Tag Archives: Income For Life Portfolio

Finally time to use RIRP as was intended

Finally time to use RIRP as was intended

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

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

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

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

Lessons start here

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

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

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

Income growth is king

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

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

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

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

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

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

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

You do the maths

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

Maintaining control

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

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

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

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

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

Douglas Moffitt, January 2018

Income for life Dividend cuts force strategic rethinking

Income for life Dividend cuts force strategic rethinking

A sense of deja vu surrounds me as i write, mingled with absolutely no Schadenfreude. Three months ago I wrote that “a surprise cut in the dividend of what had been one of my star performers …. forced me to apply dramatic surgery to the Rising Income Retirement Portfolio”. I then went on complacently to explain how nevertheless everything would come out rosy for the full year, and went on to apply similar dramatic surgery to the newer Income for Life portfolio.

In doing so I had chosen to ignore Sainsbury’s further small cut to its dividend, and had sadly overlooked its restated dividend policy. What I had not anticipated was that a month after the last article, Pearson’s new regime would be quite so ruthless in doing what the collapse in the share price had been screaming at me was likely: cutting the interim dividend by 72%, and with the likelihood of more cuts to come.

So it’s time for the pruning shears again, never mind the squeals: overall the RIRP garden is healthy enough to withstand some more surgery.

Essential action

If I did nothing – which is the avowed purpose of the RIRP, and intended to require minimal management now it is nearly 10 years old – the combined effect of these two dividend cuts would have reduced my underlying income this year by more than 6% from £6,332 to £5,937. Special dividends and realised net capital profits would admittedly have boosted that by more than 7%, nearly twice the latest 3.9% RPI inflation rate; but the whole purpose of this portfolio is that it should be invested in shares whose underlying income is likely to rise by more than the rate of inflation without what I still regard essentially as window dressing in the form of strategic realisation of capital profits.

So I am forced again to take another look at the dividend growth prospects of some of my underperformers. Assuming a similar cut in the final dividend is on the way Pearson may only yield around 1.6% next year on its original purchase cost. Pearson claim the cut will enable them to pursue a “sustainable and progressive dividend that is comfortably covered by earnings”. The original RIRP rules required me to junk Pearson (and GLIF – see update opposite). But another lesson I have learned rather late in life is that nowadays holding on in these situations can make sense: as Legal & General and United Utilities have proved, if they get it right – and the stronger choices in the portfolio can carry them for a while – companies which have cut their dividends often subsequently deliver above average dividend growth. But I will be keeping a close eye on promises versus delivery.

The same is not true of Sainsbury, who have now delivered 3 years of gently declining dividend payments, leaving them yielding less than my low-dividend growth stock Reckitt Benckiser which has at least been delivering double digit growth from its pathetic start, and has allowed me to scalp some life-saving capital gains. Sainsbury’s have redefined their dividend policy as being to pay out half of earnings, but this is just the sort of unpredictability that I don’t want from a sector where Lidl has now become the biggest player – albeit only at the cost of a huge profits squeeze. As a privately owned German company, the owners can afford the long view, but some of us have rising post-Brexit bills to pay, so with many regrets, I have to eject Sainsbury, at 238p for a loss of £1,347, in the full knowledge that there is a possibility that I may be selling right at the bottom of its cycle.

Cash in the Bankers

To make up for the loss I shall repeat my previous raid on the shares of one of the several companies whose share price has shot ahead from the purchase price. I am selling one sixth of the shares we hold in Bankers Investment Trust. At 813p, on paper these are showing me an astonishing capital gain of 137%, though some of this reflects the too clever accounting in the early days of the RIRP when I used realised capital profits to deflate the purchase price of my reinvestments. I have become more transparent since.

This sale yields me a profit of £1,375 on the original investment, £28 more than the Sainsbury loss. Taking capital profits this way goes against the grain of the whole of my investment philosophy developed over the past 50 years since I first rashly invested some of my university grant in buying entirely unsuitable speculative commodity shares which fortuitously benefited from a surge in commodity prices on the outbreak of the Arab-Israeli 3 day war; I now realise I probably have almost as much to learn now as I did then.

Rolling the dice

Nevertheless I am taking a bit of a gamble with the proceeds, and reinvesting the six £1,000 Sainsbury units into Barratt Developments, the country’s biggest housebuilder. As shown by my previous inclusion of Galliford Try in the sister Income for Life portfolio, I do not share the post Brexit gloom for the housing sector, since I – perhaps naively – believe addressing the lack of housing supply will define the success of this and future governments. The gamble is that the business is notoriously cyclical and there is a danger I am buying in at the top of the cycle. The business has just delivered a near 20% rise in profits from its highest sales volume for nine years.

The chart shows the recent spectacular dividend growth – but also the dangers when things go wrong as happened after 2007. The shares go xd at the end of this month, which means we only capture some two thirds of the underlying dividends this year, but this is more than compensated for by the special dividend.

The sales of Sainsbury and Bankers produce £7,022 cash, so with an eye to boosting underlying dividend growth next year I am putting the remaining £1,000 into Lloyds whose dividend paying capacity I think still has some way to go, for all the reasons explained in Peter Shearlock’s lead article. To make up for the £97 dividend losses this year from the two sales, I am raiding some of the £173.52 special dividends which we will get from Barratt in November to include in this year’s underlying income.

Even so as Table 1 shows, despite all the companies shown in bold in the last column which have increased their dividends since the table was last published, total underlying dividend income is still some 2.7% down on last year, although of course more than compensated for by special dividends and realised capital profits.

Positive change

The summary Table 2 for IFL shows that the changes made three months ago are succeeding in their aim of keeping underlying average dividend growth comfortably ahead of inflation.

However the figures in blue show those payments made in dollars or euros where the effect of foreign currency moves can produce some quite perverse results, as in the case of HSBC; though as Shell and Vodafone prove, it is very much a case of swings and roundabouts.

Douglas Moffitt, October 2017

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

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

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

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

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

Table 1 RIRP

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

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

Paring out the dead wood

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

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

Table 2 RIRP

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

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

Building a war chest

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

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

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

Building in the bonus

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

ITV chart

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

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

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

Douglas Moffitt, July 2017

Star holding sacrificed for post Brexit income growth

RIRP – Star holding sacrificed for post-Brexit income growth

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

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

Low maintenance, just not that low

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

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

RIRP table

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

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

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

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

Realising cash for new purchases

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

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

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

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

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

Short-term shortfall

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

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

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

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.

july-2016-dm
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.

Lower share prices are good for the IFL portfolio

Lower share prices are good for the IFL portfolio

Lower share prices are good for the IFL portfolio. This is my third instalment of my new Income For Life (IFL) portfolio, launched as a successor to the highly successful Rising Income Retirement Portfolio (RIRP), now in its eighth year.

The good news is the markets have fallen since I launched the IFL portfolio in April; the shares I bought then are now worth on average some 7% less than I paid for them.
I am particularly pleased that the average share price fall since April is almost exactly 7.5%, since arithmetical magic means that as I invest the rest of the portfolio it will yield some 8% more than originally envisaged last April, so largely offsetting the Osborne “We now really are in it together” 7.5% hike in dividend tax which comes into effect next April.

The bad news is I had set myself a very high target for IFL’s first-year yield – “as close as possible to 4% net of basic rate tax”. The first year is always the most difficult when building a portfolio from scratch because of the gap between companies’ ex-dividend dates and actually receiving the first payouts.

I wanted to try and replicate the benefits from pound cost averaging which worked so well for the precursor of this portfolio, the Rising Income Retirement Portfolio.

Struggling to gain cost averaging benefits

But the RIRP took 7 years to get fully invested, and the 12-month time limit for the construction of the IFL portfolio is frankly not long enough to reap the full benefits; pound cost averaging only really comes right over a full market cycle. Although the market is usefully lower now than it was when I started, in the short term I have sacrificed first year income for only slightly higher long-term higher yields.

As an example, one of my biggest fallers is Centrica, in which I had invested £4,000 of my guideline £5,000 maximum by last July at an average price of 267p with a yield of 4.4%. Now they are down to 225p, giving new investors a yield of over 5.3%.

But in topping them up to the maximum £5,000, this only has the effect of raising the average yield on the total investment from 4.4% to 4.7%, and because the ex-dividend date falls a couple of days before our publishing date, in the current year I lose £53 of income which I could have otherwise booked in the first accounting year to end March. It will take a long time for the higher yield on the latest purchase to make up that £53 deficit.
IFL will hit 5% yield target

Lower share prices are good
The Income for Life Portfolio as yet not fully invested

But we are where we are, and I embark on this latest set of purchases with the portfolio from July (already just over half invested) projected to exceed the full year yield target of 5%.

My strategy this time is to maximise income for the remainder of the accounting year to end March by topping up to the maximum those shares going xd between now and December, and choosing 6 new shares to bring the total portfolio up to its full strength of 20 shares, most of them paying out more than half their annual dividends between now and March.

So I am investing the bulk of the remaining funds now and am topping up every share by at least a single thousand pound unit. To capture any possible future benefit from pound cost averaging, where shares are not going xd in the coming quarter I am making only a minimum £1,000 top-up now. This leaves £12,000 available in January from the notional £100,000 available to top up the remaining shares in which we have not yet invested the maximum £5,000.

New buys have lower yields

Apart from bank note printers De La Rue, my new additions Marston’s, Sky and Real Estate Investment Trusts Hansteen and Tritax all yield a little less than the initial selections, where I naturally went for the higher-yielding low hanging fruit. I have resisted the temptation to compensate by going for BHP Billiton whose dividend for the coming half-year alone comes to 4%, but in researching yield-boosting alternatives I have discovered Utilico Investments, currently standing at a 25% discount to net asset value as it shifts its investment priorities from utilities and infrastructure to technology. I shall now add this to my own portfolio, as hitherto all the shares for both the RIRP and IFL are selections from those I own, and this should be no exception.

Lower share prices are good
The Income for Life portfolio versus open-ended funds

Before this issue’s changes, my projected income to end December came to a little over £1,100 representing a respectable return on the sums invested by July of over 2.2%. After this issue’s new purchases, and top ups, shown in the final column of Table 1, the end December cash projection rises by nearly 50% to nearly £1,600, but as a percentage of the sums invested it falls to under 2%.

That still gives an annualised return of over 2.4%, equivalent under this year’s dividend taxation rules to 3% pre-tax from a bank, which is more than most subscribers are likely to be getting even on maturing long term funds. The full-year projection of yield from the portfolio after these purchases is 5.3%.

Since the IFL’s investment mandate for January, outlined above, is straightforward, I shall devote that month’s article to reviewing the 8th year of the original portfolio, the RIRP. As Table 2 shows, this has quietly continued to deliver dividend increases of over 6% so far this year with absolutely no management from me, in addition to special dividends equivalent to a further 2.7% of the fund’s value.

Summary of the Rising Income retirement Portfolio
Summary of the Rising Income retirement Portfolio

As I have done with the RIRP, I reserve the right to tinker with some of the initial IFL share selections next year when I may jettison some of the initial income-boosters in favour of those with better prospects for dividend growth, but I am already confident that the IFL will deliver similar inflation- beating dividend growth from an even higher first full year yield than I had expected last April.

First published in The IRS Report on 3rd October 2015.

Rising income portfolio: tough decisions for RIRP

Rising income portfolio: tough decisions for RIRP

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

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

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

Gambling on RSA

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

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

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

Dividend growth is still satisfactory for rising income portfolio

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

rising income portfolio
RIRP dividend growth

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

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

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

 rising income portfolio
The Rising Income Retirement Portfolio constituents and performance

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

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

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

An off-piste stock

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

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

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

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

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

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

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

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

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

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

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

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

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

Vodafone special dividend saves RIRP

Vodafone special dividend saves RIRP’s bacon

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

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

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

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

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

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

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

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

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

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

Vodafone special dividend
The RIRP summary to date

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

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

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

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

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

Vodafone special dividend from Verizon sale foots the bill

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

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

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

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

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

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

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

Income and capital way ahead of inflation

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

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

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

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

Vodafone special dividend
RIRP dividend growth

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

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