New HYP - proposed rules

[Wizard]

All

I am just starting to build my HYP and some of the recent discussion has made me think I need to codify the principles I will manage it by, not least because it helps me think through many aspects of HYPing. My initial draft rules follow and I would very much welcome your comments and thoughts on them. Be warned, not purist from the tinkering perspective.

Terry.

HYP Guidelines / Rules
1. Minimum size of HYP 20 shares
2. Maximum size of HYP 30 shares
3. New purchases / top ups to be the highest yielding share complying with all other rules not subject to strategic veto*
4. No purchases to cause a sector** to exceed 15% of HYP income
5. No purchases to cause a share to exceed 8% of HYP income
6. No purchase of shares with a market cap below that of the 300th biggest share on the FTSE
7. No purchases of shares with a yield of less than 80% of HYP
8. No purchases of shares with a cut in dividend in previous 3 years
9. No purchases of shares with less than 2% avg. annual growth in last 5 years
10. No purchases of shares with gearing in excess of 250%
11. Special dividends to be considered on a case by case basis to the extent that they impact calculations pertaining to any other rule
12. If a share cuts it's dividend, if it is possible to reinvest in another share from disposal proceeds after tax that does not result in any other rule being broken and which results in 120% of the income from the share switch shares
13. If a share's yield falls to less than 50% of the average yield of the other shares in the HYP, if it is possible to reinvest in another share from disposal proceeds after tax that does not result in any other rule being broken and which results in 120% of the income from the laggard switch shares
14. If a share's dividend grows to contributes more than 15% of HYP income, if it is possible to reinvest in another share from disposal proceeds after tax that does not result in any other rule being broken and which results in 100% of the income from the sold shares top slice to bring share to 8% of income

* shares where there is a clear indication dividend will not be maintained in the foreseeable future
** sector definition a mixture of LSE main and sub sectors

[Lootman]

6. No purchase of shares with a market cap below that of the 300th biggest share on the FTSE

Hard to determine, I would have thought, since the order changes by the minute.

Why not use the biggest 350 shares? That is easily checked by virtue of there being a FTSE-350 index, comprising the large caps (FTSE-100) and the mid-caps (FTSE-250). Being in that index should ensure adequate liquidity, if that is your reason for this rule.

[Wizard]

6. No purchase of shares with a market cap below that of the 300th biggest share on the FTSE

Hard to determine, I would have thought, since the order changes by the minute.

Why not use the biggest 350 shares? That is easily checked by virtue of there being a FTSE-350 index, comprising the large caps (FTSE-100) and the mid-caps (FTSE-250). Being in that index should ensure adequate liquidity, if that is your reason for this rule.

Well having checked it should actually be the top 275, I must have miscounted before. The reason is that the rule originally said that they had to have a minimum market cap of £1bln, but I thought I would try to be clever and make a rule that would ot become out of date. May it is better to stick to an amount but to revisit that every few years.

But it isn't hard to determine, lots of places online that you can rank the FTSE350 by market cap, then just work up.

Terry.

[tjh290633]

All

I am just starting to build my HYP and some of the recent discussion has made me think I need to codify the principles I will manage it by, not least because it helps me think through many aspects of HYPing. My initial draft rules follow and I would very much welcome your comments and thoughts on them. Be warned, not purist from the tinkering perspective.

Terry.

HYP Guidelines / Rules
1. Minimum size of HYP 20 shares
2. Maximum size of HYP 30 shares

In the past it has been generally accepted that 15 holdings is the minimum that is acceptable for an HYP bought in one go. Double that reduces the risk on losing income if one holding stops paying out.

However experience has been that events often conspire to increase the number of holdings, because of spin-off, splits or demergers. In the past this has occurred with British Gas (as was), ICI, Hanson, GEC, Whitbread, Scottish Power, Bass, Allied Domecq, and several others.

Often these are shares that you do not wish to keep, for yield or domicile reasons, but there is always a tendency for the number to increases insidiously.

For that reason I would not set a maximum, but would be guided pragmatically.

TJH

[Raptor]

You have limits based on income but seem to have missed by value, not the sme ss income, although they could be same share.

Raptor

[Lootman]

Well having checked it should actually be the top 275, I must have miscounted before. The reason is that the rule originally said that they had to have a minimum market cap of £1bln, but I thought I would try to be clever and make a rule that would it become out of date. May it is better to stick to an amount but to revisit that every few years.

I agree that a relative measure is better than an absolute measure which, as you note, becomes outdated over time. Obviously you can pick any number like 275 or 300. But given that there is popular index of the top 350 shares, I personally would find that easier to use. Digital Look will list those shares as a guide.

Of course, some or many of those 350 may fail your other tests so in practice it's a much smaller number.

Also note that there are some AIM shares that would qualify on market cap grounds but you presumably would wish to exclude them on other grounds? Or not.

[Breelander]

In the past it has been generally accepted that 15 holdings is the minimum that is acceptable for an HYP bought in one go...
... I would not set a maximum, but would be guided pragmatically.

As one who built my HYP gradually I found that, unless you choose to 'double-up' in sectors, once past about 20 shares it becomes increasingly difficult to find shares in new sectors without compromising on diversity. I found it virtually impossible to get beyond 30.

[Wizard]

Also note that there are some AIM shares that would qualify on market cap grounds but you presumably would wish to exclude them on other grounds? Or not.

Based on past bad personal experience unless the regulation of AIM changes markedly I would not touch an AIM share with a barge pole. Too many crooks and con artists seem to be able to get listed on there.

Terry.

[Wizard]

As one who built my HYP gradually I found that, unless you choose to 'double-up' in sectors, once past about 20 shares it becomes increasingly difficult to find shares in new sectors without compromising on diversity. I found it virtually impossible to get beyond 30.

Haven't done the maths but suspect that once I am up around 20 I will be able to double up on a sector without breaking diversity rules, as the portfolio would be big enough to take two in a sector. On the face of it if share 20 is a sector double-up, assuming the same yield on all shares that would give that sector a 10% weighting for income.

Terry.

[Wizard]

You have limits based on income but seem to have missed by value, not the sme ss income, although they could be same share.

Raptor

Yes correct Raptor, but why should I worry about value concentration?

Assuming I should worry about it I suspect that (whilst I have not proved it mathematically) the other rules would deal with it. As an illustration, if value triples but dividend does not increase the share will need review under rule 13. If the value triples and the dividend also triples then it would require review under rule 5. Does that make sense?

Terry.

[Wizard]

Having looked back at my original post it appears I did not include a rule about dividend cover, I suspect I need one. I guess I would plump low on this one, maybe 1.2x.

Terry.

[Raptor]

You have limits based on income but seem to have missed by value, not the sme ss income, although they could be same share.

Raptor

Yes correct Raptor, but why should I worry about value concentration?

Assuming I should worry about it I suspect that (whilst I have not proved it mathematically) the other rules would deal with it. As an illustration, if value triples but dividend does not increase the share will need review under rule 13. If the value triples and the dividend also triples then it would require review under rule 5. Does that make sense?

Terry.

Ok. Maybe not in buy phase but top up. I have shares where their percentwge of value is high but they are good for everything else. Do not want to put more money in them. Not sure that reads well am sure others can do it better. If I get a chance tomorrow I will go on pc and check spreadsheet for examples.

Raptor.

[grimer]

If a share increases in value, but the dividend fails to keep pace, then it wouldn't be eligible for a top-up - e.g. Share purchased with 6% yield. Share triples in value after a few years and yield is now 2.3%. It would now be overweight in capital terms and low yielding, so new money should be allocated elsewhere.

Trimming the share back is another matter and additional rules would be required for that eventuality.

[Wizard]

If a share increases in value, but the dividend fails to keep pace, then it wouldn't be eligible for a top-up - e.g. Share purchased with 6% yield. Share triples in value after a few years and yield is now 2.3%. It would now be overweight in capital terms and low yielding, so new money should be allocated elsewhere.

Trimming the share back is another matter and additional rules would be required for that eventuality.

Yes, that is exactly the intent behind rule 13 I referred to...

"13. If a share's yield falls to less than 50% of the average yield of the other shares in the HYP, if it is possible to reinvest in another share from disposal proceeds after tax that does not result in any other rule being broken and which results in 120% of the income from the laggard switch shares"

Terry.

[TUK020]

No 9; 2% average annual growth
Growth in what? Dividends, Share Price, Turnover, Profits??
I am guessing you mean Dividend

[Wizard]

No 9; 2% average annual growth
Growth in what? Dividends, Share Price, Turnover, Profits??
I am guessing you mean Dividend

Good point, yes I mean dividend, but will amend to make that clear.

Terry.

[Raptor]

You have limits based on income but seem to have missed by value, not the sme ss income, although they could be same share.

Raptor

Yes correct Raptor, but why should I worry about value concentration?

Assuming I should worry about it I suspect that (whilst I have not proved it mathematically) the other rules would deal with it. As an illustration, if value triples but dividend does not increase the share will need review under rule 13. If the value triples and the dividend also triples then it would require review under rule 5. Does that make sense?

Terry.

Hi Terry,

Applied your criteria to my portfolio and you are right the "rules" did take out a lot of the shares that my own "criteria" would make me think hard about any top-up (never rule out a share totally, IMO). Here are what is left:-



What I was saying about % of value, GSK would be a share that I would have trouble adding to as my "average" for 25 shares would be 4%, but I put 2 limits to help me decide on not to top-up and whether to think about top-slicing (if building not too much of a problem as you are adding "new" money which could change the balance anyway, but I am no longer in build phase with only a small amount of divi re-investment, currently). So, I have added average X1.5 (6%) and X2 (8%). GSK meets all your criteria (IMO) but not mine.

Hope this makes sense.

Raptor.

[kempiejon]

I have a couple of thoughts and questions.
Is this a lump sum or will new monies come in, other than dividends? I use new money to help keep balance.
How strict will you be with the rules, I have guidelines for my HYP but I do flex. For example you've set a cover minimum of 1.2, I prefer 2, would normally screen at 1.5 times but that eliminates most of the utilities. Your 1.2 times, for example, would let through SSE but not Pennon and I think both would be good picks for a HYP today. If your rules don't let though your desired 20 shares what is the next step?
How often will you monitor the portfolio and test the rules on your picks. If a share cuts its dividend how quickly would you sell, immediately or something like a quarterly rebalance?
I'm not one to sell when capital appreciation forces yield down but I can see it a good way of maximising income - if you make the right picks of course, it's one of the tinkering suggestions I like even though I've not out it into practice.
"7. No purchases of shares with a yield of less than 80% of HYP" I actually set new purchases or top up at the current portfolio yield as a minimum, again I flex a bit but I'd rather than bring my yield average up, not down.

[Raptor]

I have a couple of thoughts and questions.
Is this a lump sum or will new monies come in, other than dividends? I use new money to help keep balance.
How strict will you be with the rules, I have guidelines for my HYP but I do flex. For example you've set a cover minimum of 1.2, I prefer 2, would normally screen at 1.5 times but that eliminates most of the utilities. Your 1.2 times, for example, would let through SSE but not Pennon and I think both would be good picks for a HYP today. If your rules don't let though your desired 20 shares what is the next step?
How often will you monitor the portfolio and test the rules on your picks. If a share cuts its dividend how quickly would you sell, immediately or something like a quarterly rebalance?
I'm not one to sell when capital appreciation forces yield down but I can see it a good way of maximising income - if you make the right picks of course, it's one of the tinkering suggestions I like even though I've not out it into practice.
"7. No purchases of shares with a yield of less than 80% of HYP" I actually set new purchases or top up at the current portfolio yield as a minimum, again I flex a bit but I'd rather than bring my yield average up, not down.

Like you I have a cover of 2, will go for 1.5 and above if nothing meets criteria and will not touch under 1. I also go for current portfolio yield, but my minimum is the FTSE All shares, if nothing else matches.

Raptor.

[Wizard]

I have a couple of thoughts and questions.
Is this a lump sum or will new monies come in, other than dividends? I use new money to help keep balance.

A bit of both really. I have a fairly large fixed income portfolio that will be the main source of income, but I want to add a bit of diversification and equity should give some inflation protection as well. My modelling of my future cost profile shows that in most years there will be a surplus of income over cost (my annual costs have a few 'lumpy' items so that is not the case in every year and the amount in each year varies) and my plan initially was to drip feed that surplus into an HYP. However, since I first made this plan I have worked a bit longer than I envisaged so I have built up some additional capital I have yet to invest. So my plan is to use a lump sum to kick start the HYP, but there should also be regular reinvestment.

How strict will you be with the rules, I have guidelines for my HYP but I do flex. For example you've set a cover minimum of 1.2, I prefer 2, would normally screen at 1.5 times but that eliminates most of the utilities. Your 1.2 times, for example, would let through SSE but not Pennon and I think both would be good picks for a HYP today. If your rules don't let though your desired 20 shares what is the next step?

I almost made the heading guidelines, so yes I would consider flexing a limiting factor if on other criteria a candidate share looked appropriate. But maybe unlike a purist approach where I believe the right time to invest is always considered now, I would be willing to hold cash in the hope that a better opportunity would come along in the future.

How often will you monitor the portfolio and test the rules on your picks. If a share cuts its dividend how quickly would you sell, immediately or something like a quarterly rebalance?

I would anticipate regular monitoring, say weekly at the least. Any rebalancing would depend on the ability to do so in a way compliant with the rules, so if the rule can be complied with immediately I would rebalance there and then, otherwise for as long as the rebalancing would trigger I would test on a periodic basis.

I'm not one to sell when capital appreciation forces yield down but I can see it a good way of maximising income - if you make the right picks of course, it's one of the tinkering suggestions I like even though I've not out it into practice.
"7. No purchases of shares with a yield of less than 80% of HYP" I actually set new purchases or top up at the current portfolio yield as a minimum, again I flex a bit but I'd rather than bring my yield average up, not down.

Well in an ideal world, but I thought that ever increasing may not be possible, given the best yield ears would be cherry picked upfront. But I will rank candidates by yield so will not lower it unnecessarily.

Terry.