VALUE INVESTING
High Yield Portfolio Trashes Market

By Stephen Bland (TMFPyad)
September 27, 2002

It's time for another review of my high-yield portfolio which I carry out every two months or so. I started it in November 2000 so this article brings us up to date some twenty two months from inception.

For new readers, I stress that the primary aim of the portfolio is growth of income not capital, although some people do use the concept as a growth vehicle by reinvesting dividends which in my view is an excellent idea.

The HYP was designed essentially for income investors, that are prepared to take the risks that come with investing in shares, to be held forever with no dabbling. The aim is to deliver a decent initial yield, far higher than the FTSE100 index (and currently even ahead of cash deposit rates), that grows ahead of inflation over the long-term. I believe that capital growth will go hand in hand with the income growth, but as I say that is a secondary motive for this particular portfolio.

Here are the latest figures. The start date was 13 November 2000 and the cost includes all purchase expenses.

                                £ orig.  no.  price   val  move forec
                           invest price shs.    now   now    %  yield

Un. Util(LSE: UU.)           5000  690   718    594  4265  -14.7  8.2
Gallaher (LSE: GLH)          5000  416  1190    647  7699  +54.0  4.4
Scot. & New. (LSE: SCTN)     5000  490  1010    543  5484   +9.7  5.7
Royal & Sun (LSE: RSA)       5000  498   994    103  1024  –80.0 12.4
All. & Leic. (LSE: AL.)      5000  645   768    785  6029  +20.6  5.4
Britannic LSE: BRT)          5000 1020   485    280  1358  –72.8 11.1
Lloyds TSB (LSE: LLOY)       5000  705   702    490  3440  -31.2  7.5
Six Continents (LSE: SXC)    5000  723   685    578  3959  -20.8  6.3
Boots (LSE: BOOT)            5000  575   861    504  4339  -13.2  5.8
Land Sec. (LSE: LAND)(1)     5000  771   651    744  4843   -3.1  4.9
Ass. Br. Ports (LSE ABP)     5000  321  1542    410  6322  +26.4  3.8
Hilton (LSE: HG.)(2)         5000  232  2275    168  3822  -23.6  5.7
Rio Tinto (LSE: RIO)         5000 1120   442   1036  4579   -8.4  4.1
Anglo American (LSE: AAL)    5000  942   526    804  4229  -15.4  4.5
Shell (LSE: SHEL)            5000  572   865    387  3348  -33.0  4.1


Totals                      75000                   64740  -13.7  6.3

FTSE100                    6274.8                  3791.8  -39.6

1 - Hilton replaced Blue Circle which was taken over for cash at a profit over the £5,000 cost, the whole of the proceeds being reinvested. This is why the total original cost of Hilton derived from the above table is more than £5,000. The start investment of £5,000 has though been retained here so as to maintain the original cost of the portfolio at its true figure of £75,000, which has to be done in order to facilitate accurate measurement of capital value fluctuations.

2 - Land Securities reorganised in September 2002 resulting in an effective cash repayment which was used to purchase additional shares in the company.

The income in the first year, to November 2001, was £3,451 representing an actual yield on the £75,000 invested of 4.6%.

Note the highly attractive tax situation of dividend income compared with other types such as interest, rents or pension annuities. Dividends are tax-free to a basic rate taxpayer and liable to tax at only 25% for a higher rate payer.

Notice that the forecast start yield for an investor buying this portfolio now is 6.3%. However this includes the very high yields on Britannic and Royal which may be in some doubt, although they have already suffered serious cuts so perhaps there might not be any more. If we play ultra conservative with those shares and assume nil dividends for the next year, which in my view is pretty unlikely, then the average forecast yield is still a pretty decent 5.4% on the remaining thirteen shares. Not bad, being well above the FTSE100 and bank deposit rates.

The severe market fall since November 2000 makes this a very interesting time to be looking at the secondary objective of capital growth and you can see that the value of the portfolio has now fallen by 13.7% to £64,740, an unsurprising state of affairs. That compares very well though with the index fall of 39.6%. A straight capital comparison like that in fact does the HYP a disservice because its income is far higher than the FTSE100 and a true measure of total return including income, would show a much better outperformance by the portfolio against this index and even more than that against a tracker fund. Actually a tracker is a much preferred benchmark comparison for the HYP than the FTSE100 because such a fund is the only way in practice that a person can invest in the index and thus must suffer the charges.

The portfolio is losing money right now though, which is clearly not a desirable state of affairs. However this is a very long-term strategy and performance over the short period to date means very little. It is the performance of the income growth which is of primary importance and again, we have too few years to prove the effectiveness of this. Only one whole year so far. Year two ends in November and we will have our first year-on-year comparison of the dividends received. Get the income growth right and, long term, the capital is almost sure to follow.

There continue to be massive individual swings in constituent share values ranging from very large falls of about 80% by Royal and 73% by Britannic to rises of 54% by Gallaher and 26% by Associated British Ports.  Insurance shares, being a geared play on the market itself because of their massive share portfolios, have been hit very hard by the market fall, whilst tobacco has thrived. Such variations are typical of a sector diversified portfolio and in fact illustrate why such diversification is critical for security reasons. Expect such differences in individual values to continue for all time, though not the same ones. In total, there are four rises and eleven falls. I suggest that investors consider only the total value of the holdings rather than worry about individual fluctuations, exactly as if it were a managed fund, the difference being that you pay no charges.

We have just experienced one of the occasional times when something has had to be done with a holding. Land Securities has reorganised itself, issuing 'B' shares with an option to be redeemed for cash, whilst at the same time converting its ordinary shares in the ratio of seven new shares for eight old. The 'B' shares are not equity, but a form of variable interest bearing share. The strict hands-off approach would have said do not redeem the B shares for cash but hold them and the 7/8 new ordinaries, in consequence receiving a mixture of dividends and variable interest from this company in future. However that would have taken the portfolio away from the idea of being all equity which I did not want. I therefore decided to take the option of selling the 'B' shares for cash and reinvesting the proceeds in the new ordinary shares. After costs, this leaves us with 651 new Land Sec ordinary shares, compared with 642 before the reorganisation.

My suggested approach to the whole strategy, which I designed for the hands-off investor, is simply to forget about it once invested -- don't follow the shares, don't listen to any comment, just enjoy the income. Perhaps take a peek at it once every decade or so if you feel you have to get involved in some way.