#HYP 6 - Considering the risks of a High Yield Portfolio

This is part #6 of Stephen Bland's High Yield Portfolio Series on Stockopedia.    Last week I looked at whether selection methods and filters might be able to exclude shares that go on later to prove troublesome by suspending or cutting dividends, perhaps even going bust, though I’ve never picked one of the latter so far. I employ selection filters to omit what appear to be obviously weak candidates but it is just about inevitable over the eternal holding period intended for the HYP strategy that some problems will occur at various stages. I concluded that this has to be accepted by HYPers as a known potential risk which cannot be wholly eradicated by any amount of initial filtering.

This week I’ll consider whether an HYP is all an investor needs or whether it might carry too much risk on its own so really should be just part of a much wider spread of investments. Eggs and baskets. 

Note that I am addressing this to those who have already decided to utilise the HYP idea in some proportion, whether they are reinvesting dividends for future income or are at the stage of requiring immediate income. I’m not discussing here whether HYPs should be used at all because my underlying presumption is that investors are convinced in principle about it.

There is no easy answer to the question because it depends on the specific circumstances of the individual but two main factors influence consideration of the matter. First the investor’s attitude to risk and second how much cash they have available for investment. There are some minor factors too like the degree of work and aggro required to manage their investments that people are prepared to accept.

I’ll take an example. You have a lump sum of £100,000 in the bank, the source of which is not important for this purpose. You have no immediate need of the money, nor the income from it, so have decided to put it into risk investments for your future. Should it all go into an HYP or should part of it be invested that way and part in some other areas? I’d say raise all in on your HYP, reinvesting dividends until you need them.

I don’t consider this too risky for the whole of your available investment capital. Equities in general can be very risky, just gambling the way some people do it by trying to score from very short term trading, but done the HYP way, I believe this is around the lowest risk an investor can take commensurate with being in equities at all. Widows and orphans stuff.

Now look at the same investor, same situation but with a lot more cash. Say 500,000 or more. Amounts that big are like those quasi butters, easily spreadable. Unlike the smaller sum above, you could for example put part into property for renting out and the rest into your HYP. Not a bad idea perhaps but do you want the hassle and illiquidity that accompanies owning property to let? If you are happy with that, then fine. But if you want a much easier life than again, 100% HYP could be the way to go. I see nothing wrong with investing even very large sums into an HYP because I regard the risks as sufficiently low.

For the larger investor there are many other options which combine an HYP with other investments, even those who don’t want the hassle of property letting. For example gilts or other bonds could form part of an investment portfolio alongside an HYP. Then there is a plethora of funds available amongst ETFs, investment trusts and unit trusts covering an enormous range of investments worldwide. Far too many to go into detail here.

If you decide to mix your HYP with funds, avoid those which largely duplicate your HYP holdings. An HYP consists of UK big caps. So you would not want a fund which holds a lot of the same shares. Rather, my advice would be to look at, say, a US equity income fund for example or a bond/gilt fund from the UK or US. The idea of spreading investments around, if you wish to do that, is to reduce risk, not to concentrate it.

My above comments on lump sum investors apply equally to those of any age and equally to whether income is reinvested or withdrawn. I would say the same whether you are nine or ninety.

What of the regular saver who doesn’t have a lump sum? Depends how much is being saved but choice here is far more restricted. If you can save say £1,000 per month, and that is far more than most, again I’d say stick it all in your HYP by buying shares at regular intervals to construct it. I see little need to diversify but with a sum like that, you could if you wish utilise part for your HYP and part perhaps into some funds, bearing in mind my comments above.

Much less than this per month and really it becomes too small to even consider spreading so here, you should consider the HYP your sole investment choice.

Finally this is a money and mouth job for me. I’m old now and virtually all my investment capital these days, a considerable sum, is in my HYP. I wouldn’t advise anyone to do anything that I wouldn’t do myself.

I have no fears of the risks involved, despite having had my share of the inevitable duds that suspended dividends. I’ve even still got Lloyds in my portfolio which hasn’t paid me a penny for years. Of course there are risks attached, my eyes are fully open on that, but the risks are on the low side and acceptable to me in return for the potential rewards. 

This will be my final article for the time being on my HYP strategy. I hope that readers have gained an insight into the approach, and whilst I realise not everyone will be convinced, the record shows that it works, meaning delivering an increasing long term income and secondarily dragging the capital along with it if that concerns you. All you need is immense patience and the strength to avoid tinkering. I say “all you need” but in practice my wide experience with investors tells me that those traits are not so common.

Doing nothing? Nothing doing! That’s the attitude of too many small investors. But then a very large proportion of them make no money. I’ve found with the HYP that doing nothing is actually a very positive stance to take and women for some reason are very much better at this than men.

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