VALUE INVESTING
Two Market-Beating Portfolios

By Stephen Bland (TMFPyad)
October 7, 2005

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

Both were started by investing £5,000 into 15 separate companies - a total investment of £75,000 in each case. Original prices include all purchase costs. HYP1 is close to a major milestone of five years existence so I'll be doing a full review of its performance in November after the anniversary.

HYP1 - start date 13 Nov 2000

Company	Original price (p)	Price now (p)	Gain/ (loss)
United Utilities (LSE: UU.)	620	657	+6.0%
Gallaher (LSE: GLH)	420	884	+110.5%
Scottish & Newc. (LSE: SCTN)	495	469	-5.3%
Royal & Sun (LSE: RSA)	393	98	-75.1%
Alliance & Leic. (LSE: AL.)	651	866	+33.0%
Resolution (LSE: RSL)	1,031	607	-41.1%
Lloyds TSB (LSE: LLOY)	712	465	-34.7%
Intercon. Hotels (LSE: IHG)	396	718	+81.3%
Mitchells & Butl. (LSE: MAB)	362	367	+1.4%
Boots (LSE: BOOT)	581	622	+7.1%
Land Securities (LSE: LAND)	768	1,468	+91.1%
Assoc. Br. Ports (LSE: ABP)	324	524	+61.7%
Hilton (LSE: HG.)	220	321	+45.9%
Rio Tinto (LSE: RIO)	1,131	2,212	+95.6%
Anglo American (LSE: AAL)	951	1,591	+67.3%
Royal Dutch Shell (LSE: RDSB)	2,012	1,891	-6.0%
Total invested	£75,000	£94,866	+26.5%
FTSE 100	6274.8	5427.8	-13.5%

Year ended	Income £	Yield on original capital
13 Nov 2001	3,451	4.6%
13 Nov 2002	3,474	4.6%
13 Nov 2003	3,197	4.3%
13 Nov 2004	3,205	4.3%

The estimated value including reinvested income is £113,286, an increase of 51.0% on the original investment in 4.92 years. Equating to a compound 8.8% a year, this is well ahead of cash and inflation.

The portfolio capital is up 26.5% and continues to leave behind the FTSE 100, the latter having fallen 13.5%. The result is that excluding income it is 46% ahead of it on capital alone but with income reinvested that lead is even greater because of the higher income of the portfolio.

HYP2 - start date 2 Apr 2003

Company	Original price (p)	Price now (p)	Gain/ (loss)
Lloyds TSB (LSE: LLOY)	338	465	+37.6%
Scottish & Newc. (LSE: SCTN)	348	469	+34.7%
Dixons (LSE: DXNS)	87	145	+66.7%
United Utilities (LSE: UU.)	546	657	+20.3%
Hays (LSE: HAS)	78	119	+52.6%
DX Services (LSE: DXS) *	n/a	345	n/a
Legal & General (LSE: LGEN)	75	112	+49.3%
BAT (LSE:BATS)	580	1,196	+106.2%
Bradford & Bingley (LSE: BB.)	297	340	+14.5%
Hanson (LSE: HNS)	320	583	+82.2%
Land Securities	736	1,468	+99.5%
BOC Group (LSE: BOC)	795	1,146	+44.2%
BAA (LSE: BAA)	465	626	+34.6%
Royal Dutch Shell (LSE: RDSB)	1,370	1,891	+38.0%
AMVESCAP (LSE: AVZ)	311	372	+19.6%
Anglo American (LSE: AAL)	970	1,591	+64.0%
Total invested	£75,000	£114,350	+52.5%
FTSE 100	3753.4	5427.8	+44.6%

Year ended	Income £	Yield on original capital
2 Apr 2004	4,564	6.1%
2 Apr 2005	4,347	5.8%

* demerged from Hays in 2004

The estimated value including reinvested income is £128,803, an increase of 71.7% on the original investment in 2.58 years. Equating to a compound 23.3% a year, this is substantially ahead of cash and inflation.

Readers should not expect this extremely high annual growth rate to continue into the longer term. It has occurred because I set up HYP2 in the depths of a bear market and the sharp gain includes the effect of the recovery, not a sustainable long-term growth rate. Note though that this portfolio is beating the market at its own recovery game, showing unusual strength so far. Generally I would expect an HYP to underperform during periods of very rapid market growth and outperform during periods showing a fall, static or modest growth.

The portfolio capital is up 52.5%, ahead of the FTSE 100 which is up 44.6%. The result is that excluding income it is 5.5% 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 altered my belief that HYPs are a great long-term equity strategy, both for income and growth investors. We haven't reached the long term yet, though HYP1 will have done five years by November, but the above returns to date for both portfolios have beaten cash, inflation and the FTSE 100. In the case of HYP1 this, it has achieved this through both bull and bear periods. 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 the market, with no regular 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 this cliché can be wrong. The reason high yield works and isn't arbed out is that most investors don't have the patience to follow it. It takes a certain very patient personality to stick with this strategy for many years through the inevitable bad times and to avoid almost all dabbling. These are traits not in common supply amongst a lot of investors.

Note that HYP income can fluctuate somewhat as can be seen from the tables above, though I believe it will grow long term. HYPers at the stage of drawing dividends to live on must allow for this. Having said that, HYP income is actually very much less volatile over the years than deposit interest for example.

When comparing HYP income with interest income, 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.

Stephen owns shares in Alliance & Leicester, Lloyds TSB, and United Utilities.