Back in the day, before the credit crunch – before our most precocious readers were even born – I wrote a series of posts on income investing via a high yield portfolio (HYP) of shares.

I think now may be an opportune moment to create a new HYP for dividend income, and I’ll do so in an upcoming post.

But it seems only right that we first go kick the tyres of the original, four years on.

There were several parts to my HYP series:

• Grow your income with dividends from high yield shares: HYP Part 1
• Choosing a good high yield share for the long haul: HYP Part 2
• Diversifying your portfolio: HYP Part 3
• Selecting shares for your high yield portfolio: HYP Part 4

The article sequence ended with an example high yield share portfolio in Part 4, which was published on September 26th 2007. (Parts 5 and 6 have still not been completed. Blame the distracting financial crisis!)

Unfortunately I’ve discovered that the table of final picks embedded in Part 4 has been corrupted, and no longer displays. But you can still see the constituents of the portfolio in an update from February 2009.

That update, and the one I’m about to conduct today, suffers from the fact that I haven’t considered income, only the capital value of the shares.

You may argue that reviewing an income portfolio without taking into account income is like reporting from Wimbledon after all the players have gone home. I wouldn’t disagree. Income portfolios are constructed primarily for income, not for capital gain. The latter is left to fend for itself, which should hopefully happen with a well-chosen equity income portfolio, as a rising dividend stream will sooner or later mean rising share prices.

The trouble is when I picked my original demo portfolio, I didn’t consider posterity, and so it wasn’t set up for tracking.

Now, I could spend a few hours retrospectively rebuilding the portfolio with 2007 prices, allocate it say £100,000 of pretend money, and then manually calculate the income due in 2008, 2009, 2010 and in the year to come but, well, I’m still single and I’m not getting any younger.

If anyone out there has some spare time and would like to do so and report back in the comments below, I’m sure we’d all be very grateful!

The 2007 HYP and the subsequent bear market

Having explained (though not excused!) the lack of income monitoring with this portfolio, let’s turn to capital.

The idea, rightly or wrongly, was to buy a portfolio of blue chip shares and hold them for the long-term. For the full selection criteria, please see the posts linked to above.

The strategy in short: I selected 20 shares from the upper reaches of the index primarily by yield, looked for diversification between industry sectors, then ditched and replaced companies I didn’t like the look of for some reason (usually debt).

As we all know with hindsight, September 2007 was around the high water mark for the last stock market bull run. A few weeks later the sub-prime doodah hit the fan, making mincemeat of former FTSE darlings, including three constituents of this demo HYP: the bankers at Royal Bank of Scotland, low-end lender Cattles, and housebuilder Taylor Wimpey. Most other shares took a pounding, too.

By the time of my February 2009 update, the demo HYP had fallen in value by 44%. That was worse than the FTSE 100, which had fallen 39% over the same period. (Please read that update for full details).

The 2007 HYP in 2011

So how has the portfolio fared since those dark days of early 2009, which was pretty much the low of the past bear market?

Here’s how things stand as of Friday 15th April’s closing prices:

Company	2007	2011	Change	%
A&L (delisted)	733	317	-416	-57%
RBS	517	43	-474	-92%
Tomkins (delisted)	222	325	103	46%
Taylor Wimpey	258	37	-221	-86%
Cattles (delisting)	348	1	-347	-100%
Investec	503	475	-28	-5%
BT Group	305	191	-114	-37%
Hiscox	256	403	147	57%
Royal Sun Alliance	148	133	-15	-10%
Signet Group	1621	2688	1068	66%
Pearson	739	1098	359	49%
National Grid	791	605	-186	-23%
Tate & Lyle	560	607	48	8%
Scottish & Southern Elec.	1510	1318	-192	-13%
InchCape (10:1 share consolidation)	4140	350	-64	-92%
IMI	535	989	454	85%
GlaxoSmithKline	1318	1259	-59	-4%
British American Tobacco	1777	2559	782	44%
BP	567	456	-111	-20%
Unilever	1590	1957	367	23%
Overall
2007 High Yield Portfolio				-8%
FTSE 100	6,433	5,996		-7%

Note: All rounded to zero decimal places.

Looking at the portfolio, we see the usual lurches and collapses that happen in any portfolio of individual shares.

Most strikingly, two of the companies are no longer quoted: Alliance and Leicester was acquired by Santander, and Tomkins by a bunch of Canadian pensioners. Furthermore, benighted Cattles is in the process of being taken over, and its suspended listing will soon be wiped away entirely.

Of the remaining shares, the best performer has been IMI, which is 85% higher than in 2007. That’s a huge bounceback from 2009, when it was 48% lower.

InchCape might flatter to deceive if you look at my post from 2007. The share price appears to have advanced handily since then, but in reality the company did a 10-for-one share consolidation in 2010. InchCape almost went bust in 2009, and while management is to be congratulated for avoiding that fate, it’s still smells a bit to hide the body like this.

Overall, we still see the HYP is trailing the market, though only by 1% now as opposed to 5% back in 2009. This may be surprising, given the near blowouts of the likes of Cattles and that our only selection from the booming commodities sector that dominates the FTSE is error prone BP. In my experience it’s not unusual for HYPs, though, probably because the high yield is an indicator of value in some shares, as much as lurking calamity in others. Over time, it evens out.

As for income, the initial yield was almost 4.8% versus less than 3.2% for the FTSE 100, but as warned above I have no numbers on how income has done in practice. The likes of Pearson and Glaxo have kept delivering the dividends, but RBS, BP and Cattles certainly haven’t!

Final thoughts on this portfolio

This is a very rough review. Not only does it ignore income, but I’ve not included other factors such as that you would have reinvested your A&L and Tomkins takeover money back into a rising market.

That might have reduced the performance gap with the FTSE 100 a tad further. In addition, there would have been no charges to pay over the four years of holding the shares, though given the low-cost of the best FTSE 100 index trackers these days, it will have made negligible difference.

More importantly, it’s very possible I’ve missed certain critical facts out from my quick calculations above. I almost missed the InchCape share consolidation, for instance. There could have been others, or on the plus side special dividends.

While you’d have certainly been paying more attention if they were your shares, all this fuss highlights a big advantage of a passive ETF approach to investing. Another alternative is to buy income investment trusts or even white list funds (make sure you go through a discount broker to get initial charges rebated) and to let the managers worry about takeovers and bankruptcies.

But some of us will always actively enjoy owning companies. Also, income trusts are now trading at a premium, which means every £1 you invest buys less than £1 of assets. Not a great deal, considering most are only holding big liquid blue chips.

For that reason and more, I think now might be a good time for share enthusiasts to construct a new high yield portfolio. And I’ll be doing so next week!

As for the 2007 portfolio, this is probably its final public outing. The chances of introducing errors is only going to increase as the years go by, which makes the whole exercise pointless.

If anyone has a favorite online portfolio tool they can recommend for tracking the new HYP over the long-term (one that automatically accumulates dividend income please!) then do let me know below.

Excellent reading from the Worldy Wise Web.

Once upon a time, Black Swans were rarer than golden geese. But then Nicholas Taleb wrote his bestseller The Black Swan (not to be confused with the pouting Natalie Portman vehicle) and Black Swans have ever since been ruffling feathers everywhere.

I have nothing against Taleb’s dark tome, although I prefer his earlier Fooled by Randomness, which could genuinely change your investing life.

But I do object to the ceaseless reaching for the Black Swan metaphor whenever anything happens that someone doesn’t like the look of.

• “A nuclear reactor has blown up – it’s a Black Swan event!”
• “Reckitt Benckiser’s CEO resigns – another Black Swan!”
• “The market is down today – Black Swan! Black Swan!”
• “Why knew ISA rates would fall to 3%? Talk about Black Swans.”

No, please don’t talk about Black Swans, not until you can tell one from a duck.

Anyway, The Motley Fool ran such an excellent piece on spotting Black Swans versus red herrings that I’m making it today’s post of the week.

The author, Vincent Scheurer, writes:

The rule that all swans are white was never logically provable. However, the first person to see a real black swan (in 1697) immediately knew that the rule that all swans are white was wrong.

The point about the “Black Swan” in the modern sense of the word — the unexpected event with terrible consequences — is that it cannot be predicted in advance, which means that we as a society must take steps to ensure that its impact is minimised rather than spending all of our resources trying to stop it from happening in the first place.

That, in a nutshell, is why most of the efforts going into financial re-regulation are a waste of time.

[continue reading…]

Our Slow and Steady model portfolio was especially designed to minimise costs and hassle for small, passive investors right down to its rebalancing strategy. But how exactly does that strategy guide our new purchases?

The Slow and Steady portfolio is rebalanced as a matter of course on a quarterly basis with cash from new contributions.

So every three months, fund purchases are automatically calibrated to return the portfolio to its target asset allocation:

• UK equity: 20%
• Developed World ex UK equity: 50%
• Emerging market equity: 10%
• UK gilts: 20%

N.B. Developed World ex UK equity is split between four funds (due to the lack of a single, no-trading fee fund in the UK) as follows:

• North American equity: 27.5%
• European equity ex UK: 12.5%
• Japanese equity: 5%
• Pacific equity ex Japan: 5%
• Total: 50%

Rebalancing is the act of pruning back your risk. Without it the portfolio could mutate into a much hairier beast if, for example, the emerging markets fund went on the rampage. Over years, the portfolio could end up with a much higher percentage of its value bound up in this risky asset class than the envisaged 10%, if we did stood idly by.

So when it’s time for the portfolio’s quarterly £750 new contributions, we buy more of the under-performing funds and less of the out-performers, and take advantage of mean reversion.

Rebalancing slo-mo replay

The first time the Slow and Steady portfolio was rebalanced its market value was £3,017.84

It’s important that the rebalance takes into account the new cash added, so:

£3,017.84 + £750 = £3,767.84 (total portfolio value after drip-feed)

How much of this total should then be allocated to each asset class?

A quick example should do the trick. The target allocation for UK equity = 20% of £3,767.84.

£3767.84 / 100 = 37.6784
37.6784 x 20 = 753.568

So we want £753.57 of UK equity in the portfolio once the new cash is added.

The value of UK equity in the portfolio prior to the new cash = £607.10

£753.57 – £607.10 = £146.47

£146.47 is the amount of UK equity we should buy to ensure the asset is rebalanced to its target allocation of 20%.

That calculation is repeated for each fund in the portfolio to determine how much of each asset class we need to buy.

Eventually the portfolio will grow too big to be entirely rebalanced by new cash. At that point we’ll need to sell assets that exceed their target allocation and use the proceeds to pump up assets that fall short.

That won’t cause the Slow and Steady portfolio any trading cost pain though (the bane of rebalancing) because we’re cannily invested in index funds that don’t trigger broker fees.

Take it steady,
The Accumulator