Stephen Bland runs through the basics of his High Yield Portfolio strategy.
I've had a couple of requests to run through the basics of High Yield Portfolios (HYP). So this week I'll run through some of the essentials again for the benefit of newcomers or perhaps existing HYPers who may like a refresher.
A small warning. Some of what I say may differ from that which I wrote in the past. Not deliberately so, it's just that things move on and although my fundamental ideas will likely not have changed much, there may well be a swing of emphasis on certain points. I'm far too indolent to bother identifying exactly where I've changed, but occasionally people notice and I find it thrown back at me on the message board. That's fair enough.
Talking of how we change in some ways, as a kid, I hated fish. The very smell of it made me want to vomit. In fact, my mum tells the story of when I walked past a fish shop near our house, I'd hold my nose in a calculated display of revulsion which didn't endear me, or her, to the owner. I don't actually remember doing that, it's so long ago and besides I would have been only around forty two or something.
Two things have altered since. First, fish shops have disappeared and second, I now enjoy a decent fish meal. And if I can now like fish, an unbelievably radical difference, believe me, I can vary slightly some of my HYP views.
So, the most basic question of all to start with, in considering an income strategy why HYP? For income seekers there are many alternatives, some in much safer sources in terms of the risk to capital such as bank interest or dated gilts held to maturity. Others might consider letting property or some insurance company income scheme though I advise that investors avoid the latter worse than the plague.
I believe that for income investors prepared to take some risk, HYPs offer the optimum balance of features compared with other income sources. The clear advantages are total liquidity, no management charges, complete freedom with no third party between you and your investments, and no onerous legal or other impositions forcing you in any direction. Also, very little time is required to manage the investment.
The obvious downside is the risk to both income and capital. But in practice, HYPs offer the potential of rising income and capital values long term though there can never be any guarantee. It is this last feature where the strategy scores over interest based income. Only index linked gilts can compete, as low risk as it gets but the start yield is shockingly low, unacceptably so for most income investors.
Once an investor finds that an HYP suits them, then the question is one of construction. The key is KIS, keep it simple. I designed the approach with simplicity as one foundation stone. Low risk by equity standards is the other. Despite the desire of some readers to complicate the strategy, sometimes to the point of near incomprehension, this is not the way to go for most HYPers. Do not be misled, what suits that minuscule corps of complexifyers who just love all that maths does not help most investors and critically, will not improve returns. It is more likely to damage them. I know that some people are impressed by complexity. Don't be, it is negative.
All you need to do is rank the FTSE 100 by descending yield, start at the top then work your way down, and pick a new share from a different sector until you have enough. Occasionally you can have more than one share from a sector, typically banks at present because of their numerous representation in the index and high yield. But don't prejudice sector diversification too much, it is absolutely critical as a security feature, lowering the risk to both income and capital.
The number of shares depends on how much money you have to invest but I've used a minimum of fifteen in the demo portfolios set up on The Fool. You need to do some checks. Use forecast yields so that at least in the very near future the required dividend is likely to be paid. Ignore a share if you think it has too much debt or the dividend is not covered. Look for a history of increasing dividends. Those rules are not invariable so in practice you will probably have to compromise on some of these features with some shares in order to obtain enough high yielders.
You might on occasion dip into the FTSE250 but not too much. Stick with the 100 index for all or nearly all the shares. Size matters, bigger caps are generally lower risk.
Don't try and select or eliminate shares by guessing the long term future of the economy, the sector or the company itself. You cannot know and expert opinion is worth nothing. Such futurising is I believe negative to efficient HYP share selection. This is the process I termed Strategic Ignorance, the decision to ignore all long term opinion as a deliberate part of the selection strategy.
Similarly beware of feeling that weakness in a share due to some perceived problem will affect it long term. Almost certainly it won't for big caps. In fact you should take advantage of such situations when buying, relishing the fact that some drug company's new pill for hypochondria has caused patients to grow two heads or an oil company's field has been taken over at gunpoint. Such events can depress share prices disproportionately, presenting opportunity for HYPers.
And once you've bought? Simply sit back and do nothing for eternity, enjoying the income. Don't worry about the capital. It will fluctuate, sometimes dramatically. From time to time there will be corporate action such as takeovers, share issues, demergers and so on, which will compel you to do something, maybe reinvest in a new share, but mandatory action apart, no tinkering is necessary.
Some HYPers find it impossible to leave well alone and have to tinker. If so, my advice is to trade on yield. You buy the shares with yield as the primary feature, so sell if you must on the same ground. Consider it carefully though, a share whose yield has fallen low due to a strong share price but which is still delivering good increases each year should not necessarily be sold. And if you do sell, make sure the replacement is suitable on the usual selection criteria.
That's it in a summarised form. There can be a lot more to explain, particularly to a beginner who may not know for example where to start even looking for a FTSE100 yield list. The HYP board has a lot of information on the basics like that. But don't forget KIS, I think it is important. Experience of my own and that of many other long term investors I have observed tells me that simplicity and leaving things alone to develop is the way to go.
