indicates shares to be wary of.

[moorfield]

If that's REA, please don't touch it. I had an IT with 5% in this company and they are destroying Orangutan habit to cultivate palm oil - I found it very distressing to have inadvertently been dragged into possibly killing off an endangered species.

I hope you will give some weight to this enthical side.

O/T here I think. Every company we invest in has an unethical side if one looks hard enough.

[IanTHughes]

So, you sell out at a higher yield than you buy. How is that protecting your capital?

If you switch from a share yielding 9% to a share yielding 5%, you are reducing your dividend income. In terms of capital protection, you are removing the risk that the 9% share price might collapse. In other words, you use high yield as a "sell" indicator.

Are you seriously telling me that there is no risk of the 5% yielding share collapsing? How do you know this? Crystal Ball gazing?

If you intend to buy and hold, buying into the higher quality dividend yield could make sense. So you choose the 5% yield rather than the 9% one.

50% above the FTSE 100 is an ad hoc rule of course, but it indicates shares to be wary of.

So, if the yield increases to a point where you sell, I have to ask again, how is that strategy protecting your capital?


Ian

[Alaric]

So, if the yield increases to a point where you sell, I have to ask again, how is that strategy protecting your capital?

You cut your losses whilst you can still get out with some value. Those who sold Carillion did relatively better than those who held to the bitter end.

It would have been better not to have invested in that share in the first place.

[IanTHughes]

So, if the yield increases to a point where you sell, I have to ask again, how is that strategy protecting your capital?

You cut your losses whilst you can still get out with some value.

How do you know - in advance mind you - that your now high-yielding share will not recover value? How do you know that you are "cutting your losses" and not simply ensuring a capital loss? That Crystal Ball of yours must be really good!

Once more I must ask, if you insist on selling a share because the yield has increased, how is that strategy protecting your capital?


Ian

[Alaric]

How do you know - in advance mind you - that your now high-yielding share will not recover value?

You don't. It might recover. More information is needed. The high yield is a signal that market makers or pressure of sales has depressed the price.

If you make the right call, selling at 100 before the price plummets to 50 leaves you wealthier than if you don't sell. If you make the wrong call, the price recovers.

It's an unfortunate fact that accounting standards can permit a Company to collapse within a year of an apparently clean bill of health. Sometimes, but not always that's fraud.