Kiloran's ITs

[kiloran]

Wizard asked on viewtopic.php?p=107043#p107043 if I could document my thoughts behind the ITs in my HYP. I am flattered that you think there is any thought behind the choices

I started out building up a conventional HYP of individual companies. HYP is pretty boring so I then added a bit of spice with some high-income non-UK ITs... Aberdeen Latin American Income Fund and Henderson Far East Income. I've lost a bit of capital on the former, and gained more on the latter, but both are paying nice dividends. Maybe Latin America will come good as an emerging market at some point. (as an aside, I also have a fair chunk in JP Morgan Indian Investment Trust which has done REALLY well for me over the years but it doesn't pay a dividend so I don't class it as part of my HYP)

Some years after retirement, I decided that having 40 or so shares might get a bit messy for my wife to manage if (when!) I pop my clogs, so I am gradually moving into some classic UK high-income ITs.... City of London Inv Trust, Dunedin Income Growth Inv Trust, Merchants Trust, Murray Income Trust. Very much inspired by Luniversal's baskets of TMF days. Reinvested dividends will go into these, and if I fall out of love with an individual company, I'll sell it and buy more IT.

Nothing too clever, complicated or insightful in my strategy. I know my limitations and have no pretence on being able to beat the market, I just want a reasonable exposure to the stock market which will give me good though not guaranteed returns.

--kiloran

[Wizard]

Thankyou for that Kiloran. You mention

...if I fall out of love with an individual company, I'll sell it and buy more IT.

Are you happy that your current selectikn gives enough diversity and would likely simply buy more of those or do you think you woild invest any additional funds jnto new ITs?

I note a lot of people with ITs and direct HYP investments seem to have a similar amount of each IT as they do individual shares. Given the IT is already diversified in the underlying shares I find this interesting. I know there may be a desire to diversify against one fund makjng bad picks, but when looking at UK income ITs surely they all fish in the same pond so there must be considerable overlap?

Terry.

[kiloran]

Thankyou for that Kiloran. You mention

...if I fall out of love with an individual company, I'll sell it and buy more IT.

Are you happy that your current selectikn gives enough diversity and would likely simply buy more of those or do you think you woild invest any additional funds jnto new ITs?

I note a lot of people with ITs and direct HYP investments seem to have a similar amount of each IT as they do individual shares. Given the IT is already diversified in the underlying shares I find this interesting. I know there may be a desire to diversify against one fund makjng bad picks, but when looking at UK income ITs surely they all fish in the same pond so there must be considerable overlap?

Terry.

I generally agree that UK Income ITs have many commonalities. I'll decide when the time comes, but right now I think 4 UK Income ITs is probably enough.

--kiloran

[Lootman]

UK Income ITs have many commonalities. I'll decide when the time comes, but right now I think 4 UK Income ITs is probably enough.

Indeed, and in fact I think you need a reason to hold each one. If two ITs are fishing in the exact same pond, then I am always going to pick only one of them based on whatever my criteria are, e.g. style, low expenses, long-term manager, historical performance etc. Every holding should confer something unique on a portfolio, and I don't believe in holding duplicates just for the sake of it.

This is something I had a few arguments with Luniversal about over at TMF, particularly in respect of his "basket" of 8 UK equity income ITs. I always felt that was significantly redundant, since the top ten holdings of each were very similar, there only being so many largecap HY UK shares. He would always counter that he was "more diversified" because the returns varied a lot, mostly due to differences in weightings and gearing. I consider that a faux diversification.

So like you I choose to diversify gegraphically, including the two ITs that you mentioned, as well as ITs from Europe and the US which have a focus on dividends. The only UK-based income ITs I hold are the City of London, Finsbury and Troy trusts.

Incidentally, that Latin American IT has done badly because it is so heavily weighted towards energy and mining, which have been out of favour. But it could come good if natural resources inflate, which we have started to see recently. At that time the emerging markets that are net importers and consumers of raw materials, like China and India, might do less well. So I continue to hold it as a type of hedge against the racier emerging markets that I am invested in as well.

[Itsallaguess]

Nothing too clever, complicated or insightful in my strategy. I know my limitations and have no pretence on being able to beat the market,

I just want a reasonable exposure to the stock market which will give me good though not guaranteed returns.

Well, on the first day of 2018, I think this point needs reinforcing Kiloran, and I completely agree.

I reckon this HYP malarky is a bit like getting out for a run with a view to keeping (financially) fit.

Me, I'm just happy to get out and keep the legs working. Keep mostly-invested in a wide range of income-related shares and IT's, with capital largely balanced across a wide range of equities and markets, and just keep putting one foot in front of the other....

There's often too much worry regarding the particular route to take for the run, and far too much bother about what the weather is like at any particular time, whilst forgetting that the most important thing is to just keep running, and ignore the rest of the noise...

All the very best for 2018.

Cheers,

Itsallaguess

[BrummieDave]

So like you I choose to diversify gegraphically, including the two ITs that you mentioned, as well as ITs from Europe and the US which have a focus on dividends. The only UK-based income ITs I hold are the City of London, Finsbury and Troy trusts.

Enjoying this thread (HNY everyone) and wondered if you would share your income focused ITs please Lootman?

[Gengulphus]

This is something I had a few arguments with Luniversal about over at TMF, particularly in respect of his "basket" of 8 UK equity income ITs. I always felt that was significantly redundant, since the top ten holdings of each were very similar, there only being so many largecap HY UK shares. He would always counter that he was "more diversified" because the returns varied a lot, mostly due to differences in weightings and gearing. I consider that a faux diversification.

I don't invest in UK income-oriented ITs, but if I were to do so, I wouldn't regard what I was doing as diversifying between companies or between sectors, since I would pretty obviously not be doing that because of overlaps, both between the ITs and between them and the HYP. Instead, I would regard it as diversifying between investment managers and between their strategies. This affects what I would do in a major way, specifically because of the default position of equal weightings when diversifying between alternatives in the absence of good reasons to weight them differently.

So for example, if I wanted to invest in a 25-share HYP and three ITs, I would by default diversify first as 25% into each of the HYP (which has me as manager and a HYP strategy) and the three ITs (with their respective managers and strategies), and then diversify the 25% going into the HYP as 1% into each of its 25 holdings. That's obviously a very different split from the 100%/(25+3) = 3.57% each that regarding the ITs as normal holdings alongside the individual shares would produce!

I should emphasise that I'm only talking about the default position here - i.e. the starting position that I might well adjust in the light of good reasons to do so. For instance, if the 25 shares I held in the HYP contained 5 pairs of sector duplicates, I might modify the 1% each into 0.625% into each of the 10 shares that had a sector duplicate and 1.25% into each of the 15 shares that didn't, or something intermediate like 0.7% and 1.2% respectively - that basically on the grounds that business similarities make the sector duplicates less effective as diversifiers. Similarly, I might feel that the three ITs' strategies differed less from each other than from the HYP strategy, making them less effective as diversifiers, and justifying e.g. an adjustment of the first level of diversification to 40% HYP, 20% into each of the three ITs.

But I find it very hard to see sensible adjustments changing either of the '25% into each IT / 1% into each share' split and the '3.57% into each share and IT' split enough to make it plausibly an adjustment of the other instead, so they lead to effectively completely different classes of answer to the "how to diversify?" question.

Gengulphus

[HillManMill]

Wizard asked on viewtopic.php?p=107043#p107043
Some years after retirement, I decided that having 40 or so shares might get a bit messy for my wife to manage if (when!) I pop my clogs, so I am gradually moving into some classic UK high-income ITs.... City of London Inv Trust, Dunedin Income Growth Inv Trust, Merchants Trust, Murray Income Trust. Very much inspired by Luniversal's baskets of TMF days.
--kiloran

I am interested to see that you have Dunedin Income Growth [Dig} and Murray Income [MUT] in your 4. I appreciate that the trusts have different managers but both are managed by Standard Life Aberdeen and so will access the same research and are likely to apply similar methodologies. Any thoughts about this apprarent overlap please?

I hold MUT and a little of DIG.

[Wizard]

So for example, if I wanted to invest in a 25-share HYP and three ITs, I would by default diversify first as 25% into each of the HYP (which has me as manager and a HYP strategy) and the three ITs (with their respective managers and strategies), and then diversify the 25% going into the HYP as 1% into each of its 25 holdings. That's obviously a very different split from the 100%/(25+3) = 3.57% each that regarding the ITs as normal holdings alongside the individual shares would produce!

I should emphasise that I'm only talking about the default position here - i.e. the starting position that I might well adjust in the light of good reasons to do so. For instance, if the 25 shares I held in the HYP contained 5 pairs of sector duplicates, I might modify the 1% each into 0.625% into each of the 10 shares that had a sector duplicate and 1.25% into each of the 15 shares that didn't, or something intermediate like 0.7% and 1.2% respectively - that basically on the grounds that business similarities make the sector duplicates less effective as diversifiers. Similarly, I might feel that the three ITs' strategies differed less from each other than from the HYP strategy, making them less effective as diversifiers, and justifying e.g. an adjustment of the first level of diversification to 40% HYP, 20% into each of the three ITs.

But I find it very hard to see sensible adjustments changing either of the '25% into each IT / 1% into each share' split and the '3.57% into each share and IT' split enough to make it plausibly an adjustment of the other instead, so they lead to effectively completely different classes of answer to the "how to diversify?" question.

Gengulphus

That basic 25:25:25:25 split is intuitively where I end up, which is why I have been curious by most portfolios that seem to have an IT the same weight as a single HYP share.

Terry.

[tjh290633]

My approach would be to treat them as separate portfolios and go for initially equal weight in the IT portfolio. The time may come when I transition into ITs, and my thoughts are that I would start with the lower yield end of my HYP shares. The cash thus released would go into the big global ITs, then the rest into a number of the ITs with higher yields. The end result should be 10 to 15 holdings. The global ITs give adequate exposure to the USA and other markets, including private equity. I might include commodities and property as specialised sectors, but might stick with my REITs.

Compared with my HYP, that would give holdings up to 3 times as big, but I might merge in two other UT ISAs, to make it simpler. It would all be inside the ISA tax shelter, so no limitations on the tax front.

TJH

[Arborbridge]

This is something I had a few arguments with Luniversal about over at TMF, particularly in respect of his "basket" of 8 UK equity income ITs. I always felt that was significantly redundant, since the top ten holdings of each were very similar, there only being so many largecap HY UK shares. He would always counter that he was "more diversified" because the returns varied a lot, mostly due to differences in weightings and gearing. I consider that a faux diversification.

I think the point was (as Gengulphus wrote) to achieve a spread of risk between managers. Luni was correct: fishing in the same pond they may be, but they also get widely different results and furthermore a different balance between income and capital growth. I'm fairly sure Luni didn't mean diversity in the sense you are meaning it - except at the fringes where each manager has a few percent in odd-ball share ideas. I could be wrong, but in my view that's what Luni was thinking about, not faux diversity.

Arb.

[Lootman]

This is something I had a few arguments with Luniversal about over at TMF, particularly in respect of his "basket" of 8 UK equity income ITs. I always felt that was significantly redundant, since the top ten holdings of each were very similar, there only being so many largecap HY UK shares. He would always counter that he was "more diversified" because the returns varied a lot, mostly due to differences in weightings and gearing. I consider that a faux diversification.

I think the point was (as Gengulphus wrote) to achieve a spread of risk between managers. Luni was correct: fishing in the same pond they may be, but they also get widely different results and furthermore a different balance between income and capital growth. I'm fairly sure Luni didn't mean diversity in the sense you are meaning it - except at the fringes where each manager has a few percent in odd-ball share ideas. I could be wrong, but in my view that's what Luni was thinking about, not faux diversity.

Yes, I wasn't talking about "manager risk" here. As far as IT managers are concerned, historically that has been a minimal risk, due to the fact that the assets of an IT are held by a third party custodian, so unless there is extensive fraud going on then investors should feel sanguine.

There have been a couple of issues though. The split capital IT failures were notorious, although that was more a matter of incompetence and a failure to measure risk than fraud, and not all split-capital IT's suffered. Then there was the notorious case of Morgan Grenfell European Trust AKA the "Peter Young Affair".

My point was more about what most of us think of as diversification i.e. that the underlying pool of assets should be diverse. To take an extreme example, eight funds which only invested in the top ten UK dividend shares but which weighted them differently, might have wildly different outcomes, but would not be meaningfully diversified.

In other words, being different isn't always being diverse. But for the record I have several strategies, and about 100 holdings, of which about half are funds. But I am simplifying and consolidating them, and trying to focus only on securities that confer uniqueness. I think that over-diversification can be a problem as much as under-diversification - you end up with a very expensive index fund.

[Gengulphus]

I think the point was (as Gengulphus wrote) to achieve a spread of risk between managers. ...

Yes, I wasn't talking about "manager risk" here. As far as IT managers are concerned, historically that has been a minimal risk, due to the fact that the assets of an IT are held by a third party custodian, so unless there is extensive fraud going on then investors should feel sanguine.

Well, I wasn't talking about "custodian risk" in what I believe Arborbridge is referring to. The spread of risk between managers I was talking about was for all risks associated with the choice of manager, including (but not limited to!) those of them being incompetent, untalented, distracted, lazy, or replaced by another manager who is any of those things. (And yes, some of those are probably more of a risk for my HYP's manager than they would be for managers of ITs I selected...)

Gengulphus

[Lootman]

I think the point was (as Gengulphus wrote) to achieve a spread of risk between managers. ...

Yes, I wasn't talking about "manager risk" here. As far as IT managers are concerned, historically that has been a minimal risk, due to the fact that the assets of an IT are held by a third party custodian, so unless there is extensive fraud going on then investors should feel sanguine.

Well, I wasn't talking about "custodian risk" in what I believe Arborbridge is referring to. The spread of risk between managers I was talking about was for all risks associated with the choice of manager, including (but not limited to!) those of them being incompetent, untalented, distracted, lazy, or replaced by another manager who is any of those things. (And yes, some of those are probably more of a risk for my HYP's manager than they would be for managers of ITs I selected...)

There is certainly the risk that if you choose any active fund manager that it might turn out that you invested in the very worst-performing manager for that time period.

If you have decided to place yourself in the position of choosing between funds (or for that matter between individual shares) then you are effectively making some kind of bet that you believe that you can do better than the market by being selective. It is a de facto decision on your part that you think you have some kind of edge, either in choosing shares or in choosing someone who chooses shares, which will reasonably lead to a performance that exceeds what a neutral investment like an index fund will give you.

So the risk that you refer to is inevitable if you are going to make bets that are not market-neutral. And that is a personal decision, based on (to put it crudely) how clever you think you are. Or at least how much cleverer you think you are than the average market participant. If you make any active decision then you accept that you may get it abjectly wrong, But to respond to that risk by buying, say, every active fund in the sector that you are interested is akin to the decision that an investor in a passive index fund makes, which probably has lower costs.

[Gengulphus]

Well, I wasn't talking about "custodian risk" in what I believe Arborbridge is referring to. The spread of risk between managers I was talking about was for all risks associated with the choice of manager, including (but not limited to!) those of them being incompetent, untalented, distracted, lazy, or replaced by another manager who is any of those things. (And yes, some of those are probably more of a risk for my HYP's manager than they would be for managers of ITs I selected...)

There is certainly the risk that if you choose any active fund manager that it might turn out that you invested in the very worst-performing manager for that time period.

If you have decided to place yourself in the position of choosing between funds (or for that matter between individual shares) then you are effectively making some kind of bet that you believe that you can do better than the market by being selective. It is a de facto decision on your part that you think you have some kind of edge, either in choosing shares or in choosing someone who chooses shares, which will reasonably lead to a performance that exceeds what a neutral investment like an index fund will give you.

So the risk that you refer to is inevitable if you are going to make bets that are not market-neutral. And that is a personal decision, based on (to put it crudely) how clever you think you are. Or at least how much cleverer you think you are than the average market participant. If you make any active decision then you accept that you may get it abjectly wrong, But to respond to that risk by buying, say, every active fund in the sector that you are interested is akin to the decision that an investor in a passive index fund makes, which probably has lower costs.

Yes, I agree with that - with the proviso (*) that my agreement is only about what it says: buying every active fund in the sector.

But I'm afraid that's no more interesting than saying that responding to the corresponding risk about buying individual shares by buying every share in the index is akin to the decision that an investor in a passive index fund makes.

The situation that is left uncovered is diversifying between some shares or managers - in particular, if one believes one has an edge, using it to select some of them, then diversifying between those that one has selected. That's appropriate if one believes one's edge is statistical - i.e. that the statistically-expected outcome from one's selections is above the market outcome, but any individual selection might end up producing a below-market outcome - and that the chance of any individual selection's outcome being unacceptably far below the market outcome is unacceptably high. In that situation, selecting more than one and diversifying between them can leave one still believing one has an edge, but with a much reduced chance of an outcome unacceptably far below the market outcome.

All the "unacceptably"s in that are of course by one's own standards of acceptability, which are not necessarily those of any other investor. But for shares, the chance that investing in a single selection only will produce an outcome well below the market outcome is very significant, and so it's only a very unusual investor who will find that chance acceptable for the totally undiversified strategy of 'betting the farm' on a single share selection, or even for a somewhat-diversified strategy involving selecting just a few shares. And so I'll unhesitatingly advocate a good level of diversification between shares in a portfolio of directly-held shares - the very few for whom such advocacy is not appropriate are either going to ignore any such advocacy or work out why it isn't appropriate themselves.

The corresponding statements are not true for managers, and I would expect many investors to be perfectly happy with only having one manager of their investments (possibly themselves, possibly a manager of an IT), and most of the rest with there only being a few. And I don't advocate either choice, just that investors should consider the arguments in the light of their own circumstances and preferences, and make up their own minds.

And often, the reason why they have a few rather than just one will actually be that it's a side-effect of diversification between strategies. E.g. I'm mainly diversified between two strategies: a HYP which is big enough to supply my income needs, and a more growth-oriented smallcaps strategy. I use myself as the manager of both of those strategies, and am entirely happy with that - but if I instead wanted to use ITs, I would probably only be able to match that strategy mix reasonably well by using two ITs, and they would be unlikely to have the same manager...

(*) There is also the proviso that get a perfect match, one needs to reflect what all other market participants are doing, not just IT managers, and to use suitable weightings. But I assume that's what your use of "akin to" rather than anything more exact is supposed to cover, and I have used it similarly.

Gengulphus