VALUE INVESTING
Hyping Up High Yield

By Stephen Bland (TMFPyad)
June 10, 2005

I completed the first Value Investor high yield portfolio (HYP) in April this year, built up by monthly purchases since our launch in January 2004. Like the two HYPs I monitor here on the Motley Fool website it contains fifteen diversified shares but differs in approach in that I am prepared to trade the shares occasionally should the circumstances be advantageous. We've had one trade so far in the first Value Investor HYP, selling a share at a small profit following a dividend cut and reinvesting the proceeds in a higher yielder, thus increasing portfolio income.

As of 9 June, the first Value Investor HYP was in total up about 18% including dividends received. Of the fifteen shares, twelve are in profit averaging 22.9% and three in loss, on average down 3.8%. The largest winner is Shell bought in February 2004 and now up 41.9% and the biggest loser William Hill from January 2005 down 7.8%. With HYPs though it's the whole portfolio in total that matters and this is not bad for a holding period averaging only about nine months, having beaten the market and cash. Note that these figures are not based on contrived or unachievable prices because Value Investor maintains an honest policy of measuring performance using share prices at the close of the first trading day after publication of advice.

With this portfolio and my two public portfolios all beating the market, covering various bull and bear periods, plus beating cash as well, my long-held belief that this strategy is a long-term winner can only be reinforced. Okay, the first Value Investor HYP hasn't been held anywhere near long enough to conclude anything about its long-term performance but I base my belief in HYPs not only on this portfolio but on performances of my two public HYPs, the earliest of which will complete five years duty in November. Three winning portfolios in all, still not long term but they're all going well in the right direction.

I've always known how good the HYP approach is but it's nice to be able to show actual results. Apart from my beliefs, upon which I was more than willing to devote a section of Value Investor to the strategy from the start, there is all the other research evidence out there plus personal long term anecdotal evidence of success from at least one TMF high yield board regular and other people I've know who have followed the strategy over long periods.

Add in the fact that HYPs are a very low risk approach by equity standards and you get the best of all worlds, market beating returns at low risk, the holy grail of investing. But it is long term I stress and this requires that investors are prepared to keep the faith and hold through both good and bad times that will occur over twenty years or whatever. Weak HYPers ready to dismiss it as soon as the inevitable bad patch occurs should not be following the approach in the first place. It does demand a very long-term commitment that makes marriage for life look like a one night stand. This is why the superior performance of high yield blue chips is not arbitraged away, a question I've been asked often.

Despite the open secret of long-term HYP outperformance, not enough investors are prepared to follow it to kill it. The annual returns are decent but not huge so it's not sexy. However the fact that annualised HYP returns are modest yet pretty reliable over time is exactly what creates the great long-term result.

Simply sitting on a portfolio of shares for decades with little or no trading is admittedly rather dull. Watching paint dry is likely in comparison to give you a heart attack. But as value investors know, dull is attractive. Dull is where the money is.

Finally, talking of risk, I suspect that few small investors consider this. Most will look only at the returns. But risk is important and returns really need to be compared with it to get the full measure of the quality of an investment. You can't appreciate fully the merits of competing strategies without knowing their risks, defined here as volatility, in addition to their returns. Thus two strategies delivering the same rewards but with seriously different volatilities are not really the same at all. In this case the lower risk approach would clearly be preferable. Always try to consider this when faced with claims about investment returns. What risk was involved in getting there? Ideally the risk/reward ratio should be optimised so as to deliver a decent return with as little risk as possible. HYPs do this.

For the low-risk HYP route to great long-term returns, read Value Investor where I construct an HYP month by month. A new one starts each time a portfolio is completed so you can join at any time. Find out here how you can get a free trial and the next issue of the newsletter - due out on Friday 17 June.