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

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