Successful Rising Income Fund

Successful rising income fund makes first BP purchase

Successful Rising Income Fund. In my update last month I suggested that as we approach becoming fully invested, in an ideal world we should merely be routinely reporting on dividend increases in excess of the rate of inflation — though I cautioned in the non-ideal world we inhabit this was unlikely to be literally the case.

But I am able to report that since the last full table was published at the beginning of September, that is (almost) exactly what has happened. Between the end of August and this issue’s publication date, 12 of the 16 shares have paid out, on average nearly 7.9% more than the same time last year, and only one of them, RSA, has disappointed with a below-inflation increase of only 2.1%.

The story from the three shares still due to pay out in February, the last month of our accounting year, is a bit patchier. FirstGroup has failed to increase its forthcoming dividend at all, perhaps sensibly drawing in its horns following the shambles over the new rail franchises. The market fears a rights issue, and the consensus broker expectation is for a dividend cut. Brokers’ forecasts are as often wrong as right, but their view is reinforced by the theoretical double digit historic yield available at the current share price.

United Utilities on the other hand will indeed be paying out 7.2% more than this time last year, but still has to implement a further 4.7% increase before it gets back to what it was paying in 2010 when it “rebased” (= cut) its dividend in anticipation of the new regulatory regime.

Similarly Vodafone’s forthcoming interim will be 7.2% up on last year’s, but my actual income next month from this share will be 53% less than this time last year, because the company is unable to repeat last year’s special 4p dividend, paid from their first and so far only dividend from their minority holding in Verizon Wireless.

If I look at this year’s income compared with the actual receipts a year ago, the Vodafone reduction cuts the average gain for the 15 shares from 7.9% to 5.3%.

Trouncing the RPI

This of course compares well with the 3% rise in the RPI for the latest reported 12 months. As the table shows, when the earlier dividend increases this year are also included, the actual percentage return on funds invested rises from 5.5% to just under 6.1%, a rise of over 10.5%.

As usual around year-end, I have also reviewed the fund’s capital performance. The results are shown in the table. As I have explained previously, capital performance is of entirely incidental importance to me so long as my dividend income keeps rising. My sole measure of success is securing an income stream which rises faster than inflation, and any capital gain is a bonus.

Some new subscribers, and others who were not immediately convinced of the sense of this sort of approach, have asked how relevant these articles can be to them now, since they missed all the earlier benefits of pound-cost averaging when the market was plummeting throughout 2008-09. The honest answer is that they have also avoided some of the early casualties: I make no claim to infallibility and the going has been rougher at times than even my 45 years of investing experience had led me to anticipate.

My original minimum starting yield was 4%, and no less than 14 of the existing shares still yield at least that to new investors, though the capital increases of course mean they cannot buy in to our 6.1% overall average return on capital. But after another 5 years there is no reason why investors starting their own RIRP now should not have seen this sort of growth.

Search for a new RIRP stock

We started out with a notional fund of £100,000 to invest. Originally I aimed at “up to” 20 shares, which implied a maximum holding of five £1,000 units. The rules have been amended since then to allow for larger unit holdings, and with £7,000 still to invest, I am now faced with the choice of increasing 7 of my existing investments, or adding a new one to the successful rising income fund over the months to come and/or topping up some of the others.

Successful Rising Income Fund
Rising Income Retirement Portfolio dividend income to date

This portfolio makes no claim to any sort of sectoral balance, but is instead made up of what I hoped would be my best choices from my own much bigger personal selection of shares. I have spent more time than I thought I would need to on the selections, combing through my personal holdings, looking at companies as diverse as defence, drinks manufacturing, household cleaning, health products and spread betting, but I find that the fundamentals of various companies which I was happy to buy several years ago have changed to the point where I could not justify adding them to this portfolio.

I was coming to the point of concluding I could not in fact find anything better to invest in to meet my very particular criteria but finally found one. I need to bend the rules, though, and include a company which recently spoiled its long-term record of rising dividends with a one-year suspension, and then resumed payments at only half their previous level.
One of my basic criteria for a successful rising income fund is that a company must normally have a long-term record of uninterrupted dividend growth.

But rules are not straightjackets and for various reasons the portfolio already contains Legal & General and United Utilities, both of which have still to get back to their previous best, and Lloyds, which has yet to resume payment at all. One reason is that once such companies resume payment of dividends, the growth rate is often above average as they try to restore their reputations.

Successful Rising Income Fund
Rise in capital value of the RIRP

Looking for dividend recovery

The circumstances of the share I have chosen are almost unprecedented. The company is BP. I have owned shares in this company since the 1990s, and retained them against my RIRP rules after they suspended their dividend payments after the Gulf disaster, partly because I anticipated a faster recovery than has been the case.

Longer term I still think BP is one of the best of the oil majors. After settling all criminal claims with the US government for a few billion more than it had provided for, it has said this settlement puts it in a position to “vigorously defend itself” against future civil claims. As a result I see no reason why it should not eventually recover completely. In the last quarter it paid out 9c a share, 28% more than when it resumed payments at the end of 2010.

I suspect the slow progress to full restitution is a combination of prudently conserving cash against its existing payments schedule spread over several years, and a canny political statement so as not to be open to accusations of “rewarding” shareholders too prematurely. So paradoxically the cut dividend provides an excellent opportunity for new investors to get in with a prospective yield of nearly 5%.

Successful Rising Income Fund
BP dividends versus RPI

As a predominantly US company the dividend is expressed in US cents, so its sterling value is subject to exchange rate fluctuations as the chart below shows. But assuming the 9c is maintained each quarter, at current exchange rates the prospective return comfortably beats my starting yield hurdle (4% increased by 17% RPI inflation since 2008, about 4.7%): the first dividend is due in March. So the portfolio makes its first £1,000 purchase.

Editor’s note: from now on, we will publish quarterly updates to the RIRP, but Douglas Moffitt will post web updates if his rules necessitate any urgent action in between.

First published in The IRS Report on 12th January 2013

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