Basket of Seven: 2019 review

[Luniversal]

The Basket of Seven (B7) was devised in 2010 for the ignorant and apathetic investor who needs to pay bills as they fall due. The portfolio tries for a flow of income, from equity-based investment trusts, whose purchasing power should grow sedately over time. It should as far as feasible be 'fire and forget'.

Results of the seven chosen ITs are aggregated to a common Mar. year end, since this best fits their various accounting dates. Trends since the B7's backtested launch on Nov. 10, 2000 (also when 'HYP 1' began) are reviewed.

The B7 houses an increasingly eclectic mix of big and small, British and overseas stocks in all lines of business. They are to be bought in equal amounts: Bankers (BNKR), BMO Capital and Income (BCI-- formerly FCI), JPMorgan Claverhouse (JCH), Lowland Investment (LWI), Mercantile (MRC), Murray International (MYI) and Perpetual Income & Growth (PLI). Latest results are for financial years ended between Aug. 2018 and Mar. 2019.


INCOME
The B7 lifted regular dividends per share by 9.1% (2017: +9.4%), or by 6.2% (5.5%) after retail price inflation (RPI). This was above the average real rise of 4.4% pa during 18 complete years (1).

The portfolio's yield at Mar. 31, based on historic or officially forecast payouts, was 3.6% (2018: 3.1%). Such is a little cheaper than the average of 3.4% throughout its life, but it remained a half-point below the FT All-Share Index yield; these trusts have become more wanted for income.

Cover for payouts in 2017-18 again averaged 1.08 times, above the B7's whole-life average of 1.04 times. The basket has not distributed uncovered income since the wake of the global financial crisis in 2011-12. Average revenue reserve has been steady at 12-13 months of current payout since the crisis, albeit below the 15-17 months of earlier years.

On the whole these trusts' divi rates-- though presently rising at ~9% pa-- look prepared for a slowdown in earnings. Reversing the trend of recent years, the basket's Ongoing Charges Ratio rose to 0.61% (0.56%) of year-end net asset value (NAV), which has declined. But that is against a 2000-18 average of 0.81%.

Dividends per share since the putative launch have tripled, more than doubling in real terms. Income's purchasing power increased every year. Trusts imposed real cuts, year on year, on 15 of a possible 70 occasions in the past decade, averaging 2.0% nominal.


CAPITAL
Market values have responded over time to the income stream's steadiness. But they are far from proof against general fluctuations: both NAVs and share prices took hits last year as value stocks lost popularity relative to speculative and momentum punts.

For 2018-19 the composite NAV shrank by 7.2% (2017-18: +14.6%) nominal, or by 10.0% (+10.7%) real. Share prices were 6.3% (+14.7%) to the bad in money terms or 9.2% lower (previously up 10.8%) after inflation. However real changes between year ends since the putative launch have averaged +4.6% for assets per share, 4.7% for the share price.

The B7 outperformed the All-Share Index by an average 3.8% pa on share price, and in 12 of 17 years. The latest lag of 1.3% followed outperformance of 7.9% in 2017-18... and is the third lag in five years.

Three of seven members beat the Index in latest accounting years, after five the year before; albeit BCI has missed the benchmark only by a whisker. The average is for four of seven to outdo the broad equity market.

The average discount of 6.1% at financial year ends is close to the lifetime 6.5%, shrinking by 0.9 of a point since 2017-18. The tightest 2.2% discount was in 2013-14, before jitters about the sustainability of income from 'bond proxy' blue chips set in.


CONSTITUENTS
Briefly, individual trusts' contributions over the last ten years:

First, four income metrics: compound annual real dividend growth after inflation (2), number of real cuts year on year, average cover and months in revenue reserve:

BNKR: 3.2%, 1, 1.04x, 21
BCI: 0.5%, 4, 1.09x, 14
JCH: 2.4%, 2, 1.04x, 19
LWI: 4.8%, 2, 1.02x, 13
MRC: 2.9%, 4, 1.01x, 18
MYI: 5.5%, 1, 1.04x, 13
PLI: 2.9%, 1, 1.10x, 11
--------------------------------
B7: 3.5%, 0, 1.04x, 16

Capital metrics: share price change in decade to latest financial year end, number of years trailing the index, average yield and discount/premium:

BNKR: +173.8%, 3, 2.7%, 7.6%
BCI: +66.4%, 7, 3.8%, -2.0%
JCH: +95.6%, 4, 3.8%, 6.9%
LWI: +142.4%, 4, 3.4%, 4.6%
MRC: +224.1%, 4, 3.1%, 13.4%
MYI: +92.2%, 3, 4.1%, -2.9%
PLI: +90.1%, 3, 3.7%, 5.6%
-----------------------------------------
B7: +138.3%, 3, 3.4%, 6.1%

BCI is still the back-marker for dividend and capital growth, yet usually sells on a premium. Perhaps new owners Bank of Montreal can fix it. Mercantile, with its midcaps focus, has been #1 for capital growth but far the most volatile. Bankers and Lowland are low-yielding but 'growthy' for income; so is Murray International with its foreign flavour. But MYI, and the more orthodox Perpetual more so, grew more erratic and unloved in the past few years-- whereas JPMorgan Claverhouse rallied.

Such twists and turns concern me little. The B7 is an eternity-buy-and-hold job illustrating a method, not setting one permutation in stone. When picked, there was less choice of ITs with track records; today I might chuck a foreign specialist in the mix, whereas BCI was a poor, misidentified pick. Well, most portfolios contain at least one gaffe; it makes this backward-jobbed effort more realistic. No member has blown up. Overall, I am content.


PERFORMANCE 2000-19
Let us see how the B7 would have performed in practice. An investor places the same £75,000 lump sum as Pyad's HYP1, with the same equal weighting and 1% acquisition costs and on the same date: Nov. 10, 2000.

The basket would have collared £6,575 of income last year (1), an 8.5% increase. (HYP1 got £8,882 in the year to Nov. 2018.) The B7's yield on last Apr. 1's opening capital was 3.5%, in line with the historic average. This is competitive with cash or fixed interest, if the collection is viewed as a savings account with some inflation protection for interest and principal. Receipts are free of income tax to the basic-rate payer, or to all within an ISA or using the £2,000 dividend allowance. After 18.5 years the basket's £75,000 investment would have dispensed £73,262 of regular dividends, plus £794 of one-offs.

Market value fell last year by 2.9% to £184,222, compounding at 5.0% pa or ~2.0% real since 2000; although by Mar. 2009 the B7 was worth less than at purchase. The basket has lost value during six of 19 periods, the All-Share Index during eight. Average annual outperformance of the Index has been 3.7 percentage points, 14 times out of 19.

Capital value is aethereal to a never-seller, but signals that the income stream is not being bought at the principal's expense. However faith in the stream may be more about security than expansion of its purchasing power, in the nearer term.


DERISKING
Added safety comes from 'derisking' the income. One mimics an index-linked bond and an income reserve backs it up.

The £75,000 basket here illustrated could have been derisked to pay a 2.5% yield in its first year as spendable income. The initial withdrawal rate was meagre due to 'dividend drag', but the B7's buoyancy would have enabled three revisions: in 2007 (+30%), 2012 (+25%) and 2018 (+30%).

The quasi-bond would thereafter pay 5.3% plus uplifts for inflation. It lolls on a reserve worth 15 months of payout at that level. HYP1's income has been substantially bigger but more erratic; it could be derisked to a 5.5%+RPI withdrawal rate with the same size of income reserve.

Derisking would have required 11% of the B7's receipts to be held back, over and above the ~5% which trusts retained. It is a hypercautious stratagem, if you cannot let your income's buying power wobble.

All B7 members pay out quarterly. A cost-effective lump sum would be £10,000 or more gross. With stamp duty of 0.5% and commission of, say, £12.50 a share, ten grand gets a starting income of £359, averaging £33 a time. That is some way below the All-Share yield, but one pays for stability and 'growthiness'.

No corporate actions would have required a response since 2000. Doris sleeps on.

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(1) Over the years four members declared ten special dividends excluded from income data, total £794: BCI £49 (two), JCH £73, PLI (six) £603, MRC £69. Yesterday's PLI results omitted a special for its year to Mar. 2019.

(2) Dividends' compound annual growth rate is measured from Apr. 2001, to eliminate arbitrarily different payment times and numbers during the first five months.

[TahiPanasDua]

Who writes them better?

Well done yet again, Luni.

TP2.

[Dod101]

Many thanks for this update. I was particularly drawn to your comment

'Capital value is aethereal to a never-seller, but signals that the income stream is not being bought at the principal's expense'.

That will be unlike a number of shares held in many HYPs at the moment I would think and makes this an extremely helpful report, particularly because a number of income seekers in recent months have been turning to ITs it would seem. That includes me to some extent.

Keep up the great work!

Dod

[Luniversal]

Many thanks for this update. I was particularly drawn to your comment

'Capital value is aethereal to a never-seller, but signals that the income stream is not being bought at the principal's expense'.

That will be unlike a number of shares held in many HYPs at the moment I would think and makes this an extremely helpful report, particularly because a number of income seekers in recent months have been turning to ITs it would seem. That includes me to some extent.

Dod

I feel obliged to draw comparisons with High Yield Portfolios in these basket sit-reps. There are pluses on both sides. I fully intend keeping my trial HYPs, but admit to leaning away for new investments, being solvent and ever-lazier.

A previous comment concluded that after allowing for income's greater volatility, and applying a safety margin to curb it, a portfolio of directly held equities (within the usual constraints, such as diversity, cap-size and avoiding ultra-high-yields) will furnish the most spendable income, initially and over time. ITs are more about smoothing the lumps and letting you off admin. And when considering the B7 v. the juicier B8-- you do have to wait a decade or more to see the advantages of 'growthiness'. I will try to do a B8 update c. Aug. to display the differences.

HYP1's capital value (all together now: 'doesn't matter' ) at its 18th anniversary was £155,583 against the B7's £179,957, but don't set too much store by that; HYP1 has outperformed the B7 on capital in 11 of 18 years, though overall it gained slightly less annually.

The B7 has been less volatile than the All-Share or HYP1 on the downside and more so on the up. I imagine passive investors prefer it that way round, if they must break the glass in case of emergency.

My real qualms (which are impressionistic after ceasing to log everything) concern the sustainability of income from mainstream HYPable companies. They seem to falter or break down more often than a few years ago.

Not enough newbies come into the pool (e.g. with strong dividend records going back 5-10 years) to replace the Tescos and Centricas. This could be to do with the perceived narrowing of the LSE: does dividend worthiness cluster in ever-fewer companies and industries? Feels like it. The 25-sector HYPs I was devising until end-2016 would be tougher to complete these days, though you might not need that many.

The B7's managers gradually become more cosmopolitan and use more UK 'smidcaps'. But as I wrote, if beginning now I would hunt hard for overseas-focused dividend-seekers with five years of decently covered increases. There are a few more such trusts than in 2010 when the baskets were drawn.

[Alaric]

This could be to do with the perceived narrowing of the LSE: does dividend worthiness cluster in ever-fewer companies and industries?

There seem to be plenty of Companies out there that increase their dividends faster than inflation. The "problem" is that their prices move upwards so that the initial dividend yield drops below the market average. With the yield on the FTSE 100 weighted by market capitalisation it's the plodders with the highest capitalisations that set the benchmarks.

[Julian]

Many thanks LUniversal. A fantastic review.

...
Dividends per share since the putative launch have tripled, more than doubling in real terms. Income's purchasing power increased every year. Trusts imposed real cuts, year on year, on 15 of a possible 70 occasions in the past decade, averaging 2.0% nominal.
...

I'm probably being dim here but could you please clarify the above, in particular my bolded bit. "imposed real cuts" could be ambiguous.

Do you mean that on those 15 occasions a trust either held its dividend or increased it by less than the then-current inflation rate thus imposing a real terms cut or are you using the "real" there in the less formal way, i.e. that on those 15 occasions a trust really did cut its dividend and reduced the dividend amount paid per share vs the equivalent dividend in the previous year?

If you are using "real" as in relative-to-inflation then did any of the trusts, on any of those 70 occasions, make lets call them "actual" cuts in dividends, i.e. reduced a pence-per-share declaration relative to the same declaration the previous year?

- Julian

[dspp]

Moderator Message:
I have just deleted three posts following requests/alerts. In the posts some valid points were made. But also the man was attacked - and rudely - as well as the ball. Please play only the ball, and play it politely. You are all quite capable of doing just this in the first place, hence going down the full deletion pathway.

And please hit alert rather than biting, which is what one person did.

Thank you, dspp

[Dod101]

I have no idea what the offence was but it has very effectively closed down what was an interesting discussion on ITs, which was making a for a pleasant and welcome change from Brexit.

Dod

[Luniversal]

Do you mean that on those 15 occasions a trust either held its dividend or increased it by less than the then-current inflation rate thus imposing a real terms cut or are you using the "real" there in the less formal way, i.e. that on those 15 occasions a trust really did cut its dividend and reduced the dividend amount paid per share vs the equivalent dividend in the previous year?

If you are using "real" as in relative-to-inflation then did any of the trusts, on any of those 70 occasions, make lets call them "actual" cuts in dividends, i.e. reduced a pence-per-share declaration relative to the same declaration the previous year?

- Julian

Cuts cited are reductions in purchasing power for annual totals per share compared with the prior year, measured by RPI. Specials excluded.

All are freezes (four in a row at MRC during the global financial crisis) or subinflationary rises. No 'actual' cuts, in your parlance. The AIC's Dividend Hero money-illusion gimmick must be helping.

By trust:

BNKR: 1 (0.4%)
BCI: 4 (2.2%,3.2%,0.5%*,0.5%*)
JCH: 2 (1.2%, 0.5%)
LWI: 2 (2.7%, 1.9%)
MRC: 4 (3.7%, 5.1%, 3.9%, 3.3%)
MYI: 1 (0.3%)
PLI: 1 (0.9%)

By composite year:

2009-10: 5
2010-11: 5
2011-12: 1
2012-13: 1
2015-16: 1
2017-18: 1*
2018-19: 1*

*That miscreant BCI now ties dividend rises to the CPI. Because RPI inflation is higher, I count these two as subinflationary.

[mickeypops]

Many thanks Luni. Your work on ITs over the years slowly persuaded me of their potential and opened up a new area of investing for me.

Once again,I’m glad you’re back.

MP

[tacpot12]

Many thanks Luni. Your work on ITs over the years slowly persuaded me of their potential and opened up a new area of investing for me.

Once again,I’m glad you’re back.

MP

Yes, Many thanks Luni. Your B7 & B8 posts on TMF also persuaded me to look at ITs and my retirement portfolio is now heavily based around a basket of ITs. I liked the idea of a "Fire and Forget" portfolio and also the ability to purchase investments offering a proven ability to delivery a good and growing income plus some capital growth as well. Cheers!

[BrummieDave]

Yes, as someone who started building my IT portfolio after reading TMF B7/B8 threads, and basing my retirement income generator on B7, since modified and diversified, it's always a pleasure to see these reviews pop up and to see how the baskets are performing.

But surely we shouldn't read the reviews, we should just be sitting back and taking the income; that's the whole point isn't it...?

Thanks Luni!

[Witzig]

I would also like to add my thanks for this review. Since moving both our retirement pots from the Pru to Sipps in 2011, I have tried to behave responsibly with my wife's funds while chasing (so far elusive) riches with my own. Having enviously watched my wife's pot steadily grow, despite her taking regular income, while my own funds have festered in mediocrity, I have increasingly come to appreciate the wisdom of "good enough is better than even better" which I think I recall as being one of Luni's maxims.
Having started my wife's portfolio with the "sturdy 17", I gradually moved it over to the b7 (plus Henderson far east income for a bit of oriental spice) and she has been very happy with the results. (It allowed her to retire early, years before the state pension kicked in.)
I am still dabbling with a sort of Hyp for my own Sipp, but have capitulated and gone for the B7 + HFEL for my own ISA.
Apologies for a rambling post, but wanted to voice my appreciation for all the hard work and extensive research on I'T's done by Luniversal.