VALUE INVESTING

HYP1 is 5: The End Of The Beginning

By Stephen Bland (TMFPyad)
November 18, 2005

My first high yield portfolio (HYP) had its fifth anniversary on 13 November. A real milestone in its history.

Here are the figures for capital performance and dividends received. The portfolio started with £5,000 invested in each of 15 shares but since then there has been corporate activity in many of them including takeovers resulting in shares disappearing and divestments resulting in new shares being created.

Company	Original price p	Price now p	Gain/ (loss)	Dividend Year 5 £
United Utilities (LSE: UU.)	620	640	3.2	366
Gallaher (LSE: GLH)	420	901	114.5	382
Scottish & Newc. (LSE: SCTN)	495	480	(3.0)	211
Royal & Sun (LSE: RSA)	393	106	(73.0)	59
Alliance & Leic. (LSE: AL.)	651	875	34.4	379
Resolution (LSE: RSL)	1,031	606	(41.2)	92
Lloyds TSB (LSE: LLOY)	712	470	(34.0)	240
Intercon. Hotels (LSE: IHG)	396	773	95.2	92
Mitchells & Butl. (LSE: MAB)	362	366	1.1	68
Boots (LSE: BOOT)	581	610	5.0	259
Land Securities (LSE: LAND)	768	1,503	95.7	282
Assoc. Br. Ports (LSE: ABP)	324	565	74.4	251
Hilton (LSE: HG.)	220	356	61.8	223
Rio Tinto (LSE: RIO)	1,131	2,329	105.9	201
Anglo American (LSE: AAL)	951	1,774	86.5	221
Royal Dutch Shell (LSE: RDSB)	2,012	1,802	(10.4)	220
Total invested	£75,000	£98,367	31.2	£3,546
FTSE 100	6274.8	5465.1	(12.9)

Year ended	Income £
13 Nov 2001	3,451
13 Nov 2002	3,474
13 Nov 2003	3,197
13 Nov 2004	3,205
13 Nov 2004	3,546

Yield being the focus of this strategy, the prominent feature here is the good recovery of the portfolio's income in the fifth year. So good in fact that as well as being up 10.6% on year four, it is now ahead of the start as well thus delivering one of the two principal aims of the strategy, a rising income. However even though the income is now rising, the figures have not yet matched inflation, something I want to see happen.

The annual income streams need to be seen over a very long period, much more than five years, to get a real sense of where they are headed. This is in order that several economic cycles can be traversed. HYP1 had the misfortune to go through one of those rare periods of dividend cutting by many major companies in its early years. That it happened then rather than, say, in ten years time was just chance. HYP2 suffered a similar fate. But widespread dividend cuts are not common and thus the above figures are not representative of the longer run in my view.

The capital performance is pretty good. A gain of 31.2% against the FTSE 100 loss of 12.9% means that a sum invested in HYP1 would have beaten the same amount in the index by 50.6% on an income withdrawn basis and moreover have given a much higher income along the way too, thus making the total return outperformance even greater.

Looking at total return, I estimate the value if dividends had been reinvested to be £117,870. An increase of 57.2% over the five years equating to a compound growth of 9.5% pa. Note that HYP1 was commenced near a market high, though that became known only in hindsight of course. But with the same hindsight, that made it the most unattractive time to start such a portfolio. Yet it has still done the business even with that hugely disadvantageous start in life.

Individual capital and income performances continue to show wild differentials. Best capital deliverers are Gallaher up 114% and Rio Tinto up 106%. Worst are Royal down 73% and Resolution down 41%.

On income, the highest producer is Gallaher which paid out £382 in year five, closely followed by Alliance at £379 and United at £366. Dividend duffers are Royal with a measly £59 and Resolution £92. Intercontinental and Mitchells also have low dividends but note that these were originally one company which split into two so they are only half holdings. No prizes for noticing that the two worst dividend payers are also the two worst capital performers.

The effect of these individual fluctuations, taking the highest and lowest valued holdings, is that Gallaher at £10,722 forms 10.9% of the portfolio whilst Royal at £1,350 forms only 1.4%. Similarly Gallaher provided 10.8% of the year five income whilst Royal contributed only 1.7%. These figures can change in future of course, it's just the position at this stage.

I mention these differentials purely for interest. It does not really matter in my opinion especially as this is an eternity non trading portfolio. All long term HYPs will diverge substantially their individual share values and dividends. I don't expect the relative values of the shares as they stand now to remain that way forever, just as I never expected the original investment in each share to remain constant. They will shuffle around with time. My advice is that eternity investors should concentrate on the total portfolio income and value as if it were a commercial fund.

Comparisons with some other popular competing equity investments are instructive. Using the FTSE 100 is all very well as a benchmark but in practice the nearest an investor can come to that is by using a tracker fund. For example the popular L&G UK 100 Index Tracker. Over the five years this has fallen by 9.8% with income reinvested.

Another interesting comparison is with UK Equity Income unit trusts/OEICS. Trustnet shows 61 funds in this sector with a five-year history. Their figures, which include income reinvested, show that the average return of these is 27.6% in total over the period. Way better than trackers but still well behind HYP1. In fact the 57.2% gain of HYP1 would rank it fifth in the list of equity income fund performance, beating 57 of the 61 or 93% of them. Would have been nice to trash the lot but I'll settle for 93%.

Two other useful comparisons are with inflation and cash. The RPI increased by about 12.5% in total over the five years to September 2005, the nearest date published as I write. This is a compound 2.4% pa. On cash you might have been able to get 4-5% pa, pre tax. HYP1 delivering a 9.5% pa total return has dwarfed both of these and additionally with a much lower tax regime than on interest. After tax comparisons with cash are consequently better still.

Consistency is another feature of this portfolio. It hasn't delivered a huge outperformance in only one or two years then underperformed in others. Look at these figures for the annual capital values of HYP1 and the FTSE100 with their percentage changes.

Year	HYP1 Value £	FTSE100	Index Change%	HYP1 Change%
0	75,000	6,274.8	-	-
1	75,414	5,238.2	-16.5	+0.6
2	66,180	4,029.4	-23.1	-12.2
3	72,177	4,371.2	+8.5	+9.1
4	80,450	4,793.9	+9.7	+11.5
5	98,367	5,465.1	+14.0	+22.3

The portfolio has beaten the index in every single one of its five years existence. It could not be any more consistent.

HYP1 has had a baptism of fire. As I say above, it was launched, with hindsight, at a very poor point in time when the market was near its high and was subsequently hit with one of those very rare dividend cutting seasons in its early years. Two events that you might expect would cripple both its capital and income for years to come. Yet that has not happened at all. The income is now rising and never fell by much anyway, the capital has done handsomely. Few equity investors whatever approach they follow, whether in insurance schemes, funds or individual shares will have done better than this. And all with the very minimum of input from the investor.

I think it is pretty hard to fault this approach on the evidence so far, whether it is used for drawing income or for long-term savings by reinvesting dividends. One of its very strengths is that it can be used for both, switching at any time, seamlessly, with no costs or interference from insurers, governments or other third parties anxious to force you into complying with their view of the investment world whilst dipping their mucky hands into your fund, giving you only inferior performance and onerous restrictions in return.

The five-year stage marks a rite of passage for HYP1. Performance figures now become increasingly meaningful. Hitherto, not too much conclusion could be drawn from income or capital performance because the elapsed time was too short, the HYP being above all a long-term strategy. Whilst five years does not yet put it into the long term, I think it has now passed out of the short term. It is the end of the beginning.

Previous HYP1 anniversary articles: First | Second | Third | Fourth

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