VALUE INVESTING
High Yield Portfolio Update

By Stephen Bland (TMFPyad)
January 31, 2003

This is the first of the regular two-monthly updates following the second birthday of my High Yield Portfolio (HYP). Since the last update the market has fallen quite a lot further to around its lowest point for seven years. Interesting to see how it now stands up to the severe bear times in which we have lived since the portfolio started. This is probably the greatest test so far of the strength of its capital value.

For any 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. Note that this is just a demonstration portfolio to illustrate the high yield plan with no dabbling over long periods. It is not a recommended set of shares, nor would I choose wholly the same portfolio today.

The original idea of the HYP was for income investors, to be held forever and to deliver a decent initial yield far higher than the FTSE100 index and in excess of cash as well. But above all it is intended to produce inflation beating income growth over the long term for investors prepared to take the risks of equities. I believe that capital growth will go hand in hand with income growth, but as I say that is a secondary motive for this particular strategy.

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

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

Un. Util (LSE: UU.)          5000  690   718    562  4035  -19.3  8.7
Gallaher (LSE: GLH)          5000  416  1190    541  6438  +28.8  5.4
Scot. & New. (LSE: SCTN)     5000  490  1010    402  4060  -18.8  7.7
Royal & Sun (LSE: RSA)       5000  498   994     98   974  –80.5 12.2
All. & Leic. (LSE: AL.)      5000  645   768    674  5176   +3.5  6.5
Britannic (LSE: BRT)         5000 1020   485    101   490  –90.2  0.0
Lloyds TSB (LSE: LLOY)       5000  705   702    371  2604  -47.9  9.6
Six Continents (LSE: SXC)    5000  723   685    462  3165  -36.7  5.3
Boots (LSE: BOOT)            5000  575   861    510  4391  -12.2  5.9
Land Sec. (LSE: LAND)(1)     5000  771   651    710  4622   -7.6  5.2
Ass. Br. Ports (LSE: ABP)    5000  321  1542    398  6137  +22.7  3.8
Hilton (LSE: HG.)(2)         5000  232  2275    140  3185  -36.3  6.6
Rio Tinto (LSE: RIO)         5000 1120   442   1090  4818   -3.6  3.8
Anglo American (LSE: AAL)    5000  942   526    856  4503   -9.9  4.1
Shell (LSE: SHEL)            5000  572   865    363  3140  -37.2  4.3

Totals                      75000                   57738  -23.0  5.9
FTSE100                    6274.8                  3483.8  -44.5 

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 a cash payment which was used to purchase additional shares in the company.

The income in the first year to November 2001 was £3,451 making a yield on the £75,000 invested of 4.6%. The income in the second year to November 2002 was £3,474 making a yield of 4.6% on that original capital.

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 or lower taxpayer and liable to tax at only 25% on a higher rate payer.

Considering the fall in the FTSE100 index of 44.5% over the last two years and three months, the capital of the HYP has held up quite well in falling by 23.0%. It is not good to be down of course but investors must understand that a diversified portfolio invested primarily in index companies cannot totally escape the background market conditions. However I think it proves the defensive nature of this idea admirably. In addition to this outperformance, an HYP investor would have received a much higher income than the index. At the time of inception the yield on the FTSE100 was only about 2% whereas the HYP has yielded around 4.6%.

A truer comparison for the HYP than the FTSE100 would be with a tracker fund, being the only practical alternative for someone considering whether to invest in the general market or the HYP. I don't have the figures but the comparison would show the HYP to do even better against such a fund than the market and better still on an income reinvested basis.

Some bad news occurred with Britannic since the last update in November. They will not be paying a final dividend in respect of their financial year which ended 31/12/02 or any interim dividend for the next year, hence the forecast above is shown as nil. This delivered a blow to the share price as well as a hit to the income of the portfolio for its current year to end in November 2003. It illustrates the kind of risks that anyone using equities for income must be prepared to take. It shows also how critical is sector diversification, it being no accident that the two worst performers by far are insurers which tend to suffer disproportionately in severe bear markets.

There continue to be massive individual swings in constituent share values ranging from very large falls of about 80% by Royal and 90% by Britannic to rises of 28% by Gallaher and 22% by Associated British Ports. Such variations are typical of a sector diversified portfolio and in fact illustrate why such diversification is critical for security reasons. Expect such large differences in individual values to continue for all time, though not the same ones. In total there are three rises and twelve 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.

Incidentally, whilst talking fund comparisons it is interesting to note that the HYP has not only left behind index trackers, which doesn't surprise me because I have maintained from the start that this idea is a total tracker trasher, but outperformed most other funds as well over its life especially on an income reinvested basis which is how fund comparisons are usually made. Whether that will continue over the very long period for which the HYP is designed cannot be known and it is far too early to draw any conclusions.

My suggested approach to the whole strategy, which I intended 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.

More: The High Yield Portfolio discussion board

The author owns shares in Lloyds TSB and Royal & SunAlliance.