20 Years Of ‘Hands-Off’ Dividend Investing

This comment Trawl for yield -- high-income REITs from Ben123 the other week…

however why is the search for dividend yield a good investment concept in the first place?

…got me thinking about income investing.

Some people invest in shares primarily to derive an income, with the alternatives being some sort of savings account, bond or annuity.

Not long ago a certain Mr Woodford was riding high in the Equity Income rankings and every City fund tried to shoehorn ‘Income’ into its name.

But income investing has since fallen out of favour — especially this year due to widespread payout cuts. Most investors these days seem to focus on quality or growth or both.

A quick check the other week on SharePad showed this startling stat. Of the 343 UK Equity Income funds possessing a 3-year history, just 32 had recorded a positive performance during the last 3 years (figures may include duplicates):

Is income investing now doomed? Evidence of the strategy still having merit (perhaps!) comes from a portfolio managed by an ex-Motley-Fool colleague of mine, Stephen Bland.

He set up a demonstration high-yield portfolio (dubbed ‘HYP1’) 20 years ago during November 2000: https://www.fool.co.uk/investing-basics/the-high-yield-portfolio/

The portfolio construction was simple: pick the highest yielding large-cap share from 15 different sectors.

Holders would then sit on the portfolio and collect the income, and — importantly — only make a share trade when a position was subject to a takeover. Otherwise, the portfolio was not to be tinkered with.

Original names in this HYP1 included Lloyds TSB, BAT, Bass, BT and Rio Tinto.

Stephen recently published an update 20 years on: https://www.lemonfool.co.uk/viewtopic.php?f=15&t=26213

Highlights:

  • The initial £75k investment is now £149k.
  • The initial £3.5k annual income is now £5.5k (but was £10.6k during 2019).
  • Aggregate 20-year income of £101k.

Capital doubling and income tripling (pre-Covid) over 20 years = 3.5% capital CAGR and 5.6% income CAGR.

Total return = £75k to £250k over 20 years = 233% = 6.2% CAGR assuming income not reinvested. (Could be nearer 8-9% if reinvested?)

Not spectacular, but better than the FTSE 100 which is up 350 points to c6550 over 20 years.

The all-round outcome of this HYP1 was almost certainly better than a high-income savings account, a bond (at least on the income side) and an annuity.

Indeed, Stephen’s HYP1 would now be in the top 5 of UK Equity Income funds over 20 years:

One issue with the HYP1’s ‘non-tinkering’ approach is that winners came to dominate the portfolio.

In fact, 20 years on, 60% of the portfolio’s dividend income is generated by just two shares (BAT and Rio).

How could an HYP look today for the next 20 years? I trawled the FTSE 100 to find out and identified 10 candidates.

I noted less sector diversification than 20 years ago. No high-yielding banks for a start.

Ten selections below. All are FTSE 100 members, have paid dividends during 2020 and appear relatively confident of payments in the near-term.

Note that a few, including Imperial, BP and Sainsbury, have implemented cuts this year:

HYP candidates

Could these 10 selections collectively deliver a better outcome than a high-income savings account, a bond and an annuity over the next 20 years? I would like to think so.

Arguably some of the ten could be classed as dinosaurs. But I suppose a similar criticism could have been made 20 years ago.

The hardest part is holding such shares for the next 20 years without any trading activity. I don’t think I could be so hands-off.

But Stephen’s HYP matching the progress of the top 5 of UK Equity Income funds suggests being hands-off might actually be no bad thing.

Maynard

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Hi (again!)

My personal feeling, for what it is worth, is Stephen Bland’s approach piggy-backed on (and detracts from) the returns of ‘coffee can’ investing i.e.the coffee can approach is why it (kind of) worked, rather than the properties of any associated dividend yield.

I firmly believe total returns would be much higher had a portfolio (20+ shares) of quality companies within forward looking industries (irrespective of dividend yield) had been assembled and held for 20 years, despite 5% or so of these shares having been sold annually over time to cover the equivalent of a dividend yield income.

Putting the coffee can under the bed mattress for 20 years protects us from our behavioural weaknesses due to price fluctuations, and snake oil salesmen recommending rotation into hot sectors etc.

Not easy to do in practice, though!

Ben

Hi Ben,

Yes, I think you are right with the quality angle – the hard part of course is having the cajones to hold on for 20 years and ride out the periods of underperformance and doubt that will inevitably arise. No wonder Fidelity once remarked the best investors are dead: https://theconservativeincomeinvestor.com/fidelitys-best-investors-are-dead/

Credit to Stephen, though. He set out the plan at the start and there was no hindsight involved.

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That is a sobering article! At least I will eventually reach my investing potential!!

The disagreement I have with Stephen’s approach is that it attempts to mix value investing (I believe he suggests high covered dividend yield implies value?), with long term ‘buy and hold’/coffee can investing. This approach could lead a person into holding a value trap and losing a large proportion of their capital in that particular share.

Charlie Munger got it right when he suggested price paid isn’t such an important factor, provided returns on capital are sufficient and not eroded over time, and investments are held for the long term.

My view on value investing is it should be used over the shorter term until a market anomaly has played out, rather than using value to try to create a cash dividend machine out of the stock market, and effectively closing ones ear’s to the message the stock market is telling us about future risk with the high dividend yield.

Hi Ben

Yes, the approach could lead to large capital losses in a particular share - Lloyds being an example in this HYP portfolio. But Stephen always maintained taking a diversified approach, so winners (he reckoned) would hopefully outweigh losers. In this HYP’s case, the portfolio has ended up with two huge winners that now dominate proceedings.

That said, I would agree with the sentiment here – if you are intending to hold for a very long time, you need to ensure there is underlying business quality to prevent the risk of permanent capital losses. A dividend yield on its own does not indicate business quality.

Stephen’s traditional deep-value approach (the ‘PYAD’ approach) was very much a shorter-term strategy – say over a year or two. Essentially you waited for the value to ‘out’, and then moved on to the next ‘cigar butt’. PYAD was low P/e, high Yield, decent Assets and no Debt. This style of deep-value investing may currently be even more unpopular than equity-income investing!

Maynard