HYP v Basket of ITs

[staffordian]

Over the last fourteen years or so I have used an HYP more or less to the exclusion of all else as far as my long term investing is concerned. When I started, I was potentially 12 years from retirement (with a local government pension) though I was actually lucky enough to be able to retire early in 2011. Currently, I do not need to draw any income from my investments, so it is all reinvested.

Last year I decided to dip a toe into the IT waters, by purchasing equal values of the ITs Luni suggested in his B7.

To cut a long story short, I am sorely tempted to move entirely in this direction.

Whilst there are major caveats, such as only 12 months performance of my ITs compared to 14 years experience with an HYP strategy, the IT returns are significantly better. Clearly the income (yield) is lower, but the capital return is higher, and as all income is reinvested, and will be for the forseeabe future, TR is probably the more important concern.

The other advantage of the IT route is, of course, it's hands off simplicity; perhaps not important yet, but potentially a factor in the future.

I know one or two HYPers have run both strategies and found ITs at least the equal of an HYP strategy, and with the seemingly non stop drip of bad news for long established HYP stalwarts, I do think there seems to be a sea change in future returns.

I don't plan to liquidate the HYP, but will cease building it, and direct all future funds, including HYP dividends to the basket until they are roughly equal.

By then I might have made up my mind which I prefer

I'd be interested to hear other's views on the relative merits of the two strategies.

Staffordian

[BarrenWuffett]

For a period of around 5 yrs I ran parallel hyp/IT portfolios and, like you, found the ITs consistently provided the better total returns compared to my 25 share hyp. I have long since dropped the hyp (in favour of Vanguard Lifestrategy) but continue with my ITs - Finsbury Gr & Inc, City of London, Scottish Mortgage, Edinburgh, TR Property and Aberforth Smaller.

I now compare my ITs against my VLS 60.

[staffordian]

Some might say even five years is insufficient to form a definite judgement, but it's certainly long enough to get a good feel for things, so I'm grateful for your input. Five years of comparison certainly beats my 12 months

[Itsallaguess]

I'd be interested to hear other's views on the relative merits of the two strategies.

I'm someone who also runs a significant chunk of their income-related strategy via income-Investment-Trusts, and have seen similar results as you over a similar, although slightly longer time-scale.

One thing that slightly concerns me, is to keep asking why this might be the case, and if I'm not considering importantly enough things like gearing, that might account for some of the perceived performance-difference.

Have you answered the 'how can that be?' question, in a way that both satisfies you in terms of the answer, and also if that answer contains any extra risk over and above a standard HYP, such as any potential gearing risks?

I'm planning on keeping a review on things in terms of my share-and-IT HYP, to see how things go through the next downturn, as the above is something that's been niggling me for some time now and I whilst it's good to see a similar performance-difference as you've also shown, I'd personally be nervous of going all-in without fully answering my own concerns.

Cheers,

Itsallaguess

[dspp]

FWIW I am doing the same HYP vs experiment, but in my case vs index trackers. Too early to tell the results.
regards, dspp

[staffordian]

...One thing that slightly concerns me, is to keep asking why this might be the case, and if I'm not considering importantly enough things like gearing, that might account for some of the perceived performance-difference.

Have you answered the 'how can that be?' question, in a way that both satisfies you in terms of the answer, and also if that answer contains any extra risk over and above a standard HYP, such as any potential gearing risks? ...


Cheers,

Itsallaguess

Very good points, and no, I don't have a satisfactory answer, hence my keeping a foot in both camps.

On the one hand, direct ownership should enable a better return because there are no significant overheads to pay. But on the other hand, perhaps a portfolio of 15 to 25 shares isn't really enough to avoid a sprinkling of duffers.

And as an income IT keeps a reserve, that should lower returns.

I therefore wonder if the better total returns being seen over recent times are more to do with an increased popularity of ITs because of poor returns elsewhere - interest rates have been derisory for more years than I care to remember, and certainly more than many of the IT v HYP comparisons.

Perhaps when (if?) rates return to more traditional levels, the demand for ITs will fall and the differential in total return between them and HYPs will reverse?

[Raptor]

A few years back there was a thread on TMF about what to do when or if you no longer wanted or could manage your HYP portfolio. At that time I took conrol of my pension funds in a SIPP. 50/50 split of ITs and equities, the income from my HYP has been roughly the same but the capital value of the ITs has been a lot better. Too short a time to make a conclusion but I am topping up the ITs at a greater rate than the equities.

Will be an interesting time going forward.

Raptor

[TUK020]

One thing that slightly concerns me, is to keep asking why this might be the case, and if I'm not considering importantly enough things like gearing, that might account for some of the perceived performance-difference.

Have you answered the 'how can that be?' question, in a way that both satisfies you in terms of the answer, and also if that answer contains any extra risk over and above a standard HYP, such as any potential gearing risks?
s

This is a really thought provoking question. Because ITs hold back some income reserve to smooth returns, does this have an 'integrative effect' that not only reduces volatility, but also causes it to lag the economic cycle?

[Itsallaguess]

I therefore wonder if the better total returns [from income-IT's] being seen over recent times are more to do with an increased popularity of ITs because of poor returns elsewhere - interest rates have been derisory for more years than I care to remember, and certainly more than many of the IT v HYP comparisons.

Perhaps when (if?) rates return to more traditional levels, the demand for ITs will fall and the differential in total return between them and HYPs will reverse?

I'd considered that, and came to the conclusions that if this were the case, then we'd perhaps see the results of that in the discount/premium figures, but with a step-change in income-IT's seeing larger premium figures when compared to historic charts.

I'm not convinced that this has been the case, and the majority of the income-IT's I hold which have seen an out-performance over my share-specific-HYP-section don't seem to have anything unusual going on in the discount/premium figures.

I agree with your other points with regards to IT's casting a wider net than the usual sub-set of HYP-specific shares, and do wonder if the ability of IT's to cushion the blow of individual failures, such as the recent Carillion debacle, due to such shares being a smaller percentage-holding of their portfolios, makes up for having to pay the IT management-fees.

Given the performance difference I've seen with my own HYP, when comparing my IT's to the share-specific-section, it's difficult to see much downside on current viewing. Whilst it's tempting to make hard conclusions from that position, it's also a bit of a red-flag to me that I'm missing something important that might become evident during any prolonged downturn.

I think I'd prefer to learn any potential lesson in that regards from my current 'split' position, where I can continue to compare performance, rather than go 'all-in' to income-IT's at this point, given the above.

Cheers,

Itsallaguess

[richfool]

I too have been gradually moving from holding both a HYP portfolio and an IT portfolio, to concentrating more predominantly on the IT portfolio. Over the last 12-18 months I have been selling off (some) stocks and re-investing the proceeds into my ISA based IT portfolio.

This is a really thought provoking question. Because ITs hold back some income reserve to smooth returns, does this have an 'integrative effect' that not only reduces volatility, but also causes it to lag the economic cycle?

I don't see that one can accurately determine the actual effect of IT's holding back some of their income (to smooth returns), as some of the income so retained could well have arisen before one bought the trust (so one would be benefiting/gaining there), or on the other hand, some of the income arising since one bought in could be being held back (and payment thus delayed to a future point). Thus I can't see that one could determine exactly which was happening and when, even if the Manager's report made some reference to it.

The only conclusion I would draw is that the level of income should be reasonably smooth and reliable and/as it should be less likely to suffer cuts. That would make the investment proposition more attractive to me, and I think would negate, overwhelm or obscure any possible lag in performance (relative to either the economic cycle or payment of retained dividend income). Bear in mind that the SP of IT's are also subject to market forces in terms of investor sentiment, as well as the value of their NAV's.

[Clitheroekid]

As I said in this post a few days ago, I think there's real cause for concern about the dramtic drop in dividend cover for typical HYP shares - viewtopic.php?f=31&t=6819&p=73692&hilit=clitheroekid+dividend+cover#p73594

Following on from that I think that HY shares are becoming increasingly risky investments generally. It seems that the desperate search for yield is leading income seeking investors into shares that are very unlikely to be able to carry on paying dividends as they have been, with the consequence that both capital and income losses will follow.

Perhaps one reason that IT's have been doing better - and will continue to do better - is that they are managed by people with better sources of information as to what's going on. It's not unreasonable to assume that they will get to know about problems at companies like CLLN before private investors do, enabling them to bail out earlier and cut their losses. So it may be not so much that they are choosing better shares to buy - it could just be that they're cutting their losses much earlier on the alarmingly large number of dogs that are crawling out of their kennels.

For my own part although I don't subscribe to the HYP `religion' I'm quite happy to hold some HY shares such as BP and Shell simply because of the yield. But I really don't believe that if things stay as they are that they will be able to maintain those juicy dividends for many more years.

I'm hoping, of course, that I'll have the ability to judge when that's likely to happen before it happens. However, that's at best a 50/50 chance, and I accept the risk of a significant capital loss at some stage in the knowledge that the dividends will by then have compensated for it anyway. The longer the dividends are held the better the overall outcome will have been.

But that collapsing dividend cover is something that I don't feel is sufficiently appreciated or taken into account. Quite frankly, it would very much put me off starting a new HYP at this stage, and if I were looking at a 10 year time frame I'm afraid I'd almost certainly opt for IT's.

Incidentally, I see that the shorting interest in PFG is creeping up as the share price continues to decline. I have a feeling that the way they've changed their basic modus operandi from using self-employed collection agents to employees may prove a very serious mistake. If I held PFG I would definitely be thinking it was time to say goodbye.

[staffordian]

Hi CK,

I read your post on dividend cover and sustainability and to some extent it crystallised my vague concerns.

There does seem to be an element of blind faith these days, as far as HYP investing is concerned, given that the underlying strengh of even the biggest HYP companies seem to be diminishing but then again, is this perhaps simply part of the natural ebb and flow of profitability that goes with economic cycles?

I agree with your theory that those in the know have an edge, so perhaps my change in strategy is a case of "if you can't beat them, join them"

Only time will tell!

Staffordian

[BreakoutBoy]

My experience has also been that my ITs have outperformed my HYP shares over the last 18months. That said, index trackers also edged out the HYP shares. I think the basic premise of HYP is unsound: yield is often a function of risk not value!

[Lootman]

As I said in this post a few days ago, I think there's real cause for concern about the dramtic drop in dividend cover for typical HYP shares - viewtopic.php?f=31&t=6819&p=73692&hilit=clitheroekid+dividend+cover#p73594

Following on from that I think that HY shares are becoming increasingly risky investments generally. It seems that the desperate search for yield is leading income seeking investors into shares that are very unlikely to be able to carry on paying dividends as they have been, with the consequence that both capital and income losses will follow.

I agreed with you then and I agree with you now. I've always thought it odd that nobody seems to have a problem with the term "junk bond" being used for bonds with a very high yield, in acknowledgement of the greater risk involved with them. But when the market confers a high dividend yield upon a struggling share, not only does nobody call it a "junk share" but the yield is actually marketed as an attractive feature.

And P/E ratios for HY shares are at a historically high number relative to growth shares, probably indicative of a rather mindless search for yield in a low interest rate environment.

Aside from any general merits or demerits of HYP, I would not start one or expand one at this time, for all these reasons. I'd probably be looking instead to balance out a HYP with some foreign and growth investments, some of which are at more attractive valuations. Or avoid new equity investments altogether.

[hiriskpaul]

I'd be interested to hear other's views on the relative merits of the two strategies.
Staffordian

You are comparing just one sample from each strategy, which is not going to give you a statistically significant result. Overall though it is reasonable to expect a diversified portfolio of shares to outperform a diversified portfolio of UNGEARED ITs due to the higher running costs of holding the ITs. However, as your shares portfolio is likely to be largely consisting of Large cap UK shares with a value tilt, there are factors which will not have helped you over the last 5 years or so compared with ITs:

- Non-UK markets have outperformed the UK market (Vanguard Developed World ex-U.K. +112%, FTSE allshare +64%)
- Smaller caps have outperformed larger caps (FTSE 250 103% vs FTSE 100 58%)
- Growth has outperformed value (MSCI UK Growth 60% vs Value 41% TR)

I suspect that the IT portfolio you are comparing with may have more foreign shares and may be more tilted to growth and small caps than your shares portfolio. That in itself would not have guaranteed that the ITs would have performed better, but it would have given them an edge. There may be other factors at work such as reducing discounts, and gearing, but I suspect that it is mostly down to better diversification into areas that just happened to have performed better. As such, there can be no certainty that your particular portfolio tilts and stock picks might underperform ITs over the next 5 years.

As an aside, if you are invested in a way that generates far more cash than you are likely to want to draw, why invest that way? Similarly, why go heavily into UK listed shares?

[staffordian]

You are comparing just one sample from each strategy, which is not going to give you a statistically significant result. Overall though it is reasonable to expect a diversified portfolio of shares to outperform a diversified portfolio of UNGEARED ITs due to the higher running costs of holding the ITs. However, as your shares portfolio is likely to be largely consisting of Large cap UK shares with a value tilt, there are factors which will not have helped you over the last 5 years or so compared with ITs:

- Non-UK markets have outperformed the UK market (Vanguard Developed World ex-U.K. +112%, FTSE allshare +64%)
- Smaller caps have outperformed larger caps (FTSE 250 103% vs FTSE 100 58%)
- Growth has outperformed value (MSCI UK Growth 60% vs Value 41% TR)

I suspect that the IT portfolio you are comparing with may have more foreign shares and may be more tilted to growth and small caps than your shares portfolio. That in itself would not have guaranteed that the ITs would have performed better, but it would have given them an edge. There may be other factors at work such as reducing discounts, and gearing, but I suspect that it is mostly down to better diversification into areas that just happened to have performed better. As such, there can be no certainty that your particular portfolio tilts and stock picks might underperform ITs over the next 5 years.

Thanks, it's valuable to get a wider perspective. I think, among other things, it indicates the futility of trying to second guess what will be the best option going forward. I realise my sample of one isn't going to prove anything, which is why I'm grateful for the opinions of those with far more knowledge and experience than my own.

As an aside, if you are invested in a way that generates far more cash than you are likely to want to draw, why invest that way? Similarly, why go heavily into UK listed shares?

My original post perhaps gave the impression of a huge portfolio throwing off oodles of cash which I have difficulty spending

The truth is, I have both a modest portfolio and modest outgoings. I don't have anything like the expertise necessary for sophisticated investing nor the size of portfolio to warrant "buying" such advice. I am happy enough to achieve modest returms, though still far better than keeping money in the bank, and the main reason for focussing on income investments is simply to ease the transition from accumulation to withdrawal if and when I need it.

Staffordian

[moorfield]

To cut a long story short, I am sorely tempted to move entirely in this direction.

I'd be interested to hear other's views on the relative merits of the two strategies.

Staffordian

I’ve been pondering this also for a while now. The recent Carillion breakdown and your OP have prompted me to explore the question further with some back testing. Here I’ve dug up historical prices and dividends for the City of London IT (CTY) and computed the annual income generated from a £1000 lump sum investment in 2008, with the income reinvested each year to purchase new shares (including stamp duty 0.5% and cheap dealing charge £1.50; the dates have been deliberately chosen to fall between each financial year end and the following ex-dividend date). I know I am looking at one IT rather than a basket, but bear with me …



Placing that table alongside my own objective I’ve stated on the Portfolio Management & Review board …

I am aiming to grow my SIPP portfolio income by +7.2% per annum for the next 14 years through reinvestment of dividends. In practice it is intended to aim for the ballpark of "roughly what a higher rate tax payer earns" in retirement which would be quite satisfactory.

… it becomes difficult to ignore one conclusion that moving entirely to ITs (or CTY at least) from here is unlikely to detract from my retirement goals.

However, by holding a higher yielding portfolio of shares over a basket of ITs (mine currently yields 4.9% compared to CTY’s 3.8% -ish) I think I have accumulated a larger cash reserve over time – currently equivalent to 9 months of overall income – not all of which I need to use to keep the overall income on target.

M

[flyer61]

An interesting thread!

my tuppence worth....I get reinvesting dividends over a long period of time however I don't think the 'High Yield Share Portfolio' is the way to go.
I wanted to FIRE at 55 and decided to do it through Bonds. Certainty of income was very important to me so buying the likes of Centrica etc was not the way to achieve this. Now that I have reached 55 and fired (still working though) I am now buying equities, IT's and REIT's. The individual shares I am buying are only those with high quality heavily moated businesses. Make no mistake they are expensive and I am very aware of this however in my lifetime quality has always paid off. It means I have ended up with a bias to US Companies. Most pay a quarterly dividend which gets rolled up into more quality businesses. On the IT front if you like the manager and the underlying portfolio looks sensible if you can buy at a discount....go for it! MCT has worked really well for me in this space. SLI is another, bought the day after the Brexit vote. Trades at a ridiculous premium now.

Good luck to all.

[Phileasrob]

Please could someone advise what ITs are held in Luni's B7?

Thanks!

[swill453]

Please could someone advise what ITs are held in Luni's B7?

Thanks!

BNKR.L - Bankers Investment Trust
FCI.L - F&C Capital & Income Investment Trust
JCH.L - JPMorgan Claverhouse Investment Trust
LWI.L - Lowland Investment Co
MRC.L - Mercantile Investment Trust
MYI.L - Murray International Trust
PLI.L - Perpetual Income & Growth Investment Trust

Scott.