Mainstream British companies typically upped their dividends by 5-10% pa before the pandemic struck in 2020. They are restoring payouts from a more shattered base than at any time in most memories, very cautiously. Few are matching inflation's giant loon-pants strides.
No wonder many who rely on corporate earnings distributions to stay solvent feel more urgently the perennial headache of how much to spend and how much to keep back against rainy days, or Chinese flu deluges. See, for instance, TLF's Retirement board.
The principle of maintaining a reserve to bridge gaps in income received has been observed by investment trusts since what was then Foreign & Colonial Government Trust published its epochal prospectus in 1868: its gross forecast yield was 8% but only 7% would initially be paid to holders of its 24-year 'certificates', despite the theoretical comfort of a cosmopolitan spread of government-backed bonds. That ratio was more cautious than in today's UK Equity Income ITs, which typically retain 1-5% of receipts as revenue reserves: not enough for all seasons.
The 'money illusion' is rife among self-applauding 'dividend heroes': among the big generalists I track, year-on-year increases fail to match inflation almost one-third of the time. At the moment almost every rise is illusory. So hard-pressed rentiers must supplement fund managers' efforts with their own to safeguard purchasing power.
The method I have tested against my model income portfolios is 'derisking'. Its outcomes are shown here to flesh out performance data for my five models here:
viewtopic.php?f=8&t=33342&p=480367#p480367
The 'baskets' of Seven (B7) and Eight (B8) are the income-seekers in this suite. Also derisked for comparison are pyad's original High Yield Portfolio, HYP1; my 'HYP-othetical' HYP06, a similar clutch of Footsie equities drawn in 2010 but back-tracked to 2006; and my real-money 'LuniHYPs' 100 and 250, bought in Jul, 2011 and Jul.2012 respectively and conducted a la pyad.
HYP1 is lightly tinkered by the Onlie Begetter. HYP06 has not been touched since c. 2009. Baskets and LuniHYPs are totally passive; I take whatever comes of 'market trading' and IT managers' caprices.
For the three periods to end-2021 from Nov. 2000, Jan. 2006 and Jul. 2011, City of London Investment Trust provides a benchmark and semi-alternative. It plays a straight bat as a growth and income vehicle, founded on large cap value plays with superior starting yields. Some propose it as a no-fuss counterblast to DIY income investing (1).
To derisk means to set a withdrawal rate at the end of the first year of operation at or below the historic yield on a yardstick such as the FT All-Share Index. How far below is subjective, but because your portfolio has been chosen to yield more than an index, there will be a surplus over what the withdrawal rate lets you spend. This excess establishes an income reserve.
Hopefully Year Two will bring an increase in income; this is first applied to uplift the Year One amount by inflation (I use the Retail Prices Index), preserving Year One's spendable income in real terms. If said uplift takes less than the increase in receipts, stick the difference in the income reserve.
And so ad infinitum. Sometimes you may have to tap the reserve to cover index-linked withdrawals, but more often the reserve will grow. Imitating investment trusts, I aim for one month's worth of current, inflation-adjusted dividend for each year of operation. Once 12 months are in the stash you can think about upping the withdrawal rate- though always remember that a rise is supposed to be permanent+RPI, so do not push your luck, particularly if you sniff another dividend blight looming.
Derisking is not an exact science, and yield hogs may snort at some of the initial yields it produces. But so far this millennium the method would have given purchasing power well beyond what bonds or deposits. Intrinsically those havens are more secure, but my safety mechanisms have prevented cuts in real terms, except lately in the LuniHYPs. Not so individual ITs. Buying a basket mitigates much of their risk; their revenue-reserve belt and my derisking braces eliminated it.
Detailed data is appended. For cackle-cutters, the key indicators are:
WITHDRAWAL RATE: Spendable income after reserving and indexing as a percentage of the latest year's 'raw' collections, including special dividends and returns of cash. Time-weighting supplies the average spendable yield before inflation-proofing on capital values at the start of each accounting year, including occasional hikes in the withdrawal rate.
SAFETY MARGIN: Average reserved percentage of raw income received.
LATEST INCOME RESERVE: After most recent withdrawal in each period. Amount available expressed as number of months for which the reserve would cover the latest withdrawal.
NUMBER OF YEARS RESERVE USED: Out of years in operation.
The following tables therefore sum up the portfolio's past ability to finance rising payouts; how much had to be held back to bridge shortfalls; how often the income reserve was employed; and how well buttressed is the portfolio to face future storms. Figures for 2000-21, 2006-21, 2011-21 and for 2012-21 (LuniHYP250 only):
Moderator Message:
I have had a go at table-formatting Luni's tables. Tables are not a core competency of mine, so what I've done is probably pretty rubbish. The original data is preserved in a "reply" post below, so that my efforts can be improved upon. --MDW1954
I have had a go at table-formatting Luni's tables. Tables are not a core competency of mine, so what I've done is probably pretty rubbish. The original data is preserved in a "reply" post below, so that my efforts can be improved upon. --MDW1954
TIME-WEIGHTED WITHDRAWAL RATE (%)
HYP1: | 4.5 | n.a. | n.a.
B7: | 3.9 | 3.4 | 3.8
B8: | 3.6 | 3.7 | 4.2
HYP06: | n.a. | 4.1 | n.a.
LuniHYP100: | n.a. | n.a. | 4.8
LuniHYP250: | 5.1 | |
CTY: | 4.8 | 4.1 | 4.3
SAFETY MARGIN (%)
HYP1: | 9 | n.a. | n.a.
B7: | 11 | 9 | 10
B8: | 6 | 10 | 12
HYP06: | n.a. | 7 | n.a.
LuniHYP100: | n.a. | n.a. | 14
LuniHYP250: | 14 | |
CTY: | 9 | 9 | 14
NUMBER OF YEARS RESERVE USED (of 21 | 16 | 10)
HYP1: | 5 | n.a. | n.a.
B7: | 3 | 0 | 0
B8: | 0 | 0 | 0
HYP06: | n.a. | 4 | n.a.
LuniHYP100: | n.a. | n.a. | 4*
LuniHYP250: | 4* (of 9) | |
CTY: | 2 | 1 | 0
LATEST INCOME RESERVE (months)
HYP1: | 5 | n.a. | n.a.
B7: | 16 | 19 | 11
B8: | 11 | 16 | 13
HYP06: | n.a. | 12 | n.a.
LuniHYP100: | n.a. | n.a. | 18*
LuniHYP250: | 17* | |
CTY: | 17 | 13 | 16
*after cut
Time-weighted yields range from 3.4% to 5.1%. Most fall into the 4-5% zone. The LuniHYPs have done best, though their withdrawal rates were arguably too optimistic with the hindsight of the 2020-21 dividend crisis. So I have followed many blue chip boards in prudent precaution: applying trims to withdrawal rates of 15%. They leave the Footsie portfolio still yielding 4.8% and the midcaps one 5.0%, with brimming income reserves to handle any more trauma.
A withdrawal rate is governed partly by a trade-off between 'juiciness' at launch (which depends on how markets appraise economies) and perceived safeness and steady outflow of the juice, something we are taught cannot be discerned more than a year or two ahead.
HYP1 began on a tremendously elevated yield of more than twice the All-Share's. Sentiment was polarised between bouquets for the 'new economy' (internet) and boos for the 'old', whose cheap stocks pyad naturally preferred. Such conditions gave HYP1 a flying start. They have not recurred since the end of the dotcom mania.
HYP06 and the LuniHYPs began with yields moderately (in my parlance, 'optimally') above average This has meant a more smooth progression of gross income than HYP1's and less need to keep up the spending power over time by transfers to reserves. But LuniHYPs have gained from large special payouts such as Cineworld's and Standard Life's.
HYP1 has yielded 4.5% since 2000, by dint of dipping into its reserve in five years, more than other models. It closed last year to Nov. with only five months of dividend to fall back upon despite a banner year of bounceback, thanks to the mining boom. Pyad's capital performance has been second only to the Basket of Seven's, and apart from 'not mattering' it is not sure to stay second; at times HYP1 has allowed pyad to brag about capital growth when income was going into reverse.
Sticking to one's income guns, however, one cannot help notice that City of London yielded 0.3 more than HYP1 in 2000-21. It has beaten everything for derisked income over all periods except for the LuniHYPs in the past decade or so. Which raises the question: why not pile 100% into Uncle Job's care home and forget the fuss?
CTY's only real eccentricity, though, is to keep a very low revenue reserve compared with its peers. It has always done so, and after the covid drought, in Jun. 2021 it was down from ten to seven months. Some will opt for the assurance of a collection of such trusts.
Safety margins mostly fall into the 9-12% range whatever the time period, but as CTY has laboured to retain the blue riband of Dividend Heroes- 54 consecutive annual rises- its low payout cover has necessitated a derisking SM of 14% in 2011-21. That might be ominous. Certainly capital performance over the decade has been lacklustre, topped off by the worst share price fall since 2007-08 in 2020-21. Is CTY sacrificing profit by maxing out revenue? At least it has only declared an uncovered payment twice in 21 years.
Apart from HYP1, models have used their income reserves rarely. HYP06 tapped it four times in 16 years and the B7 thrice in early years, but until 2020/21 all abstractions were small; they reflected the initial impact, soon washing out, of a jack-up in a withdrawal rate. No model shows any sign of bleeding reserves or burning capital. Apart from the B8, which narrowly missed the mark in 2011-21, all have preserved or enlarged their realisable value after inflation. And all but HYP1 hold the desired year or so's backup income.
One aspect this study does not address is 'balance'. HYP1 notoriously has depended on a few of its positions for the bulk of income, though they have rotated. My detailed analyses of other portfolios find no bothersome biases emerging over long hitches. I attribute this, without being able to prove anything, to my more disciplined praxis in reinvestment, whereas pyad inclined to go nap on his current fancies when he got a market-trading windfall. Obviously baskets are far more diversified than DIY equity spreads, and CTY alone has 82 holdings. Anyone operating a 15-25 share portfolio has to accept that she is a conviction investor, willy-nilly.
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(1) Well, up to a point. CTY is 15% in overseas stocks, churns for capital profits, has a dab of gearing, practises discount control... but otherwise Job Curtis has run probably as close to a plain-vanilla HYP as you can get.
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(1) NOVEMBER 2000-21
HYP1
Gross income CAGR 6.3%
RPI inflation CAGR 3.0%
-------------------------------------
WITHDRAWAL RATES
Initial 3.5%
--as % of FT All-Share yield 106%
Time-weighted average (21 years) 4.5%
Current 6.3%
----------------------------------------------
AVERAGE SAFETY MARGIN 9%
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INCOME RESERVE (months)
at Year Five 13
at Year Ten 9
at Year Fifteen 13
Highest 19 (Year Nineteen)
Lowest 4 (Year One)
Latest 11
Number of years reserve used 5/21
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Basket of Seven
Gross income CAGR 5.2%
RPI inflation CAGR 3.0%
-------------------------------------
WITHDRAWAL RATES
Initial 2.5%
--as % of FT All-Share yield 76%
Time-weighted average (21 years) 3.9%
Current 5.7%
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AVERAGE SAFETY MARGIN 11%
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INCOME RESERVE (months)
at Year Five 21
at Year Ten 23
at Year Fifteen 21
Highest 24 (Years Eleven/Seventeen)
Lowest 14 (Year Two)
Latest 16
Number of years reserve used 3/21
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Basket of Eight
Gross income CAGR 3.8%
RPI inflation CAGR 3.0%
-------------------------------------
WITHDRAWAL RATES
Initial 3.3%
--as % of FT All-Share yield 94%
Time-weighted average (21 years) 3.6%
Current 3,9%
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AVERAGE SAFETY MARGIN 6%
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INCOME RESERVE (months)
at Year Five 2
at Year Ten 10
at Year Fifteen 9
Highest 12 (Year Nine)
Lowest 1 (Year Two)
Latest 11
Number of years reserve used 0/21
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City of London Investment Trust
Gross income CAGR 3.9%
RPI inflation CAGR 3.0%
-------------------------------------
WITHDRAWAL RATES
Initial 3.0%
--as % of FT All-Share yield 91%
Time-weighted average (10 years) 4.8%
Current 5.5%
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AVERAGE SAFETY MARGIN 9%
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INCOME RESERVE (months)
at Year Five 15
at Year Ten 11
at Year Fifteen 13
Highest 17 (Years Twenty, Twenty-One )
Lowest 9 (Years One, Seven)
Latest 17
Number of years reserve used 2/21
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(2) JANUARY 2006 - DECEMBER 2021
Basket of Seven
Gross income CAGR 6.6%
RPI inflation CAGR 3.1%
-------------------------------------
WITHDRAWAL RATES
Initial 2.1%
--as % of FT All-Share yield 72%
Time-weighted average (16 years) 3.4%
Current 4.3%
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AVERAGE SAFETY MARGIN 9%
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INCOME RESERVE (months)
at Year Five 6
at Year Ten 14
Highest 16 (Year Twelve)
Lowest 1 (Year Two)
Latest 13
Number of years reserve used 0/16
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Basket of Eight
Gross income CAGR 3.7%
RPI inflation CAGR 3.1%
-------------------------------------
WITHDRAWAL RATES
Initial 3.6%
--as % of FT All-Share yield 104%
Time-weighted average (16 years) 3.7%
Current 3.9%
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AVERAGE SAFETY MARGIN 10%
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INCOME RESERVE (months)
at Year Five 9
at Year Ten 13
Highest 17 (Year Fifteen)
Lowest 0 (Year One)
Latest 16
Number of years reserve used 0/16
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HYP06
Gross income CAGR 3.5%
RPI inflation CAGR 3.1%
-------------------------------------
WITHDRAWAL RATES
Initial 3.6%
--as % of FT All-Share yield 124%
Time-weighted average (16 years) 4.1%
Current 4.4%
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AVERAGE SAFETY MARGIN 7%
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INCOME RESERVE (months)
at Year Five 6
at Year Ten 16
Highest 17 (Year Eleven)
Lowest 1 (Year One)
Latest 12
Number of years reserve used 4/16
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City of London Investment Trust
Gross income CAGR 4.7%
RPI inflation CAGR 3.1%
-------------------------------------
WITHDRAWAL RATES
Initial 3.6%
--as % of FT All-Share yield 124%
Time-weighted average (16 years) 4.1%
Current 4.7%
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AVERAGE SAFETY MARGIN 9%
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INCOME RESERVE (months)
at Year Five 10
at Year Ten 11
Highest 17 (Year Fourteen)
Lowest 1 (Year One)
Latest 13
Number of years reserve used 1/16
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(3) JULY 2011 - JULY 2021
Basket of Seven
Gross income CAGR 5.9%
RPI inflation CAGR 2.6%
-------------------------------------
WITHDRAWAL RATES
Initial 3.3%
--as % of FT All-Share yield 100%
Time-weighted average (10 years) 3.8%
Current 4.3%
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AVERAGE SAFETY MARGIN 10%
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INCOME RESERVE (months)
at Year Three 6
at Year Seven 7
Highest 11 (Year Ten)
Lowest 2 (Year One)
Latest 11
Number of years reserve used 0/10
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Basket of Eight
Gross income CAGR 5.4%
RPI inflation CAGR 2.6%
-------------------------------------
WITHDRAWAL RATES
Initial 3.6%
--as % of FT All-Share yield 116%
Time-weighted average (10 years) 4.2%
Current 4.6%
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AVERAGE SAFETY MARGIN 12%
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INCOME RESERVE (months)
at Year Three 9
at Year Seven 11
Highest 13 (Years Four, Nine, Ten)
Lowest 1 (Year One)
Latest 13
Number of years reserve used 0/10
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LuniHYP100
Gross income CAGR 8.1%
RPI inflation CAGR 2.6%
-------------------------------------
WITHDRAWAL RATES
Initial 4.0%
--as % of FT All-Share yield 129%
Time-weighted average (10 years) 4.8%
Current 5.0% (after cut in Year Ten)
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AVERAGE SAFETY MARGIN 14%
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INCOME RESERVE (months)
at Year Three 9
at Year Seven 12
Highest 18 (Years Four, Ten)
Lowest 2 (Year One)
Latest 18 (after withdrawal rate cut)
Number of years reserve used 4/10
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City of London Investment Trust
Gross income CAGR 3.8%
RPI inflation CAGR 2.6%
-------------------------------------
WITHDRAWAL RATES
Initial 3.6%
--as % of FT All-Share yield 116%
Time-weighted average (10 years) 4.3%
Current 4.6%
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AVERAGE SAFETY MARGIN 14%
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INCOME RESERVE (months)
at Year Three 11
at Year Seven 12
Highest 16 (Year Ten)
Lowest 4 (Year One)
Latest 16
Number of years reserve used 0/10
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(4) JULY 2012 - JULY 2021
LuniHYP250
Gross income CAGR -5.4%
RPI inflation CAGR 2.9%
-------------------------------------
WITHDRAWAL RATES
Initial 4.5%
--as % of FT All-Share yield 136%
Time-weighted average (10 years) 5.1%
Current 4.8% (after cut in Year Nine)
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AVERAGE SAFETY MARGIN 14%
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INCOME RESERVE (months)
at Year Three 12
at Year Six 24
Highest 24 (Year Six)
Lowest 3 (Year One )
Latest 17
Number of years reserve used 4/9
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