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Approach to balancing an income IT portfolio

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JuanDB
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Approach to balancing an income IT portfolio

#313970

Postby JuanDB » May 31st, 2020, 4:13 pm

Hi All,

I have a portfolio of 7 income focussed ITs which has been selected typically based on a yield >4.0% and 5 year dividend growth >3.5% per year to create a high and growing income which will outpace inflation. The portfolio was built starting in 2016 with quarterly purchases that will continue until around 2023 at which point all income will be withdrawn.

My approach has been to buy equally weighted sums of each IT however I starting to question whether that is the best approach. The yield on initial purchase cost ranges from 4.3% to 6.8% which gives a significant variation in income. To date I have reinvested dividends in each IT which has compounded the variation. I have now stopped this reinvestment and all dividends go to building new positions along with additional capital being added.

I am interested in how others manage this kind of portfolio, including rebalancing approaches (by capital, by income or a combination of the two) and dividend reinvestment.

Cheers,

Juan.

Itsallaguess
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Re: Approach to balancing an income IT portfolio

#313989

Postby Itsallaguess » May 31st, 2020, 5:26 pm

JuanDB wrote:
I have a portfolio of 7 income focussed ITs which has been selected typically based on a yield >4.0% and 5 year dividend growth >3.5% per year to create a high and growing income which will outpace inflation. The portfolio was built starting in 2016 with quarterly purchases that will continue until around 2023 at which point all income will be withdrawn.

My approach has been to buy equally weighted sums of each IT however I starting to question whether that is the best approach. The yield on initial purchase cost ranges from 4.3% to 6.8% which gives a significant variation in income. To date I have reinvested dividends in each IT which has compounded the variation. I have now stopped this reinvestment and all dividends go to building new positions along with additional capital being added.

I am interested in how others manage this kind of portfolio, including rebalancing approaches (by capital, by income or a combination of the two) and dividend reinvestment.


I'm still building my income-portfolio too. It's currently a mix of HYP-ish 'single-share' holdings and a large section consisting mostly of income-oriented Investment Trusts, which is the area where any newly-invested capital is now largely directed.

I've never understood the appeal of reinvesting dividends back into 'parent' holdings, and very much prefer to just let the various dividends accumulate, along with fresh capital from my regular savings, and then invest the capital when it's at a level where purchase costs are around 1% or less of the proposed capital outlay, and nowadays tend to wait for 0.5% or less the vast majority of the time. Fresh ISA allowances are slightly different, where I try to manage-down my holdings in my non-ISA account, and where invested sums are likely to be higher.

By letting dividends build up from all the various income-account holdings, I can then bundle them up and direct purchases exactly where I want to, taking into account any levelling-out of income and capital diversification that I wish to maintain, or into fresh holdings where I may want to open up avenues into unexplored territory with regards to new geography or themes. I want the best 'bang for my buck' whilst keeping things steady on the diversified income and capital front, with nothing getting too out of kilter with anything else for too long hopefully..

You mention 'yield on initial purchase', but it's not clear if that metric has any direct influence on your investment decisions?

I completely ignore that metric, and very much prefer to use forecast-yields to help direct any new capital that I'm going to invest. It doesn't interest me what yield I'm getting on some 'historical sum of capital' - what interests me is what yield I'm getting now, from each existing lump of capital, and what yield I might get in the future from any fresh capital I might also then invest.

The process works well, and opportunities for new investment come around often enough to keep me active and interested, and this especially helps with me simply allowing the rest of my income-portfolio to just keep chugging away, otherwise needing little in the way of direct action for the vast majority of the time, other than to keep an eye on things via automatic spreadsheets etc.

As I try to keep everything floating at around the same level, and with a generally rising tide over time with regards to the markets, bar the regular blips we've simply got to get used to from time to time, then it's surprising how quickly the broad capital and income values will rise for each holding over the years.

Cheers,

Itsallaguess

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Re: Approach to balancing an income IT portfolio

#313991

Postby tjh290633 » May 31st, 2020, 5:32 pm

JuanDB wrote:Hi All,

I have a portfolio of 7 income focussed ITs which has been selected typically based on a yield >4.0% and 5 year dividend growth >3.5% per year to create a high and growing income which will outpace inflation. The portfolio was built starting in 2016 with quarterly purchases that will continue until around 2023 at which point all income will be withdrawn.

My approach has been to buy equally weighted sums of each IT however I starting to question whether that is the best approach. The yield on initial purchase cost ranges from 4.3% to 6.8% which gives a significant variation in income. To date I have reinvested dividends in each IT which has compounded the variation. I have now stopped this reinvestment and all dividends go to building new positions along with additional capital being added.

I am interested in how others manage this kind of portfolio, including rebalancing approaches (by capital, by income or a combination of the two) and dividend reinvestment.

Cheers,

Juan.

I don't think that you can improve on equal weighting. The only alternative is to buy equal income at the outset, but that will vary as time goes by, and is out of your control anyway. Reinvesting dividends in the same source can make sense, but I would put accumulated dividends into your purchase pool, and buy whatever you plan. What that plan tells you is another matter, but my instinct would be to invest to maximise the income, but also to bring the lowest weighted share(s) up to weight.

TJH

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Re: Approach to balancing an income IT portfolio

#314012

Postby JuanDB » May 31st, 2020, 6:30 pm

Itsallaguess wrote:I've never understood the appeal of reinvesting dividends back into 'parent' holdings, and very much prefer to just let the various dividends accumulate, along with fresh capital from my regular savings, and then invest the capital when it's at a level where purchase costs are around 1% or less of the proposed capital outlay, and nowadays tend to wait for 0.5% or less the vast majority of the time. Fresh ISA allowances are slightly different, where I try to manage-down my holdings in my non-ISA account, and where invested sums are likely to be higher.

By letting dividends build up from all the various income-account holdings, I can then bundle them up and direct purchases exactly where I want to, taking into account any levelling-out of income and capital diversification that I wish to maintain, or into fresh holdings where I may want to open up avenues into unexplored territory with regards to new geography or themes. I want the best 'bang for my buck' whilst keeping things steady on the diversified income and capital front, with nothing getting too out of kilter with anything else for too long hopefully..

You mention 'yield on initial purchase', but it's not clear if that metric has any direct influence on your investment decisions?

I completely ignore that metric, and very much prefer to use forecast-yields to help direct any new capital that I'm going to invest. It doesn't interest me what yield I'm getting on some 'historical sum of capital' - what interests me is what yield I'm getting now, from each existing lump of capital, and what yield I might get in the future from any fresh capital I might also then invest.


Thanks IAAG.

My edits of your comment for brevity.

I mention yield on cost only to anchor the relative difference in yields at the point I made the initial purchasing decision. It makes no difference to any future purchasing decision. In part because I tend to decide what I’m going to buy next and then quickly ramp up purchases until I have a full holding. I haven’t been one to hedge my bets with lots of little purchases.

My prior choice to reinvest dividends in the parent holding wasn’t particularly informed by anything. Having seen how it magnifies the income difference I’ve realised it’s not the right approach, hence the switch. I am now adding dividend income to additional capital to build new positions.

It sounds like you’re looking at both capital and income balance across your portfolio? Would you mind expanding on how you manage that?

Cheers,

Juan.

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Re: Approach to balancing an income IT portfolio

#314017

Postby JuanDB » May 31st, 2020, 6:58 pm

tjh290633 wrote:I don't think that you can improve on equal weighting. The only alternative is to buy equal income at the outset, but that will vary as time goes by, and is out of your control anyway. Reinvesting dividends in the same source can make sense, but I would put accumulated dividends into your purchase pool, and buy whatever you plan. What that plan tells you is another matter, but my instinct would be to invest to maximise the income, but also to bring the lowest weighted share(s) up to weight.

TJH


Thanks TJH,

I’ve read a number of your posts regarding the rules based approach you take and this seems to have a lot of merit. From what I’ve read I understand that you make rebalancing decisions based on capital value relative to the median and if a higher yield can be achieved. On a well diversified portfolio of 20+ individual holdings, held within a range by value will naturally limit income variance to an upper bound of maybe 10% of total in the extreme case?

I don’t think holding 20+ ITs is the right approach and I doubt that many exist which meet my criteria and aren’t just a wide selection of clones from the UK Equity Income cohort. In that case the portfolio will naturally, and I think desirably, have fewer constituents and lead to my current position with one member contributing 22% of income. Hence my thought process that perhaps income weighting might be better to manage income risk.

Cheers,

Juan

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Re: Approach to balancing an income IT portfolio

#314019

Postby 1nvest » May 31st, 2020, 7:06 pm

I prefer SWR based withdrawals, taken out of total returns. 1. for the regular inflation adjusted income that provides and 2. for the potential to tune withdrawals to yield higher total returns. The differences can be significant i.e. as per this stock portfolio example where there was a 3.6% spread between combined SWR + additional CAGR of the surplus according to choice of SWR used. For example at a 7% SWR rate the combined SWR + CAGR = 14.3%, compared to 10.7% if no withdrawals were made at all.

Image

Each asset and time period will have its own curve/optimal-choice. Rebalancing with that in mind potentially directs your overall outcome towards a more favourable outcome compared to just taking the dividends at the times/amounts that the fund/stock(s) dictate.

That could be equally applied to I.T's, but other than what are held in index funds I don't hold any I.T'.s myself. Your suggesting of income however seems a interesting choice that might, at least in part, work along similar lines.

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Re: Approach to balancing an income IT portfolio

#314020

Postby bluedonkey » May 31st, 2020, 7:12 pm

What is SWR apart from South Western Railway?

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Re: Approach to balancing an income IT portfolio

#314022

Postby PinkDalek » May 31st, 2020, 7:15 pm

bluedonkey wrote:What is SWR apart from South Western Railway?


See viewtopic.php?p=270783#p270783 and/or viewtopic.php?p=307135#p307135

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Re: Approach to balancing an income IT portfolio

#314025

Postby JuanDB » May 31st, 2020, 7:28 pm

Thanks 1nvest. I do look at overall SWR and am aiming for sub 3.5% on my overall portfolio which includes pure growth orientated assets that are tracked separately.

The question in this topic is specifically around how to rebalance an income orientated portfolio of ITs. If we could keep to that topic please.

Cheers,

Juan.

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Re: Approach to balancing an income IT portfolio

#314028

Postby Itsallaguess » May 31st, 2020, 7:39 pm

JuanDB wrote:
It sounds like you’re looking at both capital and income balance across your portfolio? Would you mind expanding on how you manage that?


Hi Juan,

I use a slightly modified version of Terry's 'inverse-ranking' method, which is broadly outlined in a recent post below (which I include here only because I note your other reply to Terry, where I think you're mistaking the use of a median capital value in his ranking method) -

[Terry's is] based on a combination of inverse value ranking and yield ranking, i.e. the lowest value has a rank of 1 and the highest yield has a rank of 1. Add them together and that with the lowest overall ranking number is the one to top up.

That said, I limit the amount which I can put into any one share and the amount of dividend income generated by any one share. My limits are 5% in either case, but for a 20 share portfolio it could be 10%.


https://www.lemonfool.co.uk/viewtopic.php?f=31&t=21855&p=285137#p285137

I don't think I'll have too much of a problem reaching at least 15 income-IT's over the coming years, but I appreciate your own stated reluctance that you might ever have that many yourself.

With that said, I wouldn't be too comfortable with any single holding delivering over 20% of my dividend income, so we're into 'horses for courses' territory there..

Given that you're moving away from a 'dividend-reinvestment-into-parent' process anyway, then maybe the only other single-rule that you need at this moment in time is just to 'stop adding capital to that outlier holding', and everything might take care of itself with a quick visual once-over every now and then?

Cheers,

Itsallaguess

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Re: Approach to balancing an income IT portfolio

#314056

Postby JuanDB » May 31st, 2020, 10:16 pm

Hi IAAG,

Thanks for explaining Terry’s approach. That makes a lot of sense.

Through this thread I’ve realised the underlying issue I’m looking at it less about how to rebalance and more around the number of holdings in the portfolio. With 7 holdings the mean income would always be around 14% which is probably too high for comfort over the long term.

I notice this thread posed the same question, without any real progress https://www.lemonfool.co.uk/viewtopic.php?f=54&t=23064&p=302485&hilit=Cty+cover#p302485

I’ve spent some time this evening looking on the AIC site to test my hypothesis that outside the UK Equity Income sector there aren’t many ITs that meet my initial criteria of yield and dividend growth rate. 18 is the answer, four of which I already hold and five I’ve previously discounted due to factors such as poor total return, regional or country specialisation. That gives another 9 to take a look at.

Thanks again,

Juan.

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Re: Approach to balancing an income IT portfolio

#314057

Postby monabri » May 31st, 2020, 10:18 pm

Substitute income IT for individual share ...how about using HYPTUSS?

I'd be interested in your list, btw!

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Re: Approach to balancing an income IT portfolio

#314077

Postby Itsallaguess » June 1st, 2020, 5:59 am

JuanDB wrote:
Through this thread I’ve realised the underlying issue I’m looking at it less about how to rebalance and more around the number of holdings in the portfolio. With 7 holdings the mean income would always be around 14% which is probably too high for comfort over the long term.

I notice this thread posed the same question, without any real progress https://www.lemonfool.co.uk/viewtopic.php?f=54&t=23064&p=302485&hilit=Cty+cover#p302485

I’ve spent some time this evening looking on the AIC site to test my hypothesis that outside the UK Equity Income sector there aren’t many ITs that meet my initial criteria of yield and dividend growth rate. 18 is the answer, four of which I already hold and five I’ve previously discounted due to factors such as poor total return, regional or country specialisation. That gives another 9 to take a look at.


Hi Juan,

There is of course no 'right answer' to this question, and the one you eventually land comfortably on is likely to be shaped as much by personal considerations than purely technical ones..

If your criteria is mainly to find income-IT's with an initial yield over 4.0% and showing 5 year dividend growth of over 3.5% per year then it probably wouldn't come as too much of a surprise to find a limited universe of options, so if improved diversification does still prove to be an ambition once you've exhausted the options available using those criteria, then it might be worth considering introducing a little flexibility in those figures to perhaps offer up some useful additional options..

Many years ago when I was looking at this, I knocked up a spreadsheet (I do love spreadsheets...) which showed that once a set of 'preferable filter criteria' has exhausted all useful options, and a large enough number of 'core holdings' has been achieved, then walking down that 'preferable filter criteria' might continue to deliver sought-after diversification whilst still having a really quite limited impact on overall income..

An example below shows a portfolio of 10 holdings all yielding 4% a year, and delivering an annual income of £4,000.

The second example shows a portfolio of 20 holdings, where holdings 11 to 20 all drop away from that higher 4% yield-requirement, with three holdings at a 3.8% yield, three at 3.75%, and four at 3.6%.

We can see that the blended income from the portfolio with 20 holdings is shown as £3,852.50, just £150 per year lower than the much more concentrated 10-holding portfolio. That's around £3 per week on a £100,000 income portfolio...

Image

Whilst the above examples show that there really is a quite limited overall effect to income, what it can't show is the other area which you're interested in, which is your desired requirement for dividend-growth, but this is all the more reason, in my opinion, why it often pays to reduce individual filter criteria sometimes, to perhaps raise awareness of good candidates in a separate area, which in your case might perhaps highlight good up-and-coming dividend-growers, whilst perhaps reducing slightly one of your other important selection criteria...

For instance, if some of those lower 3.6% yielders in the above larger-portfolio happened to have slightly better dividend-growth potential than some of the 4% yielders, and the blended cost to income of holding some of them is really quite negligible from day one, then we might actually expect to see some longer-term benefit to slackening off individual elements of our initial filter criteria, if by doing so we might gain visibility of those slightly 'off-centre' options...

Just some idle musings at 5.30am in the morning on what looks to be another lovely day Juan..

Cheers,

Itsallaguess

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Re: Approach to balancing an income IT portfolio

#314127

Postby JuanDB » June 1st, 2020, 9:39 am

Hi IAAG,

Thanks again for taking the time to reply.

What you’ve written makes absolute sense. I think I would start with looking at my two criteria as inversely correlated. If the acceptable yield is reduced then in return the yield growth must be higher to compensate. I suspect it is generally true that lower yielders have higher yield growth but I wouldn’t want the exceptions I.e. low yield and low yield growth.

I’ll have a play with the criteria and see how that changes the universe.

In answer to Monabri’s question. My current portfolio of 7 includes:

UK Equity Income
City of London
Merchants Trust
Lowland - May get the chop or swap for Mercantile. I bought for the yield growth but capital performance has been poor and it’s been punished in the recent downturn.

Asia Pacific Income
Henderson Far East - this is my outlier, delivering 22% of income
Schroder Oriental Income

European Equity Income
JP Morgan European Income

International Income
Murray International

Per my original post, this is an income focused portfolio, intended to drive a salary replacement income from within ISA and GIA accounts.I have a separate, larger, growth portfolio.

ITs I am considering for next purchases include JGGI, HINT, JAGI, NAIT.

Thanks,

Juan

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Re: Approach to balancing an income IT portfolio

#314137

Postby tjh290633 » June 1st, 2020, 10:04 am

JuanDB wrote:
tjh290633 wrote:I don't think that you can improve on equal weighting. The only alternative is to buy equal income at the outset, but that will vary as time goes by, and is out of your control anyway. Reinvesting dividends in the same source can make sense, but I would put accumulated dividends into your purchase pool, and buy whatever you plan. What that plan tells you is another matter, but my instinct would be to invest to maximise the income, but also to bring the lowest weighted share(s) up to weight.

TJH


Thanks TJH,

I’ve read a number of your posts regarding the rules based approach you take and this seems to have a lot of merit. From what I’ve read I understand that you make rebalancing decisions based on capital value relative to the median and if a higher yield can be achieved. On a well diversified portfolio of 20+ individual holdings, held within a range by value will naturally limit income variance to an upper bound of maybe 10% of total in the extreme case?

I don’t think holding 20+ ITs is the right approach and I doubt that many exist which meet my criteria and aren’t just a wide selection of clones from the UK Equity Income cohort. In that case the portfolio will naturally, and I think desirably, have fewer constituents and lead to my current position with one member contributing 22% of income. Hence my thought process that perhaps income weighting might be better to manage income risk.

Cheers,

Juan

I see that others have posted a link to an explanation of my method, for which thanks. Like you, I don't think that holding 20 ITs is the way to go. There was a time, when ISAs were introduced, that I could no longer add to the shares in my PEP, so I had to build a parallel non-overlapping portfolio in the ISA. Because of the limit on annual subscriptions, it took me several years to get the original 6 holdings up to the same weight as those in the PEP. It all got a bit complicated because Allied Domecq split up and was then taken over, leaving me with a small holding in Bass, added to in the following tax year. Then Blue Circle were taken over and replaced by United Utilities. British Airways were sold and Bass became Six Continents, promptly demerging into International Hotels and Mitchells and Butlers. Before long I was totally unbalanced, and had to decide what to do. By the time I could merge it with the PEP in 2006, I had 9 shares and had worked out my ranking method for deciding where to reinvest dividends. Trying to do it on the combined portfolios before merging was not possible, because the money was always in the wrong place. Once merged, no problem.

Personally, were I to switch to ITs, I might have a mixture of 2 or 3 global ITs, 2 or 3 Income UTs with a UK emphasis, and maybe the odd specialist, like one concentrating on commodities, oil and gas or mining, plus perhaps a geographical IT.

Maybe 8 or possibly 10, but no more. My system will work with that number, because that's how it started.

TJH

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Re: Approach to balancing an income IT portfolio

#327293

Postby tramrider » July 19th, 2020, 3:38 pm

monabri wrote:Substitute income IT for individual share ...how about using HYPTUSS?

I'd be interested in your list, btw!


HYPTUSS is an excellent tool and works well for Terry TJH's reinvestment methods for his HYP. However, it is designed to promote High Yield income based on 2 main parameters, pure forecast dividend yield DY and present capital value CV (actually in inverse order). These 2 are combined in equal weightings in the spreadsheet as
1*DY + 1*CV to get the Weight Total WT.

My problem is that I have picked a mixed portfolio of ITs, some of which have a high dividend income (e.g. HFEL at 7.0% yield and 5 year CAGR of 40.6%) that is useful for reinvesting, and some of which have a high total return TR (e.g. SMT at 0.4% yield and 5 year CAGR of 245.5%), producing a lot of capital growth that could be cashed in if necessary and often tending to produce more rapid dividend growth. These figures were taken from the AIC web site today.

It is very hard to use HYPTUSS to try to keep this wide diversity of IT properties in balance as it has such a strong preference for income yield and is 'unhappy' with rapid capital growth. It would be helpful to have a further developed version of HYPTUSS which allowed the balancing of all 3 factors to allow the suggestions of which ITs to top up next, preferably by allowing variable weighting factors as
a*DY + b*TR + c*CV to get the Weight Total WT according to the investor's preferences.

Tramrider

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Re: Approach to balancing an income IT portfolio

#327328

Postby monabri » July 19th, 2020, 6:06 pm

I suggested using HYPTUSS as the question was "approach to balancing an income IT portfolio" as opposed to a total return portfolio. Maybe one should simply populate HYPTUSS with the income ITs and leave out the likes of SMT?


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