IanTHughes wrote:Lootman wrote:So I do think HYP bears additional risk compared to a tracker, which of course also means that with a favourable tailwind it can out-perform like any higher risk strategy can.
Well of course HYP is a higher risk strategy than buying trackers, whoever said it was not?
I regard the question of whether HYP is a higher risk strategy than buying trackers as unsettled - I don't say that it definitely isn't, but neither do I say that "of course" it is.
There are two main reasons for my uncertainty about the question. One is just that the question isn't very well-posed: there are many different HYP strategies, so "following HYP" isn't well-defined, and it's entirely possible that following some is less risky and following others more risky than buying trackers.
The second is that it's certainly the case that buying trackers is
sometimes higher-risk than following a HYP strategy: the clearest example of such a case in the nearly 20 years I've been actively investing in the stockmarket was at the height of the tech boom's effect on the FTSE 100 at the end of 1999: in the following 3 and a bit years, accumulation units in a FTSE 100 tracker would have lost nearly half of their value (*). I don't have exact figures for what a HYP would have done, since that predates HYP1 by about 10-11 months and my own HYPs by rather more, but I do know that HYP1 lost little of its value after it was set up (which would quite possibly have been none of it if it had been reinvesting its dividends) and that the period from December 1999 to November 2000 was a brilliant time to be investing in high-yield shares: that was pretty much when I started investing more actively in the stockmarket (having previously merely put money I had spare into privatisations and employee share options when the opportunities arose and literally put the certificates in a bottom drawer) and my original strategy was a high-yield trading strategy (so some points in common with HYP, but definitely not actually HYP!).
A further indication is given by using the FTSE 350 Higher Yield index (the total return version, in order to compare like with like) as a proxy for HYP strategies. It lost less than a quarter of its value (*) over the same period, outperforming the FTSE 100 by nearly 50%. And it's definitely an imperfect proxy for HYP strategies, selecting shares purely for high yield and moderately high market cap but nothing more, and going through a major 'tinkering' review once a year. Whether HYP strategies' use of additional criteria aimed at avoiding 'yield traps' and strong reluctance to 'tinker' would have added to or subtracted from that outperformance, I of course don't know: the example of HYP1 suggests that it would have added to it, but without a lot more evidence that's just a suggestion and nowhere near proof. But the nearly-50% outperformance in the index comparison is large enough that it's IMHO pretty clear that HYP strategies generally outperformed buying trackers over that period by a substantial margin, mainly due to the FTSE 100 index being quite heavily invested in the tech boom (though obviously nowhere near as risky as investing 100% in it, as some investors did) and HYP strategies clearly avoiding investing in it completely or nearly completely simply as a natural consequence of their insistence on high yield.
And importantly, not merely was buying trackers pretty risky at the end of 1999 as things actually worked out, the risk was IMHO in the bleeding obvious category even at the time. It was
very clear that the stockmarket was in a bubble - the only real questions were about how overinflated that bubble had become (affecting how big the collapse would be when it finally happened) and how long the bubble would last before it burst. And lasting three years was pretty implausible, because the bubble would have become ridiculously big if it had continued to inflate at anywhere near the same rate for another three years, while any significant slowdown would probably have triggered the collapse as significant numbers of the more nervous investors started to cash in on their winnings...
All that only adds up to a good case that some time periods exist in which buying trackers is more risky than following just about any HYP strategy. How common they are, I don't know and doubt I will ever know - it's only in extreme cases like the tech boom and bust that the answer about which is more risky becomes at all obvious. I've little doubt that there are other periods in which buying trackers is less risky than following just about any HYP strategy, though I don't know of any really clear example of such a period. What matters for a long-term investor is of course how the risk averages out over the decades, but all I can say about that is that I'm pretty certain it's an average of 'less risky' and 'more risky' periods, which obviously doesn't answer the question... So as I said at the start of this, I am
not certain either way about the answer.
(*) Some precise figures I've got are that the total return version of the FTSE 100 index dropped from 3140.73 to 1624.17 (a 48.3% drop) between 30/12/1999 and 12/03/2003, while the FTSE 350 Higher Yield index dropped from 2370.03 to 1841.54 (a 22.3% drop) over the same period. So £1k invested in perfect trackers of the two (if such things existed!) would have become £517 and £777 respectively, meaning that the FTSE 350 Higher Yield tracker would have outperformed the FTSE 100 tracker by about 47.4% over three and a bit years.
Gengulphus