HYP1 versus the baskets: 2000-23

[Luniversal]

Here is a 23rd-year comparison of income delivery and capital performance, including volatility, between the inventor pyad's specimen High Yield Portfolio, HYP1, and income investment trusts. HYP1's results were reported by pyad on Friday, on the HYP Practical board.

My alternatives are 'baskets' of seven (B7) or eight (B8) investment trusts (1). These are tasked with the same objective as a High Yield Portfolio. All seek a sizeable, steadily growing and reasonably stable income from a lump sum, to supplement if not replace pensions on retiral. Voluntary 'tinkering' with the original components is deemed superfluous by your correspondent. If, rarely, a trust is taken over, either the bidder's paper is substituted or cash directed into another trust that fits the objective.

The B7 and B8 were devised in 2010 and back-calculated to HYP1's launch date on Nov. 12, 2000. To provide for hindsight bias (though any such would have dissipated after 13 years' onward evolution) average outcomes are also shown for all larger UK Equity Income sector trusts available when HYP1 was launched: the 'Universe of 24' (U24) (2).

I have added stats for City of London Investment Trust (CTY) and Merchants Trust (MRCH). They are often judged as HYP-ish in their income goals and portfolios, though each also aims to grow capital values... eventually.

For all options it is assumed that £75,000 gross was invested in equal amounts before 1% purchase expenses, with no later dividend reinvestment or capital top-ups. Compound annual growth rates (CAGR) are timed to eliminate arbitrary variations in dividend entitlements arising before Jan. 2002. Deflation is by the Retail Prices Index; inflation compounded at 3.6% pa through the timespan, but has fallen from over 14% to 6.1% in the past year. It is assumed this will be Dec.'s annual rate as well.


INCOME

Totals for 2023 (£)...Change from 2022 (%)...Totals since launch (£)...CAGR 2002-23 (%)...Number of falls year-on-year (out of 22 changes)

HYP1: 7,729..-30.5...131,247...3.9...6
B7: 7,264*...+4.8...107,977...5.9...3
B8: 6,140*...+5.0...95,287...4.3...3
U24: 5,610*...+3.5...90,976...4.1...3
CTY: 6,234...+1.8...98,960...4.5...0
MRCH: 5,564...+2.6...99,716...5.5...0

*A few dividends payable by Dec. 31 are my guesses pending declarations: ASEI in B8 and U24; CTUK, in B7 and U24.

HYP1's income had rebounded mightily in 2020-21: in the latest year it sank by one-sixth in real terms. In money terms it was the lowest collection since 2016-17. The trusts scraped small nominal rises and have shed purchasing power a little less abruptly.

The Basket of Seven is plotted to grow income steadily in real terms, or at least maintain it. Not so in 2022-23. Since the sweeping pandemic dividend cuts among the companies which its portfolios hold, recovery has been limited and subinflationary. The B7's real income declined by 1.3% from 2021-22.

During the whole run HYP1 has generated 22% more income than the B7, and 38% or 44% more than the B8 or U24. HYP1"s revenue arrived far more erratically: in six out of 21 full accounting years HYP1's nominal intake fell year on year by an average of 21.4%, whereas the B7 slipped three times, averaging 9.2%.

The Basket of Eight"s stream ran smoother still, also with three falls but only 2.5% on average. It was planned for shorter-term income-seekers, on a 'juicier' immediate yield drawn from trusts that prided themselves on progressive paying out, with occasional help from revenue reserves. The drawback is lower potential: the Eight's CAGR is c. 4% pa versus 6% or more for the B7. In good times and bad, the B7"s income has been twice as 'growthy'. lts cumulative total delivery surpassed the B8's after eight years, and in 2023 was again £1,100 more. The gap will likely never be narrowed.

All this emphasises that the B8 is for the middle-distance holder, not the marathon runner. Still, all three demos produced long-term real growth in income since Nov. 2000, if not lately.

The 'Universe' takes in mavericks such as Nick Train's Finsbury, which lingers in the official UK Equity Income sector despite a low yield; STS Global and Aberdeen Diversified Income & Growth, with their mercurial policy shifts; and the family-dominated Brunner, which arguably should never have been included. These have been less able or willing to increase generous dividends steadily than vanilla trusts which, like HYP1, lean largely on British blue chips. The U24/22 houses two (then under the same management) which broke down, labouring for ever after to repair their payouts: Shires Income and Troy, the former Glasgow Investment Trust. Troy has 'reset' again, while Shires's dividend rate shows little velocity.

Hence payouts from the Universe run below the B8's. The CAGR, from a depressed base in 2000, remains fractionally below the B8's, as is its actual accumulated disbursement.


DERISKING

This is a way of ensuring that vital purchasing power is safeguarded: one sets a portion of receipts aside in an income reserve, available in tough times such as these. Spendable income increases in line with the RPI and should never buy less than at the outset. The 'safety margin' is the percentage of accumulated receipts held back since 2000.


Amount withdrawn (£)...Safety margin (%)...CAGR of withdrawn amount (%)...Average reserve, 2000-23 (months)...Reserve at end-2023 (months)...Average yield on capital (%) for amount withdrawn:

HYP1: 126,583...4...7.4...11...5...4.6
B7: 101,540...6...13.2..19...9...3.1
B8: 90,631...5...4.5...8...9...4.2
U24: 84,628...7...4.8...12...12...3.7
CTY: 91,888...7...6.6...13...13...4.1
MRCH: 103,084...0...5.0...9...0...5.3


HYP1's superior revenue generation is the flip side of that revenue's waywardness. If your income finances necessities, isolate part of your receipts to cushion purchasing power.

My way of building an income reserve is to fix a withdrawal rate once the first year's money is in the bank: somewhat below your total haul. Uplift the spendable portion by inflation annually and let the surplus accumulate until it shields you: say 12 months' worth of whatever is the current amount being withdrawn. Thereafter you may have room now and then to withdraw more, but be wary, especially while we are in the driest dividend drought in memory.

'Derisking' income furnishes a margin of safety between received and spent. In a HYP1 thus adjusted it has averaged 4% of raw income; the CAGR for spendable income was 3.9% against 7.4% from receipts. The big drop in 2022-23 means that it is set to close with a reserve of 5 months' spendable. It is a worrying six months below the average through HYP1's life. Unless inflation disappears, the withdrawal rate may have to be cut from its hitherto excellent 6.3%, though it should stay over 5%. {Had the rate been pegged at 4%+RPI throughout, the reserve today would be fiveyears, not five months.)

The baskets are reasonably protected, with nine months in reserve at each. However the reserve has dwindled at the B7 while filling up moderately at the B8: not the normal state of affairs. Merchants has far more reason to fear, since maintaining the 4.8%+RPI it could have shelled out for two decades-- the longest stasis in the survey-- would have drained its reserve dry by end-2023. A cut looks inevitable.

Both these trusts sport proud records of annual dividend increases: 57 years at City of London, 41 at Merchants. Their lead managers have been in post for 30 and 17 years respectively. Simon Gergel of MRCH has seldom walked down the middle of Capital & Income Road as adroitly as CTY'S Job Curtis, but it would have been difficult to foresee that. Moral: do not try to pick winners or count on 'reversion to the mean'. Bet the field and buy a spread.

IT directors say they are overhauling portfolios to render inflows more dependable, but that since this entails swapping in lower starting yields as a trade-off, payouts may have to lag the RPI for a while. Here's hoping refurbishment does not go on long enough to drain reserves.

So what did these variances in policy and method, and holding back part of raw inflows, do for folks who want a stabilised running return from equities, not delight followed by dearth?


ANNUAL WITHDRAWAL YIELDS (%)

HYP1: Years 1-5: 3.5...6-16: 4.4...17,18: 5.3...19-23: 6.3
Time-weighted average: 4.7
Maximum reserve: 19 months (2019)

B7: Years 1-6: 2.5...7-11: 3.3...12-17: 4.1...18-23: 5.7
Time-weighted average: 4.1
Maximum reserve: 24 months (2012, 2017)

B8: Years 1-9: 3.3...10-23: 3.9
Time-weighted average: 3.7
Maximum reserve: 12 months (2009)

U24: Years 1-8: 3.0...9-14: 3.3...15-23: 3.8
Time-weighted average: 3.4
Maximum reserve: 18 months (2020)

CTY: Years 1-2: 3.0...3-5: 3.8...6-13: 5.0...14-23: 5.5
Time-weighted average: 4.9
Maximum reserve: 17 months (2020,2021)

MRCH: Years 1-3: 3.6...4-23: 4.8
Time-weighted average: 4.6
Maximum reserve: 12 months (2007,2010,2011)


The table shows what set-asides could have meant for your pocket; how spendable income, as a yield on the £75,000 subscription, might have grown, if jacking up the abstraction rate was affordable without imperilling the reserve.

Fixing the withdrawal rate is art, not science, though the starting withdrawal yield for all but the B7 was at least as high as that of the All-Share Index at the time, honouring the H in HYP. Patterns reflect smoothness and size of the raw intake, and so are very mutable.

In conditions haunted by uncertainty, it would be rash to raise any withdrawal rate. In my illustration none could have been so raised since lockdown began in Mar. 2020. Regarded as an indexed payer-- without guarantees of capital preservation but a sporting chance of profit if held long enough-- the three portfolio options and CTY are viable. Just don't expect to cash in at any moment without fear of a loss.

Despite 'income gutted' lately, HYP1 still shows that a juicy bunch of directly held blue chips can return more, after inflation protection, than ITs with their double layer of small internal revenue reserves and derisking holdbacks. HYP1's time-weighted 4.7%+RPI withdrawal rate easily trumped the baskets or a tracker-like U24 crowd; though CTY is jostling it for pole position at present, I reckon HYP1 will see it off in the medium term.

As always, my main proviso is that HYP1's performance may not be replicable for starters in 2023. It was launched on a very unusual high tide of fat yields; in late 2000 former Footsie favourites had been eclipsed by the charisma of 'new economy' stocks, so income could be pinned down dirt cheap. A High Yield Portfolio launched in 2023 would encounter a much narrower choice of safeish yields appreciably above the 4%-odd of the FTSE 100. Added to that is the problem of finding the minimum fifteen shares in discrete sectors with 'five years of rising dividends' as pyad originally stipulated. Moreover, the Footsie's sectoral representation has narrowed bigly since 2000. Some will bend the rules and invoke the 'extraordinary times' clause.

A worry more specific to HYP1 is the narrow base of its success, analysed in other threads on this board. In 2022-23 it drew the bulk of its receipts from three constituents out of 16: Rio Tinto, Persimmon and British American Tobacco. RIO and PSN are dispensing less, and BATS's payout only limps ahead. Where else will surges of income arise?

I do not believe an untinkered portfolio necessarily concentrates its prosperity parlously. My 'LuniHYPs' have not done so after more than ten years; nor do the basket trusts display wild variances. HYP1 made some farm-bet selections after the initial equal-weight apportionment which, IMO, account for today's skewed distribution and is hampering immediate exuberance income-wise.

The Basket of Seven is a tortoise that has yet to catch pyad's hare. It could offer only 2.5%+RPI over its first six years, but growthiness propelled three rises which lie behind its spendable CAGR of 13.2%. They took the rate to 5.7% by 2020.

The B8 could have paid a derisked 3.3% for the first nine years, 3.9% thereafter... but with no more hikes for 14 years. Its torpor, compared with the B7, appears unlikely to be jolted if its managers go on rotating FTSE 100 stocks. Those firms are too fond of diverting cash surpluses to buybacks and bolt-on acquisitions, rather than giving the owners a sniff. Ukraine, increased borrowing costs and political hurlyburly are excuses from boardrooms, beyond which we keep reading that earnings cover got too low and must be permanently 'reset'. The 20-Twenties is becoming the era of jam tomorrow, and less of it than in recent decades.


CAPITAL

The time-weighted payouts from these models compare quite well with index-linked annuities; and with portfolios you keep hold of the investment. Some comfort when income is struggling, even if 'capital does not matter'.

Value at Nov. 11, 2023 (£)...Real change in year (%)...Real CAGR since launch (%)...Number of real falls year-on-year (out of 23 changes, 2000-23)

HYP1: 145,829... -11.9...-0.7...9
B7: 169,071...-11.7...-0.1...9
B8: 114,073...-11.3...-1.8...10
U24: 128,690...-12.0...-1.3...11
CTY: 118,957...-10.0...-1.6...11
MRCH: 100,188...-14.3...-2.3...13
---------------------------------------------------------
FTSE 100: 7360.55...--5.5...-2.8...11
FT All-Share: 3997.59...-7.1...-2.4...11


Dealers' prolonged aversion to British equities, and latterly to old-economy blue chips, forced valuations lower again. All six models have lost real worth since Nov. 2000; the B7 barely, the over-juicy Merchants bigly. The most that can be said is that the stockmarket did worse and fell between years broadly as often-- about half the time. HYP theory prefers FTSE100 choices, and its real capital-value shrinkage of 0.7% pa compares with the Footsie's dire -2.8%.

Taking the original £75,000 principal as 100, in deflated terms 23 years later HYP1 is 84 (2022: 96), the B7 98 (110), the B8 66 (75) and the U24 74 (84). City of London is 69 (77) and Merchants Trust 58 (68). The FTSE100 is an abysmal 52 (55) and the All-Share 57 (62). Thus the demos beat indices, but only-- apart from the B7-- inasmuch as they shed value more slowly.


OUTLOOK

HYP1 is at its cheapest in real terms since it began, the Basket of Seven cheapest for 15 years. The B8 is worth two-thirds of the original stake. How seriously a long-run income investor regards such reverses depends on how likely she is to liquidate a portfolio before death.

The most glaring divergence is between HYP1 and the Seven. On the one hand, HYP1 can probably sustain a substantially better derisked payout even after the threatened trim. On the other, whether because of its juiciness or not, its cashed-in value has now been lagging the 'growthier' B7's for more than a decade. The large but lumpy dividends HYP1 collects did not translate into bullish share prices, implying that dealers feel they may be unrepeatable; whereas B7 managers, not limited to Footsie and near-Footsie picks, hold overseas and smaller shares which possibly promise more.

The baskets also deploy stratagems not open to a High Yield Portfolio, such as gearing, discount control, option-writing and using pref stocks to bump up and stabilise revenue. Those gambits may not always polish results. In my observation they do, more often than not.

The present consensus seems to be for total equity returns after inflation of c.6-7% pa during the rest of the decade, split 50/50 between inc and cap-- perhaps a little more on the side of payouts. Together with historically cheap earnings multiple and a depressed outlook-- favouring sectoral staples and essentials over go-gos-- the stuff of HYPs and baskets could be poised for renewed popularity... despite more competitive running returns from less frisky and risky savings havens. Certainly the immemorial rule of thumb of a 4% yield from shares looks well within reach; with the Footsie and FTSE250 promising as much from Day One, you hardly need to stick your neck out. An AYP (Average Yield Portfolio) might suffice. Anyhow, over time, risk assets with income attached should hold out the best hope of positive returns.
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(1) Last year's comparison:

viewtopic.php?f=31&t=36822&p=548510#p548510

Previous year"s:

viewtopic.php?f=31&t=32198&p=459591#p459591

Detailed annual reviews of the B7 and B8 can be found by searching 'Basket of Seven/Eight' on the Investment Trusts board.

(2) Besides the fifteen, now thirteen, basket members, others in the Universe of 24 are Aberdeen Diversified Income and Growth (formerly BlackRock Income Strategies, previously British Assets) (ADIG); Brunner (BUT); Diverse Income Trust (DI8VI); Finsbury Growth & Income (FGT); Scottish American Investment (SAIN); STS Global Income and Growth (STS); Shires Income (SHRS); and Troy Income & Growth (TIGT).

The U24 is really a U22 now, since corporate events resulted in AEI and MUT being held in both baskets.[/quote]

[Lootman]

The most glaring divergence is between HYP1 and the Seven. On the one hand, HYP1 can probably sustain a substantially better derisked payout even after the threatened trim. On the other, whether because of its juiciness or not, its cashed-in value has now been lagging the 'growthier' B7's for more than a decade. The large but lumpy dividends HYP1 collects did not translate into bullish share prices, implying that dealers feel they may be unrepeatable; whereas B7 managers, not limited to Footsie and near-Footsie picks, hold overseas and smaller shares which possibly promise more.

That idea - that aiming for high income from the outset comes at the price of lower growth and total returns longer-term - is of course a fairly intuitive notion. If there is no free lunch in the markets then more jam today implies less jam tomorrow.

Similarly a focus on only UK large-cap shares is a handicap, at least in a world where we consistently see higher growth rates in other countries, as the UK sedately continues its decline. In fact the UK was 10% of global market cap 25 years ago - now it is about 4%. And the FTSE-100 has done nothing in that time. So how could any UK-centric investment approach have out-performed during that period, absent a lot of risk, luck or both?

You might include a global tracker in your study. If as I suspect that will have out-performed both your baskets and any form of HYP then there really is a very simple method of providing superior long-term cashflows, especially if the portfolio is taxable. For that matter you could probably have put the lot in Berkshire Hathaway (which pays no dividends), sold off 4% a year, and been perfectly happy.

So your conclusion does not surprise me, although it is good to see it confirmed by your deep analysis.

[pyad]

Perhaps the most interesting point imo from Luniversal's comparisons is this quote:

...During the whole run HYP1 has generated 22% more income than the B7, and 38% or 44% more than the B8 or U24. HYP1"s revenue arrived far more erratically....

Sorry IT enthusiasts, (or at least those Luniversal selected) you've been well beaten on income in every case and FWIW on capital too for all but one of his various comparisons. Of course this came with the not unexpected far greater volatility of the HYP but even so the good income outperformance is there.

[Itsallaguess]

Sorry IT enthusiasts, (or at least those Luniversal selected) you've been well beaten on income in every case

The problem with that, of course, is that I suspect that the huge majority of income-IT 'enthusiasts' are never looking for 'highest income' as being the most important aspect of their income-strategy, as they're likely to place much more emphasis on reliability and diversification than on that specific metric.

As has been discussed at length elsewhere, for many income-IT investors, 'winning the income race' seems to be much less important than being safe whilst running it...

Cheers,

Itsallaguess

[Lootman]

Sorry IT enthusiasts, (or at least those Luniversal selected) you've been well beaten on income in every case

The problem with that, of course, is that I suspect that the huge majority of income-IT 'enthusiasts' are never looking for 'highest income' as being the most important aspect of their income-strategy, as they're likely to place much more emphasis on reliability and diversification than on that specific metric.

As has been discussed at length elsewhere, for many income-IT investors, 'winning the income race' seems to be much less important than being safe whilst running it...

Yes and a rather mindless focus on income and nothing else is dangerous. So even in the IT world you can find trusts with a very high running yield but that can be done by using tricks like selling options on the constituents shares or playing games around XD dates.

Investors are often willing to accept a lower level of income in return for better growth and total return prospects, a lower risk and volatility profile, and more diversification and quality. Looking at just one variable and ignoring all the others is amateur hour.