Tag Archives: High yield

Income For Life portfolio Brexit creates house builder opportunities

Income for Life portfolio – Brexit creates house builder opportunities

The Rising Income Retirement Portfolio and its more recent offspring the Income for Life Portfolio were designed as a selection of shares requiring minimum maintenance once fully invested, delivering dividend increases above the rate of inflation.

The RIRP was constructed over a 7 year period through drip investments, designed to maximise the benefit of pound cost averaging, and has been fully invested since 2015. Table 1 shows it is more than fulfilling its mandate.

RIRP portfolio

Projected underlying income for the year to next February will be nearly 5% up on last year, and that’s before non-recurring items – which I now treat as “bonuses” – which bring the total rise in income for the year to 13%. This compares with the 1.8% rise in inflation according to the RPI over the most recent 12 months. The underlying yield on the sums originally invested is up by more than 50%, from 4% net after basic rate tax to 6.3%.

The IFLP on the other hand was built from scratch from April 2015 in just twelve months. It also had a more demanding initial yield target of around 5% in its first full year of investment. It will comfortably exceed that in its first full year to March 2017.

However this meant making some compromises between the fund’s need for an income significantly higher than is available from the FTSE 100 (and way ahead of anything on offer at any reputable bank), and its long term aim – the same as the RIRP, to deliver dividend increases which exceed the rate of inflation.

I made no secret of the fact that once fully invested it was likely I would have to revisit some of the shares initially bought just as income-boosters, but whose growth of income was likely to prove a drag on the fund’s longer term performance.

Table 2 shows how the dividends this year of the twenty current components of the fund compare with those declared the previous year. Until the most recently reported dividend increases from Kier, Manx and Sky, the reductions at GLIF meant the average underlying rises were barely keeping pace with the 1.8% inflation rate.

income for life portfolio

Well ahead of inflation

Now it is clear that we will finish the year usefully ahead of any likely inflation rate, but for the longer term any shares showing lower dividend rises than the current inflation rate obviously require re-examination as to whether it makes sense to keep them.

Some caution is needed: the IFL is only half way through its accounting year, so some – such as De La Rue – have not yet declared both their dividends for the year. On the other hand, Centrica has done, and is clearly not going to keep our spending power from being squeezed in future unless it ups its game next year. It was admittedly a risky candidate for inclusion in the first place because it had previously cut its dividend, but history shows that if you buy such companies after the nasty medicine, they can sometimes outperform – in dividend and capital terms – as both United Utilities and Lloyds have proved within the RIRP. I will watch any such underperformers carefully next year.

It walked like a duck…

The big scar in both portfolios is of course GLIF, the classic illustration of something looking too good to be true and turning out to be precisely that. A boardroom coup has already seen the dividend halved, and now the company says from 2017 dividends will be fully covered by sustainable operating income plus the proceeds of any sales of investments, which must imply another cut.

The only silver lining is the suggestion that this will provide the basis for the payment of a “progressive dividend”, which is what both portfolios are all about. The original guidelines for the RIRP disqualified any company which had a history of dividend cuts, and by implication required me to eject any company which did so after I had bought, but this proved too rigid in the testing times following the banking crisis during which the portfolio was launched. I am leaving GLIF in both portfolios for the time being as examples of how even the odd disaster can be absorbed, even within only a 20-share portfolio.

The RIRP was actually launched on a disaster I would rather now forget, and has been carrying Lloyds Banking Group almost since launch, and RSA for several years recently. In investing no one is infallible, and while I obviously prefer not to choose lemons, history shows that when I have done, jettisoning them too hastily is often a costly error – not least because the “replacement cost” is often very high. For instance, on its current reduced payout, GLIF still yields 4.4% on its original investment, but because the share price has been understandably punished, I would need to get over 10% on any new investment to avoid a reduction in ongoing income.

Similarly the original RIRP guidelines required me to ignore capital ups and downs as random noise behind the sole objective of delivering rising dividends, and by and large I did.

But the shorter timeframe and need to underpin growth means I cannot be so intellectually detached with the IFL. So when I see UIL, one of my star income boosters but with no history of rising dividends, showing a capital gain of over 66% for reasons I cannot imagine from any published information, I have to look at how I might benefit.

I bought UIL at 111p to yield 6.8%, but at the current market price of 187p its dividend yield for new investors is just 4%. So if I can find a share with the prospects of dividend growth which currently yields that or more, I would be quids in selling UIL and reinvesting.

House builders remain cheap

I am therefore going to sell enough UIL shares to buy £2,000 of Galliford Try. As a Brexiteer I have never understood why the doom-mongering should apply to housebuilders, since I do not accept that post Brexit Britain will see us all living in caves.

Galliford is one of many good companies whose shares have not recovered from their immediate post Brexit markdowns.

The company recently released a splendid set of results and boosted the year’s total payout by over 20%. Despite the 17% rise in its share price since the announcement, the shares still yield over 6% assuming the payout can be maintained; I have every expectation that it will be increased further until the housebuilding cycle goes into decline.

I don’t expect that to happen in the foreseeable future. While I have no special insight into the minds of Messrs May and Hammond, I do know that if they are serious about capturing the true centre ground of British politics, they could do far worse than do all in their power to see as many houses as possible built between now and the next election.

But I shall wait for the November Autumn Economic Statement before committing myself further.

Simple maths; simple decision

UIL has just paid the second of its quarterly dividends, so any shares I sell now will only lose me half a year’s income. The Galliford shares don’t go exdividend until October 27 so this year I will pick up their final dividend, more than two thirds of the annual payout.

The maths is a no-brainer. If I sell enough UIL shares to buy £2,000 Galliford Try I lose £40 UIL income this year, but gain £86 from Galliford; in the full year next year the Galliford dividends will be well ahead of UIL assuming there is no increase, which is unlikely.

I have thus converted high yielding shares with little or no dividend growth prospects into shares with dividend growth prospects, and given the current year’s income an additional small boost. In capital terms I will have sold shares which cost me £1,186 and acquired new shares costing £1,997.

These changes will be reflected in the table with the next article in January, when I will look at some of the other dividend laggards in my list such as GSK. If they are still showing capital gains, I will see if I can repeat the trick, though in reality it is unlikely I shall be able to switch from all the higher yielding underperformers without some short term cost to my income.

Douglas Moffitt, October 2016

Income for life trying to sit on my hands as the world wobbles

Trying to sit on my hands as the world wobbles Income for Life

The late, much maligned but consistently entertaining stockmarket commentator Bob Beckman used to claim that the most difficult thing any investor has to learn is the art of “masterly inactivity”. I know just what he means.

Even before the referendum vote and its shock result, I had been tempted to indulge in some tinkerings to take advantage of juicy situations thrown up by the stockmarket’s gyrations. I thought I might take the opportunity to chuck out some of the income boosters held in both the original Rising Income Retirement Portfolio (RIRP) and its more recent successor, the Income For Life Portfolio (IFLP), and reinvest in a couple of companies I have come across recently which are still pledging to raise dividends anything from 4% to 15% and whose depressed share prices would actually give the portfolios a further income boost.

Why I shouldn’t trade

In fact there are three good reasons not to do this.

• Both portfolios were intended to be low-maintenance, partly as an insurance policy against the day when I may be less mentally capable of tinkering, even if I wanted to. So my shares are designed as investments to “buy and hold”. If there isn’t a compelling reason to do something, don’t.

• It is not as if my selections aren’t providing what I intended. Both portfolios are more than delivering their stated aims. Without lifting a finger, and only one third of the way through its accounting year, I know that the original RIRP will deliver a 3.7% rise in underlying income for the year. This represents a return of over 6.2% on the original capital invested, and we have also pocketed a special dividend which brings the actual rise to over 7%. Similarly, within just one year I have constructed the IFLP whose dividends in its first full year will slightly exceed the targeted 5%. So, as neither portfolio looks broken in any way, why fix it?

• There is also a more practical reason, and that is that as we go to press the market has had only a few trading days in which to respond to “Independence Day”, and frankly it could still change its mind as violently as it did on the Day After. My head and experience tell me that only an idiot would make major changes in those circumstances.

But Beckman was right. Masterly inactivity is difficult when you can see opportunity staring you in the face. In both portfolios I have shares in companies whose dividend growth has stalled or disappointed, even if they have not forced me to act by cutting their dividends. In most such cases, especially with the more recently constructed IFLP, this means to sell these stocks now would mean crystallising a loss, which goes against the grain: even in the new 20-share IFLP, I can carry some sleepers if I have to. But some of my laggards are actually showing useful capital gains – don’t ask me why, I long ago stopped trying to impute any rationale to stock market valuations.

I have a further disincentive to tinker, and that is second column in Table 1 which shows the historic yield on the original cost of the RIRP shares. There are question marks over the short term dividend growth potential for GSK, Interserve, Pearson and United Utilities, but you need compelling reasons to oust shares mostly still yielding more than my 6.2% RIRP average.

Table 1 & 2

This would clinch the decision, were it not for the fact that most of the shares in the RIRP have risen in value by more than the rises in their dividends, and so anyone buying now gets much lower yields. To show the effect, I have created a new column for both tables showing what the yield is on the current value of the shares. It shows that new investors in the RIRP now get a lower yield than my initial IFLP target of 5%.

Because I launched the IFLP when the market was near its all-time high, I naturally have capital losses there. The result is that the similar current yield column in Table 2 shows an investor buying all the IFLP shares today would now get a yield approaching 5.5%.

Will RIRP deliver better dividend growth?

The logical conclusion from this would be to switch the whole of the RIRP into the IFLP — assuming the dividend growth prospects of the IFLP are as good as those of the RIRP. Because of the stocks I had to choose to maximise my first year income for the IFLP this would surprise me. And I am, as always, ignoring dealing costs. So I am not suggesting that anyone should do this. But monitoring the comparison between the RIRP and IFLP will be an interesting intellectual exercise for the future.

The principle underlying the creation of these portfolios is that they are based on my own investments, and are my best choices of what I have ended up in my own portfolio since I sold my companies in 2008. And despite Bob Beckman’s good advice, I have been unable to resist topping up my own holdings of Berkeley Group and Lloyds, which seemed to me to have been knocked back disproportionately, and where my holdings were below my average size.

So I am going to deny “masterful inactivity” for the IFLP as well – but with just one holding.

Out with esure, in with Alternative Networks

Even before the vote I had my eye on another of my own holdings as a possible substitute for esure in the IFL. As discussed in April, this company not only cut its special dividends – on which I had been relying for an initial dividend boost, but also its final. Yet the share is still showing a capital gain, and I cannot resist the temptation to sell the shares (crediting the £100 capital gain to my “bonus” line), and reinvest £5,000 in Alternative Networks.

The company delivers IT products and services to businesses, ranging from cloud computing, managed hosting, fixed-line voice, software development, mobile, systems, IP networks and various other things like “virtualisation” which are beyond my understanding. But what I can understand is the 64% rise in dividends over the past 5 years. The shares have almost halved from their all-time high when their yield was too low to come up as a possible choice for the IFLP, but at their current price will yield nearly 6% in a full year. I can see nothing in June’s interim report to justify this rating; what I can see is the commitment to raise dividends a further 10% this year.

We have unfortunately missed the xd date for the July dividend, so will only get the final in January in this accounting year. But together with the dividend already received from esure, the special dividend from GSK and the capital profit from esure, this means the actual cash flowing in up to next April will represent a yield of over 5.25% on the £100,000 notionally originally invested, against the underlying first full year yield of just under 5.1%.

After this, perhaps I can resist the temptation to deal for a few months.

The post-BREXIT outlook for my portfolios
When the Editor asked me to “comment on the outlook for the types of companies in the portfolios”, my response was to suggest that at this stage any rational judgement on individual company or sector prospects is likely to be about as helpful as the Treasury’s “calculation” that average household gross domestic product (not income) would be £4,300 less than it might otherwise have been by 2030.
All depends on the renegotiation, which is unlikely to be finalised before 2019, assuming we have not had a new election and a National Government first. But whatever the uncertainties, political or economic, I can’t see the logic for bashing the construction sector; banks will only suffer if the euro collapses, and that might have happened anyway. Cynics may think that companies currently subject to EU price caps, like Vodafone, might have an opportunity to exploit their customers once we are out, whereas pharmaceutical companies based in the UK may suffer a regulatory disadvantage.
Most of my companies earn most of their money in the UK and so might be best placed eventually to benefit from less EU regulation. It’s difficult to see how my utility and oil companies are likely to be affected either way, except in the way that all companies with significant non-sterling earnings will benefit from the lower pound.

Douglas Moffitt, July 2016

IFL off to a cracking start

IFL off to a cracking start

Exactly a year ago I launched the Income For Life (IFL) portfolio, which is an attempt to recreate for more recent subscribers the success of my Rising Income Retirement Portfolio (RIRP), now in its ninth year. I had set myself some pretty ambitious targets for the IFL – not least to be fully invested within a year. The result so far is a bit of a curate’s egg, but definitely with more good than bad.

In January I completed investing all my notional £100,000 with twelve top-up purchases, shown in red in Table 1.

378 table1

Although less than £50,000 was invested throughout the full year, dividends received since last April totalled over £2,300 net of basic rate tax. That’s equivalent to nearly 3% pre-tax from a bank on the full £100,000, and more than you are likely to find from any savings institution with the exception of the likes of Bank of Baroda.

Forecast divis at 5% net

Even better are the red figures in the dividend column. These highlight companies which are paying more than was expected at the time of my last article about the IFL in October. However the rises shown for HSBC and Shell are entirely due to the weakness of sterling and could just as easily be reversed this year. Clearly too, these companies’ prospective yields suggest that the market has some doubts about the sustainability of their dividends.

But at the moment, projected dividend income for the 12 months ahead is a fraction over 5% net. And that is despite two partial failures.

GLIF has halved its projected payout, though even after that it is still delivering the equivalent of 5.5% pre-tax interest on the original investment (and over 9% on its current price). My forecast for the coming year’s income includes the reduced payment. GLIF is a useful reminder that although I have now been investing for over 50 years, and writing about it for nearly as long, “even I” still periodically forget that if it looks too good to be true, it almost certainly is. I beat myself up about GLIF quite enough in the January issue, so I will not do so again. I am hoping a progressive dividend policy might replace the previous income-kicker attractions, but will certainly be keeping more of an eye on it than most of the other stocks.

Insurer esure has also disappointed, though here I am partly to blame for nurturing unrealistic expectations. The company’s stated policy is to pay out 50% of underlying earnings in dividends, plus special payments depending on circumstances. I own shares in esure, like all others in both portfolios, and it has provided me with a healthily rising income in the past. For the RIRP, the unpredictably distortive effects of special dividends have been a persistent problem, but I assumed they could only be a bonus in the initial stages of building the IFL.

With esure, underlying earnings are down over 25% this year. Despite paying out an extra 20% of earnings in a (reduced) special, actual dividends for the past 12 months are down from 16.8p to 11.5p per share. The forecast income for the year ahead is based on the actual dividends declared during the past 12 months.

Mixed results from drip-feeding initial capital

Paradoxically esure is one of the 7 shares out of my 20 to show an overall capital gain for the year. As regular readers will know, so long as dividends are maintained or increased, I regard capital movements as largely random noise – unless I want to rearrange my holdings, which by and large it is my aim not to do.

In taking 9 months to become fully invested – instead of the several years I took to complete investing the funds for the RIRP – I had hoped to reap some of the benefits of the pound cost averag-ing which had served me so well with the RIRP. In retrospect this was a mixed success, to really benefit from pound cost averag-ing you need to use a longer drip-feed period than 12 months – ideally over a full market cycle.

I started the IFL with the FTSE flirting with its all-time highs, around 12% higher than now, and if I had invested all the cash at the start, all my current selections would have cost more then than my average buying price apart from esure and Manx Telecom. For me this is a clear win – the lower the average purchase price, the higher the resulting yield. My only regret is that having restricted myself to only dealing once a quarter when the articles appeared, I was unable to benefit from the severe shakeout in mid-February as I might otherwise have done.

On the other hand, almost inevitably, having started with the index so much higher than now, our shares are on balance currently worth less than we paid for them, as Table 2 shows.

377 table2

If this worries you, you should not be contemplating following my sort of strategy – indeed arguably you should not be buying shares at all. But a typical fund manager would claim that a fall of under 5% against a market decline of 12% is something to boast about. In my case I am just sad I am not launching the fund now so we could buy all the fallers at today’s prices. Someone doing just that would get a prospective yield of nearly 5.5%; if they bought the whole portfolio at current prices the prospective yield is 5.25%.

RIRP income motors ahead

The aim of the IFL is to be able to sit back and watch the dividends roll in at an increasing rate so as to keep overall income well ahead of inflation – as the original RIRP has done. In fact the RIRP is now delivering in spades – its underlying income is already projected to rise by over 3% in the year ahead. Statistically the star dividend increases – of over 100% each – come from two legacy failures, Lloyds and RSA; but both of course are starting from only nominal bases, and still contribute little in absolute terms to the fund’s total income. Legal and General stands out with a 13% projected rise already under its belt, bringing its return on the original capital invested to a splendid 17.5%. Together with BT and Interserve, consistent above-average dividend growth from these three shares mean they yield an average of 12.75% on the amounts originally invested. For income-focused investors, it is figures like these – not paper gains – that are evidence of success.

My quest for as much income as possible in the first 12 months from the IFL means that some of my selections may not possess the long-term inflation-busting potential which I need, and I fear I will have to do some unwelcome tinkering over the year ahead to have any hope of delivering underlying growth matching the RIRP.

Take steps to avoid extra dividend tax

Additionally, shareholders face a googly this coming year: if the value of your dividends held outside an ISA or SIPP comes to more than £5,000, you will be liable to pay the Chancellor’s sneaky 7.5% dividend tax surcharge announced in last year’s Budget. It will not actually become payable until end-January 2018. But even if you had to give the Chancellor 7.5% extra on the whole of next year’s projected IFL income, what you are left with is the equivalent of 5.8% from a bank. I believe it will in fact turn out to be higher than that after another year of rising dividend announcements – assuming no nasty surprises from HSBC or Shell. Or anyone else!

You can now read every article on the RIRP and IFL portfolios from inception at RIRP.co.uk.

First published in The IRS Report on 2nd April 2016.

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.

High yield portfolio from scratch

Starting a high yield portfolio: Income for Life builds on RIRP

Starting a high yield portfolio: Income for Life builds on the success of RIRP.

This month’s liberalisation of the UK pension rules means that more investors will be looking to SIPPs – self-invested pension plans – to manage their retirement income and provide tax-free inheritances. Some will be looking at a high yield portfolio.

The sort of inflation-busting dividend increases which my Rising Income Retirement Portfolio (RIRP) has delivered over the past 7 years, coincidentally matched by increases in the capital value of the portfolio, is ideally suited to a SIPP, the sort of thing anyone can use when starting a new high yeld portfolio.

Some recent subscribers have said that while the thinking behind the existing RIRP may be interesting to read about, there is little actionable value from them in reports on the portfolio.

Since average yields on the shares in the RIRP at their current market prices are well below the yields on the original capital invested, is it too late to join the party?

I don’t think so, and so am rising to the challenge of starting a high yield portfolio with similar objectives, though it will differ from the RIRP in several respects. I am calling it the Income For Life (IFL) portfolio to emphasise the fact that I expect it to go on delivering (as does the RIRP) until the investor no longer has any reason to care.

The IFL’s short-term objective differs from the RIRP. It is designed to address the problems faced by investors needing to invest capital to secure an immediate income in a zero-rate environment. Some will be trying to replace fixed-term investments taken out when interest rates were nearer 5% pre-tax than today’s 3%.

As a result, the RIRP’s policy of a long-drawn out drip-feed investment designed to ride out market cycles has to be abandoned. This means investors will have to accept that if the bears are right, the IFL’s capital values could suffer – maybe for a period of years – while (I hope) the income continues to rise regardless. A factor to consider when starting a new high yield portfolio.

For those who worry about the FTSE 100 achieving its previous nominal peak, and who are aware that market peaks tend to attract the stupidest punters, I counter with the fact that to compensate for inflation since 1999 the index should be over 10,000, and that corporate earnings today are nearly twice what they were in 1999 in nominal terms. To my mind, there are no amber valuation lights flashing as there were in late 1999.
Initial 4% yield target

The IFL will invest a notional £100,000 over the coming 12 months, with the aim of delivering an income as close as possible to 4% net of basic rate tax over the coming year (the equivalent of 5% gross in interest), and higher than that in a full year, from shares likely to continue to raise their dividends on balance by the greater of the RPI or CPI.

The income target is a real challenge in the first year, largely because the gap between shares going ex-dividend and actually paying the money means investors cannot get a full year’s income for the first 12 months.

To maximise the first year income, my initial choices will therefore have more higher-yielding shares with poorer dividend growth prospects than my choices later in the year. And my investment timing will largely be determined by the dates on which the shares I select go ex-dividend. To this extent emotion will be removed from the market, at least for most of the initial year’s selections.

As with the RIRP, my selection of shares will always be from among those which I hold myself, some of which may also be duplicated in the IFL. Some may surprise, like Centrica, which recently announced a 30% dividend cut.

My initial rules banned companies that cut their dividends from the RIRP, but experience with L&G and United Utilities has made me revisit this. Now it seems that companies which “rebase” their dividends actually tend to show above-average dividend growth thereafter. The trick is to buy after their announcement, such as Centrica.

I shall aim to invest in no more than 20 shares for the IFL, which means a limit of £5,000 per share. Some investors with more to invest might like to hold more shares, so for this first instalment of the IFL I have provided a selection of 15 stocks to set the ball rolling, all of which are going ex-dividend over the coming three months.

My core selections for the 20-share IFL high yield portfolio I shall be reporting on in future are shown in bold in Table 1. They are a combination of the higher yielders and those I consider most likely to outstrip, rather than merely keep pace with, inflation.

Starting a high yield portfolio; The Income For Life Portfolio
The Income For Life Portfolio opening positions

As when building up the original RIRP we must keep our attention firmly fixed on the income stream we are building up for the future, disregarding what the capital value of the shares is doing: any capital growth is a bonus. This has certainly worked for RIRP: its original £99,442 is now worth around £158,000, with the few losers such as BP, Infinis, RSA and Sainsbury more than compensated for by those which have more than doubled in value such as BT, Interserve, L&G and Pearson.

I will add further stocks to IFL in July.

RIRP income storms ahead

In January I said that now the Rising Income Retirement Portfolio – my original high yield portfolio – had been fully invested for a year, I would adopt a much simpler and transparent method of accounting for its eighth year. The results are in Tables 2 and 3, which capture the fund’s key performance measures.

Column 1 of Table 2 shows the projected yield on the original sums invested for the year ahead, and column 2 shows the percentage increase in yield over the previous year for those companies that have so far announced rises. Table 3 shows what this means in money, but with special dividends and returns of capital now identified separately as “bonuses”.

Rising Income Retirement Portfolio
Rising Income Retirement Portfolio constituents

Last year these came from Vodafone and Direct Line. This year Direct Line has raised its basic dividends while declaring the same special as this time last year; and Standard Life has made a 73p a share return of capital to shareholders, which means the RIRP’s total income will be streaks ahead of last year’s.

Prudent investors will bank these bonuses against a rainy day; most of us will be tempted to spend them while we can enjoy them.

The SL scheme does entail a reduction in the number of SL shares the fund holds through a capital reduction, which I am happy to regard as simply increasing the average original purchase price; even with this self-deprecating accounting, I could still cash in the SL shares for nearly 90% more than my book cost. And clearly I am going to have no problems in achieving my original aim of increasing dividends by at least the higher of the rise in the RPI or the CPI; and my newly adopted aim of doubling the inflation figure looks easily achievable.

Rising Income Retirement Portfolio
Rising Income Retirement Portfolio performance to date

This is despite the fact that I am projecting a one third cut in Sainsbury’s final payout later this year, which may turn out over-optimistic. The return to the dividend lists by RSA and Lloyds so far only make a nominal cash contribution, but with a full year’s income from GlaxoSmithKline and a bumper dividend rise from Legal & General mean the fund’s underlying income will still rise by 2.4% – and we are only one month into the RIRP’s accounting year.

I am relieved that my fear of a rights issue from BT to fund its purchase of EE did not materialise. I am now getting a yield of over 5% on my original investment in this stock – though surprisingly, this is below the average projected underlying yield of 6.5% from the portfolio as a whole. If this year’s capital repayment from Standard Life is factored in, the projected yield on initial capital rises to over 8%.

Since I have chosen to treat these exceptional payments as bonuses from now on, I do not need to try to present this in future as a truly sustainable yield. Income rising at over twice the rate of inflation is good enough for me.

First published in The IRS Report on 4th April 2015.

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.


Dividend cut from RSA

Dividend cut from RSA for RIRP

Dividend cut from RSA. Barely a month after subscribers had been treated to my self-congratulatory New Year review of the Rising Income Retirement Portfolio’s performance, I was rewarded with a nasty dose of hubris.

Despite “solid performance” including a 5% growth in net premiums, a strong balance sheet and a strategy expected to deliver strong premium growth, somehow profits at one of my biggest holdings, RSA, were down a fifth, and the company decided the dividend was unsustainable and cut it by a third.

The effect of the dividend cut from RSA is to knock nearly a couple of hundred pounds off my projected income for the year ahead, and this reduces the projected percentage rise in RIRP income for the year ahead by a couple of percentage points.

In principle there is no place in the RIRP for any share which isn’t earning its keep by paying out more each year. But in practice I have previously found reasons for retaining Lloyds — which has never paid a penny since we bought it — and for not jettisoning United Utilities or Legal and General when they “rebased” (slashed) their dividends.

To an extent this is a luxury resulting from the inflation-beating performance of the rest of the portfolio. But as I described when justifying my maiden purchase of BP, buying into a company which has just cut its dividends can produce a good starting yield with expectations of above-average dividend growth.

This was certainly true with Legal & General, which we happened to start buying just before it announced a dividend cut. As Figure 1 shows it since has delivered some of the fastest dividend growth of any of our holdings, and is now paying out 28% more than it was before the cut, and twice the 2009 payout. Generally speaking the bigger the cut, the bigger the subsequent increases, as Figures 2 and 3 show.

Dividend cut from RSA
Legal and General’s accelerating dividends

Avoiding losses – for now

The argument for retaining a share in which the RIRP is fully invested when it cuts its payout is less easy to justify, as was the case with United Utilities and is with RSA. The problems are compounded when I have a capital loss on the shares, as I do to a small extent with RSA and to a much larger extent with another possible trouble-maker, FirstGroup.

This is a portfolio for investing retirement savings, so my assumption is that we do not have the salary-earners’ luxury of being able to replace investment losses from earned income.

And while capital gains are mostly only of academic interest to me, crystallising a loss causes me grief and might force me to make up my losses by taking some capital profits elsewhere.

I have convinced myself I can avoid these unpleasant choices because two white knights have ridden to the rescue. Firstly Standard Life has said it will pay a special dividend which will almost double its projected income this year, raising the return on the capital I invested in it to double figures, and more than wiping out the loss of income this year afetr the dividend cut from RSA.

I accept that this is completely hypocritical — after all, last year I railed against the special dividends paid by Vodafone and Glaxo on the grounds they artificially inflate income and store up problems for the following year.

My view on special dividends remains the same, but in deciding what to do after the dividend cut from RSA I have to work out what the investment alternatives would be if I cut my losses. The board has made it clear the interim dividend next November will also be slashed by a third, which will cut the return on my investment in the company from nearly 7.5% to just under 5%. So the right way of deciding whether to junk RSA or retain it is to ask what else could I buy yielding nearly 5% with as good dividend growth prospects as RSA.

I am sure some exist, but I suspect RSA’s still relatively new CEO will be keen to outperform in much the same way Legal & General did. On balance I conclude that jettisoning RSA now constitutes a greater risk than the possible lost opportunity of investing elsewhere.

In coming to this conclusion I am also comforted by the projection of an overall rise in income for the RIRP for the year ahead of at least 5%. A lot of this is of course due to the Standard Life special dividend, but also to the 8% increase over previous expectations in the sterling value of our maiden dividend from BP, owing to the weak sterling/dollar rate.

Dividend cut from RSA
RIRP purchases and dividends to date

BP has also announced an $8bn share buyback programme following the sale of its 50% interest in TNK-BP to Rosneft.

This is my least favourite way of “returning cash to shareholders”, since it usually benefits directors on earnings-per-share bonuses rather than dividend-receiving shareholders: I would prefer the cash in dividends, even if they are “special”!

Despite a further $4bn provision against the Gulf disaster — bringing the total to over $42bn — I take this as evidence of the company’s confidence in its future strategy and ability to deliver earnings and dividend growth. So the RIRP makes its second £1,000 BP purchase, which will qualify for the second quarterly dividend payable in June, yielding a little over 5% at the current exchange rate.

I am acutely aware that these are sticking plaster solutions which I cannot hope to be repeated if FirstGroup also makes the dividend cut which the market is expecting. The RIRP’s dividend growth since inception is more than double the near 18% rate of inflation over the same period, which could in theory enable us to suffer some years with below inflation dividend growth. I am keen to avoid such an outcome if I possibly can.

My aim for the portfolio — as for myself — has to be year-on-year increases in the cash generated to keep ahead of inflation, regardless of past over-achievement. This is a challenge which is likely to become increasingly demanding.

I suppose it is some consolation that the longer it takes for the UK to get its annual budget deficit down, the more desperate the government will be to keep the interest rate it has to pay on its sales of gilts as low as possible for as long as possible, which will continue to make shares look more attractive than bank deposits for the longest period since the 1930s.

First published in The IRS Report on 6th April 2013.

Dividends beat annuities

Dividends beat annuities: Why I expect RIRP to trounce annuities

Dividends beat annuities. Now that both the main measures of the cost of living in the UK are above 5% for the first time in 20 years, the Editor has suggested that this would be a good time to review “the more philosophical aspects of RIRP: longevity for example, comparing the fixed annuity rate for life at your age with the potential income from RIRP”.

It has proved an interesting, if sobering, exercise.

Fortuitously I am in my 65th year, the lowest conventional starting date for most annuity projections. For the illustrations in this article I am also pretending to be a non-smoker with no impairments. It is true that being a sickly smoker would improve the annuity quotations, but as Table 1 shows, any such improvement would need to be pretty spectacular for annuities to make any sense for me.

Dividends beat annuities

What is often forgotten is that annuity projections are quoted gross, but the income is taxable. True, if held outside a pension fund, some of it is regarded as a tax-free return of capital, but at my age the proportion is so low as to make little difference.

The net income comparison is startling. The table assumes that your state pension will use up your tax-free personal allowance, and that you are a basic rate taxpayer. So effectively all your annuity income suffers tax at 20%, while the RIRP tax liability is already discharged by the dividend tax credits you receive on your dividends.

Doomsday inflation

The attractions of the 4% RIRP net income target are immediately clear. It beats everything except a level annuity from day 1.

The impact of a prolonged period of inflation, even at “only” 3%, is shown in the bottom four scary lines. Even inflation around the current level for just 4 years slashes 20% off the buying power of the level annuity.

The maths holds true for higher and top rate taxpayers too. For example, higher rate taxpayers see the first year’s figures (second line of Table 1) slashed to £3,730, £2,708, £2,326 and £3,000.

Obviously I cannot predict what the RIRP will deliver longer term. It aims to achieve dividends which rise in excess of the worst cost of living measure. I am frankly amazed that in the current economic climate a recent survey showed that brokers are expecting the 200 biggest UK companies to raise their dividends by more than 12% both this year and next: I just hope they are right.

To show what a difference the odd percentage point makes, I have projected long-term annual increases for the RIRP at 1% above the 3% inflation assumptions and at 2% above the 5% assumptions — though these are only illustrations, not a forecast!

Table 2 below shows the RIRP goalposts both for the current year and to date since the RIRP’s launch in February 2008. This year’s projected yield on the fund represents an increase of over 40% on the original 4% target used in table 1, so it is comfortably ahead of the 14.6% needed to stand still in real terms.

Dividends beat annuities

Statistically, the RIP date for my RIRP could still be at least 20 years away, given my inherited longevity on my mother’s side and despite my self-inflicted impairments — I smoke cigars occasionally, drink too much, am overweight and am among the growing army of oldies on pills for blood pressure and cholesterol.

And this constitutes much of the rationale behind this issue’s purchase of the first tranche of what will probably be the final addition to the portfolio: GlaxoSmithKline, a global leader in what should be the continually burgeoning healthcare sector.

Booming demand for care pills

I am typical of a generation of baby boomers retiring after a lifetime of dietary over-indulgence and decreasing exercise. Demand in the developed world for the pills which seem to combat the worst effects of these excesses will rise strongly for at least a decade. Meanwhile demand in developing countries is growing too as expanding middle classes care increasingly for the health of themselves and their children.

GSK is well positioned on both counts. Sales outside the US and Europe already account for nearly 40% of underlying turnover, more than compensating for a third quarter decline in sales in Europe. The company is focused on bringing new products to the market: over the past 3 years it has launched more products and received more US FDA approvals than any other company.

The balance sheet is strong, with net debt at end-September under £9bn against a market capitalisation around £70bn. Since January 2008 the dividend has gone up by 26%, and the third quarter dividend is being raised 6% to 17p.

Historically this forms the floor for future quarterly payouts, bringing the prospective yield to a shade over 5%. Sadly the shares went xd in the week before publication, which means the RIRP will not get its first dividend from the shares until April.

Dividends beat annuities
How the RIRP trounces annuities

Elsewhere it has been a fallow period for RIRP results but the Greek referendum market jitters triggered further “automatic” top ups of RSA and Balfour Beatty in the week before publication. The interim trading statements from FirstGroup and Sainsbury were encouraging. So the fund makes its third purchase of Sainsbury and takes advantage of our newly amended buying limits to top up with an extra unit of FirstGroup, following what seems to me to be an unwarranted fall for their shares.

Scottish and Southern has decided to waste a lot of money changing its name to the meaningless SSE, but despite the latest political posturings both it and United Utilities say they remain committed to above-average dividend increases and are well placed to continue to deliver them.

First published in The IRS Report on 5th November 2011.