VALUE INVESTING
A Question Of Faith

By Stephen Bland (TMFPyad)
April 30, 2004

I'm asked sometimes for evidence of the success of long-term high yield portfolios (HYP). Whilst there is a lot of published work around indicating that high yield as a concept works over long periods, there is no guarantee that any particular investor's HYP will beat cash, or the market, or necessarily do well at all. The lack of guarantee is not specific to HYPs though. All equity and other risk investments suffer from this quality. That is why they are risk investments. Investors who cannot live with that should stick to gilts or the like.

As I comment often, it follows that investing in an HYP is primarily an act of faith. Faith that high yield will do the business long term. It is faith precisely because it is very long term, so that by the time you find out whether it has worked or not it will be too late to do much about it. Note though that such faith is not peculiar to HYP investing, the same goes for any long-term approach including that method advocated frequently on TMF – tracker funds.

One piece of evidence on high yield strategies can be found by examining the performance of equity income funds over long periods compared with trackers on a reinvested income basis. Now trackers start off with an advantage because their charges are usually lower than the former but despite that, it turns out that the average equity income fund not only outperforms the average tracker but does so with lower volatility. In other words, the performance is superior but it is superior at lower risk. The best of both worlds.

Over the last five years for example, according to TrustNet trackers fell by 17.6% whilst equity income funds rose by 1.4%, a pretty substantial difference. Note that these are averages meaning that some equity income funds will have underperformed trackers. The actual figures are that 66 out of the 75 equity income funds with five year records beat trackers, quite some majority, although there is an element of survivorship bias here. The volatility figures can be seen in Money Management magazine but last time I looked, admittedly quite a while ago, equity income funds showed lower volatility than the market.

I am not advocating equity income funds but using these facts as one indication that high yield works in general. I would say though that for those who prefer investing in funds to individual shares, equity income funds appear to be a much better growth investment long term than trackers and at lower risk. Again, as with HYPs, fund investors would have to accept that there can be no guarantee of that.

This article though is about HYP investing and about the likelihood of an investor's faith in the approach being justified ultimately by events. I'd love to be able to say to people that they are certain to be rewarded in the end by going this route rather than some other, but I can't put it as strongly as that. I do believe that HYP investing will leave behind nearly every other approach and moreover will do so with very little input required from the investor. In fact, I think it is precisely the lack of much input that assists the style because the majority of investors lack the skill to trade shares short term with any success. Consequently, they do much better by merely sitting on them for years and this coupled with reinvested dividends, which are fairly high to begin with, is why it is likely to work. But the likely success of HYPs remains just my belief.

It may seem paradoxical to beginners that doing nothing is actually doing a lot. They may read or hear of the sometimes frantic trading activity that goes on in the market and feel that this is the real way to make money there. However as any broker will tell you, the vast majority of investors that trade regularly will lose money, just as most punters betting on horses lose money. Only a tiny minority possess the skill to make money by trading. Far more think they have the skill and lose. Better, in my view, to go for the tortoise HYP approach that is unlikely to lose you money in the long run and, much more than that, stands a good chance of delivering great performance. As I started off by saying though, no guarantees.

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