Stephen Bland tweaks his long-term income investing strategy.
For commercial reasons, I write very little in this column about my High Yield Portfolio (HYP) long-term hold strategy, concentrating instead on my short-term value share trading approach. However, an interesting recent discussion on the HYP Practical board impregnated in me the rare seed of an HYP article, which was conceived, gestated and after a period of some labour is now ready for birth here.
Things change...
It started when a reader, not in disparaging tones, referred to an article I'd written a few years ago laying out certain principles of HYPs. In one of my second rate puns, I entitled it Fish and HYPs. I've written a ton of stuff for the Fool over the years in articles and on the boards so can't remember everything I've ever said but upon digging it up, it turns out the article was not only about HYP principles but also about how views change over the years.
When anyone has been around for a long time and made a lot of public comment, there is always the chance of a good laugh or attack from someone unearthing an old remark which is at complete odds with the former's current views. You see this trick used in Parliament sometimes.
It's been done to me too and it's one of the risks of writing a lot of material publicly over a long period. The fact is that certain of my views have changed a little on HYPs, though not the basic principles, and that is what the discussion on the board was about.
Don't double up
Specifically I advise now that in an HYP of up to say 20 shares, that total diversification should be employed so that there is no duplication of any type of business. This is in contrast to that earlier article in which I suggested that it might just be acceptable on occasion to have two shares in the same clear sector, and, looking a complete donut now, I mentioned banks in this context.
I now think this adds unnecessary risk. Even I who has seen it all before never envisaged the extent to which banks would so deeply trashed in the recent crisis. Against that though, I was happy to include two miners in my first Fool HYP and they were highly successful.
So, as the article pointed out my views can and have changed over time and now my strong advice is not to go overweight any similar shares, no matter how attractive they may appear. It worked with miners, it did not with banks.
Whichever way the overweighting pans out over time, it creates additional risk because it means that in effect the investor is taking a view that this industry is more attractive than others in the portfolio. It may win or lose but it is not HYP thinking to try and win or lose with particular shares or sectors. The HYP way is to try and win overall, especially on income, precisely by avoiding the idea that the investor knows better.
Overweighting on purchase cost conflicts with my HYP policy of Strategic Ignorance which states that I don't know or trust anyone else's view of the long-term future of the economy, any sector or any share. The answer to this is to use this ignorance to my advantage, make it part of the strategy by saying that because I don't know which will do better than others, I will buy them all, or more accurately all those which present suitably qualifying HYP shares.
The lopsided FTSE
A reader suggested that because the economy or the FTSE100 is not evenly spread across sectors, that HYPs should reflect this to some extent. It's an interesting point and it's one to which I might have given some credence years ago but I don't now.
The reason is that there is no indication far as I can see that businesses overweight in the economy or index are more likely to contribute to the HYP aim of a long term income portfolio or that those are underweight are less likely to do. There is no advantage for an HYP in attempting to model the economy or index. Which leads me back to the preferable, in my view, policy of Strategic Ignorance.
It is not always that easy to know if you are taking the risks of going overweight because some shares have confusing boundaries. Whilst the distinctions of say banks, oils, pharmas or miners are pretty clear cut, others are not always so. I don't have the space to discuss that here, I'm just pointing out that the differences between some shares are not always blindingly obvious and it will occasionally come down to your own opinion on whether they are sufficiently diversified from the rest of your portfolio.
Divide and conquer
The exception I would make to having more than one similar share in an HYP is if the standard amount the investor purchases of each share in the portfolio is divided between them. The result then is that there is no overweighting of that sector by cost.
So if an HYP is set up with say £5,000 per share, then it would not be overweight to have two similar shares at £2,500 each. If anything the risk here is reduced, not increased. The trade-off is that if they have different yields which will usually be the case, the investor would derive the average yield of the two which is clearly less than that of the higher, if all the money went into the latter.
My basic idea of the HYP remains as solid as ever. A diversified portfolio of big caps yielding over the market held for income forever. I've just refined it a little by withdrawing any idea of even slight overweighting, which in the past I would have permitted.
More from Stephen Bland:
