Can a share picked for a high yield portfolio have a dividend rate less than the market average?
To save readers' brain strain I'll say at the outset that this article is not about limbo dancing or value trading. It's High Yield Portfolio (HYP) stuff. Consequently those who feel slightly nauseated by the mere contemplation of the ultra long term hold approach of HYP investing need read no further.
If you're still here, my title refers to how low a yield a share can offer and still figure in an HYP. Which brings immediately me to a nice paradox.
I define high yield shares as those yielding above the market. A dynamic definition because obviously it varies with the prevailing market yield. For example with the yield on the FTSE100 at about 3.2% right now any share above this at present is on my definition is a high yielder and similarly any share around that figure or below is an average or low yielder. Therefore it might be reasonable to assume that an HYP should consist exclusively of HY shares.
Not necessarily in my view.
I would call an HYP an HYP where the total portfolio yield is above the market at purchase. To achieve this, it doesn't follow that every single share in it must individually yield more than the market and this is the paradox. In my view an HYP an have shares in it that are average or low yielders and still be an HYP.
If you accept this, the question arises as to why one should even consider average or even low yielders in an HYP at all? After all, the clear downside is that they must dilute the extent to which the portfolio in total yields above the market and it is not an aim of this strategy to lower overall yield, quite the reverse. The answer lies in one of my essential security features for the approach diversification.
HYPs my style are not just about picking mechanically the top yielding shares in the FTSE100 regardless. You could do that but it would be seriously overloaded with whatever sectors happen to be relatively unwanted by the market. Right now for example a mech. portfolio of the fifteen highest yielders reveals six banks, three water or electric utilities, two phones, two retailers, a life insurer and a brewer. Selecting this as an HYP would be riskier than a more diversified portfolio though the trade off is a somewhat higher overall yield. Not an adequate trade off though in my view, I don't advocate this method.
So once you start selecting shares non mechanically by insisting on diversification and other security features, inevitably you are forced lower down the yield rankings than a straight mechanical search like the above can deliver. How low down the yields you have to go depends on how many shares you want in the portfolio and whether you especially desire certain sectors almost regardless of yield. But just as you can obtain a higher yield by sacrificing diversity as above, so you have to sacrifice some yield as the trade off for obtaining diversity if you wish to follow my HYP principles.
A good example right now of wanting certain shares at any price would be the very big miners. If you want one of these you may have to accept some very modest yields depending which one takes your fancy. Rio Tinto for example is on a forecast of 1.8%, BHP Billiton is a little better at 2.2% with Anglo American on a relatively high sector yield of 3.2%, around the market average. Yet many HYPers would regard this sector as extremely desirable in an HYP which is designed to be held very long term.
Luckily the very highest yielders in the market come to our rescue. The likes of Lloyds, United Utilities, Alliance & Leicester, BT, Vodafone for example, the current top five FTSE100 yielders, are forecast to deliver between 6.2% and 4.7%. These and all the others yielding above the market average do so by a sufficient margin to allow for the inclusion of a limited number of lower yielding shares in an HYP.
So how low can you go? I can't give a precise answer because it will vary between HYPers as I say according to the number of shares required in the portfolio and the desirability of certain sectors which is a personal thing. Just make sure that your overall portfolio yield is well above the market at purchase, otherwise you will not longer have an HYP, just a P.
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