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Basket of Seven: 2021 review

Closed-end funds and OEICs
Luniversal
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Basket of Seven: 2021 review

#401947

Postby Luniversal » April 5th, 2021, 11:51 pm

The Basket of Seven (B7) was concocted in 2010 for the dim and lazy saver who must pay bills as they fall due. The portfolio seeks dependable income from equity-based investment trusts whose purchasing power should grow sedately over time. It should as far as feasible be 'fire and forget'. Capital growth or the reverse is a very minor consideration.


Shockingly, after a mere 20+ years corporate action intruded recently-- see below-- but it would have gone through by default, requiring no action by the holder.


The B7 houses an increasingly eclectic mix of big and small, British and overseas stocks in all trades. The Seven to be bought in equal amounts are Bankers (BNKR), BMO Capital and Income (BCI-- formerly FCI), JPMorgan Claverhouse (JCH), Lowland Investment (LWI), Mercantile (MRC), Murray International (MYI) and Murray Income (MUT), into whose scrip Perpetual Income & Growth (PLI) was 'rolled over' in mid-Nov.


Results are aggregated to a common Mar. year end, since this best fits varied accounting dates. Latest figures are for financial years ended between Aug. 2020 and Mar. 2021. MUT's arrival slightly alters outcomes previously reported. Trends since the B7's backtested launch on Nov. 10, 2000 (also when 'HYP 1' began) are reviewed.



INCOME
In 2020-21 the B7 lifted regular dividends per share by 1.5% (2019-20: 5.0%), or by 0.3% (3.1%) after retail price inflation (RPI). This was far below the average real rise of 3.7% pa over 20 years (1).


The portfolio's yield during 2020-21, based on historic or officially forecast payouts, averaged 4.0% (2020: 3.4%), half a point above 3.5% throughout its life; the gap narrowed from a record 0.8 of a point to 0.1 below the FT All-Share Index yield. The basket yield has reverted to its whole-life average by almost matching the index.


Covid devastated earnings remitted to the trusts. Cover for B7 payouts in 2020-21 collapsed to 0.72 times (1.09 times)-- easily the thinnest yet, and well below the whole-life average of 1.02 times. Uncovered income was declared for the first time since the backwash of the global financial crisis in 2011-12.


Revenue reserves had to bridge the gap. The average reserve was milked from 13 to 16 months of current payout between financial year ends, though that more than a year's worth remains is reassuring. The average now lies below the 15-17 months held before the Global Financial Crisis, possibly with more abstraction to come, although cover from current revenue was usually thinner before the GFC.


I wrote last time that divi rates 'look prepared for the crunch in earnings threatened by an epidemic of cuts and suspensions among portfolio companies, brought about by coronavirus hysteria'. They were, but there could well be stress this year: payouts from the trusts' holdings may reflect rates 'reset' (i.e. permanently reduced}, or lower yields from the safer positions to which managers resorted. Cuts and passes generally take a very long time to correct fully in real terms.


The basket's Ongoing Charges Ratio drifted out from a lowest-ever 0.57% to 0.66% of year-end net asset value (NAV). That compares well with a 2000-20 average of 0.76%, after such douceurs as performance fees were weeded out following the GFC. One might foresee an OCR closer to half a percentage point once markets rally.


Dividends per share in the past decade increaed by 73%, or by one-third in real terms. Trusts imposed real cuts, year on year, on eighteen of 70 occasions, averaging 1.6%. Rewriting history with MUT mars the record. It inflicted seven real cuts in ten years (3).


CAPITAL
Market value responds over time to an income stream's steadiness. It is far from proof against general fluctuations and there is no simple correlation. In 2018-19 the B7's NAVs and share prices had taken their biggest hits since the GFC: value stocks had lost support relative to speculative and momentum punts, despite strong income showings.


Last year unimpaired payouts could not soothe the flu-haunted bearishness attacking balance sheet valuations, though Nov.'s vaccine rollouts brought some relief. In money terms, the composite NAV shrank by 11.4% (2019-20, up 8.9%), while share prices were 12.6% (+12.0%) to the bad.


Real changes between year ends since the putative launch have averaged +3.0% for assets per share, +3.3% for the share price. Last year was the B7's third worst... but not nearly as grim as the crashes of the first dotcom era, when prices and NAVs shed between one-fifth and one-quarter in a year, nor the GFC when they were one-third off.


The B7 outperformed the All-Share Index on share price by 3.2 points, the same as throughout its life-- which counts such victories in 16 of 20 years. Only in 2016-17 did the basket lag the FTAS by more than three points, and that was an up year all round; the three other failures were of two points or less. It is not important except insofar as the record implies that investors appreciate a 'growth of income' approach to UK equity selection over extended periods. And that is the only timeframe during which one should hold investment trusts.


The basket's average discount also implies moderate confidence: it expanded a trifle from 3.5% to 4.9% between financial year ends, but stayed below the lifetime 6.5%. These trusts almost never go to a premium, but neither do they get cast aside. The loosest average discount was 9.3% in 2005; the tightest, 2.2% in 2013-14, before jitters about the sustainability of income from 'bond proxy' blue chips set in.


Four members' share prices trailed the Index in latest accounting years. The norm is for three to be outpaced.


CONSTITUENTS
Briefly, individual trusts' showings and comment thereon covering the latest ten financial years:


First, four income metrics: compound annual dividend growth after inflation (2); number of real year on year cuts; average cover; months' worth of latest FY payouts in revenue reserve, at latest and previous year ends:


BNKR: 3.3%, 1, 1.02x, 17 (21)
BCI: 0.4%, 4, 1.07x, 12 (16)
JCH: 2.8%, 1, 1.06x, 15 (19)
LWI: 5.6%, 2, 1.02x, 8 (14)
MRC: 4.0%, 2, 1.05x, 14 (19)
MUT: -0.7%, 7, 1.01x, 12 (12)

MYI: 3.0%, 1, 1.00x, 11 (13)
-------------------------------------
B7: 2.6%, 0, 1.03x, 13 (16)


Capital metrics: share price change in decade to latest financial year end; number of years trailing the index; average yield; discount/(-premium):


BNKR: +37.3%, 1, 2.5%, 4.8%
BCI: +16.5%, 6, 3.8%, -1.5%
JCH: +70.2%, 4, 3.8%, 5.7%
LWI: +50.2%, 5, 3.7%, 5.1%
MRC: +52.4%, 4, 2.9%, 11.8%
MUT: +20.1, 4, 4.3%, 5.0%

MYI: +22.0%, 4, 4.4%, -3.4%
-----------------------------------------
B7: +38.4%, 4, 3.6%, 3.9%


The self-professed 'plain vanilla' Murray Income joins BMO Capital & Income as an historic underperformer. Yet MUT is no capital-squanderer like, say, Henderson High Income: it has surpassed the All-Share on total return over periods from one to ten years and has lifted its payout-- if often only in money terms-- for 47 years on the trot. The profile is akin to City of London's, with Charles Luke in the Job Curtis role.


The usual spiel about economies of scale was heard with the PLI takeover, which swelled the balance sheet by two-fifths, but in your correspondent's experience they are often shy about emerging. PLI's portfolio was said to be a good fit with Murray's (why fold it, then?) and despite criticisms of its picks Mark Barnett had served the B7 admirably, shelling out more income than the other six. I regret PLI's passing, and wish Murray would stop writing call options to bump up its running returns... but we are in the lap of the gods.


BMO Capital & Income remains unimpressive, yet the premium rating defers only to Murray International's. BCI has done best during broad-market rallies, so one can but dream. It comes with high cover and reasonable revenue reserves, but its distributions have been too stingy against its capital-account torpor. Handing over management from F&C to Bank of Montreal has not galvanised it.


Conversely Lowland revved up payouts shortly before the orgy of cutting, making it top for income growth over the decade but with only eight months in reserve at its end. LWI's taste for less than gigantesque companies may pay off if post-bug-and-Brexit optimism endures. Mercantile, rigorous in its focus on midcaps, has already caught the 'smaller is less ugly' mood. Its combination of metrics is the portfolio's most optimal, though the double-figure discount betrays investors' discomfiture about the volatility inevitably haunting a FTSE250 specialist which sells any share that gains promotion to the top flight.


Punters also remain schizo about Murray International, almost unique in paying out heartily from a bunch of stocks outside these shores. MYI increasingly seeks income from emerging as well as developed markets, making it a useful diversifier. Manager Bruce Stout's fund was scorned when he stood aside from the tech stampede, but has kept its premium.


Bankers is the 'sturdiest' member. It sailed through the cuts to its 54th annual dividend rise, backed by the basket's biggest revenue reserve. Its dividend growth is so-so compared with its subpar yield, and it has swapped RPI for the less exacting CPI as a yardstick for increases. BNKR is more cashed up than most, searching for bargains while not sounding very bullish overall.


JPMorgan Claverhouse was 'taken in hand' early in the prior decade and has obtained a 70% jump in its share price by doing its orthodox growth-and-income thing better. It is firmly reserved, balancing payment increases and highish cover deftly. It explicitly plans to grow dividends' purchasing power over time, despite somewhat higher than typical gearing which can affect performance, as during last spring's nosedive.


OUTLOOK
Managers are harmonising on a theme: the worst is over, slow but steady recovery globally, got to be selective, hunt 'quality', moats and free cash flow, unearth firms that could withstand another spike and lockdown, seek bargains beyond Blighty. All this fits the B7's purpose, but insufficient allowance seems to be made for the directors' of investee companies' delight in curbing dividends.


The boardroom rigmarole is 'Need above all to conserve cash, cover must be rethought from 1.0-1.5 to 2.5-3.0 times-- progressive policy, oh sure, but only from the zero base to which we reduced you schmucks when we had a cast-iron excuse-- lots of opportunities for cash acquisitions in the depressed climate-- buybacks rather than payouts, it'll benefit you more in the end' etc., etc. Anything but resume jam tomorrow, let alone today.


Salaried and expense-accounted executives hate giving the owners their money back unless the bosses are the main proprietors, or are buttering up the rating under advisement from investment bankers. The 'legacy of Covid', all too conveniently, could hang over the high-yield equity game for aeons. 'It was a wake-up call, we were too generous to shareholders for far too long.'


Maybe this is only another phase in the eternal hostility between employees and their absentee paymasters; but the hairshirt spirit could last until it maims ITs' compulsorily passed-on income and endangers some rapidly diminishing revenue reserves. Moreover the cost of living seems likelier to tick up than stick at c. +1% pa. In short, one cannot readily see a way back to real B7 income rises of ~4% pa, as enjoyed in the years after the banking crisis. Stasis may have to suffice.


The basket's year-end cash covers half of dividends declared, against four-fifths in Mar. 2020 and all dividends, on average, in the past decade. This is the lowest liquidity since 2015. Meanwhile shares in issue have expanded by one-tenth since Mar. 2010 to hit a record number, testifying to the adoption of ITs by the income-ravenous but not easing pressure to chase equity yields. Trusts were filling their boots with HY shares just before too many turned out to be HY no more.


Despite misgivings, I back the sector not to let dividend devotees down if only because it has 150 years of dodging bullets behind it. One must stifle qualms and bet on probabilities. Then the past indeed becomes an indicator of the future-- not infallibly, not for the next eyeblink in time, but sounder than any other known to me.


PERFORMANCE 2000-20
Let us see how the basket would have developed in actual pounds, assuming that Murray Income rather than the defunct Perpetual had been in from the outset (3).


An investor places the same £75,000 lump sum as pyad's HYP1, with the same equal weighting and 1% acquisition costs and on the same date: Nov. 10, 2000. The basket would have gathered £7,730 of income last year (1), a 10.0% increase but a 6.1% reduction excluding the distribution of Perpetual's revenue reserve. Four of seven constituents did not contrive rises to equal inflation, if Mar.'s RPI rate is the same as Feb.'s 1.4%. (HYP1 got £5,553 in the year to Nov. 2020, a 48% fall.)


Had a basket been bought on Apr. 1, 2020, the first year's yield would have been 5.1% (3.7%). That reflects depressed values in the first throes of pandemic, plus the trusts' underestimated ability to resist slashing dividend cuts. Ergo it was an untypically pleasant entry point.


The B7's case does not rest on hairtrigger timing, for it has trounced rates on deposits or fixed interest at least since the Global Financial Crisis ushered in 'financial repression'. The basket can be treated as a savings account with a reasonable hope of inflation protection for interest and principal. Since 2006, as mentioned, it has on average yielded on purchase the same as the FTAS. It could be seen as a superior alternative to a tracker, with more predictable income.


Receipts are free of income tax to the basic-rate payer, or to all within an ISA or by using the £2,000 dividend allowance. After 20.4 years the basket's £75,000 investment would have dispensed £88,022, including £1,925 in one-off items (1). This compares with HYP1's £101,058 of unreserved dividends.


The anniversary valuation reveals a spirited snapback from the trough of the CO-VID panic; in the year to Apr. 1 it was 40.1% higher at £192, 250. Still some way below the month-end peak of £210,000 at Dec. 2019, but it puts 'pandemic' flapdoodle into context. Mercantile, always the most volatile member, was up 56%. Otherwise gains clustered between 30% and 41% with no black sheep.


Compound growth of capital since inception has been 4.7% pa to end-Mar. 2021, about 2% after inflation. The portfolio shed nominal value one-third of the time: moderately in accord with the 60-up-40-down peristalsis exhibited by the All-Share Index since it began in 1962. Capitalism delivers, given time.


Average annual outperformance of the index has been a little over three percentage points. The edge has been mainly on the upside, when the B7 tiptoes ahead of the benchmark and rarely flags. But it is certainly no defier of slumps like a Conviction Five wealth-preserver, nor was meant to be.


Such figures are aethereal to a never-seller, but signal that the income stream is not being bought at the principal's expense. However faith in the stream may for the perceptible future be more about security than expansion of its purchasing power.


DERISKING
Added safety can be obtained by 'derisking' the income. One mimics an index-linked bond and an income reserve backs it up.


My calculations are based on years to Nov., the anniversaries of HYP1 which the B7 and B8 stand against. The £75,000 basket here illustrated could have been derisked to pay a 2.5% yield as spendable income in its first year. The initial amount was meagre due to a mediocre starting yield and income reservation. But the B7's growthiness would have permitted three chunky uplifts of withdrawal rates: in 2007 (+40%), 2012 (+25%) and 2018 (+30%). The quasi-bond would by now pay 5.7% plus uplifts for inflation.


Pessimistically, let us project frozen income, and no specials, in the year to Nov. 2021 against 2% inflation. The portfolio would then finish with a reserve worth 17 months of payout: down from 18 at Nov. 2020 but a consoling addition to the trusts' own kitties. In two decades such a derisked portfolio would have held back 11% of its receipts, financing three calls on the reserve totalling £721, of which £412 would supplement gelid receipts in 2020-21.


HYP1's harvests have been substantially bigger but more erratic; it could have been derisked to a 6.3%+RPI withdrawal rate with 11 months in its income reserve last Nov, albeit down from 19 months at Nov. 2019. All British equity payouts were richer before the GFC. The ball game could become much tougher, with HYP1's 11 months perhaps too slim a margin.


In earlier years, beginning on a withdrawal rate of 3.5%, HYP1 threw off far more spendable cash than a 'growthy' B7-- always remembering that the early 2000s were a fine time for the juicy equities on which the HYP system feasted in its youth. However over time ITs with a dual mandate-- even if they draw much lower initial income than directly held bunches of high-yielding shares-- can compete with HYPs for income stabilised by reserving. The B7 has not deferred to HYP1 on capital either, though my 'Growth Ten' of internationalists and 'Conviction Five' shone more brightly by disregarding yield.


All B7 members pay quarterly. A minimum cost-effective lump sum would be £10,000 gross. With stamp duty of 0.5% and commission of £12.50 a share, on All Fools' Day (when better for TLF folks?) ten grand would earn a starting income of £442 pa, averaging £16 once a fortnight.

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PREVIOUS REVIEWS:
2020: viewtopic.php?f=54&t=23743&p=323293&hilit=Basket+of+Seven#p323293

2019: viewtopic.php?p=225773#p225773

2018: viewtopic.php?p=145627#p145627


(1) Four members have declared eleven special dividends, total £1,925: BCI £49 (two), JCH £73, MRC £69, PLI (six) £603 plus a terminal £1,131 when the revenue reserve was handed back.


(2) Dividends' compound annual growth rate is measured from Apr. 2001 to eliminate 'drag': diverse payment dates and numbers during the first five months.


(3) A questionable assumption, as discussed above. Murray remains prima facie fitter for the Basket of Eight, with its penchant for 'juicy' investments and a smaller revenue reserve. It strains for immediate maximum payout and small, often sub-inflationary rises.


'Market trading' incidents must be accepted in an IT assemblage. Happily they are much rarer than in a High Yield Portfolio.

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Re: Basket of Seven: 2021 review

#402001

Postby forrado » April 6th, 2021, 12:41 pm

Luniversal wrote:Maybe this is only another phase in the eternal hostility between employees and their absentee paymasters; but the hairshirt spirit could last until it maims ITs' compulsorily passed-on income and endangers some rapidly diminishing revenue reserves. Moreover the cost of living seems likelier to tick up than stick at c. +1% pa. In short, one cannot readily see a way back to real B7 income rises of ~4% pa, as enjoyed in the years after the banking crisis. Stasis may have to suffice.

Agree, inflation beating increases are going to be hard to come by.


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