On HYP vs. IT income volatility

[moorfield]

Continuing an interesting discussion developing on Jam's HYP - First Outing as of 11th June 2022 thread here ...

It's the disproportionate effect of one "bad apple" in a HYP-style portfolio that I find the greatest irritant. For instance, if you select a lovely equally-weighted portfolio of 15 shares, with an average annual dividend increase of 7%, it should provide a pretty satisfactory rising income. However, if just one share were to hit the buffers and stop paying, you would find that, rather than keeping up with inflation (almost!), your annual income would actually fall. All of the research that went into finding those 14 excellent shares would be completely negated by one (quite possibly unforeseeable) failure. Investment trusts have the capacity to absorb these hiccups and continue to provide a steady and increasing payout. Consequently, as far as income is concerned at least, I no longer look to "single-share" holdings, though a few do remain in my portfolio.

HYP may not be everyone's cup of tea, but I think it would be a mistake to believe that putting one's funds into Investment Trusts, will solve all problems, and provide an improved result. Maybe it will, but then again, maybe it will not.

If you do have evidence to the contrary, it would be great if you could share it.

Hello Ian

I know you are an ardent HYPer and I am certainly not going to tell anyone that my approach to income investing is better than anyone else's. All I would say is that, in my experience, Investment Trusts have proved more reliable than single-company portfolios when it comes to a steady and generally increasing annual dividend income. The three income IT's I am most familiar with (wrt to largely UK listed companies) are CTY, MRCH and LWDB. Two of these have increased dividends every year this century and the third has only ever held at worst. In contrast, I am unaware of a single HYP portfolio that has avoided at least a couple of annual cuts in dividends over that period. Indeed, HYP1 has actually had a cut in income four times (nearly 50% on the last occasion). It may be that some HYPs do produce better results in the long term, but I need a more reliable (and less volatile) income and I am satisfied that I get that through a portfolio of geographically and sectorally diverse ITs. However, this is simply what suits me, and if you believe your approach will satisfy your requirements then we are both happy investors - which is all that matters!

Some pictures may help here. I thought I would analyse further the variations in annual %age income changes of HYP1, TMPL and our favourite plodder CTY over the same period 2001-21, and have made an assumption that these can be sketched up as a normal distribution (bell curve). [I think this is a reasonable approach, I'm sure the late Gengulphus could have provided some input here. ] From these, one can imply the relative likelihoods of an income cut, which I have fixed at -6.7% (one fifteenth) of overall here. I don't think these charts are that surprising actually and seem to chime with the general view here that IT income streams are smoother.


HYP1
-6.7% income cut probability 28%




TMPL
-6.7% income cut probability 8%




CTY
-6.7% income cut probability - negligible

[moorfield]

And just to be clear, the above charts look at income cuts of at least 6.7%. One can just as easily look at income cuts of less than 6.7%.

In short, based on past performance one can say HYP1 is more likely to suffer larger cuts in income than the ITs, and that the ITs are not immune to smaller income cuts. (Depending on your view of large or small of course.)

HYP1
Less than -6.7% income cut probability 8%


TMPL
Less than -6.7% income cut probability 27%


CTY
Less than -6.7% income cut probability 4%

[MDW1954]

Moorfield,

OK, I'm not Gengulphus, but I think that even Gengulphus would have coughed discreetly and asked for a few more details.

I'm reasonably savvy with statistics (Ph.D in Economics, plus a bunch of real world stuff), but I'm struggling to understand what you've done.

Not wanting to be adversarial, and I'm certainly a huge fan of charts and statistics and data analytics in our collective income investing journey, but I do think that a few more details would be helpful!

One final thought for you to ponder: I assume your data corroborates the use of the Normal distribution? (If so, that's interesting.) I looked at all this in about 2006 or 2007, and struggled (although the paucity of data didn't help). In the end, I gravitated to the Poisson distribution, figuring that it was dividend cuts to zero that interested me most.

Feel free to take this to PM, to avoid clogging up the board. I'm happy to help with this, and if I can, I will.

MDW1954

[moorfield]

Malcolm I was a bit rushed putting this together (on my commute tonight, was bored and playing around with some online calculators I found) and am intending to write more, I will get round to it...

[TUK020]

Isn't there a simpler way to do this comparison? I am thinking of borrowing from much of the work done by Luniversal.

Choice 1: Invest 75k in a basket of ITs, and take the income from these.

Choice 2: Invest a smaller portion (95%?) in an HYP portfolio, and keep the balance in cash as 'derisking'. Only take a % of your dividend income as payout, and then only give yourself a payrise when your cash balance grows to 18 months payout.

[Charlottesquare]

Isn't there a simpler way to do this comparison? I am thinking of borrowing from much of the work done by Luniversal.

Choice 1: Invest 75k in a basket of ITs, and take the income from these.

Choice 2: Invest a smaller portion (95%?) in an HYP portfolio, and keep the balance in cash as 'derisking'. Only take a % of your dividend income as payout, and then only give yourself a payrise when your cash balance grows to 18 months payout.

Catch is most of us will no longer be here by the time the historic data becomes available.

Logic of course suggests one could further derisk re dividend cuts by holding far more than 15 shares, say 100 or 150, become your own in house IT without the in house salaries etc, catch is you likely would have to also start thinking about purchasing directly in overseas markets to get enough qualifying candidates.

They surely really are apples and pears, HYP seems to seek candidates solely mainly from the the FTSE 100, all UK listed, all priced in sterling, an IT approach tends to spread its international wings (maybe some confine themselves to UK focused trusts, but most I suspect have access to the ROW as one of the positive attributes of an IT approach, I certainly do)

[TUK020]

Isn't there a simpler way to do this comparison? I am thinking of borrowing from much of the work done by Luniversal.

Choice 1: Invest 75k in a basket of ITs, and take the income from these.

Choice 2: Invest a smaller portion (95%?) in an HYP portfolio, and keep the balance in cash as 'derisking'. Only take a % of your dividend income as payout, and then only give yourself a payrise when your cash balance grows to 18 months payout.

Catch is most of us will no longer be here by the time the historic data becomes available.

Logic of course suggests one could further derisk re dividend cuts by holding far more than 15 shares, say 100 or 150, become your own in house IT without the in house salaries etc, catch is you likely would have to also start thinking about purchasing directly in overseas markets to get enough qualifying candidates.

They surely really are apples and pears, HYP seems to seek candidates solely mainly from the the FTSE 100, all UK listed, all priced in sterling, an IT approach tends to spread its international wings (maybe some confine themselves to UK focused trusts, but most I suspect have access to the ROW as one of the positive attributes of an IT approach, I certainly do)

Sorry Charlottesquare, I didn't make my point very clearly.

I am not making a point about the relative merits of investment strategies that use ITs to get more diversification through larger portfolios, more geographies, and sectors of market not represented in the FTSE.

I was making the point that it is easier to compare IT dividend income with an income smoothing strategy overlaid on an HYP which results in lower yield (part of the capital held as cash reserve) and lower volatility. Luniversal labelled this income smoothing strategy as "derisking".

[Charlottesquare]

Isn't there a simpler way to do this comparison? I am thinking of borrowing from much of the work done by Luniversal.

Choice 1: Invest 75k in a basket of ITs, and take the income from these.

Choice 2: Invest a smaller portion (95%?) in an HYP portfolio, and keep the balance in cash as 'derisking'. Only take a % of your dividend income as payout, and then only give yourself a payrise when your cash balance grows to 18 months payout.

Catch is most of us will no longer be here by the time the historic data becomes available.

Logic of course suggests one could further derisk re dividend cuts by holding far more than 15 shares, say 100 or 150, become your own in house IT without the in house salaries etc, catch is you likely would have to also start thinking about purchasing directly in overseas markets to get enough qualifying candidates.

They surely really are apples and pears, HYP seems to seek candidates solely mainly from the the FTSE 100, all UK listed, all priced in sterling, an IT approach tends to spread its international wings (maybe some confine themselves to UK focused trusts, but most I suspect have access to the ROW as one of the positive attributes of an IT approach, I certainly do)

Sorry Charlottesquare, I didn't make my point very clearly.

I am not making a point about the relative merits of investment strategies that use ITs to get more diversification through larger portfolios, more geographies, and sectors of market not represented in the FTSE.

I was making the point that it is easier to compare IT dividend income with an income smoothing strategy overlaid on an HYP which results in lower yield (part of the capital held as cash reserve) and lower volatility. Luniversal labelled this income smoothing strategy as "derisking".

My post was the one not clear.

I acknowledged your point but indicated the study might take some time to be worth observing.

I then made the further point (not really responding to your post, so probably ought to have instead made it as a distinct post) , that those going for ITs did it partly for more overseas exposure. (Well in my case)

I then of course (though just 15 minutes ago ) ,contrary to this thought process, picked up some Unilever, BHP ,Smith (DS) and Coca Cola, which sort of indicates that I really follow few rules whilst investing and make decisions according to my gut (in this case decent yields from decent companies) rather than any planned approach. Effectively I buy the odd share when I see value and the odd IT when I want exposure to a particular market and cannot be bothered (am too lazy) to place the two approaches in different compartments.

[moorfield]

Just to come back on this, these are the two web calculators I was playing around with t'other day. So I thought I'd plug in the numbers mentioned to see what came out ...


https://www.calculator.net/standard-dev ... lator.html

https://www.hackmath.net/en/calculator/ ... stribution?

[daveh]

My Income portfolio is somewhat like Charlottesquare's in that I have a large block of HYP shares ( high yield listed in the UK, they do include some "foreign" shares such as BHP, WDS, S32 and go down below the FTSE 100). I then decided I wanted a bit more diversification away from the UK, but also decided I didn't want to buy individual foreign shares (not listed in the UK). I therefore added some high yield ETFs (IAPD, IDVY EMDV) and some high yield ITs (HEFL and MCT) and some green ITs (TRIG and GSF). I also added some VWRL which is not high yield at all, but has historically performed much better than the high yield version VHYL - maybe its time to switch. I've also got a couple of preference shares picked up at around par.

At the moment I'm still in the building phase, but maybe not for much longer If and when I have to live off the income I would definitely do some version of Luni's de-risking strategy. I already have ~ 1year of net income sitting in cash for emergencies, car replacement (which will have to happen at some time in the next 5 years) etc.

I'd definitely take only a percentage of the income. The running yield is ~5.5% according to HYPTUSS and my calculation using this years predicted income gives a similar result, so I'd probably aim to take ~4% and retain the rest as reserve. The question is should I retain the reserve as cash and continue to build my emergency buffer or reinvest back into to portfolio to grow the income?

If I had to live off ~4/5s of the income produce by my IP now it would be tight as that is only 55% of my present take home pay, though I do save a significant % every month. I could take my pension now, but want to wait until I'm at least 60 to take the DB part as there would be a significant actuarial reduction below 60, less after, as a large % of the pension was built up when you could take it at 60 without a cost and for that bit I'm supposed to have retained that right.

[kempiejon]

At the moment I'm still in the building phase, but maybe not for much longer If and when I have to live off the income I would definitely do some version of Luni's de-risking strategy. I already have ~ 1year of net income sitting in cash for emergencies, car replacement (which will have to happen at some time in the next 5 years) etc.

I'd definitely take only a percentage of the income. The running yield is ~5.5% according to HYPTUSS and my calculation using this years predicted income gives a similar result, so I'd probably aim to take ~4% and retain the rest as reserve. The question is should I retain the reserve as cash and continue to build my emergency buffer or reinvest back into to portfolio to grow the income?
.

Me too, still building hopefully not too much longer, I have my HYP in an ISA and other creatures in a SIPP plus a DB pension but that's linked to normal pension age and a sliding deduction 50% for 10 years early.
I hope to start living off the ISA HYP income 2024. When I start living off the income I've promised myself 3 years of cash and I'm letting that cash accumulate now. I've done sums based around taking 90% of the income but it'll only be a couple of years before I can access the SIPP pension and lump sum which would give me a more tidy margin of income over needs and a slightly more indulgent lifestyle.
I think an amount of a couple of years definately needs to be cash as emergency buffer and take the inflation hit for relative piece of mind. If you have an excess of income and a health cash buffer than perhaps re-investing though to my mind I'd rather spend a bit more indulgently. No heirs.