Tag Archives: retirement

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.

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.

Income For Life makes post-election purchases

Income For Life makes post-election purchases

Income For Life Portfolio makes post-election purchases. I launched the new Income For Life portfolio last April when most of us had been led to believe that the country faced 5 more years of uneasy coalition of one sort of another, and because of this I was deliberately cautious in my initial selections.

I chose to invest only £20,000 of the £100,000 theoretically available to the Income for Life Portfolio, even though my targets are to deliver a net income to beat something in excess of 5% from the bank (if you could still get such a return), and an actual return of over 4% net in the first twelve months.

My thinking was driven by uncertainty over how the markets might react, not least in useful potential growth-of-income sectors such as utilities.

As so often the case, I need not have worried, as markets as a whole are lower now than they were then, helped as we go to press by events in Greece. Followers of the original Rising Income Retirement Portfolio will know that this pleases me at this stage of constructing the fund, since it makes topping up most of my shareholdings more attractive now.

Utility companies, though, are a bit higher instead of quite a lot lower as they might have been on the expected election result. An exception is National Grid whose price has dropped despite being one of the three shares to have raised its dividends since April.

The first selections in April were driven by those shares going xd beween April and now, so as to maximise income during the fund’s most difficult period, its first few months. The last column in Table 1 shows the problem.

Whereas the annualised income from the 10 original stocks suggested in the initial April report was 5.3%, my best efforts at dividend date manipulation will only result in the fund receiving £482 between inception and end-August.

This represents an entirely respectable 2.4% of the £20,000 invested in the Income for Life Portfolio, equivalent to over 5.7% annualised, but it represents a yield of under 0.5% of the total I have to invest before next April.

Income for Life Action plan

So my strategy this quarter is

  • to purchase up to the maximum number (5) of £1,000 investment units in those shares which will be going xd again in the coming quarter, such as GSK, or which have fallen significantly without any apparent change to the underlying investment merits, such as BAE, National Grid, and Shell
  • top up other shares by one or two units so as to allow maximum benefit of pound-cost averaging and maximum dividend capture over the coming 9 months
  • identify new shares going xd in the coming quarter which meet the underlying criteria.

The result is 4 new shares, only one of which, BATS, is a duplication from the original RIRP, a modified and accelerated version of whose philosophy drives the IFL. BATS are a classic illustration of what rising income investment is all about. When I originally bought it for the RIRP it was among one of the lowest yielders, barely scraping in above my 4% minimum target.

The Income For Life Portfolio
The Income For Life Portfolio at 50% invested

Now, as Table 2 shows, at 7% it is among the leaders in terms of yield on the original capital invested, but unlike others where dividends have grown even faster, like BT or Legal & General, the share price has “only” kept pace with the dividend increases, meaning new investors can still get in on the game.

Rising Income Retirement Portfolio constituents
Rising Income Retirement Portfolio constituents

A safer HSBC?

Of the others, as with both portfolios, these are shares I hold myself but which still seem to be underrated by the market and likely to deliver rising payouts. I agonised a while over HSBC, as all my fingers have burn scars resulting from my unwillingness to believe the banking system was as bust as it was revealed to be in 2008. But I conclude that HSBC’s new focus and potential Midland Bank spin-off should enable it to continue to deliver rising payouts for shareholders in one form or another.

I can see nothing in anything that esure has released which can explain why it should be yielding so much above the sector average, and similarly I cannot see why Kier is rated at a discount to (for example) Costain, if only because of its large involvement in Crossrail.

The net result of all this is that at £48,000 the IFL is now nearly 50% invested, and I hope to be able to discipline myself so that I shall still have around £25,000 uninvested at the beginning of January.

Meanwhile the original RIRP continues to excel. Table 3 shows that nearly all companies have now announced that they will be paying out more this year than last, bringing the rise in the fund’s underlying income to nearly 5%.

Of the shares which show no rise, GLIF was bought as an income booster in troubled times for the fund, with little short-term expectation of growth; Lloyds and RSA have only returned to the dividend lists this year and so no percentage increases can be calculated.

Doubts over Infinis

I may have taken my eye off the ball with Infinis: I originally bought it around the IPO offer price because I did the maths on their £55m cash dividend forecast and reckoned a yield of 7% was too good to miss. But the latest figures show that this is likely to be short earned this year, or as the market seems to think more likely, cut.

The capital value of the shares is also down because of uncertainty over future government subsidies for renewable energy, and the residual 70% shareholder has told the world it wants to sell.

I had great difficulty getting hold of the latest Infinis report and accounts from their internet site, and its remarks about future dividend prospects are at best Delphic. I was tempted to reinvest some or all of the GLIF holding into Infinis on the grounds that at the current price around 200p the dividend – due to be paid in August – represents an immediate return of over 6%, and whatever any subsequent rebasing may entail seems more than discounted at the current price.

But no: I am committed not to make any changes to the old RIRP until my annual January review, which will coincide (I hope) with final top-ups for Income for Life.

Rising Income Retirement Portfolio overall performance
Rising Income Retirement Portfolio overall performance

Far ahead of target

The luxury of the mature RIRP is that I can sit out some short-term disasters, as Infinis may turn out to be in rising dividend terms, as the regular reports on the first 7 years proved; all the more so following Direct Line’s capital reconstruction and special 27.5p dividend which, together with Standard Life’s even bigger similar exercise back in April, brings my projected “bonus” for the year ahead to over £2,700, over 40% of the fund’s projected underling income.

Those of a more nervous disposition may want to use some of this windfall to make up for the capital loss you would create if you crystallise your Infinis book loss now.

The latest, bigger, measure of inflation, the RPI, shows it running at 1%, and as I concluded last time, a rise in the RIRP’s underlying income of what is now over four times that is good enough for me, even before the “bonus” income, bringing the projected rise in income for the year to over 25%. Indeed, “trebles all round”!

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

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.


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.

Investing for rising income

Investing for rising income portfolio

A blip for the RIRP – but 2014 prospects look good

Investing for rising income. As I decide how to invest the remaining six £1,000 units of the £100,000 notionally available to the RIRP when I launched it at the start of 2008, I don’t know whether to laugh or cry at the extent to which I now find myself a victim of both my previous successes and conservative accounting.

The last published table in July showed that the overall growth in dividends over the years had raised my initial return on capital by 50%, more than twice the rate of inflation, from 4% to 6%.

But this means that when I make a new or top-up investment, unless I now invest in something which will give me over 6% in the remaining 5 months of the accounting year — which is clearly impossible — my reported return for the year on the funds invested must by definition fall for each new investment I make. This is one of the pitfalls of investing for rising income.

Higher divis, but a falling yield

My two most recent investments in Direct Line and Reckitt Benckiser highlight the problem. Their latest dividend announcements mean each of them will pay me at least 5% more than had looked likely when I made my first investment. But because my first dividend from them is only the interim, they each only yield around a third of their full annual return in the rest of this accounting year.

And since they have now paid their interims, any top-up investment will now yield nothing until next year.

In retrospect I should probably have adopted an annual time apportionment in calculating the return on newly invested capital, but I rejected this at the outset, partly because the maths is a nightmare, but mostly because what is important for investors is dividend flow, not clever accounting.

In previous years this hasn’t mattered because the organic dividend growth from previous investments had more than made up any slack. But this year has been my annus horribilis, with a dividend cut from RSA and total suspension of dividends and a rights issue at FirstGroup forcing me to eject the latter and crystallise some capital losses.
My end-year performance is not helped by two companies which have not raised their dividends this year.

In Balfour Beatty I seem to have picked about the only UK construction company not to be confirming the green shoots of economic recovery. There had even been fears the company’s new CEO might have decided to cut the dividend to provide a fresh start, and the fact he hasn’t is interpreted by the market as encouraging. In normal times I can carry a sleeper or two, and though these are not normal times, the unattractive reinvestment alternatives means BB stays in, but on sufferance for the time being.

I am also starting to think I may have made a nasty mistake with BP. Despite having set aside a compensation fund the size of the combined GDP of a dozen of the United Nations’ smaller members, the Gulf disaster claims keep coming in, and the US government continues to threaten punitive fines.

The progressive restoration of the dividend towards previous levels on which I had predicated my investment has ground to a halt this year, and insult has been added to injury by the “sterling effect”: the dividend is declared in US cents, and at the dates on which the last two sterling payments have been calculated, the pound has been relatively strong, so slightly reducing our income.

I have considered various measures to try and boost this year’s income to achieve our target of at least matching inflation. But even though I could engineer an inflation-beating rise in the actual income received by investing all the remaining funds in shares still to pay dividends before end-February, my method of accounting means that I would still be showing a fall in the yield on the total capital invested.

Investing for rising income portfolio.
% year dividend growth from the Rising Income Retirement Portfolio

So I have decided to put aside the hair shirt, remind myself that my dividends over the 5 years are up by more than twice the rate of inflation, and stick to the fund’s basic Investing for rising income rules which have more than proved their value so far.

BP: pay more, please

These are to top up those companies where I do not yet hold my minimum 5 units of investment, whose fundamentals have not changed, and whose share price is below my average purchase price to date. I am ruling out BP because unless and until they can prove otherwise by resuming dividend growth, I assume their fundamentals have changed. This leaves only Direct Line and Reckitt Benckiser meeting the criteria to qualify for new money, so they each get another £1,000.

Because they have now both paid their interim dividends for this year, the fund’s accounting problems are highlighted in spades because we have to wait until next summer to see any return at all on this new money.

The projected cash income for the year is slightly higher than last year, despite this year’s disasters, but the higher capital employed reduces it as a percentage. The RIRP needs nearly another £400 income to meet this year’s inflation target.

I continue to wrestle with this issue and am hopeful that in the January issue I can present a solution.

My consolation is that next year none of this should matter, and will just seem a blip with investing for rising income. The fortuitous distribution of cash by Vodafone and a full year’s income from Direct Line and Reckitts should more than compensate for this year’s travails. And who knows, we may even get our maiden dividend from Lloyds.

Investing for rising income portfolio.
The RIRP summary

This allows me to view with equanimity the Labour conference pledge to resurrect the Command Economy by imposing price controls on the energy companies. SSE and United Utilities make up over a tenth of the portfolio, and any rewriting of the acceptance by government of a need for a proper return on capital would indeed undermine the logic for holding such investments. But in investment terms the 2015 election is still far enough away for such posturings to be seen as random noise — at least for the moment.

First published in The IRS Report on 5th October 2013.