VALUE INVESTING
A Different High Yield Strategy

By Stephen Bland (TMFPyad)
July 22, 2005

As chance would have it, the High Yield Portfolio (HYP) selections of my Value Investor newsletter have performed better overall than the value share selections since we launched the publication. Our latest performance figures show that the HYP shares show an average gain of 19% whilst the value shares have an average gain of 6%.

I'm not sure that too much can be concluded from that. For a start, there are about twice as many value shares as HYP shares selected. Also, it could be that this period was better for the kind of very large cap shares that constitute HYP holdings than for the smaller caps that comprise most value shares. Over periods of time, if you split the market into various capitalisations you find that there are times when smaller caps do well and times when larger caps do the business. Value Investor, which we've been publishing since January 2004, has not been going anywhere near long enough to cover a period of these cycles when both smaller caps and larger ones have had their day in the sun.

Due to the relative success of the HYP shares in Value Investor and also the great success of my two public HYPs, the latest update of which I featured last week, I've been asked many times whether one could base a trading strategy around the HYP approach.

Going back to basics, my original HYP idea was for income investors prepared to accept the risks inherent in shares as an alternative to sources such as often poorly performing and restrictive insurance company schemes, interest, rents etc. Income investors would primarily be retired people but the idea then developed into a long term savings approach whereby dividends were reinvested until such time as the income was required.

In this way the HYP became the perfect equity-based answer to a lifetime investment strategy, accessible on demand, unrestricted by any regulations and capable of being switched at will with no costs or problems between savings or income.

Note that I envisaged no trading at all in the original HYPs and even in the Value Investor HYPs there will be only very occasional trading. So I definitely did not see these approaches as being for traders but for the very long-term holders. My reasoning is that through experience gained in my accountancy practice with a number of investors over a very long time, those who traded tended to end up worse over time than the eternity holders. I believe that the causes of this were that too many people over rate their trading skills, often reacting to short-term events.

However, having said all that though it is possible to develop a trading strategy around the HYP big cap style. One way is to a share that has shown a good gain where its yield has fallen substantially and reinvest in a higher yielder. You might also sell any share where the yield has fallen due to dividend cuts, even if it shows a loss. In other words yield is your buy and sell signal. You set dynamic yield levels relative to the current market average which dictate mechanically when you go in or out of a share. Mechanically is probably the best approach in my opinion, it takes out all the emotion.

Be careful though, in practice this could lead you to lowering portfolio quality in the search for replacements. The reason is that assuming you stick to big caps, say FTSE100 primarily with a sprinkling of FTSE250 perhaps, there just aren't that many shares available that fit typical HYP requirements of yield and safety. Your selection pool is very limited. If you insist on replacing a sold share immediately, you may compromise and buy something inferior. Probably better to go cash in that case.

Another thing you would have to consider abandoning to a large extent if you want to be a HYPertrader is sector diversification. Because of the limited selection pool, maintaining the same level of diversification as a normal long-term HYP will make it even harder to find replacements for sold shares. If you don't want to be in cash too much, you will probably need to seek shares in some duplicated sectors.

If you do all this you don't really have an HYP at all as it is understood round here, you have a variation on the value trading strategy based on large caps with yield as the timing signal. The big question is whether a HYPertrader will do better than a normal long-term HYPer over time. A question I cannot answer for sure of course but my gut tells me that the long-term holder will win. Nevertheless, I know that some people think they can do better by trading and I wish them luck. Value Investor HYP selections have produced some very handsome gains which such investors would find of great assistance.

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