Category Archives: RIRP

Finally time to use RIRP as was intended

Finally time to use RIRP as was intended

I launched the Rising Income Retirement Portfolio (RIRP)  ten years ago this coming March after phasing myself out, as planned, from the private companies I had sold two years earlier. One reason was that well wishers advised me that as I had been a notorious workaholic I should get involved in some other activities to prevent myself curling up and dying from boredom; resuming writing after many years broadcasting was one of several commitments I undertook.

I soon realised that the advice – although well meant – was based on a wicked puritan lie. Now as I approach my 72nd birthday I have decided to wind down all my outside activities. I find I am quite capable of passing my time very agreeably without getting the slightest bit bored. My ideal retirement is an extended version of my working-life definition of a holiday: a time when I never have to look at my watch or meet a deadline; my various commitments are now increasingly frustrating this ambition.

So in this final review of the RIRP and its younger offspring, the Income for Life Portfolio, I am distilling the main lessons I have learned during this fifth decade of my life as an active investor; they may also act as pointers for anyone wishing to continue or emulate a portfolio such as these.

If my original aims had been fully achieved, there should be nothing for them to do unless a company gets taken over, cuts its dividends, or goes bust.

Lessons start here

But the first main lesson is that even for a “buy and hold” investor like me, all portfolios require a greater degree of active management than I now want to provide, other than to my own investments. The second lesson is that the original concept – finding shares with a likelihood of delivering above-inflation dividend increases – is entirely possible, as the RIRP proves; but the second part of the plan, to be able to largely forget about them, is not practicable, and not least because of the distorting effect of special dividend payments, to which companies seem increasingly attracted.

The third lesson is one every honest journalist or fund manager knows, but is easily tempted to forget: however experienced we may think we are, none of us is infallible. Although most of my RIRP shares are those I started with, various unforeseen failures – ranging from a change from rising to gently declining dividends, such as Sainsbury’s, through big cuts such as Pearson recently, to outright suspension such as Balfour Beatty and Interserve – have combined with successful or unsuccessful takeovers such as Sky to produce more changes over the years than I had ever anticipated.

But even given the impact of my most recent manifest error, GLIF, overall I can claim considerable success. The total income available this year from the RIRP equates to a yield of over 7.2% on the sums originally invested, and even the three year old IFL could distribute over 6.7%. But in both cases some of this comes from a combination of special dividends or realised capital gains, which were very much not part of the original plan.

Income growth is king

The real test for me is the growth in the underlying income, the first bold figure in the penultimate columns of tables 1 and 2. For the current year the RIRP only squeaks in just ahead of inflation, and that only thanks to an adjustment I made last year from my “bonus” fund when I was facing a short term income reduction from reinvesting halfway through the dividend year. But the overall rise is despite the complete collapse in dividends at GLIF, which I greedily included in both portfolios, compounded in the RIRP by the massive cut in Pearson’s most recent dividend. In both cases the full impact will not be felt till the forthcoming accounting years. The fact that special dividends and realised capital gains boost the total available income of both funds well above any measure of inflation only disguises the failure this year to achieve the core investment aim.

Excluding the party poopers, the underlying dividend growth for the other shares has been strong: 11.2% in the RIRP and 5.8% in the younger IFL. Over the decade the RIRP’s underlying income is up 56% on its initial 4% target, while underlying projected full year income from the existing shares in the IFL represents growth of nearly 6% on the initial 5% target yield.

I have always claimed that so long as the dividend targets were achieved, I could afford to be entirely indifferent to changes in the capital value of the portfolio. In the long term, market values should rise at least in line with dividend payouts, and so it has proved with the RIRP. In this final appraisal I am showing the market value of each of the shares, and their percentage rise or fall from their original purchase price. The RIRP’s 37% increase in market value has marginally exceeded the rise in the RPI over the decade shown in Table 3.

So I have preserved the real value of my capital while seeing my underlying income rise from an initial 4% by nearly double the 30.4% rise in the RPI.

The IFL currently fares less well, but may be excused to some extent since it was constructed within one year with an ambitious first year fully invested yield target of 5%, which it exceeded.

But the fact the year ended with the (unrepresentative) FTSE 100 index at an all time high means I cannot ignore the fact that these selections are living proof that a rising tide does not necessarily lift all vessels equally. I find I am ending the year with paper losses in nearly half of the IFL shares, which makes it all the more impressive that overall the portfolio shows a tiny capital gain. In neither case should this be relevant, except that I have previously resorted to realising some capital profits to make up for the mistakes I have not been clever enough to avoid.

In providing some guidance for the future, quite apart from GLIF I cannot ignore the doubts the market clearly has over Centrica, Connect, Kier and Marston’s. Normally I would take comfort from the fact all these companies except Centrica raised their dividends this year; but equally I remember that in the year before the banking crash all the UK banks rashly raised their dividends by an average of double figures.

You do the maths

The final lesson I take away for the last decade is a mathematical formula for resolving the dilemma of whether and how to reinvest in such cases. The problem is always how to preserve the underlying income flow when the capital value has collapsed. To take a current example: if Centrica merely maintains its dividend, it is still only yielding me 4.7% on my original investment against a higher portfolio average of 5.3%. But if I sell it, at its current diminished market value I need 8.7% just to suffer no fall in income, and that is simply unobtainable from anything I know of which shows any prospects of dividend growth. The only way to plug such a gap is to use the capital profits generated by reducing the stake in one or more of the star capital performers, such as HSBC or BATs, which in both cases requires sacrificing shares with record-breaking dividend growth, helped in HSBC’s case by declaring its dividends in US dollars.

Maintaining control

I’m aware that people who do not know me may conclude I am chucking everything in at the first signs of problems. To restore the balance I must boast that I have come out well against some of the “control” shares which we built into the RIRP, to make sure I was not reinventing the wheel. Early on I included Bankers IT, the only investment trust I could find whose aim was the same as mine: dividend increases above inflation. A surprise 12.2% dividend spurt over the past 12 months coupled with the RIRP’s below par performance means they have finally fractionally beaten the RIRP: their dividend increases over the decade are 60% against my 56%; and although my earlier slightly creative reinvestment accounting means the table overstates the rise in Bankers’ capital value, it has significantly outpaced the RIRP, even though it has had to bear transaction and administration expenses which my portfolios ignore.

But there is a cost: just as its starting yield was well under my minimum 4% target, so anyone thinking of buying today has to make do with a 2.1% yield against 4.5% from my mature portfolio. If in the future any capital gains are needed in the RIRP for any reason, this is clearly a prime candidate.

The same is true of Reckitt Benckiser, added at the same time as the much higher yielding Direct Line, in response to some subscribers’ suggestion that I should include a lower yielding “growth” share as a comparator.

To my pleasant surprise its 25% rise in underlying dividends only marginally beats DL, so RB is still only yielding half as much on the original cost of its shares as Direct Line. DL has therefore paid out twice as much actual money to the RIRP as RB. My income from DL has been further boosted by regular special dividends which far outweigh the benefit received from RB’s spin off of Indivior, which I sold and treated as a special dividend.

The last column of each table shows why I am content to take my curtain call with every reason to be confident that the coming year will prove that the changes I made last year will restore the underlying dividend growth in both portfolios. The only caveat has to be the possibility that the three big share price falls (apart from GLIF) in the IFL are accurately predicting disasters ahead, rather than a temptation to top up: in which case the same sort of surgery which saved the RIRP from its earlier scars in the immediate aftermath of the financial crisis are still available, with similar medium term prospects of success.

Douglas Moffitt, January 2018

RIRP – Flexing the rules now to save for that rainy day

RIRP – Flexing the rules now to save for that rainy day

Three months ago a surprise cut in the dividend of what had been one of my star performers, Interserve, forced me to apply dramatic surgery to the original Rising Income Retirement Portfolio (RIRP)  in order to Brexit-proof it for the inflationary challenges then only just starting to appear.

Three months on and the inflationary pace has accelerated to 3.7% by the highest measure – and I am expecting a peak of at least 5%, confirmed by the fact the come-on 3-for-1 offer of one of my favourite beers at Tesco has just gone up 5%.

Table 1 shows the portfolio is likely to come out smiling.

Table 1 RIRP

The average full year yield on the sums invested is up to 6.4%, 60% up on the original 4% target 10 years ago, and more than twice the highest measure of inflation over that time. The last figure of column 2 shows the shares have already increased their underlying dividends by more than 5% over the previous year even though we are less than half way through the current accounting period. So with the extra bunce of some special dividends, I anticipate the RIRP will resume its original brief of being a low maintenance have-and-hold portfolio.

For most of its life, low inflation means I was able to carry a few failures and sleepers in the RIRP, but rising inflation now forces me to be less indulgent. I shall be keeping a beady eye on companies unable or unwilling to raise their payouts, regardless of their high yields.

Paring out the dead wood

This time I must perform a similar exercise on the newer junior portfolio, the Income for Life, constructed over a one year period designed to deliver at least 5% income rising so as to beat inflation. The first was a deliberately ambitious challenge, and the second is increasingly becoming so.

Table 2 shows that in its second year, and its first year being fully invested, the underlying return on the £100,000 capital was over 5.2%, boosted to over 6% by special dividends and an enforced share sale.

Table 2 RIRP

But just like Interserve in the RIRP, one of my holdings has turned into a cuckoo; and just like the takeover of Alternative Networks forced me to sell a share at a time not of my making, so the Fox bid for Sky is effectively forcing me to do the same. I have always justified my professed indifference to my shares’ capital values with the argument that the value of my share certificates does not pay the bills, but the dividend cheques do. And the nasty small print in the Fox bid is that Sky pays no dividends this year. The sex scandals at Fox are again raising concerns as to whether the UK should consider it a “fit and proper person” to own such an influential broadcaster outright, and frankly I cannot any longer afford to forgo any return on one twentieth of the portfolio.

So entirely aware that I am throwing away the chance of a 5%+ capital gain if and when the bid does go through, I am selling all my Sky shares for a small capital loss.

Building a war chest

To compensate for this I am selling another chunk of the formerly high-yielding UIL, whose big capital gains have actually reduced the return on its current share price to under 4.6%. I am similarly cashing in £2,000 of the investment in De La Rue which still has to generate the dividend growth I want, but which for reasons I find as difficult to understand as UIL’s valuation, has risen by 50% since I bought it; since even I cannot resist banking a £1,000 capital gain to provide a war chest against future possible dividend disappointments.

All this generates nearly £9,000 cash of which I am using £8,000 to buy 4 units of two very different shares, each something of a gamble in their own way.

The first is what I hope will be a solid but unspectacular provider of income which will rise at least to match inflation: HICL Infrastructure, launched by HSBC back in 2006 as the first of what are now many infra-structure companies listed on the stock exchange. The nature of their contracts effectively allows investors a guaranteed inflation-linked return, unless the management lose track of their costs. Dividends have risen from 6p at launch to a target of 7.8p for the current year, bang in line with inflation over the period. Dividends are paid quarterly, which means this year we will only get three quarters of the projected 4.7% full year yield. In keeping with the lessons I have learned late in life about sometimes dipping into capital gains when they seem too good to be true, I am using the De La Rue and UIL profits minus the Sky loss to further boost the “bonus” line, already standing at nearly £500 because of which a welcome surprise special dividend from National Grid last month.

Building in the bonus

And for all my railings about the distortive effect of special dividends, I am buying my second share very much in the hope it will continue the pattern of the past 5 years by further supplementing its above average underlying dividend growth by generous regular special dividends. It is ITV which after some difficult years has found ways to continue to generate viewers and revenue despite the huge changes in viewing habits.

ITV chart

Underlying dividends have increased by two and a half times over just the past 5 years, and the projected percentage yield in the table is based on last year’s basic dividends. But the special dividend last year boosted the yield by more than two thirds. Unfortunately we will get only one dividend in our current year, but I am hoping for a bumper bonus next May.

The table shows we have some way to go to get underlying full year income even back up to last year’s £5,215. I am hoping GLIF will provide at least something to help narrow the existing £129 gap, but in view of the current share price around 14p I am not holding my breath. Clearly this is going to be a year when I shall have to dip into the war chest.

I realise of course that in doing so I am spending the two sources of money which I claim not to want, special dividends and realised capital gains. But when needs must, it is surely a fool who feels constrained by his own dogmas. And to salve my conscience I am pretty sure that by the year end next March I shall not have had to boost the income figures by more than last year’s £828 bonus, which prudent investors should have kept aside for precisely such a rainy day; but which I fully realise most of us will have spent.

Douglas Moffitt, July 2017

Star holding sacrificed for post Brexit income growth

RIRP – Star holding sacrificed for post-Brexit income growth

When I last wrote 3 months ago, I anticipated that I would have to review some of my holdings in my RRP and IFL portfolios. This is forced by the inevitable imported post-Brexit inflation making it more difficult for my shares to continue to raise their dividends by more than inflation, as they have so spectacularly done since I launched the two portfolios.

I anticipated that the main problem would be with the more recently launched Income for Life portfolio, because I initially had to settle for some higher yielding shares with lower growth prospects in order to achieve my rather demanding starting income target.

Low maintenance, just not that low

I had grown used to just periodically updating the original Rising Income Retirement Portfolio (RIRP) and complacently reporting that most companies had increased their payouts by two or three times the (undemandingly low) rate of inflation, and so conveniently compensating for any temporary laggards. After all, the portfolio was specifically constructed so as to be a low maintenance selection of shares, designed essentially to look after itself, as insurance against the day when I may have lost those marbles still remaining to me, rendering me less able to take financial decisions.

So it was a shock to me as I updated the table below to discover that whereas seven of my companies had already announced dividend increases for the accounting year ahead averaging over 11%, shown in bold in the last column of the table, Interserve had spoiled the party by “suspending” its forthcoming payout.

RIRP table

Only recently I had been heralding it as one of my star performers, only one of three in the portfolio to be delivering the coveted double figure yield on the original sums invested. This is where my professed indifference to the capital value of my shares may have let me down. For as Interserve’s dividends had risen since I first bought the shares, so the capital value had climbed to more than 3 times my original purchase price by 2014. This is what I would expect. But what I had not appreciated was the steady fall in the share price from its peak, despite continuing rises in the payout – up nearly 5 per cent last year.

Now it is marginally less than we paid for it, and we know the reason why: not only are underlying profits down, but exceptional costs in getting out of its Energy From Waste business has resulted in a £160m exceptional charge, and the need for new banking facilities to see it through the painful transition.

The passed dividend will “only” save some £23m, so I anticipate the dividend “suspension” may be rather like Norman Lamont’s suspension of the UK’s membership of the European Monetary system back in 1992. Since I cannot see how the pound’s post Brexit decline can fail to feed through to anything less than price rises of 5% before much longer, I need to undertake some drastic surgery to protect my future income flows in the RIRP.

Because Interserve’s cumulative dividend growth had been so good, it leaves a £600+ hole in the coming year’s income, assuming the dividend “suspension” lasts the whole year, and not just the final which should have been paid next month. Before this I had decided the portfolio was strong enough to ride out both the projected further dividend cuts at GLIF, partly because I have little appetite for crystallising the resulting large capital losses, but also because I still have some hope that it – like Lloyds and RSA – might eventually come good. And because I suspect that may happen before Interserve resumes its former payouts, I still think that makes sense.

Realising cash for new purchases

So I think it makes sense to take a small capital loss on the Interserve shares by selling them all. To pay for this, and also to compensate for the inevitable short-term dividend reduction resulting from my reinvestment decisions, I will also sell two fifths of my holding in Reckitt Benckiser, whose shares are currently up around 50%. In some ways this is a painful choice, since this dollar-earner has just announced a dividend increase of 10% which may well be exceeded for the full year, but in terms of its current share price it is only yielding just over 2%, and in the short term I can put both the capital and the capital gain to better use.

My sale of Interserve and the RB shares generates cash of around £8,836 from investments originally costing around £8,000.

So I am going to add the net capital gains of £836 to the £43.30 already sitting in this year’s annual “bonus” account as a result of Lloyds Banking Group’s latest special dividend payable, and use £3,000 to top up my below-average holding in Lloyds to the standard 5 units, since I now anticipate continuing above average dividend increases as the company recovers from its near-bankruptcy after the HBOS takeover. (I am assuming the latest legacy liability regarding illegal actions by rogue staff will be negligible in the context of the costs of PPI misselling). This latest purchase means a big rise in the average price we have paid per share, and though the apparent yield is still below the portfolio average, the latest special dividend to be paid in May brings the actual return to over 5.25% with every expectation of further growth.

In place of Interserve I am investing the remaining £5,000 “original” capital into Phoenix Group.

Formerly Pearl Assurance, this company really has reinvented itself, moving to the Cayman Islands and developing an eagle eye for making money out of other companies’ zombie life funds – those closed to new business but whose liabilities can be run down very profitably. Although the current dividend is technically not covered by earnings, the group is actually throwing off cash at an impressive rate, and the board is confidently forecasting a further overall 5% increase for the year. The City gossip is that it may relocate its domicile from the Cayman Islands to facilitate fundraising for more acquisitions. I am buying this share (as I have recently bought for myself) even though the portfolio will miss the xd date for the May dividend, and so will only deliver half the full year’s anticipated 6.4% yield in our accounting period.

Short-term shortfall

The short term effect this year will be that based on dividend increases for the year ahead declared so far, the portfolio’s underlying income will fall from £6,325 to £5,843. I expect this gap to have narrowed substantially over the remaining 10 months of the accounting period as more companies announce further increases, but meanwhile I have no compunction in including the “bonus” income in the yield calculations. Just as I have always claimed that unrealised capital profits do not pay the grocery bills, so the corollary is true that realised profits can do. If we choose to deplete the whole of this year’s current war chest, our disposable income will be more than 6% up for the year ahead, way above any anticipated inflation rate. The expectation of further announcements of higher dividends over the coming 10 months mean there should be no need to crystallise any further capital profits, unless an exceptional reinvestment opportunity arises; barring another Interserve of course.

I am leaving the IFL alone for this issue as there are no horrors other than the known question mark over GLIF’s future dividends, though several other shares are showing little or no growth, problems I shall address in the July issue.

First published in The IRS Report on 1st April 2017.

RIRP pays double the inflation rate as IFLP demands my attention

RIRP pays double the inflation rate as IFLP demands my attention

As with most new arrivals, the Income for Life portfolio which I launched less than two years ago has occupied more of my attention than I intended. As a result, its predecessor, the Rising Income Retirement Portfolio (RIRP) – nine years old in February – has effectively been ignored for the second 12 months in a row. Again no changes have been made to the portfolio, and this is exactly what was intended when it was constructed: a low maintenance selection whose dividend increases would comfortably outstrip inflation.

To be frank, this has not really been a very demanding target over the past few years, and even though the most recent annual inflation rate for the RPI has risen to 2.2%, as Table 1 shows the fund’s underlying income went up by 5.5% – two and a half times faster.

I no longer include special dividends in the basic calculations, rather treating them separately as “bonuses” because they are so unpredictable: this year’s specials from Direct Line, Glaxo and Lloyds provide a further £468, equivalent to nearly 0.5% on the original investment, but in fact the total bonus sum is nearly £2,300 less than the previous year’s truly exceptional and clearly unrepeatable receipts.

The future will be harder

But life is going to be tougher for the next couple of years. Since June and for most of the coming year, dividends of companies designated in dollars or euros, such as BP, HSBC or Vodafone, or with significant international earnings such as BATs or Reckitt Benckiser, will benefit from the fall in sterling which the foreign exchange markets so obligingly gifted the Brexiteers. But by the same token imported inflation will increasingly start showing through, so I must look carefully at some of the small print behind my funds’ performances.

The last column of Table 1 shows the actual rises or falls in income compared with the year before. The fact the market is around all time highs means the RIRP has unrealised capital gains approaching 40 per cent which means I now need to have pretty good reasons not to weed out shares which have gone ex growth or cut their dividends. The next article in April may see me jettison Pearson, Sainsbury and the two utilities unless they can raise their games.

IFLP beats its target in year 1

Table 2 shows that the junior portfolio, the Income for Life, will complete its first fully invested year in March with flying colours, delivering an underlying yield of over 5.2% on the original capital, usefully above the original 5% target.

There have been a lot of changes to the IFL since the last full table was published 6 months ago. Not only does it now reflect my post-Brexit decision to realise some of the inexplicably large capital gains at UIL and reinvest in what seemed to be the unreasonably depressed Galliford Try, but also the rather surprising year-end takeover of Alternative Networks.

Alternative profits

When I originally bought Alternative Networks for the portfolio in July I was attracted by the rising dividend record on the basis of which I had myself invested when the share price was significantly higher and the yield correspondingly lower and so below the IFL’s initial targets. This was reinforced by the company’s confident forecast of a further 10% dividend increase this year.

I can only conclude the directors suffered a collective case of terminal post-Brexit depression, because they have since unanimously recommended a cash takeover from one of their biggest rivals. A reference to “Brexit uncertainty” is the only new factor I can discern in the lengthy statement of recommendation which makes any sense at all. For all the talk about how the group has created long term value for shareholders, unless – like the IFL – you were lucky enough to buy between the end of May and the beginning of September this year, there is precious little profit for anyone who bought the shares after mid 2013, and losses for anyone who bought during 2014 or 2015 – as I did. The all time high in 2014 was 570p – 70% above the recommended takeover price.

So I think the IFL is very lucky to be able to book a 15.5% profit, even though it is deprived of the forecast £188 initial January dividend. I am applying some of the gain to replace the lost dividend.

I dislike takeover bids for two reasons. They sometimes force me to crystallise a paper loss I might have been happy to live with, as I was with my personal holding based on the dividend and pre-Brexit forecasts. But even when bids crystallise a gain they force me to make reinvestment decisions at a timing which is not of my choice.

I thought about using the Alternative Networks bid proceeds to bring in a new share, but because the portfolio was constructed in the space of 12 months it has never been able to benefit to any significant degree from the multi-year pound-cost-averaging drip investment technique employed to create the RIRP.

Top-ups win over new shares

So I have applied the RIRP rules, and topped up on shares whose fundamentals seem unchanged from when I originally bought them, but whose share prices are either still around or below my original purchase price. To my surprise and delight one of the qualifying candidates was Galliford Try, so my maiden £2,000 investment is now topped up to the standard 5 units, and the remaining £2,000 is split between Connect and Marston’s. All three shares are yielding more than the fund’s current average 5.2%. I have booked the capital gain minus the £188 dividend to the “bonus” line.

The IFL will face the same challenges as the RIRP as inflation starts rising, but with the disadvantage of initially having been forced to invest in higher yielding shares, the corollary to which is normally lower dividend growth longer term. Like the RIRP it also faces a further dividend cut from GLI Finance, but even if GLIF pays no other dividend this coming year than the remaining quarterly to which it is committed in March, the full year dividends from Galliford Try and my other increased holdings already largely make up the loss.

I also admit I quite like leaving a failure in if I can afford it. There are two reasons: sometimes they come right, if you can wait long enough; and meanwhile they are an enduring reminder that none of us gets it right all the time, and should therefore not beat ourselves up too much for our failures.

Douglas Moffitt, January 2017

Income growth record in 2015

RIRPs record 32% income growth in 2015

Income growth a record 32% in 2015. In the year since I last published full details of the original Rising Income Retirement Portfolio I have pursued a policy of benign neglect towards its management. This was partly because my attention has been focused on constructing its successor, the Income for Life Portfolio, but also as a test of one of its original aims.

It was launched in March 2008 to deliver dividend increases each year at least equal to – and ideally exceeding – the rate of inflation; but just as importantly entailing minimum maintenance once fully invested.

The much maligned market commentator Bob Beckman used to claim that “masterly inactivity” was one of the most difficult disciplines to embrace, and I have forced myself to observe it over the last year, other than to consult my Excel sheet on what my dividend flow should be.

Now I come to look more closely, I find quite a few surprises, not all of them pleasant.

Four nasty surprises

I did write in the summer that I feared that my laissez-faire approach might have meant I had missed a developing problem at Infinis. This duly culminated in December when the original private equity sellers took the company private again for 185p, 29% less than the price at which they had floated it less than 2 years previously. This is nice work if you can get it. We lose nearly £1,500 of our £5,000 investment, and a dividend stream of over £231.

The second surprise was that GlaxoSmithKline had gone ex-growth over my accounting period, at least in dividend terms. This was always a danger, as had already happened at competitor Astra Zeneca, but I had not expected it so soon at Glaxo. I am taking no action yet as the company’s recent acquisitions may allow it to resume rising payouts and not affect the income growth.

And although the dividend at Pearson has continued to rise, worries about its future sustainability have knocked the share price nearly back to the average price we paid for it years ago.

The capital fluctuation does not worry me in itself, but a dividend cut of course would, as is now happening at GLI Finance. Its share price collapsed towards year-end to under 35p, following proposals to repay nearly £25m maturing loans with a zero dividend preference share issue.

In the week before Christmas those plans were abandoned in favour of selling 7% of the company to a Jersey-based venture capital group for 37p a share and other cash injections which will allow it to repay its loans. The former CEO has resigned and the dividend will be halved. This reduces the prospective yield to only 4%; the fund can live with this if it has to, but I will be reviewing this holding in April.

Income growth record
Income growth record at 32% in 2015

Three shares now yield sustainable 10%+

There have been some pleasant surprises too, notably a double figure rise in the dividend at BT, as also Legal & General and BP, the latter boosted by favourable currency fluctuations. This means that three of our shares now yield 10% or more on our original investment. This more than offsets the anticipated dividend reduction at Sainsbury.

The other surprise was that the increase in income which my spreadsheet was showing at Reckitt Benckiser was entirely accounted for by the spin off of their anti-addiction unit into a new plc, called Indivior. Reckitt itself actually reduced its sterling payout.

As the Indivior holding in total was only worth a couple of hundred pounds I have decided to sell it and show the proceeds as an adjustment in a separate line in the table, in the same way as I brought in £127 of unusual items this time last year, as explained at the time.

The Indivior payout had artificially boosted the increase in underlying income recorded in my interim reports over the past year on the fund’s dividend growth. The fund’s underlying income was boosted by £2,750 in special dividends or capital repayments from Direct Line and Standard Life. Unlike Reckitt, where the impact on dividends is transparent, both these companies implemented capital reconstructions, reducing the number of shares in issue so as to compensate for the capital repayment.

Effectively this reduces the payouts, as the cash income figures from Standard Life show. And because the huge capital repayment from Vodafone the previous year had straddled the end of my accounting year, the figures shown this time last year for Vodafone’s income unfortunately included some £500 which should have been included in the bonus line in my summary updates over the past year: my apologies, and I have corrected it in the current tables.

Even after the above adjustments, and the dividend cut at Sainsbury, the fund still shows an entirely healthy rise in underlying income for the year of over 4.7 per cent, to nearly £5,994 – a return of 6 per cent on the original capital invested. My target of at least doubling the rate of inflation so long as it remains abnormally low has been helped by the mere 1.1 per cent rise in the RPI over the latest twelve month period available.

Table 2 shows the longer term achievement, and the increasingly sizeable impact of the non-recurring bonuses.

RIRP dividend income growth
RIRP dividend income growth

Bonus payments help income exceed target

Over the 8 years my original at target yield of 4% needs to have grown to nearly £4,928 to keep up with the 23.9 per cent rate of inflation since I started the fund. In fact the underlying income has grown over twice as fast to nearly £6,000, and that’s before the bonuses and adjustments amounting to over £2,900 this year alone, plus others over previous years.

This year’s rise of nearly one third in total income can obviously not be predictably repeated, the main reason I have started showing one-off payments separately from underlying income. Another benefit of identifying specials and capital repayments separately is the ability to regard such income as a slush fund for a rainy day.

Similarly, if I wanted, I could use some of it to pay for the capital loss on the forced sale of Infinis. But I don’t think I need to.

Compensating for the £231 loss of income from Infinis with only just over £3,500 to reinvest requires a yield of nearly 6.6 per cent, which is almost impossible to get without undue risk.

I have decided to leave my slush fund untouched this year in case I need to top up my underlying income next year, as a result of this forced sale and reinvestment and dividend cut at GLI, and instead will correct a feature in the table, which worries some readers because it shows “artificially depressed” purchase prices for a few stocks which I had paid for or topped up in previous years by scalping some capital gains from shares which had shown significant capital profits.

What this meant, for example, was that if I sold a £1,000 unit of a share which had risen by 50 per cent, I would buy shares in (for example) Bankers Investment Trust for £1,500, but only show a book purchase cost of £1,000; in other words reducing the apparent purchase price by a third. I justify this because it keeps the book value of my original capital constant just under £100,000 and so lets me see what the real achievement has been in terms of the yield on that original capital.

So now I am going to spend my actual £3,503 realised from the sale of Infinis to top up the existing £4,000 investment in Bankers and £3,000 investment in Vodafone by a book cost of £5,000 in total to 6 units each. This will have the effect of raising the average purchase price of those two shares, and reducing their projected percentage yield, though between them still to an average of over 5.

On current projections the fund needs to deliver an extra 1.3% underlying growth to make good for these lower reinvestment yields. As happened last year I am expecting another healthy round of dividend rises over the year ahead to deliver much more than this, even if higher interest rates do make some inroads into corporate profits.

I am hoping that my long-term sleeper Lloyds may also compensate for GLI letting me down. If as is widely mooted Lloyds is sold off with a prospective yield of 5 per cent or more at a significantly higher price than my average purchase cost, the resulting sharply higher dividends will solve a lot of my potential shortfall. I may even consider topping up the holding in the public offering by selling off a couple of units in companies whose share prices are up sharply and where I am overweight, such as Interserve or Standard Life, if the reinvestment yield makes sense adding to the income growth.

Filling out the IFL portfolio

So far as the Income for Life Portfolio is concerned, as foreshadowed in the previous article I am spending the fund’s remaining £12,000 in topping up to 5 units those shares in which I have currently invested less than the full £5,000, and will report on the first full year’s income growth, with the fund fully invested over those twelve months, in the April issue.

My New Year’s Resolution is to apply the lesson from this past year, which I already knew in my bones: that there is all the difference in the world between masterly inactivity and neglect, and will take a proper look at the RIRP components at least every quarter. Clearly the market – I dare not say insiders – knew something was up at GLI and Infinis, and I suppose the market valuation for Pearson is as likely to be as right or wrong as it was less than a year ago when the share price was more than twice what it is now.

And although only of interest to my heirs, it turns out that despite these scars the market value of the portfolio has ended the year slightly higher than a year ago, unlike the major UK indices, underpinning my faith that dividend income growth is the best defence against capital erosion.

First published in The IRS Report on 9th January 2016.

Inflation beating income: RIRP keeps on winning

Inflation beating income: RIRP keeps on winning

Inflation beating income: RIRP keeps on winning. This is the seventh year I have reported on the performance of the Rising Income Retirement Portfolio, and for the seventh year I am able to report an increase in income significantly greater than inflation, both during the year and since inception, despite a much greater number of disasters on the way than I had anticipated.

The portfolio still contains two shares which paid no dividend last year, one of which never has paid one since I bought it – Lloyds. And my latest disappointment is dear old Sainsbury’s, which has signalled it will cut its dividend this coming year because of the cost of the price war with Lidl and Aldi.  Not what I want to deliver inflation beating income.

According to the original rules I should junk Sainsbury’s and switch into something yielding more, but the fall in its share price means it will probably still yield well over 5% on what the capital is now worth. So partly in the spirit of the season I have decided to leave it in.

Another reason is that the result of undertaking a more detailed review of the past 7 years is the realisation I do not need to work nearly as hard as I did to make up for my early failures.

Inflation beating income - RIRP
How the RIRP produces its inflation beating income

This is the first year during which the fund has been fully invested for the whole period. I am not sure whether it is due to the wisdom that comes with maturity, or a fiscal version of the seven-year itch, but I decided it was time to take a longer view, and introduce a simpler and more transparent way to report the inflation beating income produced by the RIRP results from now on.

Readers may have tired of reading every year that the fund’s rise in income has consistently been more than double the rise in the cost of living. To achieve this both year on year and cumulatively has admittedly required some complicated accounting adjustments to smooth out the distorting effect of one-off special dividends, and to deal with shares on which I have unwillingly had to crystallise a profit or a loss.

Inflation fall is a bonus

The latest bigger-than-expected fall in inflation means I turn out to have overreached myself spectacularly this year, always useful when the objective is inflation beating income. As usual at the start of a year, the table shows the known performance of the fund up to the end of its accounting year in February. It shows dividend rises of 6.3% against a rise in the RPI of a fraction under 2% to November.

That looks – and in cash terms is – terrific, but most of this is in fact due to the huge return of capital by Vodafone, some of it in the form of special dividends, which more than compensated for RSA’s passed dividends.

So I have re-cast the figures. I have removed this year’s and last year’s special dividends to better reflect the underlying income growth over the life of the RIRP.

The small table shows what that really means.

Inflation beating income - RIRP
Rising Income Retirement Portfolio performance

This shows that if I do nothing, dividends in 2015 will be some £800 more than I need to keep ahead of the recent RPI inflation rate: 2% dividend growth only represents a little over £100.

Another way of looking at it is to look at the actual dividend growth since inception in percentage terms. It works out at 44.8% – more than twice the rate of inflation. As above, this figure excludes the special dividends from Vodafone and Direct Line in the current year.

So from now on I propose to ignore special dividends entirely in my computation of the fund’s underlying performance shown in the large table, but to aggregate all such payments in a new line called “Annual Bonus”. This will hopefully be enough each year to more than compensate for any dividend storms ahead.

Up till now the RIRP has not declared by how much it aims to beat inflation – I thought I would be doing well enough just to match it. But in the light of the achievement of the past 7 years, I am making a doubling of the inflation measure my aspiration – at least so long as inflation remains at these historically low levels.

Raising the income target

At the moment, based on recent payouts but factoring in a dividend cut for Sainsbury (and nothing from RSA or Lloyds), the RIRP will produce an income rise of only a little over 1% for the coming year, but we have a year of dividend announcements ahead of us.

I gather that some fund managers are becoming increasingly jittery about the sustainability of dividend growth in future, arguing that dividends cannot continue rising indefinitely faster than wages, even though that is precisely what they have done since incomes started being squeezed in 2010. This may be true in aggregate, but is not necessarily true in individual cases. There is no doubt that Aldi and Lidl will be paying their shareholders more this year, at the expense of Sainsbury and Tesco.

More worrying is the renewed fear of deflation. I do not discount the danger entirely, but think the markets are forgetting that much of the current “problem” is caused by a drop in the oil price. Back in the 1980s when Britain was at the peak of its oil exporting history, the Treasury still judged the effect of a falling oil price as on balance benign for the UK, and lower oil prices have always historically been reflationary in their impact on the economies of all except the oil-producing countries.

If deflation were to occur, then if companies were only to cut their dividends by no more than the fall in the general price level, the portfolio would in theory still be delivering its original aim – the preservation of purchasing power through Inflation beating income. But sadly, history suggests this is not what happened last time round.

Although the historical information is far from robust, everything in the best we have, the Barclays Equity and Gilt study, indicates that when prices last fell over a prolonged period in Britain (every year bar one from 1924 to 1932) the dividend payouts from shares fell much faster. But capital values did fall much less than the cost of living, and the value of income shares fell less than the market as a whole, so an equity income strategy still benefited investors.

I think deflation is improbable. I am – so far – only mildly discomforted by the conclusions of a growing body of academics who are claiming that quantitative easing is itself inherently deflationary rather than inflationary, and that is only partly because I lack the patience to follow the economic maths involved.

The RIRP’s approach is based on the premise that the biggest risk to my wealth in retirement is inflation, rather than the fluctuation in capital values inherent in stockmarket investment; and that shares represent the only likely protection against inflation – apart from property, whose management headaches I do not want to get involved in.

Ultimately I believe politicians will choose to inflate away the national debt and its rising interest burden as they always have done in the past, and which Britain will still be able to do so long as we do not join anyone else’s currency union.

How to deal with BT rights issue?

But do not forget the old City warning: “Never forget the 1% chance”. Presumably the only reason for a private investor to hold gilts with taxed redemption yields of under 2% is as insurance against a prolonged period of deflation.

For what it is worth, I am putting my money – or rather someone else’s, and with it my domestic safety – where my mouth is. I have finally convinced my pathologically risk-averse former partner that as his 5-year bank deposits yielding an average of 4.5% mature, the only way to avoid a massive collapse in his income is to embrace the principles of the RIRP.

His income requirements mean I have had to abandon one of the points of the original RIRP – drip-buying over a long period to benefit from pound-cost averaging, which has certainly proved its worth. Instead since November I have been creating a “Son of RIRP” with the additional short-term aim of maximising its underlying income over the coming 12 months.

The editor has suggested that a forward-looking version of this in the next issue could help those subscribers who have joined less than 7 years ago and who fear they might have missed the inflation beating income provided by the RIRP boat.

So with this in mind for April, I am anticipating a period of “masterly inactivity” for the original portfolio: I hope to watch the underlying inflation-busting dividend increases continue to roll in, perhaps supplemented by continuing specials from Direct Line. I hope the only strategic decision I shall have to make will be what to do if BT launches a rights issue to help fund its mobile phone acquisition.

As the RIRP is fully invested I will be forced either reduce my holdings of one or more other shares in order to increase my BT weighting, or to tail-swallow – sell the rights to fund a small take-up. I shall advise my decision on a web update as and when the details are known.

First published in The IRS Report on 10th January 2015.

Problems with success in RIRP

Problems with success in RIRP

Problems with success in RIRP.  When I first began thinking about what I would write this time, I was hoping that I would at last be able to begin with the introduction I had planned for the moment the Rising Income Retirement Portfolio (RIRP) first became fully invested:

  • Dividends already announced for this year will way outstrip inflation
  • No major changes in the financial fundamentals are envisaged for any of my holdings, therefore
  • No action is needed other than to sit back and watch the rising income roll in.

Sadly, the day after this pleasant fantasy, point 2 was out with the news that BP had lost its latest court case over the Gulf oil spill and might now be facing damages of $15bn more than the fortune it has already provided for, and largely already paid out.

And though I was as always indifferent to the short-term knee-jerk share price reaction, I must ask myself whether this fresh potential blow could prejudice the further inflation-beating dividend growth on which my continued holding of the stock has been based.

Unfortunately, I haven’t a clue. For instance, I have been following tobacco shares for years, along with their endless court wranglings involving US smoker class actions, yet the ramifications of the American legal system remain a complete mystery to me – as I suspect they are for most Americans.

BP will of course appeal against this judgment. The test for me will be in the tone of BP’s third quarter dividend declaration, due at the end of October. Any hints that the current payout may not be sustainable will necessitate more emergency decisions of the sort I had hoped were now finally behind me. Even any indication that the scope for future payout increases might be prejudiced could well make me decide to part company.

Watch and wait at BP

I had toyed with the idea of switching my whole BP investment to Shell right away. This would entail only a small sacrifice in income, which happily I could now afford this year.

My concern over maybe being hasty in selling Balfour Beatty proved unjustified, as another profits waring this week confirmed, but I have decided to wait and see what BP’s October statement brings.

I am also mildly encouraged by the fact the company has continued to find the cash to continue its share support programme, even though I personally regard such repurchases as a huge waste of shareholders’ money: I would prefer to see any “spare” cash paid out in cash dividends.

What BP has spent in share support since the US court announcement could have paid for an extra rise of over 4% in the dividend.

And this would have been useful. The RIRP’s actual income from BP continues to be bedevilled by the inevitable currency effect for a company which accounts and determines its dividends in US dollars – quite rightly given the source of most of its profits. So although the most recent quarterly dividend is unchanged in US dollars at 9.75 cents, the recent weakness of sterling has transformed this into a 2.6% sterling increase for the quarter. But despite this, for the past four quarters the overall strength of sterling has almost exactly wiped out the 6.9% by which the company raised its dollar dividends. My only consolation is that I would have the same currency distortion problem with Shell.

Problems with success:
Problems with success: The distortion of special dividends

Latest dividend increases are good

Superficially, though, the fund’s position is strong enough to withstand any BP squalls.
Since the beginning of July, 8 of the RIRP companies have announced dividend increases, and they average no less than 12%. Their dividends themselves are shown in blue in the table, unless the companies have both announced increases and already paid them out in the last quarter, in which case it is the “dividends received” figures which are in blue. Two of them, BT and L&G, have made us wait a few days longer than I would have expected based on last year’s timetable,

These announcements are the basis of the projected income for year 7, to the end of February 2015, will now be very nearly 7% higher than last year, even after reversing some of the questionable accounting I employed last year to keep my yearly performance ahead of inflation. This compares with the current RPI inflation of under 2.5%. I remind you again that technically I did not need to don the hair shirt, since cumulatively the fund’s dividend growth since launch is more than double inflation, but obstinacy made me keen to claim inflation-busting income increases for every single year, not just cumulative ones.

So does anything else need to be said? Can we just sit back and watch the dividends roll in? Sadly, maybe not, but that is one of the problems with success.

In some ways my emergency surgery following Balfour Beatty’s profit warning may have been too clever. The first dividend from Infinis has provided a one-off boost, and I also received a further unexpected bonus from a second special dividend from Direct Line.

Problems with success of the RIRP
Problems with success of the RIRP

But while I am loath to look gift horses in the mouth, the fact that Vodafone’s massive special dividends this year will not be repeated next year poses a challenge in continuing to deliver a rising income on a year-to-year basis. As I have said before, in theory we should all be banking these special payments and saving them for a rainy day, but I have been around too long to trust in the triumph of my own good intentions over experience.

More specials ahead

I have tried to show the effect of these special payments, shown in yellow in the graph. Last year our income was boosted by a very useful special payout from Standard Life, which I am therefore showing on the minus side of the graph. This year our actual income from the company will be nearly halved, though the underlying regular dividends have been raised by over 7%, as shown in blue on the graph.

The Vodafone special payment represents the equivalent of organic dividend growth for the entire RIRP of over 7%. It is quite possible the portfolio will achieve this again next year, and maybe more. This, though, assumes the continuation of big special payments from Direct Line. I am encouraged by their announcement in September that they would return to shareholders the bulk of their £160m profit on the sale of their international operations: I reckon this to be worth another 8p per share “special”.

There is also a chance that Lloyds may finally resume payments, but I have been hoping for this for longer than I care to remember so I am not holding my breath; nor for RSA, even though the only reason for continuing to hold it is the expectation that it will come back to life sooner rather than later: but it would be unwise to assume it will be next year. Here are two examples of problems with success.

Maybe I worry too much. Perhaps I should reflect more on the fund’s achievements, which are substantial. Over its 7-year life the yield on my original investments has grown some 70% from the initial target of 4% to nearly 7%, way ahead of the cumulative rise in the cost of living of under 25%.

When a company like SSE looks like a laggard for “only” raising its dividends this year by a touch more than the RPI, I realise my problems are essentially those of success. My investment freedom, should I want to make changes, is only constrained by the difficulty I would face in achieving comparable yields to the mouthwatering returns I am getting on my originally invested capital. Perhaps these are not bad problems to live with.

First published in The IRS Report on 4th October 2014.

Dividends back on track

Dividends back on track

Dividends back on track. When I last wrote three months ago I had two main concerns. One was about the continuing press and political verbal assaults on the utility companies, two of my core holdings.

The other related to the decision by the financial regulator to dig back far deeper in the past than hitherto to examine whether a large number of longstanding investment-linked life-assurance policies might have been missold, which might have impacted two other holdings. I ended my last article by saying I would address these subjects this time.

But as so often with stockmarket scares, it is difficult now to see what all the fuss was about. The Labour mantra about the cost of living crisis seems to be losing appeal both through its unchanging repetition and by rising consumer confidence and the sharply falling unemployment figures, even if real wages still have some catching up to do.

SSE cleverly led the industry in announcing its own price freeze, so simultaneously taking the wind out of the sails of both Mr Miliband’s pledges for a price freeze if he becomes Prime Minister, and the existing incumbent’s strident insistence that such a freeze would be impossible for the utility companies to survive.

But from my viewpoint, the only relevant fact is that of the five companies shown in blue in the table which have announced dividend increases since the last issue, two are my utility companies, SSE and United Utilities, raising their latest payouts by an average of 3.9%. Of the others, the recent strength of the pound sabotaged BP’s 2.6% rise in its dollar payout, turning it into only a 1.7% sterling increase; despite this, the average of the five increases exceeds 3.1%, still well ahead of inflation. So dividends are back on track.

Battered Beatty’s strategy in question

Similarly the life assurance sector has shrugged off what now seems to have been a much over-egged portrayal of what the FCA will in fact be probing.

But I was presented with a real wake-up call one morning at the start of May by the Editor asking if I had “seen Balfour Beatty”. I hadn’t, because one major advantage of my approach to investing is that I feel no need to monitor my shares daily, as I am in for the long term and the dividend stream. But when I saw my construction sector pick was starring as the day’s fastest mover, down over 20% from 286p to 225p, this made even me curious to see what had frightened the horses.

It seems I have managed to have chosen almost the only construction company which is failing to cash in from the economic recovery. The announcement prepared shareholders for a significant shortfall in profit expectations, largely due to delivery failures by the company. Even more worrying was the likelihood of the disposal of the big US acquisition they had made in 2009, which was funded by a rights issue to which we subscribed.

Although they say this has delivered higher profits, it has failed to produce the wider group synergies which had been the main reason for its purchase. So it smacks of a fire sale. The CEO duly fell on his sword, and the interim executive chairman talks of a recovery programme which will take “12-18” months.

Forced sale

There was a useful silver lining to all this: there was no announcement about the final dividend which had been declared in March and which went xd at the end of April, before these announcements, so I decided to take no precipitate action in the belief that it is now far too late for the company to rescind the scheduled July payment.

Getting dividends back on track
Getting dividends back on track

However, history suggests that any new boss charged with cleaning up is likely to suspend future payouts while he sets the house in order, and this has forced my nose to the grindstone. I was already starting to doubt if mere dividend growth elsewhere in the portfolio would more than compensate for the ravages of RSA’s dividend suspension, but the BB fiasco has forced me to act.

When I reworked the table factoring in no further dividends from BB for this year, all hopes of achieving inflation-busting dividend growth between now and February seemed impossible. It is true that some of this is due to my hairshirt way of accounting for Vodafone’s massive repayment of capital to shareholders, and my decision to repay this year my “borrowing” last year from those anticipated gains to make up last year’s income shortfall.

But because the whole of my strategy is about living from my investments’ income, I can’t reverse that accounting decision now just because it is inconvenient.

However, this short-term blip must be set in context: on a long-term basis since the fund was started the dividends have grown by nearly twice the rate of inflation. I make life difficult for myself by trying to deliver inflation-beating performance on a year-on-year basis as well.

So I am applying drastic surgery to ensure – subject to no further dividend shocks – that this year’s dividend income again comfortably outpaces any likely rate of inflation.
On the assumption BB will produce no more income this year, I have decided to take a few hundred pounds loss on my £7,000 investment by selling the lot cum div, so retaining the right to the July dividend.

And I am also pruning my (currently) non-income producing investment in RSA by selling one-seventh of my £7,000 investment in that company. If I am proved wrong and BB maintains the dividend I shall still have no regrets – another of the keystones of my investment philosophy is to act and move on.

These two transactions generate £7,029 for reinvestment, but I shall treat the cost of my reinvestments as £8,000, the book value amount of my original capital invested. I am sorry that this way of treating my capital transactions will have accountants reaching straight for the valium or other drug of choice, but I have applied this approach consistently since launch and will continue to do so because it lets me sleep easy at night and ignore the capital gyrations of the stockmarket.

The fact that my £100,000 investment is currently worth some £140,000 is just random noise for me, as is the fact that my accounting foible artificially increases the apparent purchase cost of my new shares: this only matters if I have to sell them, which is never my intention, even if events do occasionally force me to do so.

Energy buy has good credentials and divi

I am reinvesting £5,000 of the BB proceeds into another of my personal holdings, like all the others in the RIRP, one which will pay out a dividend next year representing over 7% of its current market capitalisation, and with a commitment to raise it in future by at least the rate of inflation.

The company is renewable energy electricity producer Infinis, which came to the market at the end of last year but is still some way below the offer price, since it immediately ran into the government’s emergency retreat from its green commitments prompted by a desire to mitigate the rise in voters’ energy bills.

The pensioners friend
RIRP – The pensioners friend

The short-term attraction for me is that Infinis has just announced its maiden results, above market expectations, reaffirmed its dividend policy, and will pay a first dividend in August with an xd date at the end of July. So by switching the bulk of the BB money now we pick up a payment in August which will nearly equal what I had previously been assuming BB would pay as an interim in December, helping to get dividends back on track.

And – as Chancellors of the Exchequers say as they pull their final rabbit out of the Budget hat – “I propose to go further.”

I shall invest the remainder of the proceeds in more shares in high-yielding GLI Finance, from which we have already received our first quarterly dividend, and from which a further investment now will yield us over 4% between now and January.

These two measures bring the total projected rise in income this year to a respectable 4%, still leaving me some ground to make up to equal the 5.5% rise generated so far this year by the Editor’s control stock, Bankers Investment Trust. But after these exertions I am hoping to settle back in my semi-retirement and anticipate reporting a steady further stream of inflation-busting dividend increases for the remainder of the year.

Those with long memories will recall eras in which beating inflation was a far more challenging target than it is today – in fact it was impossible with equity dividends for many years in the 1970s. I do not rule out the possibility of an inflationary surge at some point, but for the forseeable future with the dividends back on track I am confident the RIRP will continue to do “what it says on the tin”.

First published in The IRS Report on 5th July 2014.


Rising income portfolio: tough decisions for RIRP

Rising income portfolio: tough decisions for RIRP

Rising income portfolio: tough decisions for RIRP. The Rising Income Retirement Portfolio was conceived as a way of building up over several years of drip investment a selection  of shares designed to produce a rising income likely to outpace inflation each year, and which would require minimal maintenance once fully invested.

The importance of minimal maintenance in the rising income portfolio is that as I approach my eighth decade I am realistic enough to recognise that either my enthusiasm or capability of dealing with investment choices may wane.

But just as the portfolio became fully invested, I now find myself having to decide what to do with RSA, the second of my investments within two years to make a rights issue and suspend its dividends; my two utility companies are finally threatened by the sort of governmental interference I had feared when I first invested in them; and all this on top of having to apply my mind to what to do with the cash windfall generated by my sell-off of the shares in Verizon which were spun off by Vodafone as part of their unprecedentedly huge return of capital to shareholders.

Gambling on RSA

Last issue I admittedly tempted fate by writing “so long as [RSA] do not resort to a right issue and suspension of dividends I can weather [the storms] with equanimity.” I had already assumed in my dividend projections for the year ahead that they might not pay anything, but even though I now have the bonus from the sale of Verizon shares (representing an effective return of over £2,000 of the £5,000 I had originally invested in Vodafone) I am loathe to commit new money in the rising income portfolio to RSA.

According to the RIRP’s original rules, I ought just to kick RSA out. But having stuck with it this far I am inclined to take a gamble and retain it since I believe, perhaps naively, that Stephen Hester will turn it round. The 3-for-8 issue at 55p has been priced sufficiently realistically that the rights have a value of around 31p each in the market, so what I propose to do is “tail swallow” — sell enough of the rights in the market to be able to take up my remaining entitlement.

My existing holding entitles me to 2,099 rights; if I sell 1,342 of them for £416 I am left with 757 shares, which will cost me a few pence over £416. This will bring my existing holding up to 6,355 at no extra cost, and so reduces my average purchase price from 125p to 110p a share — though this is still well above the price the shares are likely to command after the rights issue. This also entails some dilution of my holding, but as it was one of my biggest investments I am not going to worry about that.

Dividend growth is still satisfactory for rising income portfolio

My overall dividend forecasts for the rising income portfolio for the current year are lower than they would otherwise have been because in order to compensate for last year’s lack of dividend growth following cuts or suspensions at RSA and FirstGroup, I decided to “borrow” some money in advance from the Vodafone payout.

rising income portfolio
RIRP dividend growth

If it were not for that, projected dividend growth this year would already be over 6%: as it is, it is only currently showing a small projected growth for the year, even though since January six of the shares have already announced higher dividends than last year.

I am paying the price this year not only of the absence of dividends from RSA, but also of Standard Life’s special dividend last year, which will not be repeated and which contributed several hundred extra pounds last year.

I have every reason to believe that dividend increases across the rising income portfolio will accelerate in the year ahead, barring fresh disasters amongst my choices. The 2-point reduction in corporation tax to 21%, which comes into effect this year, had been pre-announced in last year’s Budget, like so much else these days, and so got no publicity this year. It means that even a company with unchanged pre-tax profits will see its after-tax earnings — and hence its dividend-paying potential — rise by more than the projected 2% increase in the CPI for the year ahead.

 rising income portfolio
The Rising Income Retirement Portfolio constituents and performance

When it comes to how to reinvest the Verizon cash, the Editor has suggested that I should consider including a collective investment in overseas markets, since the portfolio is so UK based. I have three problems with this:

  1. At least six of my shares have huge non-UK income and all but BP present their accounts in sterling;
  2. BP shows the problems with non-sterling dividends when sterling is strong: their latest quarterly dividend is unchanged in dollars, but the sterling payout is nearly 2% lower; and Reckitt Benckiser is paying out 1p less in final dividends than their previous record might have led us to expect.

But most importantly of all (3) with over £99,000 previously invested and a £2,000+ windfall from Verizon which appears to cost me nothing, I think we deserve now to include what most investors have somewhere in their portfolio, a silly “fun” investment that we could afford to lose, but which we secretly believe we are clever enough to identify as a potential winner that the market has overlooked.

An off-piste stock

Nearly everyone who follows the markets from time to time comes across such a company which just feels undervalued, but which is so far off the wall that they do not stand up to rational inclusion. I had toyed with adding shares in bombed-out annuity specialist Partnership, since for all the post-Budget froth annuities will remain the right solution for many pensioners.

I have bought some myself, but because there is a question over how profitable annuities will be in future for the providers, instead I am buying for the rising income portfolio two £1,000 units in an AIM-listed Guernsey-based provider of loans to small and medium sized businesses in the US and UK.

GLI Finance, formerly Greenwich Loan Income Fund, has had a chequered history, but since passing the dividend in 2008 has restored it from 3p in 2009 to the previous 5p, when the shares were trading around 100p.

At the end of last year it embraced a new investing policy, designed to transform it into a leading alternative provider of finance to SMEs in the UK and US through non-banking platforms, but with the centre of the business remaining firmly in the UK, “reflecting the sterling investor base, share price and dividend policy.”

The stated aim is to “to produce a stable and predictable dividend yield, with long-term preservation of net asset value”, currently 50p. Admittedly the 1.25p quarterly dividend currently has skimpy cover, which is probably the main reason the shares yield nearly 8.5% at the current 59p.

But the dividend was raised last year, which encourages me to believe it is safe, and with an xd date later this month, we will start getting an income from June. I am also using under £300 to top up the remaining Vodafone share stake to a round number of £1,000 book price purchase units following their consolidation after the capital refunds.

There is probably little prospect of significant dividend growth from GLI, and in that respect its inclusion in the RIRP is a sort of challenge to the basic philosophy: it is the only share in the RIRP which I have bought with the intention of selling if it generates useful medium-term capital profits.

If peer-to-peer lending — soon to be eligible for inclusion in New ISAs — takes off as the board hopes, I think this is the sort of share which might well attract more widespread attention.

Respectable institutional shareholders already own over 60% of the company; one of my reservations is the relatively low direct director shareholding at under 2%, worth only around £1m between three of them.

Like all other shares in the rising income portfolio, I already have a small personal stake in this company among my own shares, acquired in the past few months.

I should however add a note of caution for newer subscribers: the last share I had this sort of gut undervalued feeling about, one which similarly seemed poised to exploit a gap in the financial marketplace, was Cattles, which became my first casualty when it went spectacularly and fraudulently bust.

I shall reserve until next time further discussion of the apparent threats to my utility and life assurance holdings posed by politicians and the Competition Commission.

First published in The IRS Report on 5th April 2014.

Vodafone special dividend saves RIRP

Vodafone special dividend saves RIRP’s bacon

Vodafone special dividend saves RIRP’s bacon. Since the last article in October, twelve of the shares in the Rising Income Retirement Portfolio have paid another dividend, or will have done so by the end of the RIRP accounting year in February.

Ten of them, whose current year income is shown in blue in the main table, will have paid out more than this time last year. That includes a restoration of dividend growth at BP, and a surprise special dividend of 4p a share from Direct Line following the sale of its closed life assurance business.

I normally rail against these erratic special payouts because they wreak havoc on my efforts to achieve smooth dividend growth. But I cannot ignore the fact that the extra income from DL and Standard Life earlier this year has significantly mitigated the effect on the RIRP of the two failures in this, my first annus horribilis.

The big one was the total loss of income from FirstGroup following its rights issue earlier this year, at which point it was ejected from the portfolio with a big capital loss. The second was the recent cut in dividend at RSA following news of a black hole at their Irish subsidiary  — see Peter Shearlock’s update here.

And now it looks as though my income from RSA will be further reduced in the year ahead. But so long as they do not resort to a rights issue and suspension of dividends, I can weather that with equanimity, largely because of the impending massive return of cash from the Vodafone special dividend to its shareholders in March.

My immediate problem is my current year income. The impact of FirstGroup and RSA means that despite the sturdy rise in dividends from most of the portfolio shown in Table 2 — averaging more than three times the rate of RPI inflation this year — there is still a hole of several hundred pounds between my actual dividend income for the current year and what I need to beat inflation for the year.

I am in some ways setting my income bar for the year artificially high, ignoring the fact that the cumulative rise in return on capital since the fund was started actually amounts to more than twice the rate of inflation.

As always I choose the higher of the RPI and CPI to calculate inflation: I have beaten the CPI rise nearly threefold. I am also choosing to ignore the possibility that some of the Vodafone payout may in practice be encashable right at the end of February, within my current accounting year.

I am doing so partly as a result of having had to face the “problem” earlier this year of what to do with shares whose capital value has raced ahead of my average purchase price, as many of them have.

Theoretically, capital gains or losses do not interest me, but I was forced to address them to help restore the scars of the FirstGroup capital losses, which I reduced by cashing in one fifth of my holdings in Bankers Investment Trust and Pearson, both of which had almost doubled in value.

Vodafone special dividend
The RIRP summary to date

And it is this which has enabled me to sleep easily for the rest of the year despite its disappointments: for if it was right to do that, then the rabbit I am about to extract from my hat to compensate for this year’s income shortfall must be just as defensible.

Earlier in the year I was staring at the prospect of a £600 income deficit, but dividend growth elsewhere and further falls in inflation have reduced the gap to under £250. I propose to fund this by cashing in some of the RIRP’s Lloyds shares.

I had hoped they would be providing some income well before now, but their failure to do so means I suffer no immediate income loss by selling some of them. By cashing in just 1,592 of my existing 5,840 shareholding at 78p, I get cash of £1,242 representing:-

  • a capital gain of £494 — 66% — which I can add to my “income”
  • return of £748 original investment, applied to defray the cost of this month’s new purchases.

This also eliminates the previous untidy fractional Lloyds holding, now reduced to 2 units from 2.75.

Vodafone special dividend from Verizon sale foots the bill

But for all the logic, I find it difficult to resist a sense of Puritan guilt at this solution, so I propose to exorcise it thus.

Our 2014 accounting year starting in March will kick off with the Vodafone special dividend, it’s unprecendented return of cash to shareholders resulting from their realisation of the embedded value of their joint venture with Verizon.

The RIRP will receive a payout of an estimated 30p a share, and twice as much value in Verizon shares. The £1,000 plus cash payout alone would provide the RIRP with dividend growth of 17% for the year, assuming all the other shares deliver no growth at all. Of course I shall be left with fewer Vodafone shares after their consolidation and as yet the dividend prospects there are unclear.

So to salve my conscience I shall refund £494 of the payout to the capital account so that essentially I shall just have lent myself the cash for this year’s inflation-beating “income” — consuming some of tomorrow’s jam today.

In February the RIRP will be 6 years old and I propose to round off this year by making it fully invested. So I will buy further units in those companies in which I am underweight: two in BP, and one each in Direct Line and Reckitt Benckiser.

Because nothing I buy now comes anywhere near matching my current effective average yield of over 6% on my originally invested capital, this reduces the projected yield for the year ahead slightly, and so has the further effect of raising the bar a little higher for next year’s dividend growth requirement.

At the moment, if I assume the additional income from Verizon will offset any fall in income from Vodafone, and assume zero income from RSA and bring in only half the special cash from the Vodafone special dividend, the portfolio shows broadly unchanged income from the current year, assuming there is no income growth from other holdings.

Income and capital way ahead of inflation

I do not expect an entirely easy ride between now and the 2015 election, but I have reasonable confidence that in practice the RIRP income will continue to outperform inflation, without needing to consume any more capital gains.

It is true that the RIRP is overweight in the two sectors which are likely to be political footballs as targets of “cost of living crisis” electioneering between now and 2015: energy and transport. But frankly all the shares in the portfolio could come under headline-grabbing attack if the fight gets really nasty, with the possible exceptions of Balfour Beatty, Interserve and Pearson.

On balance I doubt if the boards of any of the RIRP holdings will punish their shareholders unless forced to by their regulators — who currently lack the power to do so — or by persuasion by government, public opinion and the press. Apart from RSA the prospects for dividend growth from the rest of the portfolio look as sound as ever and — who knows — Lloyds might yet restore the dividend in 2014!

And to end on an upbeat note: I started investing with a yield target of 4% net. My actual dividend income for the current year before the Lloyds fudge represents 5.8% of the funds invested. That is the equivalent of a pre-tax interest rate of 7.25% for a basic rate taxpayer. There has also been cumulative income growth of 45% from the initial target against a rise in inflation of under 21%.

Vodafone special dividend
RIRP dividend growth

And just for the record, despite the 25% current book loss on RSA, the £100,000 invested to date could be sold for just under £146,000, a percentage capital gain which is uncannily close to the cumulative dividend growth. Even a new investor in the RIRP at today’s prices would get an underlying yield of at least 3.7% net, equivalent to 4.6% gross at a bank, assuming nothing from RSA and no further dividend growth elsewhere in the year ahead.
So I keep my fingers crossed for a prosperous and healthy 2014, and wish you all the same.

First published in The IRS Report on 11th January 2014.