HYP1 is 21 - thread discussing income and capital diversification

[Itsallaguess]

Last November, Pyad released his 'HYP1 is 21' anniversary post here -

https://www.lemonfool.co.uk/viewtopic.php?t=32154

I've started this separate thread looking at the HYP1 income and capital diversification so as not to disrupt that thread with this analysis, as I completely understand that it may not interest everyone, and I do want to be respectful of Pyad's great ongoing HYP1 experiment by not including discussion of this specific aspect on that anniversary thread.

The data discussed in this thread is specifically looking at the ongoing lumpiness of the income and capital derived from HYP1.

Over the years, HYP1 has developed in a way that relies on a really quite small subset of holdings to deliver the bulk of its income and capital performance, and we can still see that the current HYP1 portfolio now stands at a record high when considering the percentage of overall dividend-income delivered from its current top five holdings -



The underlying historical HYP1 income and capital data for the above table can be found here - https://i.imgur.com/df09cmQ.png

Here's a chart showing the reliance that HYP1 has continued to develop on it's top five holdings for both income and capital over the last twelve years -



Pyad has reported that HYP1 has seen a 104.9% rise in dividend income since last year's COVID-related income-drop of 47.6%, a welcome recovery, and one that continues to show the resilience of this type of income strategy to short and medium term market-related issues.

However, the final table that I show below is an aggregated-income table, showing how much income is currently being delivered by HYP1 when we look at the ranking of top income-producing shares -



As we can see from the above table, no less than 60% of HYP1 income is currently being delivered from just two holdings, with nearly 87% of HYP1 income being delivered from just four...

I hope this exercise to look 'under the bonnet' a little regarding the income and capital concentration of HYP1 is instructive to those of us who might be interested in how a largely 'hands-off' income-portfolio can develop over the years, and in ways that might not be immediately obvious to anyone just looking at the headline HYP1 numbers...

Cheers,

Itsallaguess

[Dod101]

Thanks IAAG, not only that but three of the four shares delivering 87% of the income are from the same sector. Talk about concentration. Diversification has been totally ignored and I do not think that any investor in real life would want to be in that position.

Dod

[dealtn]

Pyad has reported that HYP1 has seen a 104.9% rise in dividend income since last year's COVID-related income-drop of 47.6%, a welcome recovery, and one that continues to show the resilience of this type of income strategy to short and medium term market-related issues.

Sorry I have to disagree. What this shows is a "potential" resilience. There will be a huge set of potential HYPs, and this is a subset of one that has performed well (this year and previously) but many others will look far less healthy. There is a huge selection and survivor bias being made.

On the broader point though, it strikes me as close to surreal that a strategy designed for the less comfortable and sophisticated in financial matters, that even has safety and diversification at its core at the point of selection, then (potentially) develops into a hugely risky portfolio (in terms of lack of diversification and concentration of both income and capital), and yet seemingly this contradiction is of no issue to its creator and (many of its) followers.

[moorfield]

This is an old and circular discussion that will never resolve itself (again). IAAGs numbers are interesting though, and with it's bumper dividend RIOs contribution will be even more skewed this year. Remember Pyad did caveat such risks (although didn't explicitly name them) right at the start.

https://web.archive.org/web/20140219210 ... 01106c.htm

I wish to stress, though, that anybody considering this approach must be made aware that there are risks. Neither the income nor the capital is guaranteed. If you cannot live with that then, clearly, don't do it. I believe, however, that the risks are less than many people imagine.

The less comfortable and sophisticated investor with an interest in deriving income from equities should be using Investment Trusts imho, of course they should be.

[Dod101]

Pyad has reported that HYP1 has seen a 104.9% rise in dividend income since last year's COVID-related income-drop of 47.6%, a welcome recovery, and one that continues to show the resilience of this type of income strategy to short and medium term market-related issues.

Sorry I have to disagree. What this shows is a "potential" resilience. There will be a huge set of potential HYPs, and this is a subset of one that has performed well (this year and previously) but many others will look far less healthy. There is a huge selection and survivor bias being made.

On the broader point though, it strikes me as close to surreal that a strategy designed for the less comfortable and sophisticated in financial matters, that even has safety and diversification at its core at the point of selection, then (potentially) develops into a hugely risky portfolio (in terms of lack of diversification and concentration of both income and capital), and yet seemingly this contradiction is of no issue to its creator and (many of its) followers.

Well I think many of its followers do take account of these factors and from what I read, many either trim the most successful holdings or top up the weaker ones so as to reduce this imbalance/exposure. That does not sound the best idea to me either. The trouble with this sort of discussion is that it of course gets us oldies or more experienced absolutely nowhere but let's hope that it does help some of the newbies to take heed of the flaws in the 'pure' HYP argument so much espoused by its creator.

Dod

[Bubblesofearth]

Sorry I have to disagree. What this shows is a "potential" resilience. There will be a huge set of potential HYPs, and this is a subset of one that has performed well (this year and previously) but many others will look far less healthy. There is a huge selection and survivor bias being made.

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you? Of course we can all go back in time and design HYP's that cherry pick dogs and would now look awful but that's different from what reality presents us with.

Markets, and portfolios taken from markets, will always evolve this way, i.e. where performance (both capital and dividend) will be largely driven by a small fraction of the total. Interfering with that risks channeling money into poor performers and carries the certainty of higher charges.

Maybe some people will be uncomfortable with the imbalance within HYP1. Are those same people uncomfortable with the outperformance of HYP1 vs the FTSE100? Would they prefer the portfolio was perfectly balanced but with half the capital?

BoE

[Dod101]

Sorry I have to disagree. What this shows is a "potential" resilience. There will be a huge set of potential HYPs, and this is a subset of one that has performed well (this year and previously) but many others will look far less healthy. There is a huge selection and survivor bias being made.

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you? Of course we can all go back in time and design HYP's that cherry pick dogs and would now look awful but that's different from what reality presents us with.

Markets, and portfolios taken from markets, will always evolve this way, i.e. where performance (both capital and dividend) will be largely driven by a small fraction of the total. Interfering with that risks channeling money into poor performers and carries the certainty of higher charges.

Maybe some people will be uncomfortable with the imbalance within HYP1. Are those same people uncomfortable with the outperformance of HYP1 vs the FTSE100? Would they prefer the portfolio was perfectly balanced but with half the capital?

BoE

I don't think it is a matter of having a perfectly balanced portfolio but it is a matter of getting a portfolio better balanced than HYP1 is currently. Miners and housebuilders are cyclical whether you are prepared to admit that or not and yet, out of the top four shares, we have two miners and a housebuilder which between them are providing over 70% of the entire income of the HYP. BAT is the only one I would be happy with where it stands. I appreciate that in the end we are all dead but that setup seems to me to be tempting fate.

Dod

[BullDog]

Thank you Iaag for doing this work. I don't have anything to add beyond what's been said above. Thanks again. Take a rec

[MrFoolish]

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you?

How would you know? Nobody has maintained a list of all the HYPs that started out. The ones reported here are likely to be subject to survivorship bias.

[BullDog]

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you?

How would you know? Nobody has maintained a list of all the HYPs that started out. The ones reported here are likely to be subject to survivorship bias.

Indeed, there are a few posters here (and the total population is really very small) who have said in the past they tried the pyadic strategy and gave up on it. Myself, I didn't try it, but I considered it before rejecting it. I guess in reality there's very few "pyadic to the letter" portfolios out there anyway. To be clear though, I am not inviting yet another fruitless discussion about that in particular. It's pretty pointless to do it all over again.

I enjoy seeing such work from Iaag and others though.

[Itsallaguess]

Pyad has reported that HYP1 has seen a 104.9% rise in dividend income since last year's COVID-related income-drop of 47.6%, a welcome recovery, and one that continues to show the resilience of this type of income strategy to short and medium term market-related issues.

Sorry I have to disagree. What this shows is a "potential" resilience. There will be a huge set of potential HYPs, and this is a subset of one that has performed well (this year and previously) but many others will look far less healthy. There is a huge selection and survivor bias being made.

I think in general terms, we've seen over the years that income-strategies reported here tend to be fairly resilient to short and medium-term market-related issues, and dividends generally hold up quite well in broad terms, and where they don't, due to short or medium term market-related issues, then they generally tend to recover fairly quickly. I hope that in general terms, we might be able to agree that as a broad outcome of income-investment on the whole...

If we're then going to get into holding up the potential for outlier income portfolios not to have shown such general resilience over the years, then of course you won't find any argument from me on that point, but the danger of that approach is that absolutely any investment strategy can have outlier investors implementing them that skew into outlier results when set against more general outcomes for a given strategy, and so I don't think getting into granular discussions around this area is likely to produce any really useful debate, given that we could take that approach against any particular investment strategy and start to claim that any evidence anyone ever sees about them as only being 'potentially' representative...

On the broader point though, it strikes me as close to surreal that a strategy designed for the less comfortable and sophisticated in financial matters, that even has safety and diversification at its core at the point of selection, then (potentially) develops into a hugely risky portfolio (in terms of lack of diversification and concentration of both income and capital), and yet seemingly this contradiction is of no issue to its creator and (many of its) followers.

I always try to play these reports with a straight bat, but I fully agree that many investors who might have owned a 'black-box' portfolio called 'HYP1' for 21 years might get quite a shock if they were able to one day open the lid and fully comprehend the quite stark level of both share and sector diversification going on under the bonnet, in terms of income and capital returns. That is, of course, the primary reason for my regular updates in this area - to take a look under that bonnet in terms of ongoing diversification risk.

With that having been said, I don't tend to see many people actually saying that they'd be happy to own it, and I think the vast majority of people simply see it in terms of the ongoing market-led experiment that it is, so I'd perhaps ask people not to think HYP1 could be held up as any real evidence that income-investment as a general strategy, for those that are looking for those types of returns, should be avoided.

If someone suggested that perhaps single-shot income-portfolios, initially investing in a relatively small group on income-producing shares, and then being left 'hands-off' for the remaining lifetime of the income-investor should be avoided, then again, you'll find no arguments from me there, but again, I don't actually see many people ever trying to make the case that they shouldn't be....

For me personally, the HYP1 experiment has clearly shown that an income-investor who might continue to place a personal ongoing preference in trying to maintain ongoing broad diversification (as the original articles initially advised, let's not forget...), both in terms of income and capital, whilst also maintaining (as far as possible) a much-preferred 'hands-off' long term approach as well, then they might be best looking into the large range of income-related Investment Trusts that are available nowadays, often having huge global reach in terms of geography, markets, and sectors, and perhaps take advantage of some of the 'contracted out' portfolio-management processes that such Investment Trusts can offer over the very long term.

That's certainly the approach I've taken in recent years, and I'm extremely happy with both the returns and the continued diversification of those returns, that income-related Investment Trusts have delivered for me, along with a relatively smaller section of single-company holdings from my earlier HYP-like holdings.

I continue to believe that Pyad was a little unlucky with the timing of his original HYP articles, in terms of the rapidly maturing investment world around that time, and I've often wondered if those articles had been delayed for a few years, whether a more income-IT related approach might have been proposed instead, taking advantage of the broader reach into markets, geographies, and sectors that taking such an alternative approach might have benefited from.

On the whole, I wouldn't really think there'd be much excuse nowadays, for a private income-investor to find themselves in the same risky position as Doris...

Cheers,

Itsallaguess

[MDS1951]

I've been interested in the discussions about how skewed the income and capital re HYP1 has become over the years, with an increasing % of both concentrated in the 5 largest holdings; so I thought I'd look at my own HYP-ish portfolio to see what has happened there. I've stripped out my Investment Trust shares so that the figures relate only to what I thought were HYP shares at the time I purchased them. I found that 50% of the dividend income comes from 5 out of 19 shares. They are

15.6% Billiton
10.9% Legal & General
10.8% Rio Tinto
6.4% National Grid
6.3% Tate

However, capital values tell a different story. These 5 shares account for 31.5% by value of my HYP shares. Only 1 of these shares, Legal and General, appears in the 5 shares whose capital has increased the most; the other 4 (Diageo, Compass, AstraZeneca and RELX) are the lowest yielders in my portfolio. In total these 5 growth shares form 35% by value of my stripped-down HYP portfolio.

My conclusion is that all HYPs are different in their fortunes, and while HYP1 looks like a case of extreme concentration of both capital and income generation in increasingly few companies as time has passed by I'm not sure that happens in such an extreme fashion with most HYPs; though if left relatively untouched they might sort themselves into winners and losers as my HYP has done, and the income winners may not be the same shares as the capital winners.

I should say that if I held HYP1 in the real world I'd have found the ride too exciting by now and would be trimming radically the Big 5 into more diversified shares to try to reduce what I think are the risks to both dividends and capital for the portfolio as a whole.

MDS 1951

[tjh290633]

What we have to remember is the fundamental error made when companies were taken over. Instead of reinvesting in replacement companies at the then average holding value, 100% went into a new share. This happened at least twice from memory, and resulted in extreme imbalance. It also resulted in the unequal distribution of dividend income that we see.

There is much to be said for the "Leave well alone" concept with portfolios, but some changes are enforced, and failing to take the opportunity to rebalance to some extent was a major mistake. One I recall was to move 100% from Gallagher's takeover into BATS. Another occurred when Alliance and Leicester (I think) was taken over. All the money was ploughed back into the same sector.

My own method is to impose upper limits on weight, share of income, and share of cost. If the weight limit is exceeded, I trim the holding back, and I do not top up any share which would then exceed my limits on share of income or cost. Any new replacement share is bought at median weight and the excess money used to top up other holdings. If the limits are set widely enough, there is little need to take action frequently. With a 15 share portfolio, and a median holding weight of about 7%, a 15% limit ought to be adequate. That would still allow 3 shares to be 45% of the total, so limits of 12.5% or even 10% might not be too severe.

The real lesson is that you cannot ignore what is going on in a portfolio completely. Sometimes you have to do something. What you do is dependent on your own philosophy and ideas.

TJH

[Itsallaguess]

One other thing I would like to add as a more general point, whilst we're discussing Pyad and his investment articles from all those years ago, is that almost all of my financial education can be traced back to a single fork in the road that led to his writing on investment matters back on The Motley Fool.

I come from a background where absolutely no-one, either in my home-life or my work-life, discussed financial matters in those days, even of a basic kind - never mind in terms of such lofty ideas as 'stock market investment'...

I think Pyad's legacy should revolve as much around allowing inexperienced people like me to believe that they should be able to access things like personal investments, and to take control in their lives of the important long-term financial benefits that such processes can deliver, and whilst I think it's quite right to be able to look under the bonnet of something like HYP1 over the years, and perhaps discuss some of the issues related to it, I think it's very important to also credit him as an investment journalist, first and foremost, who found a way to convince people like me that they could open a door into an investment universe that they previously thought was simply 'out of bounds' for people with their background, and then helped them to step through it into a world with many broader options then being available.

I'll be eternally grateful for Payd being where he was, when he was, and doing what he did in the way he did at that time. Whilst I wouldn't ever claim to agree with all of his investment proposals, they were always made in such a way as to shine a beacon into a world which he convinced me I could be brave enough to walk into and make a good go of it on my own...

Cheers,

Itsallaguess

[Bubblesofearth]

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you?

How would you know? Nobody has maintained a list of all the HYPs that started out. The ones reported here are likely to be subject to survivorship bias.

I said I wasn't aware of poor performing HYP's and asked if dealtn was. It's a question not a statement of knowledge.

I'm always sceptical of theoretical arguments trumping evidence. The only evidence I've seen on here is of successful HYP's, admittedly few with the detailed history of HYP1. Yes, that could be survivor bias but it's still the only evidence we a have. Until we see the logged poor performance of an actual HYP then these remain hypothetical (no pun intended).

I've not done a thorough analysis of the probabilities but I suspect that if a large number of HYP's were constructed over 20 years ago from FTSE100 shares then only a relatively small fraction would have performed very badly. This is because of the selection criteria, 15 shares, equal weighted, with each selection taken from a different economic sector. A major reason for this is that there have been certain sectors, most notably banks, that have tanked miserably during this time and likely dragged the cap-weighted FTSE100 down with them. By only having single representation in this sector, and only equal weighted with other shares, any HYP would have been largely shielded from that carnage.

BoE

[tjh290633]

My conclusion is that all HYPs are different in their fortunes, and while HYP1 looks like a case of extreme concentration of both capital and income generation in increasingly few companies as time has passed by I'm not sure that happens in such an extreme fashion with most HYPs; though if left relatively untouched they might sort themselves into winners and losers as my HYP has done, and the income winners may not be the same shares as the capital winners.

This led me to look at my own 36 share portfolio. I have to get down to 15th position before I get to a cumulative weight of 50%:

Value                          
Rank    EPIC   Weight   Com Wt.
    1   BHP     4.04%     4.04%
    2   S32     3.83%     7.86%
    3   BA.     3.73%    11.60%
    4   NG.     3.59%    15.18%
    5   DGE     3.41%    18.59%
    6   BP.     3.36%    21.95%
    7   AV.     3.29%    25.24%
    8   SHEL    3.19%    28.43%
    9   BATS    3.14%    31.57%
   10   TSCO    3.12%    34.69%
   11   RIO     3.08%    37.78%
   12   UU.     3.08%    40.86%
   13   VOD     3.03%    43.89%
   14   SGRO    3.03%    46.92%
   15   GSK     2.99%    49.91%

Looking at income, the top 10 provide virtually 50% of dividend income:

Rank   EPIC   % Income   Cum Inc
   1   RIO       7.52%     7.52%
   2   BHP       6.38%    13.90%
   3   ADM       5.75%    19.65%
   4   IMB       4.90%    24.55%
   5   BATS      4.74%    29.28%
   6   LGEN      4.21%    33.49%
   7   AV.       4.00%    37.50%
   8   VOD       3.98%    41.48%
   9   IGG       3.74%    45.22%
  10   TW.       3.74%    48.96%

Of those, ADM, IMB, LGEN, IGG and TW. do not feature in the top 15 by weight. Only 5 are in the top 15, RIO, BHP, BATS, AV. and VOD.

It's an observation, nothing more. The weight of miners, insurers and tobacco is obvious.

TJH

[Dod101]

[q

No, what this shows is actual resilience of an actual HYP. I'm not aware of many other actual HYP's that look far less healthy, are you? Of course we can all go back in time and design HYP's that cherry pick dogs and would now look awful but that's different from what reality presents us with.

Markets, and portfolios taken from markets, will always evolve this way, i.e. where performance (both capital and dividend) will be largely driven by a small fraction of the total. Interfering with that risks channeling money into poor performers and carries the certainty of higher charges.

Maybe some people will be uncomfortable with the imbalance within HYP1. Are those same people uncomfortable with the outperformance of HYP1 vs the FTSE100? Would they prefer the portfolio was perfectly balanced but with half the capital?

BoE

HYP1 shows resilience until it doesn't. But you really ought to define 'resilience'. Remember the whole idea of a HYP is that it is an income strategy, Capital appreciation is very much secondary. So resilience in this context presumably means 'able to maintain and hopefully increase income'. At its most simplistic it is doing that but at considerable risk. People seem to have forgotten that miners and housebuilders are both cyclical sectors. They happen to have been on a roll recently but it is not that long ago that we were seeing dividend cuts in particularly with miners and HYP1 is very sensitive to that happening again. It seems unlikely that the extraordinary dividends from the miners will continue at current levels indefinitely.

You say,

'I'm not aware of many other actual HYP's that look far less healthy'

I would agree with that, but then I am not aware of many other actual HYPs. I do not run one although I do run a largely income portfolio.

Dod

[Arborbridge]

I don't think it is a matter of having a perfectly balanced portfolio but it is a matter of getting a portfolio better balanced than HYP1 is currently. Miners and housebuilders are cyclical whether you are prepared to admit that or not and yet, out of the top four shares, we have two miners and a housebuilder which between them are providing over 70% of the entire income of the HYP. BAT is the only one I would be happy with where it stands. I appreciate that in the end we are all dead but that setup seems to me to be tempting fate.

Dod

The cyclical nature is showing up, but the diversity down the years has - to some extent - been autobalanced inHYP1, though not as well as I would like. It doesn't seem long that we were criticising HYP1 because most of the income was from BAT. Now it is from holes in the ground. Swings and roundabouts: diversity in action, but that does not mean equal balance at any particular moment.

Still, having made that case, for my personal HYP I do keep things reasonably balanced. Let's not forget that HYP1 was a demonstration hands-off portfolio - it's up to us to use the results of this valuable experiment in any way we like.

Arb.

[MrFoolish]

I come from a background where absolutely no-one, either in my home-life or my work-life, discussed financial matters in those days, even of a basic kind - never mind in terms of such lofty ideas as 'stock market investment'...

Whilst I can't comment on your experience, I find this rather odd. We are only talking 20 years ago, not the stone age. I remember back in Mrs Thatcher's day, people around me were dabbling in privatision shares (tell Sid!) and unit trusts, etc. All the share prices were listed in the newspapers as well.

[Arborbridge]

I come from a background where absolutely no-one, either in my home-life or my work-life, discussed financial matters in those days, even of a basic kind - never mind in terms of such lofty ideas as 'stock market investment'...

Whilst I can't comment on your experience, I find this rather odd. We are only talking 20 years ago, not the stone age. I remember back in Mrs Thatcher's day, people around me were dabbling in privatision shares (tell Sid!) and unit trusts, etc. All the share prices were listed in the newspapers as well.

The key word was "background" - this may not be a mere 20-30 years ago. Assuming IAAG is past the first flush of youth, or similar in age to me, I would say my background would mean my parents' generation and that's way before the Thatcher kids. So, I would have say my experience is the same: I am probably the first to become interested in the stock market from 1986 onwards. There must, however, have been some sort of ideas floating around. I remember me Dad talking about making your money work for you, and myself playing about with compound interest. But he never had any shares, of that I'm sure, and he never discussed finances. Except that after he retired I became aware that he was still making mortgage payments which came out of his state pension. I went to pay it off, and it turned out the balance was only £109! - around 1972.

Arb.