FOOL'S EYE VIEW
High Yield Portfolio Update -- April

By Stephen Bland (TMFPyad)
April 30, 2001

It is now five months since I put up my high yield portfolio as an example of a long-term buy and hold portfolio with income as the primary objective. In fact contrary to a lot of thinking on the subject of long-term hold, I am suggesting that this be held at least forever because I believe that this attitude will improve performance. Also, this style frees the investor from the worry of share price fluctuations. You ignore them, simply relax and watch the income roll in.

This is the original Motley Fool investment concept, with the added bonus of getting a growing income while you wait, that growing income being in fact the primary purpose of the whole exercise. The beauty of it is that if you achieve a growing income then the secondary object of capital growth has to follow eventually.

No guarantees, of course, but if you want guarantees then you should not be in shares in the first place. To achieve the twin aims of an inflation-beating income and capital growth you have to take some risk, simple as that. I believe those risks to be modest with the kind of blue chips featured here, but they do exist. Detractors, though, tend to pitch the risks much higher than I think they are. Not something you can really quantify, it requires faith and the ability to ignore media comment and just keep holding through good and bad.

Careful initial selection though is very important: critically, sticking only with the very largest companies and no small caps, those most likely to keep the dividends growing every year, avoiding faddish businesses and so on.

Here is the latest situation:

                                   Nov 00    Price            Forecast   
                                    price     now   Change%     yield%

United Utilities (LSE: UU.)            690     609    -11.7        7.8
Gallaher (LSE: GLH)                    416     450     +8.2        5.7
Scottish & New. (LSE: SCTN)            490     503     +2.7        5.8
Royal & Sun (LSE: RSA)                 498     490     -1.6        5.7
Alliance & Leic. (LSE: AL.)            645     820    +27.1        4.7
Britannic (LSE: BRT)                  1020     929     -8.9        6.4
Lloyds TSB (LSE: LLOY)                 705     735     +4.3        4.8
Bass (LSE: BASS)                       723     766     +5.9        4.6
Boots (LSE: BOOT)                      575     629     +9.4        4.4
Land Securities (LSE: LAND)            771     895    +16.1        3.8
Ass. British Ports (LSE: ABP)          321     405    +26.2        3.5
Blue Circle (LSE: BCI)                 454     485     +6.8        4.2
Rio Tinto (LSE: RIO)                  1120    1400    +25.0        3.0
Anglo American (LSE: AAL)             3770    4529    +20.1        3.2
Shell (LSE: SHEL)                      572     586     +2.4        2.7

Average                                                +8.8        4.7
FTSE 100                              6274.8  5954.6   -5.1        2.5

A reader on the High Yield Portfolio board asked after the last update whether the income on the original portfolio can be shown, rather than the current forecast yield. This information would indeed be interesting, but of little use until at least one year has passed. Then the actual cash dividends received will be known. Such data will in addition be more useful in future years when the dividends received in each complete successive year will be known, to establish whether they follow my belief that this income will increase, and moreover at a rate above inflation.

However to establish what went on in the past I checked out the dividend growth over the last five years on the 15 shares shown comprising my model portfolio. Bear in mind that unbroken dividend growth was in any event a condition for qualifying for this list, but I had not actually measured the rate of that growth before.

The results are very interesting. The annual compound dividend growth rates range from about 21.0% for Lloyds TSB (LSE: LLOY) down to about 4.5% for Land Securities (LSE: LAND). The average annual rate for the whole portfolio works out at 9.8%.

What has inflation been over the last five years? I do not have the figure, but it is currently around 2% and I doubt it has averaged more than 4% or so over this period. So even the dividend growth of the lowest share on the list beats inflation. Overall the portfolio income has shown  a handsome margin of real growth, some 5-6% over the rate of inflation.

Putting it into cash, supposing the start income had been £10,000 per year. Applying the 9.8% growth rate means that after five years that income would have grown to £15,959. Matching inflation at say 4% would have meant that the income need grow to only £12,167. Looking at it in cash terms makes it clear how much additional real income the investor would have received to  make their life that much more enjoyable. And all for doing precisely nothing except some careful share selection at the start, the willingness to take a modest risk, and the sense not to meddle with the holdings.

Compare this with one of the alternative and unfortunately popular methods of investing for income: insurance company products like so-called maximum income bonds. Such things are so poor by comparison that I cannot understand why anybody invests in them. Well, I can really, it is the marketing effort by the insurers and IFAs. Nobody markets equity income portfolios because there is no money to be made out of them. The investor makes all the money, not an insurance company. The lack of any charges after the small initial purchase cost is a powerful contributor to the long-term performance of the income and capital, compared with the packaged alternatives offered by the insurers.

More: High-Yield portfolio introduction | discussion board

The author holds shares in Scottish & Newcastle.