Basket of Seven: 2018 review

[torata]

As I recall, Luni got a lot of stick for his B7 and B8 portfolios because of possible hindsight bias in choosing them (Was this to enable direct comparison with the PYAD portfolios?).

While the fact that he chose them looking back in time will never disappear, with each passing year, the performance data based on actual results after their choice becomes an increasing solid track record (to compare against HYP for example), which should be welcomed.

torata

[Dod101]

As to the substance of the report, an average yield of 3.1% at year end or 3.4% over its lifetime, however steady, is not very good compared to what even a conservative HYPer can achieve although I grant you that it can be achieved by doing nothing, which will be a great bonus for some.

I am not sure I understand the comment that dividend increases are likely to slow because of a reduction in the Ongoing Charges Rate to 0.56%.

I am also interested to see that the sometimes maligned Murray International has come out of it very well especially as an income IT.

Dod

[Itsallaguess]

As to the substance of the report, an average yield of 3.1% at year end or 3.4% over its lifetime, however steady, is not very good compared to what even a conservative HYPer can achieve although I grant you that it can be achieved by doing nothing, which will be a great bonus for some.

This is where it's potentially a little dangerous to continue to concentrate on a 'yield' figure for an ongoing income-portfolio, thinking it might determine whether we think it's been successful or not.

The Basket of Seven is there to provide income. It's possible that the initial yield and income, when the portfolio was first purchased, was acceptable and adequate.

It's also possible, from that point onwards, that dividend income may have steadily increased, perhaps with a lock-step increase in share-prices of the underlying investments as well. These dividend increases may well also be quite acceptable to the owner of the Basket, as it clearly might increase income levels over time.

In such a scenario, it's quite possible for the single 'portfolio yield' figure to stay roughly the same, or even to drop if the share-prices of the underlying investments rise at a pace above and beyond any growth in the dividends. Would we then view potentially rising income, accompanied by a potentially rising set of share prices as being poor portfolio-delivery? Concentrating on a single portfolio yield figure might lead us to think that....

I'm not saying that this is the case for this Basket of Seven review, as I've not studied the details sufficiently to see yet, but I just wanted to highlight that just pointing at a year-end yield figure and determining that it's 'not very good' might well not tell the full 'income-related story' for the portfolio itself...

Cheers,

Itsallaguess

[Dod101]

It's also possible, from that point onwards, that dividend income may have steadily increased, perhaps with a lock-step increase in share-prices of the underlying investments as well. These dividend increases may well also be quite acceptable to the owner of the Basket, as it clearly might increase income levels over time.

In such a scenario, it's quite possible for the single 'portfolio yield' figure to stay roughly the same, or even to drop if the share-prices of the underlying investments rise at a pace above and beyond any growth in the dividends. Would we then view potentially rising income, accompanied by a potentially rising set of share prices as being poor portfolio-delivery? Concentrating on a single portfolio yield figure might lead us to think that....

I take your point but we would need to see some actual figures although the capital values do seem to have been increasing apace as well. With my HYP though, I have tried to maintain the yield at somewhere around 4.50% by judicious culling and replacement, in other words 'tweaking' the portfolio, quite unpyad like. I think a number of us do that if the yield for an individual share falls far enough.

It needs a different mind set to take the B7 approach although I can see it would appear to be ideal for a Doris or in real life for a widow left with a load of investments about which she knows nothing and has no interest.

I suspect you may have indirectly answered my other comment, because if the OCR is reduced that will increase the capital value (in theory at least) and thus reduce the yield a bit. Is Luni guilty of conflating (to use that somewhat pompous expression) yield and dividend?

Dod

[Itsallaguess]

It's also possible, from that point onwards, that dividend income may have steadily increased, perhaps with a lock-step increase in share-prices of the underlying investments as well. These dividend increases may well also be quite acceptable to the owner of the Basket, as it clearly might increase income levels over time.

In such a scenario, it's quite possible for the single 'portfolio yield' figure to stay roughly the same, or even to drop if the share-prices of the underlying investments rise at a pace above and beyond any growth in the dividends. Would we then view potentially rising income, accompanied by a potentially rising set of share prices as being poor portfolio-delivery? Concentrating on a single portfolio yield figure might lead us to think that....

I take your point but we would need to see some actual figures although the capital values do seem to have been increasing apace as well.

With my HYP though, I have tried to maintain the yield at somewhere around 4.50% by judicious culling and replacement, in other words 'tweaking' the portfolio, quite unpyad like. I think a number of us do that if the yield for an individual share falls far enough.

It needs a different mind set to take the B7 approach although I can see it would appear to be ideal for a Doris or in real life for a widow left with a load of investments about which she knows nothing and has no interest.

I tend to carry out similar 'active-management' on the non-IT section of my HYP too, and will quite happily cull a very low yielding component of it if either the dividend is reduced or (as happens every so often with HYP's with a large number of shares) a particular share price drifts away higher over a period of time, and drops the yield to a level where a swap-out or trim becomes financially viable, even if such action isn't directly driven by the dividend-delivery of the share itself - it's often simply the case that some HYP components begin to deliver poor yield-returns due to share-price movements that mean that the yield can be improved by looking elsewhere in the market....

I think one of the big benefits to including income-IT's in the mix is that we'd expect a lot of that 'under-the-bonnet' stuff to get actioned behind the scenes by the IT-manager in charge, and so whilst there will inevitably be a cost to providing that IT-management, I think it's good that it's at least possible to 'contract-out' some of those sorts of actions and decisions.

Having taken a quick look at the Basket review again, it does tend to show that the investment capital has seen regular increases at the same time as the dividend-payouts have risen over time, so that might well explain what could possibly seem to be a relatively benign set of yield metrics, whilst the actual underlying 'income-delivery' process of the Basket may well continue to be seen to be delivered, which was the reason for my initial post highlighting the danger of perhaps just concentrating on that single 'yield-metric'...

I suspect you may have indirectly answered my other comment, because if the OCR is reduced that will increase the capital value (in theory at least) and thus reduce the yield a bit. Is Luni guilty of conflating (to use that somewhat pompous expression) yield and dividend?

I don't think so; I think he's reporting income, capital, and yields, which is everything that we might be interested in, but we've just got to be careful not to use just the yield figures to form a view - it's the initial and ongoing income that's important from a real-progress point of view, and I think the capital and yield figures might just help explain what else might be going on with regards to some overall Basket metrics that might well be interesting, but are much less important than the actual dividend-income delivery and growth from the Basket itself.

Perhaps some income and capital unitisation metrics would be the icing on the cake for such a long term portfolio review, but I'm assuming that this isn't something that's likely to become available if it's not done so already....

Cheers,

Itsallaguess

[hiriskpaul]

When I saw this thread my initial reaction was scepticism about the strategy as it incorporates huge hindsight bias in the back testing. However, the portfolio appears to have been proposed in 2010, so I put together the portfolio as at the end of 2010 to remove the bias and looked into how it had performed since.

Here is my raw data, prices from Yahoo (mid prices), dividends from AIC. The dividends include all the specials. I don't think my bucketing into calendar years is precise due to ex-dividend periods, but is close enough for now. I may correct this later.



*Corrected for 10:1 share split April 2018

Using the above data and investing £10k per IT and ignoring bid/ask spread and stamp duty, gave the following results:



I have not checked against RPI, but it would appear to me that, apart from a small drop in 2012, the portfolio has delivered on rising income and an income that has almost certainly grown faster than inflation.

However, 2010 would have been an excellent time to invest in equities, so how has the portfolio done compared to the broader market? To answer that question, I compared against the MSCI World TR Index. The way I did this was to start with a £70k investment in the index, then subtract quarterly dividends to match those produced by the IT portfolio. So £597.75 at the end of March, June, September and December 2010, and so on for for the following years. The capital value at the end of 2017 was £126,376 - remarkably close to the IT portfolio closing value of £123,405. So it would appear that, for this portfolio, the strategy has not suffered unduly due to management charges or the self imposed restriction to try to hold or increase dividend payments each year.

A few observations:
- The income per IT was less dispersed in 2017 than is was in 2011 (standard deviation 11% vs. 20%), which is curious, but likely just a fluke. I would expect this to widen over time as dividend growth rates are unlikely to be consistent.
- A warning to anyone wanting to buy into this portfolio now is that it is much more expensive in terms of yield than it was in 2010. 2.85% at the end of 2017 compared with 3.31% at the end of 2010.
- Another warning is that these ITs are able to use gearing. The period examined was a great one to utilise gearing, with low borrowing costs and high equity returns. Going forward the use of gearing could backfire if/when we see some significant stock market drawdowns.

[Chrysalis]

@hiriskpaul, I’m not sure whether the conclusion of your test against the world index is that one could achieve similar results investing in a world tracker? I suppose not, as you haven’t subtracted the costs of the tracker fund. It would be interesting though.

[Chrysalis]

But I too welcome luni’s decision to posts again, I hope it’s not a one time only experience!

[Breelander]

But I too welcome luni’s decision to posts again, I hope it’s not a one time only experience!

Me too!

But if it transpires that it is a solitary epistle, then here's some light reading to console you...

TMF - The 99 Most Recommended Messages By Luniversal
https://web.archive.org/web/20161116190 ... byrecs=yes

[hiriskpaul]

@hiriskpaul, I’m not sure whether the conclusion of your test against the world index is that one could achieve similar results investing in a world tracker? I suppose not, as you haven’t subtracted the costs of the tracker fund. It would be interesting though.

The test against the index was purely to gauge how the IT portfolio performed compared to the market. I was not proposing it as an alternative strategy. It would be a bizarre strategy to invest in a tracker fund and then make withdrawals according to the dividends paid from a portfolio of ITs!

Investing in a world tracker fund will produce market returns less a small amount due to running costs. The return from the IT portfolio has been remarkably close to the market, but this is just a one off sample portfolio tested over a single period. I would expect quite a wide variety of outcomes with different portfolios, and I would be very surprised if the returns from this portfolio were as close to the market over the next 7 years as they have been over the last.

[Lootman]

Investing in a world tracker fund will produce market returns less a small amount due to running costs. The return from the IT portfolio has been remarkably close to the market, but this is just a one off sample portfolio tested over a single period. I would expect quite a wide variety of outcomes with different portfolios, and I would be very surprised if the returns from this portfolio were as close to the market over the next 7 years as they have been over the last.

A good analysis. I think the main reason such an IT portfolio might under-perform going forward is what you noted earlier. 2010 was an improbably fortunate time to have made a large one-off investment, and so the inherent gearing of ITs would have been a decent headwind the entire time.

Moreover discounts to NAV have narrowed and in some cases even gone to a premium as investors have become hungrier for yield as rates have fallen.

Both those factors could work against ITs in the future, relative to a neutral tracker such as you suggested.

Also note that the cited portfolio is heavy in UK exposure and that might count against it. In fact I am rather surprised it did as well as it did given that it was surely under-weight in the names that have produced the most gains in market cap e.g. Apple, Amazon, Google, FaceBook etc.

All that aside an IT portfolio such as this must contain as many as 1,000 or so shares. Even discounting the not-inconsiderable overlap of shares held. if you hold enough shares you are going to get a market-like return. The question is then whether you want to pay active management charges for passive returns?

[hiriskpaul]

I have only had a quick glance at the ITs, but it seems to me that the portfolio as a whole would have been overweight mid/small caps and these have done much better than large caps over the period, even the UK listed ones, so that would have helped even though the portfolio might have been underweight Apple, Amazon, Google, FaceBook etc. If the bias to mid/small is kept going forwards, the portfolio could behave quite differently to the market and may not end up a closet tracker.

On the NAVs, again I have just had a quick look, so don't know overall, but some of the discounts have actually risen over the last 7 years.

[Lootman]

I have only had a quick glance at the ITs, but it seems to me that the portfolio as a whole would have been overweight mid/small caps and these have done much better than large caps over the period, even the UK listed ones, so that would have helped even though the portfolio might have been underweight Apple, Amazon, Google, FaceBook etc. If the bias to mid/small is kept going forwards, the portfolio could behave quite differently to the market and may not end up a closet tracker.

You may well be right about the mid/small bias, although there are a few choices there that are fishing in the "usual suspect" waters, like Lowland and Claverhouse. The most evident bias I see is towards the UK and Luni admits that "today I might chuck a foreign specialist in the mix". He's got MYI in there but I agree with him that he needs more foreign exposure.

I'd probably adopt your tracker solution, and then tilt it with specialist ETFs or ITs where I want a skew, e.g. towards income, towards the UK, or whatever. I don't personally like generalist ITs and prefer to use ITs for specific purposes e.g. biotech, property, private equity and so on.

[hiriskpaul]

@Lootman, Just to illustrate my point about UK mid/small caps, the FTSE 250 TR index was up 117% during the 7 year period, compared to 123% for the MSCI World TR index, so being underweight the FANGs would not have mattered too much if the portfolio was also overweight UK mid/small. It is really just a small number of large caps that made UK returns look dismal compared to the rest of the world.

Like you, I would not adopt a strategy like this, but in defence of the strategy, it is designed for unsophisticated or very lazy investors. Given this remit, there are a number of positives. Most importantly the do not sell rule. I have been trying to help a number of relatives with investments and it is damned difficult. Even if you go for a 2 investment solution, global equites/global bonds, and say keep them balanced and take regular income, there are people out there who will struggle with sticking to the rules and may panic into selling out completely after stock market falls. For such people a one fund Lifestrategy solution might be the answer, but this again would require regular selling to provide an income. Picking a portfolio of generalist, low charging ITs with a policy of growing the dividends and then doing nothing but collecting the income until life circumstances determined otherwise might well be a good solution for some investors. The strategy may have faults and risks lagging market returns, but the outcome may be better for some investors than alternatives involving ongoing selling/trading. That said, after just 7 years the portfolio is starting to become unbalanced, so some post investment trading might still be required at some stage.

[toofast2live]

Luni, welcome back. This is most worthwhile.

[Dod101]

TMF - The 99 Most Recommended Messages By Luniversals

A lot of these turn out to be 'The Week Ahead' which is not of much interest a few years later. The best post seems to be the first which is quite illuminating and in the Luniversal inimitable style.

But thanks anyway, Bree.

Dod

[todthedog]

Thanks Luni

[Kantwebefriends]

A welcome return.

[midgesgalore]

Much appreciated

midgesgalore

[MDW1954]

Welcome back, Luni. Good to see you.

MDW1954