HYP1 versus the baskets: 2000-20

[Luniversal]

Here is a 20th year comparison of income delivery and capital performance, including volatility, between pyad's High Yield Portfolio (HYP1) and income investment trusts. HYP1's results were reported on Nov. 14:

viewtopic.php?f=15&t=26213

My alternative, using investment trusts rather than directly owned equities, is 'baskets' of seven (B7) or eight (B8). These are tasked with the same objective as a High Yield Portfolio. Both routes seek a sizeable, steadily growing and reasonably stable income from a lump sum, to supplement if not replace pensions on retiral. Voluntary 'tinkering' with the original components is discouraged by pyad and your correspondent.

The B7 and B8 were selected in 2010 and back-calculated to HYP1's launch date in Nov. 2000. To provide for hindsight bias (though effects would have dissipated after a decade's onward evolution) average outcomes are shown for all larger UK Growth & Income sector trusts available when HYP1 was launched: the 'Universe of 24' (U24) (2).

Four U24 dividends payable by Dec. 31 are projected pending declarations: ASEI 5.8p, (2019: 5.8p); BCI, 3.65p (3.75p); IVI, 2.5p (2.5p); KIT, 12p (23.67p), after a switch to quarterly payouts.

All figures assume £75,000 gross invested in equal amounts before 1% purchase expenses, without dividend reinvestment or capital additions. Compound annual growth rates (CAGR) are timed to eliminate random variations in dividend entitlements arising before Jan. 2002. Deflation is by the Retail Prices Index. RPI inflation averaged 2.7% pa through this study's timespan.


INCOME

Totals for 2020 (£)...Change from 2019 (%)...Totals since launch (£)...CAGR 2002-20 (%)...Number of falls year-on-year (out of 18 changes, 2002-20)

HYP1: 5,533...-47.6...101,058...2.6...4
B7: 7,929...+14.4...87,140...7.4...1
B8: 5,296...+1.2...77,562...3.7...1
U24: 5,488...+4.0...74,812...3.7...1


HYP1's income all but halved last year: not only because of the panicky cuts triggered by the flu scare but because large one-off distributions by Persimmon and Rio Tinto did not recur. Over two decades the portfolio has garnered one-sixth more income than the B7 and almost one-third above the more comparable B8. The growth rate remains a little ahead of the 'growthy' B7's.

The B8 was planned for shorter-term income-seekers, on a 'juicier' immediate yield but with weaker dividend growth potential. The B7's cumulative total delivery passed the B8's after eight years, and in 2020 will be £2,700 more. However the B8's purchasing power was greater in as much as it was weighted towards early years.

The U24 takes in mavericks such as Nick Train's 'conviction' trust, Finsbury, which lingers in the official UK Income sector despite a low yield; Securities Trust of Scotland and Aberdeen Diversified Income & Growth, with their mercurial policy shifts; and the family-dominated Brunner. These have been less able or willing to increase generous dividends steadily than vanilla trusts which like HYP1 draw largely on British blue chips. The U24 houses two (under the same management) which broke down, labouring subsequently to restore their payouts: Shires Income and Troy.

Hence payouts from the Universe are running about the same as the B8, but more spikily. The U24's CAGR (from a depressed base in 2000) is the same too.

Each option seldom failed to swell its income stream in nominal (and mostly in real) terms year by year. HYP1 missed the mark four times out of 18, with an average dip of 24%. Trusts failed on this front only once or twice-- trivially so in baskets. HYP1 has ridden a switchback since its birth; twice it confounded Pyad's belief, voiced in early days, that income from 15 disparate sources was unlikely to decline in total by more than one-fifth between years.


DERISKING

Amount withdrawn (£)...Safety margin (%)...CAGR of withdrawn amount (%)...Average reserve, 2000-20 (months)...Reserve at end-2020 (months)...Average yield on capital (%) for amount withdrawn:

HYP1: 92,531...8...7.0...11...11...4.3
B7: 76,389...12...13.6...20...19...3.0
B8: 73,058...6...3.9...7...11...4.1
U24: 67,544...10...4.1...12...18...3.6

HYP1's superior revenue generation is offset by its waywardness. If you need to finance necessities, set part of your 'raw' receipts aside.

My way of amassing an income reserve is to fix a withdrawal rate once the first year's money is in the bank, somewhat below your total haul. Increase the spendable portion by inflation annually and let the surplus accumulate until it should shield you: say, 12 months' worth of whatever is the current amount being withdrawn. Thereafter you may in time have room to withdraw more.

'Derisking' income opens a margin of safety between received and spent which has averaged 8% of raw income for HYP1; the CAGR for spendable income has been 7.0% against 2.6% from receipts. The dip in Year 20 was so abrupt that at its close the reserve of 11 months' spendable, though no worse than the average throughout HYP1's life, was eight months below Nov. 2019.

Nevertheless, today's reserve may be a nadir. The corollary of widespread cuts, and the prospect of slower growth as companies payouts come out of lockdown, is that inflation should stay tame, requiring little indexation uplift. Most trusts have furnished income streams without interruptions, while keeping revenue reserves at 9-15 months. Typically a UK Equity Income sector member books around 5% of earnings to its reserve-- not an onerous insurance premium.

The three trust-based options range from 11 and 19 months in reserve now. The Basket of Seven, with its 'growthier' bias-- tortoise to the B8's hare- has achieved a spendable CAGR as high as 13.6%, albeit from a low initial yield. Yet the B7's withdrawn income has been only £3,000 higher. As said, the Basket of Eight paid more sooner: its withdrawn income averaged a yield of 4.1% pa on the year's brought-forward capital value, against the B7's 3.0%.

HYP1 exceeded the B8 with a 4.3% average withdrawal rate. But the B7 has the comfort of far stronger reserves than the juicy two, as well as quicker rises.


ANNUAL WITHDRAWAL YIELDS (%)

HYP1: Years 1-5: 3.5...6-16: 4.4...17,18: 5.3...19,20: 6.3
B7: Years 1-6: 2.5...7-11: 3.3...12-17: 4.1...18-20: 5.7
B8: Years 1-9: 3.3...10-20: 3.9
U24: Years 1-8: 3.0...9-14: 3.3...15-20: 3.8


The table shows what set-asides could have meant for your pocket, i.e. how spendable income as a yield on the £75,000 subscription might grow-- once jacking up the abstraction rate was feasible without imperilling the reserve. All yields are index-linked, so rises boost purchasing power.

Since 2019 I have reappraised withdrawal rates for the B8 to provide a more cautious balance between abstraction and retention. The choice is art, not science, though in each case the starting withdrawal yield is at least as high as that on the All-Share Index at the time, honouring the H in HYP. Patterns reflect smoothness and size of the raw intake, and so are very various.

HYP1 kicked off on a 3.5% yield, improved to 4.4% after six years. Until Year 17 inflow was too erratic to venture on a higher withdrawal rate that might have come unstuck. The latter-day boom in divis until spring 2020 eased the dilemma: it would have permitted 5.3%+RPI for two years, and a point more in 2019 and 2020.

The Basket of Seven could only offer 2.5%+RPI for its first six years, but income's buoyancy has allowed three rises. They took it to 5.7% by 2020. Caveat: this year's aggregate is swelled by Perpetual Income & Growth, which just dispensed its entire revenue reserve before being gobbled by Murray Income, a B8 (and henceforth B7 also) member. The net effect of this assimilation on the B7 is hard to foresee, but should not be enormous. Meanwhile, its reserve got a timely top-up.

The B8 could have paid a derisked 3.3% for the first nine years, 3.9% thereafter. Its sluggish acceleration of payouts compared with the B7 has left it becalmed on that rate, with no short-term prospect of better things if the course of big, 'value' companies' dividends is to be a reclining L shape from Q1 2020 onward. The B8's evolution leads me to prefer moderately superior initial yields ('optimal zone') to alluringly superfatted ones; I doubt the market often crassly misjudges intensely researched Footsie stocks, and divis are easier to forecast than prices.

The U24, as in many respects, has a profile between that of the baskets. Its overall distribution was so skewed by eccentric trusts rejected from baskets that its current safe yield is only 3.8%.

Beyond such distinctions, remember the purpose of these portfolios: all would have furnished secure purchasing power, growing at different speeds but well above riskless but miserly cash deposits. Those latterly have offered ~1% without indexing, and now we hear whispers of negative rates. Bonds have been similarly grudging. Index-linked annuities for single male retirees are quoted at 3%+RPI, with capital surrendered. I wrote a year back: "Dividends from UK companies still look best, for all their near-term uncertainties and possible decay or disruption." That verdict stands.


CAPITAL

Value at Nov. 12, 2020 (£)...Real change in year (%)...CAGR since launch after inflation (%)...Number of falls year-on-year (out of 20 changes, 2000-20)

HYP1: 148,627... -8.0...3.5...5
B7: 174,902...-10.7...4.3...7
B8: 101,441...-16.6...1.5...8
U24: 128,254...-10.3...2.7...8
------------------------------------------------
FTSE 100: 6338.94...-15.2...0.1...8
FT All-Share: 3569.99...-13.0...0.9...8

As a forever fellow, I will let my executors dispose of whatever capital growth eventuates from income investments. Meantime I keep one eye on values, since they can hint at the revenue flow's healthiness.

HYP1 lost value less rapidly than the B7, but remains worth £26,000 less on their twentieth birthdays. Real compound growth rates for capital since launch have been 3.5% pa for HYP1, 2.7% for the U24, 1.5% for the B8 (closest to HYP1 in character) and 4.3% for the B7.

The High Yield Portfolio lost value, year/year, in five of 20 periods: fewer than the baskets, albeit HYP1's ups and downs (like its income's) were more pronounced. Versus the B7 the rotated bunch of c. 15 stocks outperformed the basket for the first time since 2013: an intriguing result in the teeth of the plunge in HYP1's income, perhaps discounting a rally in dividends.

Certainly on a longer view HYP1's benchmark, the FTSE 100 index, has been 'crushed' or 'slaughtered', in pyadic parlance. The Footsie has stagnated for two decades. The more broadly based All-Share Index, among which baskets fish more, has done little better. Even the wheezy Basket of Eight is appreciably ahead of indices. Trusts lost value as often as the broad market, but by less, while outperforming indices in bullish conditions.

Options other than the B8 have outpaced the 2.7% pa inflation of this timespan. Anyone who went into them for income should not feel she has crippled capital in the process. A tracker would have done worse on both counts.


CONCLUSIONS

I run two HYPs and a clutch of trusts. The HYPs are more exciting, require more monitoring, stockpicking and admin-- though not a huge load-- and they pay more. Until the current PLI-MUT merger the baskets would only have disturbed apathetic investors to make sure dividends were timely and correct. In my experience of broking platforms, they are. (They would also have exchanged PLI stock for MUT by default, without pestering the lazy for an election.)

If income is fun money, you may ignore all the derisking palaver, taking fat and lean years in their stride. But three words of wariness about HYP1 as an exemplar of the theory should be reiterated, and one about its viability for 2020 starters.

First: it saw the light when the millennial infotech craze was on; big shares' ratings were sharply polarised between glamorous futuristic issues, often yielding little or nothing and selling on hope, and 'old economy' blue chips.

Pyad's choice naturally fell on the old plodders. Their unpopularity promised much bigger immediate payback than one could obtain from them a little later after dotcom mania subsided. It was a wonderful time to be into juiciness. Thirteen of HYP1's 15 initial selections would have stood on yields at least half as high again as the market, some far more. Pyad predicted a 4.8% Year One yield (actual outcome 4.6%) versus the FTSE 100's 2.2%.

My retrospective research into dividend growth rates, frequency of interruptions and relative yields this century warned that HYP1's blended starting return might hit squalls. So it proved. The first few years' collections were fitful before bounding ahead. Then, during the global crisis, HYP1 gathered less income in 2010 than in its debut year: a 37% plunge from 2009.

Secondly: the crucial principle of diversification was not fully observed at the outset. Two of HYP1's first fifteen were banks, three were resource-extractors (miners and an oil producer). Then, and maybe now, the most alluring immediate yields clustered in a minority of sectors, if choice was confined to the Footsie and a bit below.

Thirdly: there was no codified guidance about how much to recycle funds when 'market trading' threw up cash, e.g. from a bid. HYP1 notoriously sank a lot of freed-up capital into BT which might have been spread more diversely. BT, a perennial dasher of hopes, is now a cutter again with scant chance of booming.

The much-discussed concentration of income into a minority of members might have been reduced. OK, fun-money holders might prefer bonanzas from the few... but are any more in sight, opportunistic bids apart? The vogue seems to be to parlay the temporary interruption of normal dividend service into 'resetting' payouts on much higher target levels of cover-- say 2-2.5 times earnings, whereas last year 1.25-1.5 times was routine. Hence the leaning-backward L or hockey-stick pattern of recovery.

Following about a dozen paper or real HYPs, back- and front-tested, hitherto reassured me. Being stricter about diversification, and reinvesting freed cash with the same per-holding commitment as in the original group, would thwart polarisation. HYP1's skews were self-inflicted.

But where does this leave anybody thinking of beginning a High Yield Portfolio today?

According to one brokerage, there have been six 'dividend recessions' in the last century. The present wave is broader than the previous two: the early 2000s, which hit infotech stocks while leaving many in the trad economy unharmed, and the Global Financial Crisis, when finance and real estate came off worst. All the same, widespread and sharp reductions in equity payouts happened, and it is prudent to expect one or two if a HYP's lifetime be measured for 25-35 years of retiral.

That leads me to uphold the principle that a company must show five years of rising dividends to be eligible for a lump-sum choice of fifteen (3). If too few remain for genuine diversity-- not the blurred lines pyad allowed himself in HYP1-- then the system must go into cold storage until enough healthy five-year histories emerge again.

It could be a long wait.
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(1) Latest detailed annual reviews on the 'Investment Trusts and Unit Trusts' board:

B7: viewtopic.php?f=54&t=23743&p=314953#p314953
B8: viewtopic.php?f=54&t=25362&p=342370#p342370


(2) Besides the fifteen basket members, these are Aberdeen Diversified Income and Growth (formerly BlackRock Income Strategies, previously British Assets) (ADIG); Aberdeen Standard Equity Income (formerly Standard Life Equity Income) (ASEI); Brunner (BUT); Finsbury Growth & Income (FGT); Keystone (KIT); Scottish American Investment (SAIN); Securities Trust of Scotland (STS); Shires Income (SHRS); Troy Income & Growth (TIGT).


(3) "...we aint living in normal times and several modifications to the usual selection criteria will often have to be made for new selections."

viewtopic.php?f=15&t=25034&p=337545&hilit=normal#p337545

Dividend recessions are part of normal times.

[Itsallaguess]

Great review.

I've re-compiled the Income and Capital data so it's a bit easier to digest -

INCOME -



CAPITAL -



Cheers,

Itsallaguess

[Lootman]

Great review.

I've re-compiled the Income and Capital data so it's a bit easier to digest -

INCOME -



CAPITAL -

Very good. What screams out at me there is that, both in terms of income stability and capital growth, B7 is the clear winner.

And whilst I cannot recall what exactly is in it, I believe it was a portfolio that had a target of a lower headline yield but better safety and growth prospects. And had a non-UK allocation.

This accords with my earlier example which shows how a US index fund out-performed HYP1 over the same time period.

What isn't captured here is the respective risk taken by each portfolio. And certainly at this point, if not at the outset, HYP1 surely has the highest risk due both to its concentration problem and its single country risk.

[tjh290633]

Very good. What screams out at me there is that, both in terms of income stability and capital growth, B7 is the clear winner.

And whilst I cannot recall what exactly is in it, I believe it was a portfolio that had a target of a lower headline yield but better safety and growth prospects. And had a non-UK allocation.

It just so happens that I have a note of it and the B8:

B8
City of London (CTY)
Dunedin Income Growth (DIG)
Edinburgh (EDIN)
Invesco Income Growth (IVI)
Merchants (MRCH)
Murray Income (MUT)
Schroder Income Growth (SCF)
Temple Bar (TMPL)

and

B7
Bankers (BNKR)
F&C Capital and Income (FCI)
JPM Claverhouse (JCH)
Lowland (LWI)
Mercantile (MRC)
Murray International (MYI)
Perpetual Income & Growth (PLI)

TJH

[Itsallaguess]

The latest comprehensive reviews for both the Basket of 7 and the Basket of 8 were linked at the bottom of the opening post.

For clarity, here they are on their own -

Basket of 7 (2020 Review) - https://www.lemonfool.co.uk/viewtopic.php?f=54&t=23743

Basket of 8 (2020 Review) - https://www.lemonfool.co.uk/viewtopic.php?f=54&t=25362

Cheers,

Itsallaguess

[funduffer]

Thanks Luni,

I have missed your eloquence in writing about such matters.

Its a soothing read, compared to some of the posts on here!

FD

[Mulberry]

Thank you very much Luni. I have been a basket enthusiast for a number of years since reading your posts on Motley Fool. Your reviews are always very interesting and informative. I appreciate all the time and effort you put into producing them.