VALUE INVESTING
High Yield Portfolio Update

By Stephen Bland (TMFPyad)
June 1, 2001

The High Yield Portfolio is now six months old. Here is the latest situation:

                                 Original  Price  % Change  Forecast   
                             price Nov 00    now            % yield

United Utilities (LSE: UU.)         690      665     -3.6      7.2
Gallaher (LSE: GLH)                 416      466    +12.0      5.5
Scottish & New. (LSE: SCTN)         490      516     +5.3      5.7
Royal & Sun (LSE: RSA)              498      464     -6.8      6.0
Alliance & Leic. (LSE: AL.)         645      762    +18.1      5.1
Britannic (LSE: BRT)               1020      926     -9.2      6.4
Lloyds TSB (LSE: LLOY)              705      700     -0.7      5.1
Bass (LSE: BASS)                    723      778     +7.6      4.6
Boots (LSE: BOOT)                   575      597     +3.8      4.7
Land Securities (LSE: LAND)         771      865    +12.2      4.0
Ass. British Ports (LSE: ABP)       321      421    +31.2      3.4
Blue Circle (LSE: BCI)              454      490     +7.9      4.2
Rio Tinto (LSE: RIO)               1120     1405    +25.4      3.1
Anglo American (LSE: AAL)           942     1137    +20.7      3.2
Shell (LSE: SHEL)                   572      610     +6.6      2.6

Average                                              +8.7      4.7
FTSE 100                            6274.8  5796.1   -7.6      2.5

For the benefit of new readers, this portfolio was put together by me as an example of how to generate income from equities to give both a decent starting yield and, crucially, one that stands a good chance of growing with time and beating inflation. The idea was to produce an alternative to other income ideas such as insurance company products or high yield funds to which lump sum income seeking investors may be drawn, or perhaps propelled by IFAs. It starts off with the tremendous advantage over these alternatives of having no management charges. That fact alone has got to be worth a considerable sum over periods like ten or twenty years.

It is hoped also that the capital will grow over long periods, though naturally there may be substantial fluctuations on the way which the investor has to be able to ignore. I believe this capital growth will, like the income, beat inflation, and I am expecting it to beat the market as well (though the latter is not important because income is the overriding consideration with this portfolio). It is designed to be held permanently with no meddling whatsoever except where forced because of takeovers and the like.

Talking about capital fluctuations, it can be seen above that there have already been some quite dramatic changes, even over the very short period of six months. They range from the highest increase of 31% by Associated British Ports to the greatest fall of 9% by Britannic. Only four shares are losing money and those by only modest amounts. Generally I am extremely satisfied with the capital performance to date, though I must warn that six months is nothing against eternity so no inference can be drawn about long-term performance from these figures.

It is far too early to comment on the real point of the portfolio, though -- its income performance. That will take years until we see how the actual dividends received compare year on year. We will then know whether the target of an increasing income is being met and by how much.

However, note that the current forecast yield is 4.7% whilst the original forecast yield was 4.8%. Hardly changed, despite the fact that the portfolio value has increased by 8.7%. What this means is that the portfolio doing exactly as expected by increasing dividends. If there had been no change in the payouts, then the increased capital valuation would have resulted in a fall in the yield to about 4.4%.

Put another way, on the original capital the forecast yield is now 5.1%, up from the start forecast yield of 4.8% and that in just six months. That is, the expected yield on the capital invested has risen by 0.3 percentage points, an income increase of over 6% in only six months, miles ahead of inflation. The goods are being delivered handsomely.

A few words now on the design of HYPs for anyone looking to have a go themselves. There are two rules which I would consider absolutely fundamental to this concept. First, stick with large caps. Second, spread your selections among sectors. Whatever other criteria you adopt I advise strongly that these two rules are not broken. Income investors need security above all and this must not be sacrificed for a better yield. Clearly some risk has to be taken if it is desired to derive an income from shares in the first place, but within that it must be minimised. Never, never compromise this for a few extra points on your yield target.

Another important feature is balance. I don't mean just sector spread; that is implicit in the design anyway if you follow my two unbreakable rules above. What I mean is that it is not necessary to produce a portfolio in which every single share has a huge yield. It is the portfolio return that is important. For example, Shell is in my list. It was originally, and still is as it happens, the lowest yielder. Now Shell's yield on selection was only  2.7%, roughly around the FTSE 100 mean. It was not thus not a high yield share in comparison with the index. But I included Shell because I wanted an oil company and Shell is one of the most conservative and strongest balance sheet big cap companies around.

"Balance" thus does not mean simply selecting a load of big caps even though spread amongst sectors. Try to think differently, seeking the lowest risk of dividends being cut against the rewards of growing those dividends. Seek out strength for a number of your shares, even if it means accepting lower yields on some of them. Balance this out with higher yields, which may mean some compromise on strength. United Utilities, my top yielder originally and remaining so, has very high borrowings but a huge yield for a FTSE 100 company. Despite that it has grown its dividend and has some potentially interesting developments outside its regulated water and electricity businesses. This potential is the counter to the otherwise excessive gearing and the fact that it is highly regulated, a common problem amongst the utilities which are some of the highest yielders in the market.

More: High Yield Portfolio discussion board

The author owns shares in Scottish & Newcastle.