VALUE INVESTING
Profiting From High Income Investing

By Stephen Bland (TMFPyad)
May 13, 2005

Here are the latest valuations of my two eternity high yield portfolios (HYP).

In this month's Value Investor I'm starting the newsletter's second high yield portfolio. Encouraged by the success of the first one in its very short life to date, I have every confidence in the second. Unlike the HYPs here, I intend trading shares in the Value Investor HYPs occasionally when I spot attractive opportunities for readers. I have already made one switch in the first portfolio, increasing its yield and scoring a small profit too.

Back to the eternity portfolios. Both were started by investing £5,000 into 15 separate companies - a total investment of £75,000 in each case.

HYP1 - start date 13 Nov 2000

The estimated value including reinvested income is £99,345, an increase of 33.5% on the original investment in 4.42 years. Equating to a compound 6.6% a year, this is ahead of cash.

The portfolio capital is up 11.8% and continues to leave behind the FTSE 100, the latter having fallen 22.0%. The result is that excluding income it is 43% ahead of it on capital alone but with income reinvested the lead is even greater because of the higher income of the portfolio.

HYP2 - start date 2 Apr 2003

The estimated value including reinvested income is £116,022, an increase of 54.7% on the original investment in 2.08 years. Equating to a compound 23.3% a year, this is way more than cash.

The portfolio capital is up 39.9%, ahead of the FTSE 100 which is up 30.4%. The result is that excluding income it is 7% ahead of it on capital alone but with income reinvested the lead is even greater because of the higher income of the portfolio.

General Comment

Nothing so far has disturbed my belief that HYPs are a great long term equity strategy, both for income and growth investors. That is why I have devoted a section of Value Investor each month exclusively to the approach.

We haven't reached the long term yet but the above returns to date have beaten cash, inflation and the FTSE 100 by a long way, the latter in both bull and bear periods in the case of HYP1. This suggests that HYPs are not just a fad that works only in certain circumstances but a strategy which should cope over time with everything the market can throw at it. And all with no more risk than shares generally, with almost no costs and with very little involvement required from the investor.

If it all sounds to good to be true, well, for a change it is true, look at the figures they show that the this cliché can be wrong. The reason high yield works and isn't arbitraged out as some might expect is that most investors don't have the patience to follow it. It does take a certain personality to stick with it for years, to avoid almost all dabbling and those are traits not in common supply amongst a lot of equity investors.

When comparing HYP income with cash, note that interest suffers a much higher tax liability than dividends. The latter are tax free to basic rate payers and charged at 25% on higher rate payers. The effect is that gross interest would have to be 25% higher than dividend income in order that the net incomes after tax are the same. So for example a dividend yield of 4% gives the same after tax income as gross interest of 5% whichever tax rate is applicable.

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Stephen holds shares in Alliance & Leicester, Lloyds TSB, Royal & SunAlliance and United Utilities.