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
- 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:
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.