I am now the proud owner of a new high yield share portfolio.

Since the method for picking the portfolio’s shares was not exciting enough to prompt Simon Cowell call me up with an offer to turn it into the new X Factor, we’ll not go through it again.

Instead, please refer back to see which high yield shares I bought and why.

This post will detail how much it cost to buy the 20 companies in my new HYP, and where I’m holding them.

In the future I’ll explain how I intend to manage the portfolio long-term, as well as what benchmarks we might use to judge its performance. Do subscribe to keep on-board with progress.

An ideal home for my High Yield Portfolio

As mentioned last time, all the online tools I tested to track a paper portfolio were flawed in some way, especially when it came to dividends.

So I decided to do it the proper way with real money. Carlsberg don’t do model share portfolios, but if they did they’d probably do the same thing.

Readers, much as I love you, I did not want to sink my entire wealth into a new portfolio, least of all one that I won’t be able to sell for years. (Houses don’t just buy themselves, you know).

I therefore limited my invested funds to £5,000.

Now, that’s not exactly a token amount of money, but it’s too modest to withstand much share purchasing at £10 or more a pop with 20 of the blighters to buy. But happily there is a cheap way to buy shares that’s worth exploring if you don’t have a lot to invest: Halifax’s Sharebuilder service.

The great attraction of Sharebuilder is it enables you to buy shares for a mere £1.50 an order – a fraction of the normal dealing fees at rival online brokers.

I have had a Halifax Sharebuilder account for many years, having originally opened it to buy a portfolio for income. (Long-time readers may remember my pain at calculating capital gains on the reinvested dividends. Not a mistake I will make again!)

Halifax enables you to run multiple accounts under the one roof, so it was a simple matter to allocate a new one for the Monevator HYP.

How to do the £1.50 share purchasing shimmy

The Sharebuilder service was conceived for people who want to transfer in perhaps £300 from their salary each month, and then build up a portfolio by regularly investing into a slate of shareholdings.

It’s a great idea in theory, and I’m all for encouraging wider share ownership. But in practice it can be costly if you invest too little per month, or if you spread yourself across too many holdings, even with just £1.50 trading fees.

For example, invest £300 across six different companies or ETFs every month, and you’ll pay £9 in dealing fees (£1.50 x 6), which is equivalent to 3% of your funds invested. That’s expensive.

But there’s a cunning plan! Rather than invest monthly, you can make a one-time investment of a larger lump sum, which is what I did. You can then turn this regularly reinvestment back off.

This is pretty much the equivalent of using the Sharebuilder like any other online broker, only it’s much cheaper. The snag is you can’t deal in real-time. Rather, you have to set up your trades the day before, and take whatever price you’re given in the market the next day.

In practice, when you’re buying a portfolio of blue chips at once, it doesn’t matter at all. Some will be higher priced on the day than you expected, and some lower, but it’s just random and nothing to worry about.

Of course, it doesn’t exactly make you feel like Gordon Gecko – more like your mum making out her Ocado grocery order. But we’re investing here, not playing Farmville for thrills, so that’s no bad thing.

Trading costs to buy my high yield shares

Faustian pacts with Mammon aside, here’s what I paid to buy my model HYP:

Dealing fees: There are 20 companies in my new high yield portfolio, and I wanted to invest equal amounts into every one. This meant putting £250 into each company, for a cost of £1.50 each time.

Stamp Duty: I also had to pay the UK’s ridiculous stamp duty tax for each transaction. This is a flat 0.5%, which came to £1.24 for each purchase.

The bid/offer spread: Market makers pay for their daughters’ school fees by charging you a bit more for shares they sell you than they will pay to buy them off you (think of a currency exchange at the airport). This bid/offer spread increases your costs, but for very big companies like those in the Monevator HYP, the spread is tiny. So tiny, in fact, that I can’t be bothered to work it out for each share – we’re talking a few pennies for each purchase.

In total, that’s £2.74 per share purchase for fees and stamp duty, plus a titchy bit more each time for the spread.

Multiply it up and you get to £54.80, or just over 1% of my £5,000, plus the price of a hamburger for that bid/offer business.

What I got for my money

Obviously I bought a different numbers of shares for each £247.26 lump sum I had left after fees to put into each company, depending on the share price.

Sharebuilder does the sums for you – you just say how much you want to invest.

For example, Vodafone had a share price of about 168p last Friday, so my £247.26 bought me nearly 148 shares in that company. In contrast, I’ve got barely 11 Royal Dutch Shell shares to my name.

I say ‘nearly’ and ‘barely’ because Halifax Sharebuilder allocates you fractional holdings of shares (behind the scenes, your shares are lumped together with other customers in a pool). As it happens, I have specifically got “11.244775” Shell shares.

In reality, this precise number doesn’t make any odds. I’m interested in tracking the value of my shares, not the fiddly number I happen to own – as well as the total dividends they pay out, of course.

But for the record, I’ll conclude this post with a snapshot of exactly what I got for my money, and what share price I paid for them:

Company	Quantity	Cost per share
Aberdeen Asset Management	106.9	233.8p
Admiral	14.2	1,759.7p
AstraZeneca	8.0	3,121.1p
Aviva	56.4	443.4p
BAE Systems	76.1	328.6p
Balfour Beatty	75.6	330.6p
BHP Billiton	10.4	2,397.4p
British Land	41.8	597.5p
Centrica	79.3	315.1p
Diageo	20.1	1,245.5p
GlaxoSmithKline	19.0	1,318.3p
Halma	67.3	371.4p
HSBC	30.0	657.3p
Pearson	22.0	1,137.2p
Royal Dutch Shell	11.2	2,223.3p
Scottish & Southern Energy	18.9	1,351.0p
Tate	40.8	612.1p
Tesco	60.6	412.0p
Unilever	12.6	1,986.6p
Vodafone	147.9	169.0p

Note: Shareholdings and prices rounded to one decimal place. Costs include all fees.

Incidentally, having spent 30 minutes copying a load of fiddly numbers by sight from my web browser into this post – and rounding them as I go – I see one advantage of using an online tool… it would have done this for me!

Luckily I don’t plan on doing a review of the value more than every six months or so. This is a steady portfolio for income, remember, not a DIY hedge fund. 😉

Global regulators lining up to beat on Exchange Traded Funds (ETFs) has been an unnerving experience for passive investors, not least yours truly. A number of potential risks have been highlighted and – given the shortage of decent passive investing alternatives available in the UK – it would be a grievous blow if ETFs prove to be about safe as a cluster bomb in a playschool.

While warnings about the counterparty risks and conflicts of interest that bedevil synthetic ETFs sired by investment banks are not exactly new, it did come as a jolt to learn that physical ETFs share many of the same problems.

What’s more, the reports are long on scary ‘what if’ scenarios but short on suggestions for practical action that retail investors might take.

So while the wheels of global regulation grind into gear, here’s my action plan. Bear in mind, this is a personal response that suits my investment needs and attitudes. I offer it purely as a discussion point, not as fail-safe, portfolio bomb-proofing.

Who knows whether the current clouds of uncertainty will drift away, turn more threatening, or eventually transform into golden rays of investor-friendly enlightenment? Until then I’m going to…

Favour index funds

Index funds are like the slower country cousins of ETFs. They’re simpler, and only like to trade once a day in the afternoons. The expectation of intra-day liquidity does not burden these investment bumpkins, and they’re sturdy physical, security-holding folk, not synthetic replicants fresh from the lab.

True, index funds can lend securities but, crucially, they’ve been around since 1975 without blowing up. Sure, the past is not a guide to future performance, but it’s the best clue we’ve got.

The basic asset classes can all be held very cheaply in index funds without worrying about trading costs and a passive investor can create a well-diversified portfolio without recourse to ETFs, especially if you use Vanguard funds.

Use physical ETFs rather than synthetics

I will still use ETFs to access broad asset classes that are not catered for by index funds.

In the UK, that means I need to buy ETFs to cover commodities, property, value, and UK small cap.

Where I have a choice, and the cost differential isn’t too great, I’ll choose physical ETFs over synthetics.

With most of my assets in index funds, I can accept the potential risk of using a more complex vehicle to gain exposure to a few extra asset classes – especially as the main risk highlighted for physical ETFs is the potential fallout from security lending during a market apocalypse. The world and his financial services’ mother lends securities, so it’s difficult to protect myself from this particular spectre by choosing some other type of investment vehicle.

You can check how the ETF is structured on its factsheet or web page. Variations on physical replication are:

• Physical
• Full
• Sample
• Optimised

If it says ‘synthetic’ or ‘swap-based’, then it’s not a physical ETF.

• Major physical ETF providers include iShares and HSBC. Credit Suisse also offers a reasonable scattering.

• Db X-trackers, Lyxor and ETF Securities generally, if not always, stock synthetics.

iShares currently discloses the most information by far about its security lending activities, although it hardly arrives in easy-to-digest form. In the future, investor-friendly presentation of the facts will be my tie-breaker for individual ETF selection.

An alternative approach favoured by Monevator co-author The Investor is to use fairly low-cost investment trusts. If you’re looking for reliability borne out by history, then investment trusts have been around since 1868. They’re actively managed but some have relatively reasonable TERs, and The Investor has done an excellent job of explaining the foibles to watch out for.

The last resort: Synthetic ETFs

Synthetic ETFs could be a flashpoint for global financial contagion in extreme market conditions, according to those regulator warnings.

It’s important to stress the reports cited potential risks rather than cast-iron certainties. They called for further investigation, they didn’t pass a damning verdict. All the same, the regulators are clearly unhappy at the current level of ETF operational transparency.

My attitude to synthetics is a trickle-down version of my physical ETF outlook. In the index tracker food-chain, synthetic ETFs are:

1. More complex
2. Therefore more risky

However they are useful for reaching otherwise inaccessible asset classes cheaply. Therefore I’ll buy them as long as I:

1. Have no other suitable choice
2. Keep their use to a minimum
3. Diversify among providers

I currently hold one synthetic ETF, which is worth less than 10% of my portfolio. I’m comfortable with that as there’s no other way for me to track that asset class.

I also console myself that it will have to be a pretty cold day in hell before the envisaged nightmare scenario occurs. It’s not impossible, but my exposure to a malfunctioning ETF is minuscule in comparison to the damage plunging markets would do.

What’s in the basket?

The G20’s Financial Stability Board (FSB) report proposes:

In particular [ETF providers] should make publicly available detailed frequent information about product composition and risk characteristics, including on collateral baskets and arrangements for synthetic ETFs.

Due diligence for investors would then include checking the counterparty viability and collateral quality that underwrites the synthetic ETF.

The swifter industry operators already post some of this information about individual ETFs on their websites:

Those that do:

• db X-trackers
• iShares
• Credit Suisse

Those that don’t:

• Lyxor ETF
• ETF Securities

I’d rate the information they provide as nigh on useless to the average punter in its current form. Even if you can competently analyse the quality of potentially hundreds of securities held as collateral, it changes on a daily basis.

Frankly disclosure is not the answer here. Only a tightening of regulations that govern the quality of collateral will do.

We can’t spend our days squinting at a spreadsheet of Japanese small caps, or whatever else the investment bank has put up behind its synthetic ETF. What we need is the assurance that the ETF is backed by an adequate amount of high-quality, liquid collateral that can be shifted sharpish in an emergency.

Reputation counts

Conflicts of interest are a major theme within the recent ETF risk reports. They raise the question of whether investment banks use their synthetic ETFs as a dumpster for illiquid collateral, and as a source of cheap funding.

In the conflict of interest stakes, private investors versus investment banks equals easy meat for the banks.

In the shadow of the credit crunch, I’d argue trusting big banks is like trusting a python to babysit your pet mouse. If I can choose an ETF from anyone other than a big bank then I will. That’s easier said than done, though, as subsidiaries of the banks dominate the synthetic ETF market.

Tried and tested

So that is how I plan to deal with the situation for now, until the industry and/or the regulators make the risks of ETFs plainer.

In truth, this has always been my tracker selection policy anyway. But the regulators’ warnings have helped to ram home how carefully I should tread in the face of rampant financial innovation.

It’s best to stick to the tried and tested, and when it comes to asset classes, to the broadest, deepest end of the pool. There’s no real need to go sticking my nose in the glowing sludge that collects at the fringes.

Take it steady,

The Accumulator

Some reading for the weekend.

Anyone who still believes that markets are ultra-rational got yet another rude awakening this week, when a huge sell-off in commodities sent prices for everything from silver to oil tumbling.

In a superb column for Reuters, John Kemp writes:

Front-month Brent crude futures sank almost $12 per barrel (well over 9%) in a series of vertiginous declines that took the market down from over $120 at the start of the day to under $110.

The price change was more than 4 standard deviations — which is something that should be seen on average only once in every 63 years — if the market was well-behaved and changes followed a normal or Gaussian distribution.

At times the move has approached 5 standard deviations — which should only occur once every 7,000 years.

Yet again, the markets are proving academic theories about Gaussian returns absolutely wrong. This is why you must read The Black Swan even though the book has become a trite buzzword, and is far less easy on the eye then the bonkers Portman movie of the same name.

Once every 7,000 years – either investors of 20,000AD are going to find the markets a millpond, or the theories are absolutely bunk.

However, realizing that markets are not rational is not the same thing as being able to profit from it. In fact, most market timers lose money, as academic studies have shown. The difficulty, basically, is that the bubble of tomorrow is the rational re-valuation of today.

Call time on market folly too soon, and you risk missing the gains that make investing profitable over the long-term. Or, even more commonly, you fail to get back in again because you expect more falls to come.

On that score, it’s worth noting that Goldman Sachs expects this fall in oil to be temporary. Central bankers will hope the squid is wrong, given how lower oil prices would take the edge off inflation, as Stephanie Flanders points out:

If the global price of oil averages, say $110 a barrel over the next year or two, and not the $120 forecasters had been pencilling in, that could take about 0.2 percentage points off the rate of inflation in 2011 and 2012, relative to what was previously thought. If you’re the ECB or the Bank of England, or the Federal Reserve, every little helps.

The perma-bullish investors in oil companies who plague the bulletin boards (and the boardrooms of hedge funds!) will be backing Sachs over Stephanie, of course. They’ve been doing so all year, to the chagrin of those of us invested in companies that dare to do something other than dig stuff up:

(Via Business Insider).

I am not going to predict the bursting of the commodity bubble, even if silver’s 30% price fall in a week looks suspiciously like the top (and confounds those who say the price of precious metals is driven by fundamentals).

But I think it’s worth heeding these thoughts from Larry Swedroe:

There are two […] reasons to be cautious and to avoid being caught up in the speculative hype:

• The prices of both gold and silver are now way above the marginal cost of production. When that happens, you get new supply (though it may take some time for production to come on line).

• Unlike oil, which is a depleting asset, all the gold and silver ever mined is still around and is available to be sold. That means supply can quickly swamp demand as those family heirlooms that have been sitting in attics become prime material for melting down.

Having some money in commodities as part of diversification is very sensible, if you can find a way that fits into your overall investing strategy.

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