Early on in the life of Monevator, I wrote a series of posts explaining how to pick [1] high yielding shares for long term diversified [2] dividend income, and why you might want to do so [3].
The series culminated with a example portfolio [4], which I reviewed for the last time in April 2011 [5].
As promised, I am now going to create a new high yield portfolio (HYP). What’s more, I’m going to do the sensible thing this time, and track the dividend income.
Income is, after all, the entire point of a HYP. And while I’m fairly pleased with how well the capital value of that last HYP withstood the carnage of the credit crunch, I haven’t really got a Scooby as to how the income fared. This time I want to be sure.
Having weighed up various tools to enable me to track both the portfolio and its income – and taking into account the entire Monevator research department seems to have absconded, together with all our interns AND the hapless but dependable jobsworth who might otherwise have been lumbered with tracking the portfolio – I’ve decided to simply buy the shares in real-life to do it.
Yes, I am investing my own hard-earned money to buy and track this HYP here on Monevator.
As a fan of Airfix in my childhood, I can’t really resist having another mini-model portfolio to play with. More importantly, this way is guaranteed to be correct, if rather expensive, unlike the online tools which all have downsides. Also, buying and holding the shares will give us a better idea of how much faff it takes to run even a largely hands-off portfolio, as companies are acquired, go bust, do an Enron, and so on.
I’ll give the exact details, such as prices paid and initial costs next week. For the rest of this post, I’ll tell you what shares I’ve chosen and why.
Important: I’m not recommending you buy these shares, and take no responsibility if you do so. I’m just a private investor, not your personal adviser nor Warren Buffett. Also, if you’re going to hold shares directly, you need to learn about, choose and follow your own shares, not just blindly copy someone else’s picks. There’s no shame in going for an index tracker [6] instead!
Let’s do it like we did last year
There’s no point in repeating what I’ve previously written about selecting shares for a HYP. Please follow the various links in the first paragraph of this article for the specifics (or else see this archive [7] of all my HYP posts).
I think the original strategy stood up fairly well last time, and steered me away from indebted disasters like Yell or from buying too many housebuilders or banks – even if it didn’t avoid banks altogether. (I did note yields on bank shares were high because of fears of a credit crunch, but I said it could go either way and so bought a couple of banks anyway!)
The importance put on diversification [2] and avoiding excessive debt proved itself in the bear market, too.
All that said, my HYP thinking has evolved a little bit since 2007, in that I now think the sustainability of the yield is also worth an extra moment of guesswork thought.
It won’t pay to try to be too much smarter than the market here; let’s be honest, our 20-minute evaluation won’t beat a full-time analyst’s efforts. Our edge, if we have one, comes through buying a basket of higher yielders, not by second guessing the earnings forecasts for every company in the FTSE.
Put simply, I’d now pick a hugely dependable cash generator on a slightly lower yield like Unilever – which only just made my 2007 portfolio – over the average engineering firm or cyclical, unless its yield is stupidly low. (Still no room for ARM then).
The 2011 high yield portfolio
Again, please see my 2007 post for a step-by-step walkthrough [4] of how you can pick your own portfolio of high yield shares using a combination of a screener, further research, and gut feel.
Needless to say, that old portfolio is wildly out of date. Yet I think reading the previous post is arguably more demonstrative than detailing every step today. Truth is, making pronouncements about share A versus share B as commentators and fund managers do gives an illusion of exactitude. By looking at that four year old post, you can see the warts and all, in the harsh light of what happened next.
Here’s my final chosen portfolio for this year, followed by a few brief notes on what’s in it and why:
| Company | Size (m) | Sector | Cover | Yield |
| Aviva | £12,440 | Life assurance | 2.2 | 6.0% |
| BAE Systems | £11,065 | Aerospace | 2.2 | 5.6% |
| AstraZeneca | £42,670 | Drugs | 2.5 | 5.6% |
| Scottish & Southern Energy | £12,461 | Utilities | 1.5 | 5.5% |
| GlaxoSmithKline | £67,632 | Drugs | 1.7 | 5.3% |
| Vodafone | £87,075 | Telecoms | 1.9 | 5.2% |
| Admiral | £4,468 | Insurance | 1.1 | 4.7% |
| Centrica | £16,181 | Gas supplier | 1.8 | 4.7% |
| Royal Dutch Shell | £60,467 | Oil | 1.8 | 4.6% |
| British Land | £5,253 | Property | 1.1 | 4.3% |
| Balfour Beatty | £2,231 | Construction | 2.7 | 4.1% |
| HSBC | £115,135 | Banking | 2.2 | 4.0% |
| Tesco | £32,857 | Retail | 2.3 | 3.9% |
| Tate & Lyle | £2,831 | Food | 1.8 | 3.9% |
| Unilever | £25,561 | Household | 1.8 | 3.8% |
| Aberdeen Asset Management | £2,661 | Funds | 2.0 | 3.5% |
| Pearson | £9,149 | Media | 1.9 | 3.5% |
| Diageo | £30,787 | Beverages | 1.9 | 3.4% |
| Halma | £1,383 | Engineering | 2.2 | 2.5% |
| BHP Billiton | £51,522 | Mining | 4.3 | 2.4% |
| ——— | ||||
| Overall yield |
4.3% |
Note: The forward yield is rounded to one decimal place.
While I’m not going to run through every company I’ve picked – or indeed the ones that got away or were pushed overboard – a few points are worth noting.
First off, I’ve not included British American Tobacco. I’ve never bought tobacco shares – it’s a mental weakness of mine but I just can’t bear to profit from a habit I loathe, especially given how such companies’ future growth is predicated on selling cigarettes to less well-educated parts of the world.
If you’re made of sterner stuff, then grab the diversity and swap them in for either Glaxo or AstraZeneca. Doubling up on healthcare instead of cigarettes is my idea of share humour, but it’s also a chance to buy an out-of-favour sector that finally looks cheap.
I’ve included two utilities, both of which have a fair bit of debt. As I explained in the original series, utilities always come with debt, which is considered sustainable due to their long-term pricing arrangements.
Vodafone’s debt is horrible, too, but it’s a monster utility-like company. BAE’s pension deficit isn’t great, but it’s debt looks sustainable, provided the US military’s recent coup doesn’t mean the end of defense spending.
Aviva’s high yield is a bit of a mystery. I suspect it’s because it holds a lot of European government bonds. I’m sanguine, given the 6% reward for the risk.
Admiral and British Land both have lower dividend cover than the strategy looks for, but they’re special cases. Admiral has a superb record of paying out nearly all its income as a dividend, but that does make for low cover (and the potential for some lean years in the future). British Land is a REIT, which means it has to pass through most of its income, by law. It’s also got a fair bit of debt, albeit it backed by a great portfolio of commercial property.
The two lowest yielding shares at the end are in for diversification. Halma has one of the very best dividend records on the London market. I first bought it years ago on a near-4% yield, and I don’t deny it looks pricey now, but it’s a super business. As for BHP Billiton, I’m not comfortable setting up a long-term portfolio without a mining company in it, and BLT is as good as it gets today. Again, I can remember a 5%+ yield less than a decade ago on this share.
A purchaser could skip these last two and take the yield up to 4.5%; I’d rather have their proven prowess in the portfolio.
Incidentally, the ability to focus on whatever sector is down in the dumps and thus get higher yields is an advantage of buying your HYP over a period of years, instead of all in one go like this. If you’ve got the cash and you need to buy an income now, it’s better to get the diversification and lose some yield, I say.
I’m happier with the quality of shares in this portfolio than the 2007 version. True, the starting yield is lower, but the quality of companies seems overall higher. Of course, that might just be because we haven’t had the car crashes yet!
This HYP versus cash, trusts, and annuity
Our final yield of 4.3% is much higher than the FTSE All-Share’s yield of roughly 3%. It’s also much higher than cash.
But the HYP yield only just matches the current forward yield on my favourite income investment trust, City of London, which is slightly disappointing. The latter is trading on a 2% premium [8], but owning it (or better a basket of such income trusts [9]) will be a lot less hassle for most investors. I’ll probably use the trust as a benchmark comparison against this HYP in the years to come.
HYPs were originally conceived as an alternative to an annuity, and the income compares well here, only a little below the £4,583 starting level a 65-year old man might get from the best single life annuity with 3% escalation and a 5-year guarantee. It’s much lower than the £6,491 he’d start with if he skipped the 3% escalation and the guarantee, though. (These quotes come via the Hargreaves Lansdown best buy table [10]).
Of course, a HYP has a big advantage over an annuity in that you don’t lose it just because you’ve done the indecent thing and died. A portfolio of shares can be left to your heirs.
The other key advantage is that both the income and the capital value of our shares will, hopefully, grow ahead of inflation in perpetuity.
The downside of the HYP route – aside from the extra work in buying and monitoring a portfolio – is that either through poor share picking or a market meltdown, your income is hit and you get less than the guaranteed payment of an annuity. I’m decades away from retiring, but if I was I’d probably split a pension pot 50/50 between shares and annuity, to hedge against this risk.
In terms of expectations, I don’t expect fireworks from my mini-portfolio. A HYP shouldn’t beat the wider market, according to the boffins, as that higher starting yield will be paid for by lower capital growth. Over 20 years or so, a FTSE tracker’s income might well have overtaken it, too, due to faster dividend growth. But a HYP is about a higher income now, not some day in the future – a pensioner hasn’t got 20 years to wait!
While it may not beat the market, I’d certainly hope the income will rise ahead of inflation, though, and it’d be nice if the capital value does, too.
We’ll see.
There’ll be more details of the benchmarks I’ll be tracking this HYP against in next week’s post, so if you’ve not done so already please subscribe [11] to make sure you get it.