HYP1 is 23 - Total Return

[Bubblesofearth]

The former. Plus, especially in this context, it is the potential fall in Income not value surely?

In which case it is an even more pertinent question to ask which is more important, income falling by a certain % or a drop in income to below a certain value? If you set up a HYP to provide a given level of income and the income rises above your needs then you will likely tolerate a fall more easily than if the income has just kept pace with your needs and then falls. If prudent you will have saved or reinvested the extra income in the first scenario to provide a buffer.

BoE

[dealtn]

The former. Plus, especially in this context, it is the potential fall in Income not value surely?

In which case it is an even more pertinent question to ask which is more important, income falling by a certain % or a drop in income to below a certain value? If you set up a HYP to provide a given level of income and the income rises above your needs then you will likely tolerate a fall more easily than if the income has just kept pace with your needs and then falls. If prudent you will have saved or reinvested the extra income in the first scenario to provide a buffer.

BoE

Indeed. But the question was about "risk" and whether a balanced strategy was less risky. You are now introducing someone's tolerance to that risk. I think I would agree that someone with excess income is more tolerant to that "riskiness" to someone that has lower income. Regardless, for any portfolio holder, at each income value would have a tolerance for less risk, or more balance to that income stream. That is the choice any HYPer has at any point in time. It isn't possible to rebalance and create additional capital value so to minimise risk a balanced portfolio is optimal.

Interestingly though, from an income perspective, it is possible to "create" additional income, by selling low yielders (for whatever reason they have become such) and buy high yielders. So why, both at inception, and during the portfolio's life, doesn't the author, or the protaganists, undertake that switch to a single (or few) high yielding shares? At inception it is considered that to be too high a risk and sectoral diversification is necessary. That concern about the "risk" evaporates, it seems, the next day? The risk doesn't evaporate, indeed it grows with each passing day, the portfolios aims and reality potentially diverge with each passing day, or dividend declaration.

And therein lies the dichotomy of the HYP system. It is both simple and low risk, such that an ordinary person, a Doris, can undertake it, but also a system that grows in risk over its life with no simple system or set of rules to limit that risk such that a simple ordinary person (perhaps unknowingly) is exposed to growing, and eventually significant, risk.

In practice it seems most practitioners of the method aren't purists (and also probably aren't HYP monopolists either), so that total risk is less of a concern. Pure Doris HYPers however are taking risk they perhaps weren't aware of, and in the real world might in practice be "mis-sold" and parallels with long term products such as endowment mortgages exist, and how they were industry scandals from the past.

[Bubblesofearth]

Indeed. But the question was about "risk" and whether a balanced strategy was less risky. You are now introducing someone's tolerance to that risk. I think I would agree that someone with excess income is more tolerant to that "riskiness" to someone that has lower income. Regardless, for any portfolio holder, at each income value would have a tolerance for less risk, or more balance to that income stream. That is the choice any HYPer has at any point in time. It isn't possible to rebalance and create additional capital value so to minimise risk a balanced portfolio is optimal.

Interestingly though, from an income perspective, it is possible to "create" additional income, by selling low yielders (for whatever reason they have become such) and buy high yielders. So why, both at inception, and during the portfolio's life, doesn't the author, or the protaganists, undertake that switch to a single (or few) high yielding shares? At inception it is considered that to be too high a risk and sectoral diversification is necessary. That concern about the "risk" evaporates, it seems, the next day? The risk doesn't evaporate, indeed it grows with each passing day, the portfolios aims and reality potentially diverge with each passing day, or dividend declaration.

And therein lies the dichotomy of the HYP system. It is both simple and low risk, such that an ordinary person, a Doris, can undertake it, but also a system that grows in risk over its life with no simple system or set of rules to limit that risk such that a simple ordinary person (perhaps unknowingly) is exposed to growing, and eventually significant, risk.

In practice it seems most practitioners of the method aren't purists (and also probably aren't HYP monopolists either), so that total risk is less of a concern. Pure Doris HYPers however are taking risk they perhaps weren't aware of, and in the real world might in practice be "mis-sold" and parallels with long term products such as endowment mortgages exist, and how they were industry scandals from the past.

Firstly, for clarity, the issue I'm trying to address is not risk per se but the argument made by some that rebalancing reduces risk and is therefore a no-brainer for HYP. To make that argument it is not enough to simply look at the balance within a portfolio at a snap-shot in time. You need to look at the total value of the portfolio as well.

To give another example, let's say 20 years ago you had invested in 15 shares and one of those had been Apple. You could now have a portfolio that comprises 14 shares that have wobbled around and are now worth more or less what they were 20 years ago in real terms. Plus one that is now worth 1000X as much as 20 years ago. Your portfolio is horribly unbalanced but worth massively more than a well balanced portfolio that had rebalanced Apple out of it. Partial rebalancing reduces that differential of course but it will still be there. Which portfolio would you prefer to have?

This is an extreme example but it is nevertheless an example of how markets evolve. They are asymmetric with a handful of big winners (income and capital) that will, over time, come to dominate a portfolio. At the same time they will be responsible for a large part of that portfolio's value. At inception you have no idea where the big winner(s) will come from so you diversify and equal weight on purchase. Allowing the maket to then do it's thing is a perfectly sensible strategy.

Interesting you mention endowment mis-selling. The reason those policies failed was nothing to do with market performance, it was down to exorbitant costs of management. Reducing costs is also an important part of keeping trading (rebalancing or otherwise) to a minimum. I'm sure brokers are more than happy to encourage rebalancing strategies!

BoE

[Arborbridge]

To give another example, let's say 20 years ago you had invested in 15 shares and one of those had been Apple. You could now have a portfolio that comprises 14 shares that have wobbled around and are now worth more or less what they were 20 years ago in real terms. Plus one that is now worth 1000X as much as 20 years ago. Your portfolio is horribly unbalanced but worth massively more than a well balanced portfolio that had rebalanced Apple out of it. Partial rebalancing reduces that differential of course but it will still be there. Which portfolio would you prefer to have?

This is an extreme example but it is nevertheless an example of how markets evolve. They are asymmetric with a handful of big winners (income and capital) that will, over time, come to dominate a portfolio. At the same time they will be responsible for a large part of that portfolio's value. At inception you have no idea where the big winner(s) will come from so you diversify and equal weight on purchase. Allowing the maket to then do it's thing is a perfectly sensible strategy.



BoE

Certainly, quite a convincing argument, particularly with regard to growth. As you say, we cannot tell which will be winners, so letting it all "run" let's them shine out in due course. I wonder how that would work if all one needs is a regular income from an already established pot? Would you be happy with all the income arriving from one mega successful company?

Arb.

[Bubblesofearth]

Certainly, quite a convincing argument, particularly with regard to growth. As you say, we cannot tell which will be winners, so letting it all "run" let's them shine out in due course. I wonder how that would work if all one needs is a regular income from an already established pot? Would you be happy with all the income arriving from one mega successful company?

Arb.

No, I wouldn't be happy if all my other holdings produced no income at all.

BoE

[kempiejon]

Certainly, quite a convincing argument, particularly with regard to growth. As you say, we cannot tell which will be winners, so letting it all "run" let's them shine out in due course. I wonder how that would work if all one needs is a regular income from an already established pot? Would you be happy with all the income arriving from one mega successful company?

Arb.

Yes it's a good argument. Following HYP1 review and recent commentary it was suggested that some people wouldn't be able to live off the income as it was produced by too few constituents.
In the example if that one mega successful company was now providing 1000 times the income I expected from it at the outset, I wouldn't be too worried. I've seen the last 20 years being able to set aside an increasing amount of that increasing income. Of course income might not have grown proportionally with capital.

[Arborbridge]

Of course income might not have grown proportionally with capital.

And I think that is Terry's argument: if the yield falls due to outsized capital growth, then rachet up the income by going to a higher yielding share. In that way, he and I are quite unHYPish

By the time anyone has an answer, either the market will have changed, or I will be in gagaland!

Arb.

[Alaric]

Interesting you mention endowment mis-selling. The reason those policies failed was nothing to do with market performance, it was down to exorbitant costs of management.

Both really. If you borrow to invest, which is what an endowment mortgage does when stripped to its basics, it's going to work only if the net return on investments after charges exceeds the net interest paid on the borrowings. If it ever was true even with charges it ceased to be so when the FCA/FSA forced switches to fixed interest after the Equitable debacle.

[dealtn]

To give another example, let's say 20 years ago you had invested in 15 shares and one of those had been Apple. You could now have a portfolio that comprises 14 shares that have wobbled around and are now worth more or less what they were 20 years ago in real terms. Plus one that is now worth 1000X as much as 20 years ago. Your portfolio is horribly unbalanced but worth massively more than a well balanced portfolio that had rebalanced Apple out of it. Partial rebalancing reduces that differential of course but it will still be there. Which portfolio would you prefer to have?

This is an extreme example but it is nevertheless an example of how markets evolve. They are asymmetric with a handful of big winners (income and capital) that will, over time, come to dominate a portfolio. At the same time they will be responsible for a large part of that portfolio's value. At inception you have no idea where the big winner(s) will come from so you diversify and equal weight on purchase. Allowing the maket to then do it's thing is a perfectly sensible strategy.



BoE

Certainly, quite a convincing argument, particularly with regard to growth. As you say, we cannot tell which will be winners, so letting it all "run" let's them shine out in due course. I wonder how that would work if all one needs is a regular income from an already established pot? Would you be happy with all the income arriving from one mega successful company?

Arb.

No it really isn't a convincing argument. It's a self selected example with massive bias. How convinced you were to be if an alternative example swapped Apple for Carillion?

The argument here, and what appears to being missed, isn't what brings the higher return, but whether one is more risky than the other?

If it can be agreed that an unbalanced portfolio has more risk (and potentially high return), why would a system designed to mitigate risk at inception choose to ignore that growing risk over time when it is possible to reduce it at almost negligible cost?

[Bubblesofearth]

No it really isn't a convincing argument. It's a self selected example with massive bias. How convinced you were to be if an alternative example swapped Apple for Carillion?

The argument here, and what appears to being missed, isn't what brings the higher return, but whether one is more risky than the other?

If it can be agreed that an unbalanced portfolio has more risk (and potentially high return), why would a system designed to mitigate risk at inception choose to ignore that growing risk over time when it is possible to reduce it at almost negligible cost?

I think we're becoming a bit entrenched in our positions here and not sure there's much to add. Maybe one reason is that we are looking at different risks? I'm guessing you view risk as being the industry standard of volatility? I see it somewhat differently. Of course reducing volatility risk is part of the purpose of diversification but I see diversification having just as important (maybe more important) role in avoiding the risk of missing out on selection of one or more shares that go on to be big winners. These are what I believe will drive income and capital growth and I'm happy to accept the imbalance that will inevitably arise from that.

So, yes, you can sub out Apple for Carillion but if you spread the net wide enough you should capture a big winner or two. This attitude to risk is where I would deviate slightly from PYAD's HYP. I would have more than 15 shares as I believe a larger number is required to be confident to capture big winners than to reduce volatility risk to close to that of the whole market.

As an aside I don't think a cost of 1% every time you carry out a buy/sell trade is negligible. It's the difference between passive trackers and some active funds and the main reason why so many active funds lag the market. You know as well as I do how these costs can add up over time.

BoE

[Arborbridge]

No it really isn't a convincing argument. It's a self selected example with massive bias. How convinced you were to be if an alternative example swapped Apple for Carillion?

Isn't Apple and Carillion illustrating the point, though. At the outset, one wouldn't know which to back - eventually the winners are left to do their thing and the others drop away.


BTW, this isn't the way I run my portfolio, as you know, but I do see why the idea of leaving a basket to find its own balance may have legs. Survival of the fittest companies - don't interfer, just watch the mayhem play out!


Arb.

[dealtn]

No it really isn't a convincing argument. It's a self selected example with massive bias. How convinced you were to be if an alternative example swapped Apple for Carillion?

Isn't Apple and Carillion illustrating the point, though. At the outset, one wouldn't know which to back - eventually the winners are left to do their thing and the others drop away.

Absolutely

BTW, this isn't the way I run my portfolio, as you know, but I do see why the idea of leaving a basket to find its own balance may have legs. Survival of the fittest companies - don't interfer, just watch the mayhem play out!


Arb.

So if you unluckily pick a basket of fallers, or Carilions, what do you do? Don't interfere?

What if you pick winners, such as Vodafone (1990- 2000) and they become losers (2000 - 2002) or worse UK banks, or property companies, or ... Don't interfere?

There are numerous examples of failure to lock in the gains from winners that eventually lead to huge losses. That's what HYP (as defined by its rules) exposes you to. These are real and avoidable risks. Doris would certainly feel uncomfortable buying options alongside her leave alone portfolio, but the same principle of accepting missing some of the upside to protect the absolute downside can be achieved with a few simple rules, and little work. Why not?

[GoSeigen]

As an aside I don't think a cost of 1% every time you carry out a buy/sell trade is negligible. It's the difference between passive trackers and some active funds and the main reason why so many active funds lag the market. You know as well as I do how these costs can add up over time.

This truly is nonsense. 1% of trade value is negligible. Active funds charge 1% of portfolio value year in year out. HUGE difference. Top slicing only costs this much if you churn your portfolio 100% every year -- a ridiculous idea.

The reason active funds cost so much more is NOT the trading commissions and spread on occasional top-slicing. It is the cost of maintaining a fund manager with expensive tastes in food, wine, cars, and boats and an admin team to support him. This shouldn't need to be spelled out to anyone but the most mathematically challenged.

In fact the comment is SO wrong-headed that it is in fact the cheap trackers that are doing the regular top-slicing and rebalancing and incurring those trading and spread costs, not the active fund! The active fund is being run in quite a different way as alluded to above.

GS

[Bubblesofearth]

This truly is nonsense. 1% of trade value is negligible. Active funds charge 1% of portfolio value year in year out. HUGE difference. Top slicing only costs this much if you churn your portfolio 100% every year -- a ridiculous idea.

The reason active funds cost so much more is NOT the trading commissions and spread on occasional top-slicing. It is the cost of maintaining a fund manager with expensive tastes in food, wine, cars, and boats and an admin team to support him. This shouldn't need to be spelled out to anyone but the most mathematically challenged.

In fact the comment is SO wrong-headed that it is in fact the cheap trackers that are doing the regular top-slicing and rebalancing and incurring those trading and spread costs, not the active fund! The active fund is being run in quite a different way as alluded to above.

GS

You're making the same mistake TJH does in looking at trade cost as a function of portfolio value. You need to consider it instead as a function of trade value because any benefit only accrues from the trade. Active funds aim to benefit the whole portfolio from their charge. Whether they do of course is a different matter. The point being that paying 1% for a supposed benefit is not IMO negligible.

Apart from rare equal weight trackers passive funds do not top-slice or rebalance. They will buy and sell constituents as they enter or fall out of the index and, yes, there is a cost to that activity.

BoE

[Bubblesofearth]

So if you unluckily pick a basket of fallers, or Carilions, what do you do? Don't interfere?

What if you pick winners, such as Vodafone (1990- 2000) and they become losers (2000 - 2002) or worse UK banks, or property companies, or ... Don't interfere?

There are numerous examples of failure to lock in the gains from winners that eventually lead to huge losses. That's what HYP (as defined by its rules) exposes you to. These are real and avoidable risks. Doris would certainly feel uncomfortable buying options alongside her leave alone portfolio, but the same principle of accepting missing some of the upside to protect the absolute downside can be achieved with a few simple rules, and little work. Why not?

Because rebalancing is not a free lunch. If shares all reverted to mean then, yes, it would be. But they don't and it isn't.

We know that once you get to 15 shares, especially with sectoral diversification, your volatility risk is close to that of the whole market. Loads of research has demonstrated that so to postulate a basket of carillons is fanciful. I challenge you to dig up the FTSE100 components of 2000 and pick 15 shares according to the HYP criteria that could even come close to being described as a basket of Carilions.

Yes, there are shares that go up a lot only to fall back down. And others that fall down only to recover. And a lot that wobble about without much overall headway. But there are those few that go up and continue to do so until they have added a lot of value. Not everything that goes up comes back down.

BoE

[dealtn]

So if you unluckily pick a basket of fallers, or Carilions, what do you do? Don't interfere?

What if you pick winners, such as Vodafone (1990- 2000) and they become losers (2000 - 2002) or worse UK banks, or property companies, or ... Don't interfere?

There are numerous examples of failure to lock in the gains from winners that eventually lead to huge losses. That's what HYP (as defined by its rules) exposes you to. These are real and avoidable risks. Doris would certainly feel uncomfortable buying options alongside her leave alone portfolio, but the same principle of accepting missing some of the upside to protect the absolute downside can be achieved with a few simple rules, and little work. Why not?

Because rebalancing is not a free lunch. If shares all reverted to mean then, yes, it would be. But they don't and it isn't.

We know that once you get to 15 shares, especially with sectoral diversification, your volatility risk is close to that of the whole market. Loads of research has demonstrated that so to postulate a basket of carillons is fanciful. I challenge you to dig up the FTSE100 components of 2000 and pick 15 shares according to the HYP criteria that could even come close to being described as a basket of Carilions.

Yes, there are shares that go up a lot only to fall back down. And others that fall down only to recover. And a lot that wobble about without much overall headway. But there are those few that go up and continue to do so until they have added a lot of value. Not everything that goes up comes back down.

BoE

Noone is claiming rebalancing is a free lunch are they? But avoiding risk is negating where possible the worst of outcomes, not seeking the best.

Lets see how Carilion entered this discussions shall we? It was in direct response to your introduction of Apple. So go and produce a portfolio of 15 qualifying Apples from the FTSE in 2000 first then I will counter with your request.

[tjh290633]

This truly is nonsense. 1% of trade value is negligible. Active funds charge 1% of portfolio value year in year out. HUGE difference. Top slicing only costs this much if you churn your portfolio 100% every year -- a ridiculous idea.

The reason active funds cost so much more is NOT the trading commissions and spread on occasional top-slicing. It is the cost of maintaining a fund manager with expensive tastes in food, wine, cars, and boats and an admin team to support him. This shouldn't need to be spelled out to anyone but the most mathematically challenged.

In fact the comment is SO wrong-headed that it is in fact the cheap trackers that are doing the regular top-slicing and rebalancing and incurring those trading and spread costs, not the active fund! The active fund is being run in quite a different way as alluded to above.

GS

You're making the same mistake TJH does in looking at trade cost as a function of portfolio value. You need to consider it instead as a function of trade value because any benefit only accrues from the trade. Active funds aim to benefit the whole portfolio from their charge. Whether they do of course is a different matter. The point being that paying 1% for a supposed benefit is not IMO negligible.

Apart from rare equal weight trackers passive funds do not top-slice or rebalance. They will buy and sell constituents as they enter or fall out of the index and, yes, there is a cost to that activity.

BoE

I think that the point you are missing is that trading costs are negligible in comparison with share price movements. A day or two delay can have far more effect. If the price of the sold share rises, or the price of the bought share falls, the costs can be wiped out.

TJH

[Bubblesofearth]

Noone is claiming rebalancing is a free lunch are they? But avoiding risk is negating where possible the worst of outcomes, not seeking the best.

Lets see how Carilion entered this discussions shall we? It was in direct response to your introduction of Apple. So go and produce a portfolio of 15 qualifying Apples from the FTSE in 2000 first then I will counter with your request.

No FTSE100 share has performed as well as Apple but there have been some pretty big winners. When I looked a few years ago BAT, Whitbread, Diageo, Reckitts, BHP, Unilever, Hays and Imperial Tobacco were examples. As we are dealing with already large companies you are unlikely to see Apple-style gains but that goes for failures as well. Upside and downside will be more muted for big-caps. Banks were an exception but the HYP rules should have only left you exposed to one of these.

Remember, my thesis is that a small fraction of shares go on to be big winners so I'm not suggesting a basket of Apples is likely, merely that you should be able to capture at least some, especially if you opt for 20-30 shares rather than 15.

If, by some miracle (I await your analysis), you managed to pick a basket of Carillons using the HYP rules then how would top-slicing have helped you? Unless you top-sliced once any given share had fallen significantly less than the others. Not sure I've come across anyone doing that or any HYP portfolio that has done that badly.

BoE

[Bubblesofearth]

I think that the point you are missing is that trading costs are negligible in comparison with share price movements. A day or two delay can have far more effect. If the price of the sold share rises, or the price of the bought share falls, the costs can be wiped out.

TJH

No, I understand that. I think we've reached the point where we can simply agree to disagree. You see a 1% charge as negligible, I don't.

BoE

[dealtn]

Noone is claiming rebalancing is a free lunch are they? But avoiding risk is negating where possible the worst of outcomes, not seeking the best.

Lets see how Carilion entered this discussions shall we? It was in direct response to your introduction of Apple. So go and produce a portfolio of 15 qualifying Apples from the FTSE in 2000 first then I will counter with your request.

No FTSE100 share has performed as well as Apple but there have been some pretty big winners. When I looked a few years ago BAT, Whitbread, Diageo, Reckitts, BHP, Unilever, Hays and Imperial Tobacco were examples. As we are dealing with already large companies you are unlikely to see Apple-style gains but that goes for failures as well. Upside and downside will be more muted for big-caps. Banks were an exception but the HYP rules should have only left you exposed to one of these.

Remember, my thesis is that a small fraction of shares go on to be big winners so I'm not suggesting a basket of Apples is likely, merely that you should be able to capture at least some, especially if you opt for 20-30 shares rather than 15.

If, by some miracle (I await your analysis), you managed to pick a basket of Carillons using the HYP rules then how would top-slicing have helped you? Unless you top-sliced once any given share had fallen significantly less than the others. Not sure I've come across anyone doing that or any HYP portfolio that has done that badly.

BoE

No. Your thesis is that rebalancing isn't any riskier than a rebalanced portfolio.

That thesis is backed up by your postulation that it is possible for the portfolio to have grown significantly, and therefore if it has any downside from there it isn't particularly risky.

This fails as an argument on 2 simple points.

Firstly, it might not have grown (instead of capturing an "Apple" and 14 average, you might capture a "Carilion" and 14 average, or worse).

Secondly, even if it has risen before falling, that potential fall still represents a risk.