High Yield Portfolio: What Is HYP Investing?

HYP is a passive/non-trading large-cap income investing strategy articulated by writer/investor, Stephen Bland back in 2000. It aims to achieve ? as an alternative to purchasing an annuity -?a well diversified portfolio of shares in big, solid companies chosen primarily for high yield (i.e. significantly above the FTSE 100 average), as well as some other characteristics that help to ensure security of dividend (and to a less extent, capital). A HYP portfolio typically has 10-15 stocks.?As dividends are received, they are reinvested.

Background?

Stephen Bland is a writer for Moneyweek and the Motley Fool (known as TMFPyad). He previously ran an accountancy practice in London, and has been an active private investor for some 40 years. Bland ran a TMF Value Investing newsletter which has since closed based around the concept of PYAD (P/E ratio, Yield, Assets, Debt) as the 4 key value ratios.?

The idea of the HYP? (High Yield Portfolio) emerged from a series of Motley Fool articles in 2000 as a higher return alternative to safer income source like bank interest or gitls. You can see the composition of the original UK HYP detailed here. Since then, it has been extensively discussed/debated/revised on TMF by Pyad and other posters like Gengulphus. In March 2008, Stephen set up his own investment newsletter based on the HYP strategy. It is called The Dividend Letter?and is part of the Moneyweek/Agoracom Group.?

How it Works

This is a passive strategy which aims to build a sector-diverse high-yielding portfolio of large-cap shares that will provide a high and increasing income from dividends. Its intended advantages are liquidity, no management charges, no third party involvement, and very little time required to manage the investment. It shares some of the same thinking as the Dogs of the Dow, although it is a bit less mechanical.?

This is a strategy that has evolved over time, as well as being re-interpreted by others, and not all of the writeups are consistent, but, in broad terms the approach is as follows:

• Rank the large-cap universe (i.e. FTSE100 or maybe the FTSE 350 shares ? usually with a market capitalisation above ?1 bilion) by descending forecast yield.
• Select one stock from the list from each sector to ensure broad sector diversification (total diversification should be employed so that there is no duplication of any type of business).
• Examine fundamentals to make sure that he yield appears sustainable, preferably rising. Bland discusses some additional criteria for this, specifically:
  • Very low borrowings (less than 50%, except in special cases, e.g. a utility company)
  • High dividend cover (at least 1.5x)
  • A history of dividend growth (over, say, the last five years)

However, Bland also notes that these rules are flexible ? ?almost certainly you will have to give up on a lot of that for the sake of essential sector diversification?.?

Investment Philosophy

The key principles of HYP investing are:

1) High Yield - The idea behind the HYP is that a shares are bought on a basis of their yield (usually a higher yield than the FTSE100 at the time of selection). However, a small number of average or even lower yielders can be picked, usually for the sake of essential diversification.

2) Income, not Capital ? The exclusive focus is on achieving a high and rising income, with the view that the capital value of the underlying investments at any given moment is irrelevant.? What matters is that the income continues to rise. If it does, over the long term capital growth inevitably follows. This point is discussed in more detail here.?

3) Strategic ignorance ? This means deliberately ignoring all forecasts and opinions for the long term future of the economy, the sector or the individual share on the basis that nobody knows and that those who think they know, know even less. According to Bland, such ?knowledge? is likely, for most investors, most of the time, to be counterproductive. As Warren Buffet once said:

?once dumb money realizes its limitations, it then ceases to be dumb.???

4) Risk Reduction and Diversification ? There are two aspects to risk reduction. Firstly, the HYP investor invests only in the largest capitalised shares in the market (on the basis that these companies are hard to disrupt and tend to be stable) and assesses sustainability based on fundamental criteria. The second aspect of risk control for the HYPer is diversification. Simply put, it means ?don?t put all your eggs in one basket, or in the HYP world, in too few industries?.??

5) investing for ?eternity? ? This is a passive/long-term holding strategy. The idea is that, after setting up the portfolio, it shouldn?t be changed, meaning no trading of shares to minimize costs. Upon retirement,? you simply shift from re-investing the dividends to taking them as income to live on. The only reasons to sell or remove a stock from the HYP portfolio are if (1) the dividend is cut, or (2) the company is acquired. Bland argues that, every time you do change a company, you?re taking another risk of picking a company that will go wrong.?

Does HYP investing work?

Between November 2000, when the original HYP was started during the TTM bubble, and December 2007, the strategy apparently had a 5.9% annual dividend yield. As a result of the credit crunch, the approach had a number of high profile issues from a capital perspective, including Lloyds (down 90%) and BP. As of November 2011, the strategy had apparently generated ?40,823 in come over eleven years (4.95% p.a. on the original ?75,000 cost). From a capital perspective, the value of ?114,218 was up 52.3%, versus an index loss of 11.6%, although ? as discussed above ? the value of the capital invested is not the point of the strategy. The other HYP demonstration portfolios have not been tracked for as long (arguably a form of survivorship bias).

Bland argues?that the poor performance during 2008 doesn?t invalidate the approach since a) it is based on wide sector diversification to reduce the impact of these events and b) the focus is on long-term income generation, not capital growth/preservation. Bland suggests that investors should not even be focused on near-term income stabiity in times of extreme market volatility (not least because the volatility of, say, bank interest can be much higher):

?HYPers will suffer during these really bad times from widespread dividend cutting and suspension? total portfolio income will fall and that is unavoidable in the poorest years. The strategy is not for people who cannot live with that possibility?.

Further Reading?

There is an extensive TMF guide / compilation to the approach?here.?The initial TMF articles where Stephen Bland set out the strategy and describes the first HYP (known as HYP1) are here:

The?Monevator?blog has also written up a?good 4-part guide?to a UK-based HYP.?It?s worth reading/listening to the following article/podcasts:

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Source: http://www.dailymarkets.com/stock/2012/09/02/high-yield-portfolio-what-is-hyp-investing/

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