Stocks vs ITs & ETFs ?

[PrefInvestor]

Hi All, In March last year I was forced to make a big change to my investment strategy by developments in the preference share market caused by a threat by one company to redeem their preference shares at par and cease paying the dividends. What with interest rates on the rise and pref prices likely to come under pressure because of that as well, I decided to sell up and move to an equity income strategy.

Initially I researched and then bought a very diversified range of mostly UK single stocks all of which had a yield of at least ~4.5%. I also included a few overseas investments, but in this area I chose to invest via investment trusts priced in GBP to avoid the currency charges levied by my broker for anything priced in a foreign currency. I had long practised keeping my maximum holdings in any one single stock to about £6,000 and I ended up with just over 50 holdings.

I ran with this portfolio for a while but I soon developed the following concerns:-
1. I felt like 50+ holdings was far too many to manage (reading RNSs, checking results and trading updates for possible red flags etc)
2. I became concerned at the quite large number of FTSE 100 (and other) companies whose share prices took a precipitous fall with little or no advance notice. While my strategy of having a maximum holding size offered some protection I could not help but feel that it wasn’t enough.
3. The last straw was the major downturn in the market in late 2018 when the share portfolio started to accumulate capital losses and with the threat of brexit on the horizon I decided to take action to try and move to less volatile / troubled waters.

I decided to move out of many of my single stocks, keeping only 6 trusted names. I held the cash for a while and slowly drip fed the money into the following investments:-

a) Selected preference shares. A number of my old favourites had reduced in price to the mid 110s and were offering very attractive 6%+ yields. I saw buying some of these as as a safe income bet if times became troubled, those I chose I could not foresee falling below par (100p) and so the redemption risk was not that great. Obviously having only just baled out of these a few months earlier I didn’t buy too many though.
b) Renewable energy investment trusts. I saw (see) these as investments with very stable prices and good dividends increasing on an RPI basis in many cases.
c) A diversified set of high dividend paying investment trusts and ETFs many invested in overseas stocks to provide some brexit protection.

Being a masochist I maintained separate spreadsheets for each portfolio to try and see whether my changes had been effective or not. However we also took a sizeable chunk of cash out of the portfolio in late 2018 (as we had some things that we wanted to spend it on) and my comparison of the two is simplistic in that it just took the one portfolio valuation from the other and further reduced it by the sum that we had withdrawn.

The purpose of this post is to outline the effects that I saw over the tail-end of 2018 and YTD 2019.

To begin with at the end of 2018 with the markets falling the new portfolio did much better and was up almost £10,000 compared with the old one at one point. The single stocks in the old portfolio seem to produce greater losses with the market falling than the average of the diversified range of stocks held in the ITs and ETFs. Some single stocks like KIE, INTU, CRST and VOD did really badly – whereas by contrast the ITs and ETFs that I had replaced them with dropped more slowly.

Come the end of the year though and the recovery in the markets that we are now enjoying (which started about Xmas time) that performance has totally reversed. Now the old stock portfolio is typically outperforming the new one most days, partly due to the greater price movement on single stocks I think but also in part due to the fact that we took a significant chunk of capital out of the new portfolio and that extra capital has in turn increased the gains of the old portfolio. I also think that the greater exposure to overseas investments in the new portfolio has been a headwind due to the strengthening of the £. As I write this the old portfolio has gone from being ~10% down at one point to about 2% up. The yield of the two portfolios is roughly equivalent at just over 6% in each case, but in absolute terms therefore the income of the old portfolio was higher.

Now it’s still early days obviously and I plan to continue monitoring the performance of the two portfolios going forward. Do I feel that I made a big mistake in re-jigging my investment approach ?, no not really, not yet anyway. I am happy that the new portfolio is far more defensive than the old one, and if the market turns down again that may be a big benefit. But I guess I am surprised that despite some conspicuous poor performers amongst the stocks in the old portfolio day after day it has outperformed the new portfolio by as much as a factor of two on some days.

Looking critically at the new portfolio it looks like I have what I designed it to be – a defensive portfolio that delivers good income. About a third of the portfolio is in prefs and renewables, these are never going to set the world alight in growth terms but deliver excellent income. A further 50% is in high yield ITs and ETFs, again good from an income perspective but they aren’t likely to keep pace with equities when those are rising strongly due to the averaging effects of these diversified investments. Only 20% of the portfolio is in equities and therefore likely to mirror any equity outperformance (or underperformance obviously !).

I have a broad target of about 8-10% growth per annum in the portfolio with all dividends re-invested. That’s typical of what I used to achieve over the period from 2011-2018 while invested in preference shares, as these just went from strength to strength as interest rates fell. This may be optimistic but we’ll just have to see. With a ~6% yield the new portfolio needs only 2% capital growth to achieve my target. So far YTD (ie in only ~10 weeks) the new portfolio is up 5.7%, the old portfolio is up by 9.25% (!) and the FTSE 100 by 7.4%. I think that I will be happy with the new portfolio provided that it meets my growth target in the good years AND proves to be more defensive than the old portfolio when markets are falling. Only time will tell though….

Its been a bit of a torrid year for my investments with far too much positioning and trading going on and I’m very conscious of that. Im going to try hard to stop tinkering now and just see how things develop.

ATB

Pref

[Itsallaguess]

I'm going to try hard to stop tinkering now and just see how things develop.

Why not try hard to stop monitoring the old portfolio too?

Is there any benefit to it, other than as a potentially anxiety-causing exercise?

You've moved from a volatile portfolio that you were uncomfortable living with, but there's still likely to be periods of out-performance compared to your current set of holdings.

Well, so what? Would you learn anything actionable from knowing that?

I used to monitor shares that I'd sold out of, and there often an element of 'what-if' to that process if something continued to do well, even though there may have been valid 'non-performance' reasons for me to have exited the investment in the first place...

I decided that there was no merit in continuing to do that, and so I just stopped looking. I've never regretted the decision to do so.

That approach should go for portfolio-strategies too, if we've got good reasons to switch strategies, and it sounds like you've made a decision that this is the case....

Cheers,

Itsallaguess

[Dod101]

I think the first thing to say is that 8/10% growth is probably over optimistic year on year. You will achieve that and more some years but then one bad year can wipe out several year's gains, whatever portfolio you hold.

The second thing to say is that 50 holdings and more in any portfolio is too many. As you have found, monitoring it, reacting to corporate events and so on is just too much work. I firmly believe as well as these concerns, the more holdings you have the greater the chances of finding a disaster. Avoiding disasters is more important than finding a ten bagger.

And finally as Itsallaguess has said stop monitoring the old portfolio. It is the same if you sell a share. Forget it. It is done and gone. All you do is cause yourself unnecessary anguish. There is enough of that in investing without actively seeking it.

I will not comment on your choice for your current portfolio because we do not know enough of your aims, circumstances and so on, but having made the choice, concentrate on it and monitor it closely. Be prepared to make changes if you think something is going wrong but try to stand back and let it tick along for a couple of years at least, preferably much longer. Any portfolio takes time to settle down into a pattern. Only then can you judge it.

Best of luck.

Dod

[tjh290633]

You have obviously changed to a set of investments with which you are more comfortable. What you need to do is not be worried by market movements. The market goes up and down and is for that reason that an HYP investor is advised to follow the flow (and growth) of dividends and to ignore capital movements to a large extent.

viewtopic.php?p=207855#p207855 contains details of the annual changes in the unit value and the dividend per unit of my portfolio, unitised as income units. You will see that the capital value fluctuates a lot, in the first 12 years the IRR was up to 13%, but overall it has been 9.8%. During the course of a calendar year, some share prices will rise and some will fall. The next year the reverse may happen, with last year's loser being this year's winner. Often the "losers" offer the more attractive yields, and are a better proposition for topping up. I always look at how shares stand in relation to each other, using the median holding value as the yardstick.

It is always worthwhile comparing one type of investment with the others. Long ago I came to the conclusion that I was better off going for a higher yield, rather than capital growth per se. In fact I reckon that I got a better total return that way over the long term.

Good luck with your investments, and learn not to take precipitate action when an unexpected event occurs.

TJH

[MaraMan]

Thanks for the post, very interesting. One thing my portfolios lack is preference shares and I am considering changing that but have no experience with them. You mention you have some favourites, could you expand on that?

MM

[Itsallaguess]

It is always worthwhile comparing one type of investment with the others.

I'd agree with that, so long as it's worthwhile to do so, but in this case I fail to see the merit.

If we were to continue to compare two or more palatable strategies, then any outcome of those comparisons might instruct a change in direction from one palatable strategy to another palatable one, but where a strategy has already been seen to be so volatile that it's discounted for reasons other than outright performance (the volatility...), then what is the worth in continuing to monitor it?

To do so would seem to be a form of investment self-flagellation, and it was for this reason that I stopped monitoring investments that I'd already sold out of, unless there was a valid reason for a potential re-purchase at some point. If there were any reasons that would stop me from repurchasing the investment under any circumstances, then I simply stopped looking at all....

Cheers,

Itsallaguess

[tjh290633]

I wasn't proposing following shares disposed of, just comparing the current range. Equities v. ITs v. ETFs.

TJH

[PrefInvestor]

Hi Maraman, Glad you found my last post of interest.

Regarding preference shares there is much to tell, I guess some of the key points are as follows:-

1. Preference shares are a fixed interest type of investment, akin to a bond, and so have some different characteristics to ordinary shares (equities).
2. They pay a coupon rather than a dividend, different name but much the same thing. But with preference shares the amount of the coupon is defined as part of the product. Eg NWBD is a 9% NatWest preference share. The 9% defines the amount of the coupon that an investor receives as a proportion of the “par” value, the price the preference share was originally issued at. For most prefs this is 100p. So NWBD pays out 9p in coupons over the year. Most prefs pay their coupon in two equal half yearly payments, though a few pay in four equal quarterly payments. So NWBD (a 9% pref) pays out 2 x 4.5p coupons at half yearly intervals and RAVP (a 12% pref) pays out 4 x 3p coupons quarterly.
3. Unlike equities the amount of the coupon can NEVER be varied as it forms part of the product as do the coupon payment timings. Companies can’t declare different coupons for prefs as they do with dividends for equities.
4.Prefs come in several forms:-
a. Cumulative or Non-cumulative. In theory a non cumulative pref can withhold coupon payments if the company is not in a financial position to be able to pay them. A cumulative pref can skip a coupon payment but if it does it must make up the missed payment at a later payment date.
b. Irredeemable/Redeemable. Redeemable prefs have an end date rather like a bond at which time holders are typically repaid at par and coupon payments cease. Irredeemable prefs have no such end date and in theory once you own them payments go on forever.
5. Some prefs have “must pay” clauses built into their prospectus. Eg NWBD has such a clause which says if the company ever decides not to pay the coupon for any reason then they have to issue the holders additional preference shares to a value of 4/3 of the amount of the missed coupon.
6. You should also know that a company cannot pay a dividend on their ordinary shares if they withhold the coupon on their preference shares. The net result of such clauses is that the companies tend to always pay the coupon on their prefs.
7. All prefs have a prospectus which is a document expressed in highly technical legal language which defines all of the characteristics of the preference share.
8. While prefs are initially issued at par they are traded on the stock market (like bonds) and their price can rise above par and fall below it. Reliable prefs paying high coupons are (were ?) much sought after and prices in recent years soared way above par. For example LLPC a 9.25% Lloyds preference share that I held was priced at about 175p in March 2018. I bought most of mine for less than 100p way back around 2012.
9. Prefs are sensitive to the prevailing level of interest rates. As rates go up prices fall and the yield increases, if rates fall then prices rise and the yield decreases. In this respect they behave like bonds.
10. Like ordinary shares prefs have a bid and offer price. The prices typically quoted on most financial sites is referred to as the “official spread” and it is typically quite large, normally about the amount of a half yearly dividend payment. In actuality though if you do dummy buy and sell, trades on a pref you will often find that the actual buy and sell figures are considerably inside the official spread. But prefs are generally considered illiquid investments and some are traded relatively infrequently and hence the large spreads.
11. Be aware that liquidity can be a significant issue particularly when selling any of the smaller pref issues. I have never had a problem buying however many I wanted, but have frequently had problems selling. You may find that you cannot sell your entire holding and may be limited to selling no more than X shares on any given day. But this can change day to day. It can be annoying though.
12. Personally I always thought that the best time to buy prefs was on the XD date. On that date the offer price drops by close to the dividend amount, allowing you to buy more shares for the same amount and increasing your yield. You just have to then wait 6 months to receive your first coupon payment.
13. Investing in prefs of smaller companies can be a risky business. If the company goes out of business then you will likely be looking at a total loss. Personally I wouldn’t invest in such issues.

At this point I should provide a brief summary of the disastrous events that happened in the preference share world in March 2018. In their results presentation in early March 2018 Aviva made a statement to the effect that they intended to cancel all their preference shares at par and cease paying the coupons. They said that they had received legal advice saying that this was a valid interpretation of the wording in their pref prospectuses. As most other preference share prospectuses contained similar if not identical wording this caused panic in the preference share universe and prices of pretty well all preference shares collapsed.

There followed an extended campaign led by Mark Taber (of the fixed income investor website) supported by a number of major corporate holders of preference shares. Eventually Aviva were forced to back down, but the preference share world has not recovered, prices remain depressed and the cancellation threat potentially remains. Raven Russia are the only company that I know of that have modified their articles of association to explicitly remove the cancellation threat though Aviva has said in its retraction that it will not cancel its preference shares at par in future but would pay “fair market value” if it did so.

See the following links for more detail:-

https://www.aviva.com/newsroom/news-rel ... ce-shares/

https://www.telegraph.co.uk/investing/s ... 4m-payout/

Now the cancellation threat is less of an issue if you have only paid ~115p for your prefs but if you are holding them in your portfolio at ~175p and might only get paid closer to 100p for them that’s a different order of magnitude of problem.

Now to my knowledge this whole cancellation issue has never been tested in court and it it were it may be that it would not succeed. But then again those holding Lloyds ECNs (these are not prefs but are similar fixed interest products) did raise a legal challenge to their redemption by Lloyds and they lost their case and their income from those investments.

So what I had thought to be a pretty ironclad asset class providing excellent income and security has to my mind been severely damaged by these events. Most of the leading preference shares continue to trade but at much lower prices than prior to March 2018.

So I would say that you need to think very carefully if you are prepared to invest in this asset class under the circumstances that currently prevail. I have personally decided that I will, but will only purchase prefs which are on offer at low asking prices to help avoid the risk of capital loss should the cancellation issue raise its head again.

The preference shares that I currently hold are as follows:-
a) BWSA, Bristol & West 8.125% pref shares
b) GACB, General Accident plc 7 7/8% cumulative irredeemable pref shares
c) RSAB, RSA Insurance Group 7 3/8% cumulative pref shares
d) STAB, Standard Chartered plc 7 3/8% non-cumulative irredeemable pref shares
e) RAVP, Raven Property Group cumulative pref shares.

I bought a) to d) when they were all available for around 115p around November 2018. Most have since increased in price since then with the exception of STAB. RAVP is the one preference share that I am aware of that has amended its articles of association to eliminate the cancellation threat. I have decided that I will NOT buy some of the big names like LLPC, NWBD and SAN which are still trading at 140p and above.

One other big name is worthy of a mention I guess, that being ELLA (Ecclesiastical Insurance). I believe that they issued a statement at the time of Aviva cancellation issue saying that they had no plans to cancel their prefs. And being that they are really the Church of England one would hope that they can be trusted to deal fairly with their investors !.

Well I have probably been wittering on about this for far too long now. I believe that the information that I have provided is correct (gleaned over my many years of holding prefs) but I cannot ABSOLUTELY guarantee it and you should definitely do your own due diligence should you consider investing.

This post is not intended as any form of financial advice and if you choose to invest then you do so totally at your own risk.

ATB

Pref

[ursaminortaur]

Hi Maraman, Glad you found my last post of interest.

Regarding preference shares there is much to tell, I guess some of the key points are as follows:-

1. Preference shares are a fixed interest type of investment, akin to a bond, and so have some different characteristics to ordinary shares (equities).
2. They pay a coupon rather than a dividend, different name but much the same thing. But with preference shares the amount of the coupon is defined as part of the product. Eg NWBD is a 9% NatWest preference share. The 9% defines the amount of the coupon that an investor receives as a proportion of the “par” value, the price the preference share was originally issued at. For most prefs this is 100p. So NWBD pays out 9p in coupons over the year. Most prefs pay their coupon in two equal half yearly payments, though a few pay in four equal quarterly payments. So NWBD (a 9% pref) pays out 2 x 4.5p coupons at half yearly intervals and RAVP (a 12% pref) pays out 4 x 3p coupons quarterly.
3. Unlike equities the amount of the coupon can NEVER be varied as it forms part of the product as do the coupon payment timings. Companies can’t declare different coupons for prefs as they do with dividends for equities.
4.Prefs come in several forms:-
a. Cumulative or Non-cumulative. In theory a non cumulative pref can withhold coupon payments if the company is not in a financial position to be able to pay them. A cumulative pref can skip a coupon payment but if it does it must make up the missed payment at a later payment date.
b. Irredeemable/Redeemable. Redeemable prefs have an end date rather like a bond at which time holders are typically repaid at par and coupon payments cease. Irredeemable prefs have no such end date and in theory once you own them payments go on forever.

It should be noted that although in the past Redeemable prefs were almost always redeeemed on the end date specified in the prospectus they typically also provide the issuer with the option of not redeeming but instead continuing to pay coupons but at a different rate. This new coupon rate typically is a small percentage above some standard rate such as 3 month Libor. In the past when interest rates were higher this generally meant that not redeeming was more expensive for the issuer and hence was an incentive for them to redeem on time. Nowadays with low interest rates the coupons being paid out after the redemption date may well be less than they were before and hence there is less incentive for the issuer to redeem. In that situation prices of the preference shares may well fall though probably not too far from par as the prospectus will provide other opportunities for the issuer to redeem the preference shares at regular intervals often every 6 months or so.

[PrefInvestor]

Hi ursaminortaur, Thanks for adding your clarification. Personally I only ever invested in the irredeemable prefs as I wanted my income to go on forever - that worked out well didnt it !. Not.

Probably should also have said that prices of redeemable prefs will likely fall back towards par as they get close to their redemption date ?.

ATB

Pref

[BusyBumbleBee]

Regarding preference shares there is much to tell ...

And you told it really well - thank-you. I too used to invest in prefs - in happier times - but sold out not far off their peaks (before the AVIVA fiasco) and moved all the cash into the Green Infrastructure ITs believing that : returns were greater, security of income was greater, there was an increasing RPI linked yield, and the downside risk was very much less. I have not regretted that decsision.

Since 2008 we have lived in a low interest 'bubble' - when we return to more normal interest rates and/or inflation emerges as a problem, Prefs will take an almighty hit.

[MaraMan]

Thanks PrefInvestor for a very comprehensive and interesting reply to my question. I am still interested in buying a modest amount of prefs, but definitely take heed of your warnings.

Thanks again, much appreciated.

MM

[Alaric]

Thanks PrefInvestor for a very comprehensive and interesting reply to my question. I am still interested in buying a modest amount of prefs, but definitely take heed of your warnings.

If buying outside a SIPP or ISA, be aware that Pref Income payments are treated as dividends for tax purposes rather than interest.

[EssDeeAitch]

I echo other compliments to PrefInvestor, a succinct but comprehensive review which made an unknown topic (for me) comprehensible.

Many thanks
SDH

[scrumpyjack]

It may for most purposes be academic but distributions on preference shares are legally, and are usually referred to as, Dividends.

They are not deductible in computing the taxable profits of the paying company. Any form of Interest would be tax deductible

When there was a dividend tax credit, preference share dividends got that credit just like dividends on ordinary shares. Many companies adjusted the amount paid on preference shares so that the 'gross' dividend (ie the net amount paid plus the notional tax credit) equally the fixed 'Coupon' or rate of dividend per the company's articles of association.

The term 'Preference' share arose because the preference share fixed dividend was payable before any dividend could be paid on ordinary shares.
In many cases the preference dividend was 'cumulative'. This meant that is the company didn't pay the pref div (eg because they were loss making), all arrears of pref divs had to be paid before the company could resume paying an ordinary share dividend.

I used to hold Preference shares in the 1980's (received in a scrip issue) so have seen the effect of the various changes in their treatment over the decades.

[everhopeful]

I also congratulate PrefInvestor on an excellent summary. I hold Eclesiastical Insurance. Raven Property and REA prefs as well as Nat West 9% (NWBD). I remember at the time of the Aviva upset there was a lot of discussion about the relative safety of different prefs with regard to redemption on the Fixed Investor boards and all of these were considered to be OK. NWBD is trading at about 138p with a yield comfortably over 6% and I am happy to continue to hold. There is always a threat to capital value in a rising interest rate environment but that is also true of so called bond proxy shares held in HYPs. The mantra amongst the HYP investors is to not pay much attention to the capital value and enjoy the income. Surely this also applies to prefs.

[PrefInvestor]

Back to my original theme of stocks vs ITs & ETFs the performance of my new and old portfolios over the llast 3 days has been interesting. The first two days the FTSE was up and the £ was doing well and my old (stocks) portfolio outperformed the new (ITs and ETFs) by a factor of around 2 both days. Today after the brexit shambles the FTSE and £ were both down and the brexit sensitive stocks (housebuilders, REITs & financials) were down and Kier was down big time as it declared an interim loss and cut the dividend (take care you HYPers !). So today both the new and old portfolio lost money but the old one lost 3x as much as the new one.

No rocket science going on here though I don’t think, this performance is easily explained by the averaging effects of the ITs and ETFs. In particular the old portfolio was damaged by the 11%+ drop in the Kier share price, it would need to be a very bad day for an IT or ETF to do quite that badly.

Anyway I am planning to stop monitoring the old portfolio in accordance with recommendations from others on this board. But in part the reason for doing it was to see how the two options perform under the same conditions - and to try and form as accurate a view as possible on the differences. That done I shall now cease monitoring the old portfolio, it has served its purpose.

ATB

Pref

[richfool]

I've just added two ETF's - VEVE and VAPX - to my IT portfolio, so I can see how they perform as compared with my IT's (and my mini-HYP) over the coming years.

I also added two Multi-Asset (Flexible sector) IT's to the portfolio - (MATE and SIGT).

VEVE - Vanguard Developed World
VAPX - Vanguard Asia Pacific

MATE - JP Morgan Multi-Asset trust
SIGT - Seneca Global Income & Growth trust

[PrefInvestor]

Hi All,

Back to preference shares for a second, I note that Lloyds have just published the set of resolutions for their AGM one of which is to be able to buyback their preference shares. I must say that I see this as a relatively positive development for the preference share market as it at least indicates that they have no plans to cancel them (a la Aviva) or try to take the ECNs route. And I'm pretty sure that Lloyds (who are pretty litigious if they think its to their benefit) dont plan to take either of those routes then other preference shares on the market can probably be considered to be a bit safer than they were (no guarantees though !).

ATB

Pref

[Alaric]

I note that Lloyds have just published the set of resolutions for their AGM one of which is to be able to buyback their preference shares.

Followers of Lloyds Bank AGMs have noted that these resolutions are put forward every year and that's been the case for a few years. They need to do this as the resolutions are time limited. This doesn't seem to affect whether they actually use the powers or not