Replacing LGEN with PHNX

[Newroad]

Morning All.

Another replacement suggested by the methodology I follow (or at least my version of it) below. I know that replacement (or "substitution" as the methodology refers to it) is not to everyone's taste. If you want to follow some of the discussion along those lines, go to the following, but I don't propose to rehash any of it. If you're interested, stay tuned, if not, fair enough.

https://www.lemonfool.co.uk/viewtopic.php?f=31&t=40770

We have discussed these two stocks a while back, when I was first looking to build my pseudo-HYP. You can find that discussion within here if interested

https://www.lemonfool.co.uk/viewtopic.php?f=15&t=33691

Since then, the share prices have behaved as follows

PHNX then 617.20 now 482.20 (down 21.9%), yielding 10.78%, according to Dividend Data
LGEN then 271.00 now 222.50 (down 17.9%), yielding 8.83%, as above

If I am going to switch, it's a shame I'm a bit slow - PHNX rose 2.07% on Friday compared to LGEN's 0.32%

The methodology typically uses an approximation called the "Rule of 20" (but actually depends on your investment horizon and assumed interest rates, as it is in effect based on discounted cash flows). So, if you're trying to work out the effect of a single annual cost, you times it by 20. The methodology uses the reverse process after discounting for the effect of uncertainty (i.e. in dividends). Carver's research suggesting taking the dividend differential and dividing by 5 (from his statistical analysis, reflecting the uncertainty) then multiplying by 20 to get a present value.

Here, that would give

10.78-8.83=1.95%
1.95/5=0.39%
0.39*20=7.8%

Clearly, with all the above, you can use your own time horizon and assumptions about interest rates - I'm OK to use the approximation.

So, how does that work in this case. Let's assume my current LGEN investment is worth £2000.00, which it is there or thereabouts. I/we need to compare the cost of the transaction versus the statistically assumed future upside. On stocks such as these with the (small) amounts I purchase, I've been able to get very tight pricing (indeed, usually the right side of the midpoint) but I'm going to make one further conservative assumption - that I'm going to lose 0.1% bid-offer pricing. So the cost for selling and buying are

Sell LGEN: (£2000.00 *0.999)-£3=£1995.00
Buy PHNX: (£1995.00*(0.994)-£3=£1980.03

Where the 0.994 is 0.5% Stamp Duty and the aforementioned 0.1% bid-offer pricing. The 0.999 is similarly defined and £3 is what IBKR charges for a trade. So a cost of transaction, in round terms, of £20.

The upside is the discounted dividend increase. This is

£1980.03*7.8%=£154.44

where both figures are as derived above, which suggests the trade is very much worth doing. Anyway, this will have been of interest to some, but not others. My apology in advance to Carver and any readers for any errors above.

The key remaining question is whether there is different (and if so, then adequate) reason not to do the trade, based on fundamentals or something else?

Regards, Newroad

[Itsallaguess]

The key remaining question is whether there is different (and if so, then adequate) reason not to do the trade, based on fundamentals or something else?

I'm not familiar with the Carver method that you've described in the above post, but on the face of it, and taking into account that you only seem to have bought LGEN just 18 short months ago, isn't there a danger that the Carver process as described in your previous post simply channels you towards higher and higher yielding options, which might then potentially be seen as being nothing more than an accelerated advance towards a 'Too High' yielding portfolio?

I don't wish to be seen as being too critical with the above, and I'm concious that I might have missed a key element in your approach that might help to reduce that specific risk, but as an income-investor who's made long-term trading-inactivity a key plank of my strategic goals, along with seeking out more moderate yields with long-term records of stability, then seeing quite short-term income-investment trading into ratcheted yields that perhaps start to look like they're bordering on 'Too High' territory begins to make such an approach look like it's building in the type of poor-outcome-inevitability that I've worked for many years to purposely avoid, as I've left my single-share HYP years behind me.

Is there anything in the Carver method that helps to avoid that sense of 'Too High' inevitability that I might well have missed?

Cheers,

Itsallaguess

[monabri]

A decision based purely on relative yields with no consideration as to anything else....?

Why not simply sell everything and put it "all on black"?

[moorfield]

Re: Replacing LGEN with PHNX

An obvious question springs to mind, and forgive me if I'm struggling to keep up at the back and sounding like I'm depriving a village somewhere.

Why not hold both ?

[Newroad]

Hi IAAG.

There is nothing that I recall reading in the Carver approach (i.e. the methodology outlined in his book "Smart Portfolios") which has the concept of "too high" for yields.

However, he is very big into the concept of diversification, so we are talking, at most, one share in eleven, or less if you have more elevens, i.e. he advocates a second eleven, not topping up the first eleven, then a third eleven etc. So, in that sense, there is a limiting factor. According to Dividend Data, my current pseudo-HYP has a trailing dividend of 5.95% and a forward dividend of 6.00%, which may give some sense as to how that works in practise.

On a related note, he suggests doing comparisons such as I am doing either six-monthly, or annually - otherwise you might find yourself chopping and changing too much (depending on portfolio size etc). In future, I plan to do my reviews in July, immediately after my end of June annual report, but I missed that this year for a few reasons, so I'm catching up.

{Monabri} If there is nothing to the yield (or momentum, another argument Carver covers, but more for the short term} arguments, all else being equal, then indeed, why not all on "metaphoric" black. You can form you own view on that.

{Moorfield} It goes to the "elevens" of sectors. If there was a third eleven (and there could be, but currently isn't) then you would hold both, but from the sector, it would be, in order, PHNX, MNG, LGEN. I do know they come from two different sub-sectors.

Regards, Newroad

[kempiejon]

Re: Replacing LGEN with PHNX

An obvious question springs to mind, and forgive me if I'm struggling to keep up at the back and sounding like I'm depriving a village somewhere.

Why not hold both ?

I asked Newroad some Qs on their strategy on another thread and I expect it's because of the methodology. The portfolio trades based on yield and weightings and the description up thread. If the method says trade out of LGEN to PHNX to realise the profit and increase future extra profits the time to say goodbye to PHNX is now. No point in having a methodology and ignoring it.

[Alaric]

The key remaining question is whether there is different (and if so, then adequate) reason not to do the trade, based on fundamentals or something else?

PHNX has a higher dividend yield. But the success or otherwise of a switch is going to depend as much on future share prices as on dividends. For reasons not totally explainable market values of insurers are depressed thus increasing their yield as they seem to have no current difficulties in paying and maintaining dividends.

Insurers have to set aside capital to meet guarantees to policyholers. As time passes the cost of providing these guarantees reduces as the guaranteed payments are made and no longer have to be reserved for. Perhaps there's a perception that the dividends are in part a release of capital. That may apply more to PHNX than LGEN as the Phoenix model was to buy up closed books of business and extract value from them.

[Itsallaguess]

There is nothing that I recall reading in the Carver approach (i.e. the methodology outlined in his book "Smart Portfolios") which has the concept of "too high" for yields.

However, he is very big into the concept of diversification, so we are talking, at most, one share in eleven, or less if you have more elevens, i.e. he advocates a second eleven, not topping up the first eleven, then a third eleven etc. So, in that sense, there is a limiting factor. According to Dividend Data, my current pseudo-HYP has a trailing dividend of 5.95% and a forward dividend of 6.00%, which may give some sense as to how that works in practise.

On a related note, he suggests doing comparisons such as I am doing either six-monthly, or annually - otherwise you might find yourself chopping and changing too much (depending on portfolio size etc). In future, I plan to do my reviews in July, immediately after my end of June annual report, but I missed that this year for a few reasons, so I'm catching up.

Thanks Newroad, and especially coming at the above reply in the same spirit my earlier questions were asked in. As stated earlier, I'm not wanting to criticise, but rather trying to just better understand Carver's approach.

I don't consider 12-month reviews to be problematic in and of themselves, but when they're accompanied by mechanical processes that create opportunities for data-led 'yield-ratchetism', if we might call it that, into potentially extreme yield-territories with no consideration of any potentially associated investment-risk, then I'd have to say that it's an approach that wouldn't suit me personally, but I will follow the development of your HYP as it aligns to these Carver-related processes with interest, and I note that this is just one smaller part of your overall investments whilst you also consider the long-term merits of Carver's approach using a live experiment.

One of the problems I found in my earlier HYP days, which also concentrated on diversification and with little regard for 'too high' yield levels, was that over the years a figure for overall portfolio-yield seemed to hide a multitude of sins within the underlying holdings, where, for example, a 6% portfolio yield might have been generated from a set of 'diverse' holdings with a yield range of 0% to 10%, with many of those 0% 'mistakes' being ones I'd put down to concentrating on yield too much in the first place, and I simply came to the conclusion that focussing on more reliable 'middle ground' yields might offer me a route to investment success whilst still maintaining an 'income-investor' approach, but which then delivers far fewer strike-points at the 'too-low' or 'too high' yields on that earlier-mentioned wider yield-curve.

I'll be interested to see how the Carver HYP approach develops on that front as you continue with this interesting experiment.

Cheers,

Itsallaguess

[Dod101]

I hold both L&G and Phoenix but I consider that L &G is the better share, and I suspect so does the market; hence the higher yield for Phoenix. They are quite different shares. Phoenix used to be a zombie life insurer but, a bit like Chesnara, they are now building up a current book. For Phoenix that occurred when they bought the Standard Life business, so they are much less dependent on closed funds nowadays.

I know nothing of Carver but Newroad is in danger of ending up with a portfolio of second rate companies if he carries on like this. First he substitutes SSE for a water utility and now is thinking of substituting a first class life company like L & G for Phoenix.

Anyway it is his portfolio.

Dod

[monabri]

{Monabri} If there is nothing to the yield (or momentum, another argument Carver covers, but more for the short term} arguments, all else being equal, then indeed, why not all on "metaphoric" black. You can form you own view on that.

Regards, Newroad

All else is very unlikely to be equal as they are not the same business models, same size, same management, same debt, profit, margin, shareholders etc. These are the known knowns.

[Newroad]

No problems, IAAG.

As I mentioned in another thread, most people here are either to help themselves, help others, or both. In my case, I hope both - even if the latter is simply helping people avoid remaining in an echo chamber.

As an aside, let's call what I'm doing as Newroad's "Pseudo-HYP" method. It would be unfair to paint Carver with any of my sins, whether that be a poor or narrow interpretation of his book. What he actually advocates, for most, is a top-down "handcrafted" approach, based mostly on ETF's and other low cost instruments - type (equity/bond/alternative) then macro-region (developed/undeveloped) then region (e.g. Americas/Europe) then country then individual instruments within countries.

The narrower part of his work that I am leaning on is if you think you are a good stock-picker (he doesn't of himself) or you want to do so for "fun", or because you need to do so on an industrial scale (e.g. a fund manager). In other words, if you must pick them, then he advocates doing it a certain way.

As an aside, to expand slightly further on the above, the sector based approach means I invest in SGE (yield 1.89%) and SN. (3.00%) - and their closely related friends BA. (2.82%) and GSK (3.72%, but was higher, IIRC, at point of first investment).

{Monabri} See above, but of course, if you or anyone else thinks their approach is better, critically in risk weighted terms, then fair enough - you need to do what you think is best.

{Dod} Once again, Dod, you may be right. Or it's possible some of these "second rate" companies may provide better risk weighted value. Only time will tell.

Regards, Newroad

[Dod101]

There is of course no right or wrong way to invest so I may just be an old man sticking to his prejudices. I know what works for me and I suspect that the outcome for Newroad will not be all that different. I am in the fortunate position of not having to squeeze out every extra dollar from my dividends, so I nowadays take a fairly relaxed attitude to my share picks. I see no benefit in exchanging Legal and General for Phoenix.

Specifically Legal and General has been in my portfolio for the last 30 years or so and I have known it for 25 years or so before that on a professional basis. Like my portfolio, it has evolved over the years but has seldom got it wrong.

Phoenix in contrast is a newcomer. It was established from a collection of second rate insurers which simply could not survive in the modern world. Indeed, Phoenix itself was one of those. In bringing together these companies they spent a long while sorting them out and consolidating them and then of course did the deal with abrdn to buy the ‘live’ life insurance funds of Standard Life. So they have a lot of baggage but seem to be maturing as a company so we’ll see.

I do not understand ‘risk weighted value’ but as far as risks are concerned I know that I have managed to avoid most of the worst outcomes over the last 25 years or so, sold most of the banks before the disasters of 2007/8 and never held Carillion. My last real disaster was holding on to Cable and Wireless in 2000 for far too long waiting for a recovery that never came. That was when I realised at least some of my errors, at least up to that point.

Disasters wait around every corner though.

Dod

[88V8]

Let's assume my current LGEN investment is worth £2000.00, which it is there or thereabouts.
The key remaining question is whether there is different (and if so, then adequate) reason not to do the trade, based on fundamentals or something else?

I hold LGEN and PHNX and MNG and CSN, all of them in size. CSN and PHNX are underwater, MNG and LGEN not, but all have paid me a decent divi.

Fortunately you are looking at two very liquid shares with small spreads, even so your cost of switching at £20 is 1% of your holding.
It will take six months of extra yield to get that back, and then you're ahead. Except that the next divi is due in May, I think it is, so rather longer, more like seven months.
So on the face of it, OK. Provided that your next review... in six months... doesn't suggest another swap.

One cannot really argue with swapping to improve yield. It's what tjh does by rebalancing.
If this is currently a pilot exercise designed to test methodologies, well, bash on... but if it's a real portfolio then it will obviously work better when you can put more funds into it so as to marginalise your costs.

V8

[moorfield]

As methodologies go, this has to be the most over-engineered I've seen described.

Incomprehensible.

But good luck with it, nonetheless.

[tjh290633]

One cannot really argue with swapping to improve yield. It's what tjh does by rebalancing.
If this is currently a pilot exercise designed to test methodologies, well, bash on... but if it's a real portfolio then it will obviously work better when you can put more funds into it so as to marginalise your costs.

V8

I think that I should emphasize that improvement in yield is not the objective. Trimming is done to bring a holding back into an acceptable range. The fact that reinvesting the cash so realized may result in an increase in yield is an added bonus. It's not 100% guaranteed. I have had the target holding reduce it's dividend after such an exercise.

TJH

[Newroad]

Evening, All.

Just picking up a few of the discussion points since my last comments.

"Risk Weighting": In the context used, this means starting with an asset allocation based on risk, rather than (final) cash (weighting). An example may make understanding easier - using a top-down hand-crafted approach. Assuming one starts with equal weights for asset classes, in this case, the trivial case one with two (equities and bonds)

Cash Weighting: gives 50% equities/50% bonds cash weight (by definition)
Risk Weighting: gives c30% equities/c70% bonds cash weight (50%/50% risk weights then Sharpe Ratio optimised)

Others of course may wish to optimise for something else, e.g. maximum (geometric mean total) return.

{88V8} Yes, you appear to understand the theory (whether or not you agree with it). On the fact the relevant shares are liquid, that is pretty much true for anything I'm buying/selling in the Pseudo-HYP. However, even if that were not the case, the transaction cost would simply rise and hence the burden of proof (in short, the yield difference) needs to be greater to justify the substitution.

{Moorfield} It's not that over-engineered, IMO, especially with the heuristics/assumptions which can be used. In large part, I do use these heuristics - the main exception being that I choose to derive my own cash weights for each of the 22 equities (starting out with equal risk weights for each).

{TJH} Though I know you were responding to 88V8 not me, for the clarity of others, what you refer to as "trimming" is one part of what Carver and many others would describe as "rebalancing". "Substitution" (aka "replacing") is a different process for a different reason - this different reason explains the different objectives, as you imply.

Regards, Newroad

[CryptoPlankton]

The key remaining question is whether there is different (and if so, then adequate) reason not to do the trade, based on fundamentals or something else?

My "something else" would be that the 10 year compound annual growth rate of the LGEN dividend is 9.27% compared to PHNX's 2.53%. If these growth rates are sustained, the income generated by a £2000 holding in LGEN would outstrip that of one in PHNX (even before considering the dealing costs) in a little over three years. Assuming the main purpose of the investment is income then, given the recent return to higher inflation rates, I'd find it hard to justify giving up the long-term inflation protection afforded by the LGEN dividend without a better reason than that which seems to be being proposed.

[Newroad]

Thanks CryptoPlankton.

That's an intelligent response and one I will consider.

On a couple of technical points, firstly, the main purpose of the investment is total return within certain constraints to minimise risk - the theory is that, all other things being equal, that starting with higher dividend paying stocks from a given choice is the best way to achieve that.

Whether the historic compound annual growth rate cited is a "better" reason than the methodology (which implicitly assumes such things are fully baked in to the price) is a matter of opinion, but it's certainly something which makes one wake up and consider.

Regards, Newroad

[dealtn]

Thanks CryptoPlankton.

That's an intelligent response and one I will consider.

On a couple of technical points, firstly, the main purpose of the investment is total return within certain constraints to minimise risk - the theory is that, all other things being equal, that starting with higher dividend paying stocks from a given choice is the best way to achieve that.

Whether the historic compound annual growth rate cited is a "better" reason than the methodology (which implicitly assumes such things are fully baked in to the price) is a matter of opinion, but it's certainly something which makes one wake up and consider.

Regards, Newroad

If Total Return is the objective (and actually even if it isn't!) the long-term result is best looked at through the lens of the company investment return, and the expected growth of that return over time. So look at profit (or better cashflow - although this is particularly difficult to disentangle in financials and insurers). A start point of analysis based on dividends is at best a proxy for "return" being an annual decision made by a few men around a boardroom table. If dividends "have" to be a component of the analysis then at a minimum that input should be caveated by the "cover" so earnings at least are an input to the decision making too.

Buying a share (and deciding between different types of shares) is getting ownership of a "share" of the company assets and a "share" of the returns on those assets. It really is that simple. Looking at the "dividend", and usually historic at that, is at best a proxy for what your "share" is worth both today, and into the future.

[tjh290633]

{TJH} Though I know you were responding to 88V8 not me, for the clarity of others, what you refer to as "trimming" is one part of what Carver and many others would describe as "rebalancing". "Substitution" (aka "replacing") is a different process for a different reason - this different reason explains the different objectives, as you imply.

Regards, Newroad

Good point. The object of trimming, or Top-slicing, is to reduce imbalance, not to rebalance, which implies a more wholesale adjustment of holdings.

TJH