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Basket of Eight: 2021 review

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Basket of Eight: 2021 review

#464307

Postby Luniversal » December 8th, 2021, 5:16 pm

The Basket of Eight (B8) was devised in 2010 for the ignorant and apathetic investor who needs to pay bills as they fall due. The portfolio pursues a flow of income from UK equity-based investment trusts. Its purchasing power should at least be constant over time. It should as far as feasible be 'fire and forget'.


B8 members were to be bought in equal amounts: City of London (CTY), Dunedin Income & Growth (DIG), Edinburgh (EDIN), Invesco Income Growth (IVI), Merchants Trust (MRCH), Murray Income (MUT), Schroder Income Growth (SCF) and Temple Bar (TMPL).


IVI was absorbed by Invesco Select Trust and has been replaced by Aberdeen Standard Equity Income (ASEI). Data from the retroactively calculated B8 launch date in 2000 has been adjusted accordingly, but actual results suppose that ASEI was bought to replace IVI on Apr. 21, with dealing costs provided for. See the 2020 review update [1]:

viewtopic.php?f=54&t=25362&p=405863#p405863


Latest results are for financial years closing between Jul. 2020 and Jun. 2021. Results are aggregated to a common Jun. year end, since this best fits accounting dates. Trends since the B8's backtested launch on Nov. 10, 2000 (also when pyad's 'HYP 1' began) are reviewed.

Apologies for a belated report, due to domestic distractions. Comparisons between the B8 and HYP1, as well as the Basket of Seven [1], can be found at

viewtopic.php?f=31&t=32198[1]



INCOME
The B8 endured more strain and change in its 21st year than in all others put together. The wave of pandemic dividend cuts among trusts' holdings was more widespread and deeper than in the two earlier recessions, 2000-02 and 2008-10.


One member, Temple Bar, suffered a worse collapse of asset value and income between years than any seen before. Edinburgh sacked its longstanding managers and tried to regroup from a more cautious base. Both constituents retained their objectives and will be left to heal themselves, in line with my hands-off inclinations.


The portfolio absorbed these buffetings relatively well. Regular dividends per share fell 3.4% (2019-20: up 1.1%) after retail price inflation (RPI). Nevertheless, it was the poorest year-on-year showing to date; but directly held assemblages of British blue chips, in unit trusts or High Yield Portfolios, were taking hits of 30-50% without benefit of the revenue reserves maintained by investment trusts for hard times.


The B8 has averaged a real rise in income of 0.3% pa over its lifespan, but that was only in its first decade. A drop of 1.0% pa is the fruit of the second half, and the latest year is to blame.


Trusts were taking in-- or being denied-- payouts from companies which had reacted by reducing or skipping dividends as they waited for pandemic dust to clear. Since mass vaccination last autumn, many companies (especially the FTSE100 stocks the B8 chiefly relies on) have set about reinstating pre-covid levels of distribution; most trusts sound optimistic that their revenues will duly snap back. For example, MUT said that it expects to cover an increased dividend from revenue in the year to Jun. 2022, and though others are less explicit, the general mood is sunnier.


However, they tend to talk about nominal rather than post-inflationary increases when trumpeting 'dividend hero' credentials. Inflation has shot up from 0.5% to 6.1% since the last annual review.


Some companies are resetting dividend rates substantially lower. Other rates are becalmed or becoming more variable: special handouts instead of the ideal progressive trend. So one cannot be too optimistic that it will be business as before-- a real rate of payout growth of 2% pa or more-- any time soon.


The portfolio's yield at Jun. 30-- based on historic or officially forecast payouts and £75,000 gross invested-- was 4.4% (2020: 5.6%). This is cheaper than the average yield of just over 4% throughout its life; the B8 yielded 1.6 percentage points more than the FT All-Share Index (FTAS) at the year end, twice as much as a year earlier. but one must allow for FTAS yields being much tougher to guess than normal.


The basket distributed income uncovered by current earnings for the second time since the wake of the global financial crisis in 2011-12: average cover was 0.75 (0.98) times, the thinnest year. whereas it never reduced below 0.94 times previously. Every constituent drew on revenue reserves, five more heavily than in any earlier year.


We can only hope that reserves will last until covered payouts become feasible again, which means in no more than two or three years. Otherwise trusts will either have to 'rebase' or begin to supplement earnings with handouts of realised capital gains-- an expedient hardly any have wanted to employ since it was legalised in 2014.


Over its lifespan the B8 has covered dividends 1.02 times. The average revenue reserve shrank from 11 to 9 months of current payout in the composite year: the smallest since the dotcom bust ended. A year's worth of the latest payout in hand is customarily regarded as adequate, but only Dunedin, Edinburgh and Schroder Income can now boast as much now.


Boards have pressed managers to pummel fees and scrap incentive payments. The basket's Ongoing Charges Ratio was 0.51%, down from 0.58%, or 0.64% throughout the B8's span. That alerts us to the compensatory effect of net asset values (NAV) after the relief rally, and the near-doubling of Murray Income's: a broader base spreads fixed costs. There is, too, a continuing uplift from the refinancing of fixed debt, taken out years ago when interest rates were not yet flattened by fiat. Trusts are anxious to install debt now money is cheap while investment returns are swinging back up, though gearing of no more than 10% is the norm.


Revenue expenses, which come off distributable income, reduced from 5.3% of the payout to 5.2%, the lightest yet. This ratio has lain in the 5-7% range since c. 2008, though tending to reduce as expenses are loaded more on to the capital account.


Dividends per share since the B8's putative launch are up 29% in real terms, compounding at 4.3% pa against inflation of under 3% [2]. Trusts imposed real cuts, year on year, on 29 of a possible 80 occasions in the past decade, averaging 4.9% real. Temple Bar's butchery has skewed the average.


Income's purchasing power peaked in 2019-20, 31% higher than in the first full year. So the latest massacre turns out to be less than terminal, but in purchasing power terms dividends have declined in eight of 19 years to Jun. History as well as the likelihood of more squalls recommends extra reserving in the owner's hands: see 'Derisking' below. Of course, if a basket is only to top up State and/or private pension income, this may not trouble you.



CONSTITUENTS AND CAPITAL
Briefly, individual trusts' contributions. First, four income metrics: compound annual dividend growth before inflation, 2002-21 (3); number of real cuts year on year in past decade; change in latest year's payout from 2019-20; months in revenue reserve at latest financial year end:

CTY: 4.7%, 1, +0.3%, 6
DIG: 3.4%, 4, +3.4%, 15
EDIN: 4.1%, 2, +4.1%, 18
IVI>ASEI: 8.2%, 2, +71.1%, 10
MRCH: 2.6%, 8, +0.4%, 8
MUT: 4.0%, 7, -19.9%, 9

SCF: 4.2%, 3, +0.0%, 16
TMPL: 2.2%, 2, -27.5%, 8
----------------------------------------------
B8: 4.3%, 6, +2.1%, 9


Capital metrics: value (£) at Jun. 30; share price change since launch; average yield over past decade; average discount/premium over ten years:; FE Trustnet Risk Score at Dec. 7

CTY: 15,218; +62.3%, 4.4%, -0.5%, 107
DIG: 11,885, +26.8%, 4.6%, 7.5%, 114
EDIN: 10,463, +11.6%, 4.2%, 6.7%, 137
IVI>ASEI: 15,556, +72.4%, 4.4%, 4.8%, 164
MRCH: 12,796, +36.5%, 5.5%, 7.3%, 144
MUT: 15,798, +68.5%, 4.3%, 5.5%, 111
SCF: 20,373, +117.3%, 4.3%, 3.8%, 130
TMPL: 16,038, +71.1%, 3.5%, 3.0%, 183
-------------------------------------------------------------------
B8: 118,728, +58.3%, 4.2%, 4.6%, 120


There has been no reversion to the mean in recent times. The same trusts show the same diverse behaviour as in mid-decade. The fallacy that because stock picks overlap substantially outcomes must cluster narrowly is further refuted by variant falls in share prices from the market rout began at the end of Feb. until Dec. 3:

CTY: -3.1%
DIG: +11.3%
EDIN: +13.0%
IVI>ASEI: +2.7%
MRCH: +11.1%
MUT: +2.1%
SCF: +6.5%
TMPL: -11.5%
--------------------------
B8: +4.0%
FTAS: +10.5%


The only reason to follow share price movements from my standpoint is to check that income is not rising too fast at capital's cost. If punters are marking down trusts because their dividends are seen as parlous, watch out. On the contrary, in 2020-21 divis dithered while market value hit an all-time high, implying faith that the B8's custodians are keeping income and growth in mutually beneficial equilibrium. The B8 added capital worth faster than HYP1, whose handsome receipts were rather narrowly sourced and potentially unrepeatable.


PERFORMANCE 2000-21
Let us see how the B8 would have performed in practice. An investor places the same £75,000 lump sum as the original High Yield Portfolio, with the same equal weighting and 1% acquisition costs and on the same date: Nov. 10, 2000.


The basket would have collared £5,557 of income in its 21st year to Nov. 12, 2021, a 4.8% increase. (HYP1 got a whopping £11,338 in the year to Nov. 2021 and the B7 £6,647.) The B8's yield from Nov. 2020's opening capital was 5.2%, equal best ever, against the lifetime average of 4.1%. This looks good against cash or fixed interest, if the basket be viewed as a savings account... with some inflation protection for interest and less for principal. After 20.5 years the basket would have dispensed £83,120 of dividends, exceeding the £75,000 subscription.


Market value gained 24.0% in the year to Nov. reaching a record £125,818 (2020: down 14.2%). It has compounded at 2.5% pa. This is below the cost of living, 2.9%, so in reality capital was eroded. But the All-Share Index grew by a mere 1.6% pa. Total return would make the All-Share look worse, since it furnishes smaller dividends.


The Basket of Eight depreciated during ten of 21 years. Average annual outperformance of the FTAS in the composite years to Jun. has been 0.2 percentage points, eleven times out of 20. Half the shortfalls, as mentioned, are recent. The overall picture is that the B8 does a wee bit better than an index tracker would.


In 252 monthly changes from launch to Nov. 2021, the portfolio's market value has risen or stood still 148 times at an average +3.1%, and fallen 104 times averaging -3.7%. On only 28 occasions did the basket gain 5% or more, and on 19 lost as much, so the short term was normally calm sailing. Respective figures for the All-Share are 144 times on the up, month on month, averaging +2.9%; 108 going down, by -3.4% average. Almost identical to the B8.


The B8' tranquillity may become less dependable as it alters shape. FE Trustnet's risk score-- a measure of volatility over the past three years loaded towards the present-- has it at a blended 120 (114 about 14 months ago) where the FTSE 100 index is 100 and cash 0. The more erratic, smallcap-oriented ASEI and the reshuffles at EDIN and TMPL may inject volatility. The Steadiest Eddies, after IVI has quit, are CTY and MUT, though all members score over 100 now.


Yet discounts have stayed fairly tight, suggesting that investors for income will tolerate more price fluctuations and the unpopularity of old-economy blue chips-- as long as dividends keep flowing, and their purchasing power is not gnawed away by inflation or the need to restock revenue reserves. A demanding mission, but no other asset type can come close for running yield, which is what this portfolio is about.


DERISKING
Added safety comes from 'derisking' the income. One mimics an index-linked bond and an income reserve backs it up [3].


Using receipts for the same years as HYP1, to Nov., the £75,000 basket here illustrated could have been derisked to give a 3.0% yield in its first eight months' operation as spendable income, against a historic All-Share yield of 2.2% at inception. That would have absorbed all collections in the inaugural 'stub' period (eight months to Jun. 2001); but the B8's income in its infancy could have combined inflation protection for the 3% return with a reserve growing to 12 months by Jun. 2006.


Thereupon an increase of one-fifth in the withdrawal rate to 3.9%+RPI would have been compatible with 10 months' reserve after ten years, at Jun. 2007. The buffer has been battered by 20 months of KungFlu, and it would be rash to bump withdrawal any higher for the time being.


The B8's inflation-protected 3.9% for most of the its existence stands against a similarly derisked 5.2% from HYP1. The latter shelled out a far larger gross income, tempered by the need to iron out its ups and downs by setting more aside.


Derisking would have required 6% of the basket's receipts to be held back, over and above the ~3% which trusts retained. It is a hypercautious gambit for those who cannot let income's buying power wobble. Such savers might opt to accept the lower initial yield of a 'growthier' income portfolio, unless they expect to drop off the twig fairly soon.


All B8 members shell out quarterly: dosh arrives little and often, just under once a fortnight. A cost-effective lump sum would be £10,000 or more gross. With stamp duty of 0.5% and commission of £12.50 a share, ten grand gets a starting income of £440 at Dec. 3's prices, averaging £13.75 for 32 dividends a year. Receipts are free of income tax to the basic-rate payer, or to all within an ISA or using the £2,000 dividend allowance.


Since 2000 Doris been faced with only one decision: which stock to substitute for IVI. She moans that she would rather choose among her beloved Belgian chocolates.
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[1] Review for 2020:
viewtopic.php?f=54&t=25362&p=405863#p405863

Review for 2019:
viewtopic.php?f=54&t=19695&p=257088&hilit=Basket+of+Eight#p257088

Latest B7 review to Mar. 2021:
viewtopic.php?f=54&t=28791&p=401947#p401947


[2] Dividends' compound annual growth rate is measured from Apr. 2001, to ignore arbitrarily different payment dates and numbers during the first eight months.

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