VALUE INVESTING
High Yield Portfolio Update

By Stephen Bland (TMFPyad)
March 27, 2003

This is the latest of the regular two-monthly updates of my high yield portfolio (HYP) which is now some two years and four months old. The FTSE100 index has recovered by about 7.4% since the last update at the end of January 2003.

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. It is designed to be held forever and to deliver a decent initial yield far higher than the FTSE100 index. The income level should excede cash as well and, crucially, 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 that is a secondary motive for this particular strategy.

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

                                £ orig.  no.  price   val   move 
                           invest price shs.    now   now      % 
Un. Util (LSE: UU.)          5000  690   718    598  4294  -14.1 
Gallaher (LSE: GLH)          5000  416  1190    600  7140  +42.8 
Scot. & New. (LSE: SCTN)     5000  490  1010    352  3555  -28.9
Royal & Sun (LSE: RSA)       5000  498   994     74   736  –85.3
All. & Leic. (LSE: AL.)      5000  645   768    816  6267  +25.3 
Britannic (LSE: BRT)         5000 1020   485    155   752  –85.0 
Lloyds TSB (LSE: LLOY)       5000  705   702    345  2422  -51.6 
Six Continents (LSE: SXC)    5000  723   685    624  4274  -14.5 
Boots (LSE: BOOT)            5000  575   861    545  4692   -6.2 
Land Sec. (LSE: LAND)(1)     5000  771   651    734  4778   -4.4 
Ass. Br. Ports (LSE: ABP)    5000  321  1542    400  6168  +23.4 
Hilton (LSE: HG.)(2)         5000  232  2275    150  3412  -31.8 
Rio Tinto (LSE: RIO)         5000 1120   442   1240  5481   +9.6 
Anglo American (LSE: AAL)    5000  942   526    944  4965   -0.7 
Shell (LSE: SHEL)            5000  572   865    390  3374  -32.5 
                            -----                   -----
Total                       75000                   62310  -16.9 

FTSE 100                   6274.8                  3739.9  -40.4

Notes

1. Land Securities reorganised in September 2002 resulting in a cash payment which was used to purchase additional shares in the company.

2. 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..

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 40.4% over the period, I think the capital of the HYP has held up quite well in falling by 16.9%. Two and a bit years is not long in the life of an eternity portfolio. It is not good to be down of course. but investors must understand that a diversified portfolio invested primarily in large companies cannot totally escape the background market conditions. However, since the HYP went straight into a severe bear market right from the start, I think the performance to date proves the defensive nature of this idea admirably, though it is much too early to be able to draw any long term conclusions.

In addition to this outperformance, a 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%.

For those utilising the HYP idea to accumulate capital by reinvesting dividends, a comparison with a FTSE100 tracker fund including reinvested income, which is the way fund comparisons are usually made, would show even better outperformance than the above figures reveal because of the higher income. A crude calculation (taking the actual dividends for the first two years and an estimate of the dividends to date in year three then allowing for movement in that income of half the overall portfolio change to date) gives an approximate value for the HYP including reinvested income of around £69,600. This is a fall of about 7.2%. This will have beaten the great majority of all equity income funds as well as leaving trackers way behind.

There continue to be massive individual swings in constituent share values. These range from very large falls of about 85% by Royal and Britannic plus Lloyds down 52%, to rises of 43% by Gallaher, 25% by Alliance & Leicester and 23% by Associated British Ports. Such variations are typical of a sector diversified portfolio and 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 four rises and eleven falls. However, I suggest that investors consider only the total value of the holdings rather than worry about individual fluctuations. In other words treat the HYP exactly as if it were a managed fund, the difference being that you pay no charges.

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.

If you're interested in seeing or taking part in debates regarding the HYP strategy then you can find them on this discussion board. 

The author holds Lloyds and Royal & Sun shares.