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.
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.
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.