VALUE INVESTING
Strategies For High Yield Investing

By Stephen Bland (TMFPyad)
July 9, 2004

In the latest issue of my Value Investor newsletter, due out later this month, I've considered the property sector for one of the selections, in addition to the usual main value tip and the next choice for the sector diversified high yield portfolio (HYP) I am building up. I've located a property share with a slightly unusual approach to its business, with a good discount to net assets and historically modest gearing by sector standards.

The HYP I'm building up in the newsletter now has seven shares. It has reached a point of sufficient diversification to make a mini portfolio, an HYP Lite if you like, for anyone willing to incur the additional risk to income and capital of holding just seven shares compared with, say, a fifteen share portfolio. The current yield of the seven share portfolio based on the prices at the time of selection is a healthy 6.2%, assuming of course that dividends are maintained in total. This compares very favourably with cash on a gross basis and even more so after tax because of the advantageous tax treatment of dividends.

Is it too risky to hold only a seven share HYP? For most investors, particularly those living on the income, I'd say yes it is. Income investors need something more like the fifteen or so member portfolio I am constructing. The reason is that a dividend cut in a seven share portfolio will have a greater effect on the total income than a cut in a fifteen share holding. You could argue the opposite and in favour of a smaller HYP, in that a dividend rise in a smaller portfolio will have a more beneficial effect on the total income than in a larger portfolio. However, an income investor needs to consider the risks attached to the potential downside of the income more than the benefits of the potential upside.

For a growth investor though, that is one using an HYP to build up capital by reinvesting dividends, some may well be attracted to the Lite version. I'd say that a seven share HYP is potentially likely to do better long term but with the clear additional risk that it may not. In other words, it will be much more volatile than fifteen shares, volatility equating to risk. For most people this additional risk is too much to take, but I suspect there may be a few willing to try it in return for the chance of more growth, whilst accepting that the greater volatility brings with it the risk of less growth.

Note that the newsletter's HYP is one that is open to trading, unlike the eternity HYPs I feature here on the main Fool website. I don't envisage regular trading, it will be rare, but I intend to sell shares on occasion when I find it attractive, probably those showing a large gain and a current low yield. This contributes the double benefit of realising a profit and increasing portfolio income by reinvesting in a higher yielder. Perhaps an HYP Lite for a growth investor is made more attractive by allowing trading.

A few words on property share value, since I have one in this month's Value Investor and have featured them before. Unlike shares in general, property shares traditionally trade on a discount to book value. That discount fluctuates with the fashion for the sector but it is nearly always there in some measure, so the mere existence of a discount is not particularly interesting, not as it would be in other value shares. Also, property shares will nearly all have debt, you will not normally find net cash.

The search for value in the sector therefore concentrates on the degree of discount to assets and the degree of gearing. The bigger the discount and the lower the gearing the more value the share has on the face of it, though you then have to consider other things like the nature of its assets etc. Note too that earnings are relatively unimportant, the principal market measure is asset value, not P/E as with trading companies. The pyad test becomes merely ad with property, or maybe yad if you desire a nice bit of yield with your property value share.

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