Portfolio Buy: 10% Yield - Asset or Hand Grenade?

"Three shall be the number of
the counting..."
Source

At the risk of being repetitious: high yield = high risk.

To quantify that a little, the average yield on my portfolio usually runs at 5-6% and this is the sort of yield (and risk) that I feel comfortable with. So, to paraphrase the Monty Python 'Holy Hand Grenade of Antioch' sketch: 10% is right out (of the question).

A so-called 'free lunch' would entail getting an abnormally high yield with no consequent risk. However, given that the stock market is driven by thousands of decisions - many of which are very well informed indeed - means that this kind of situation is unlikely to arise. So unlikely, in fact, that spotting them is probably impossible.

In other words, even if you do your homework, buying anything with an abnormally high yield is a gamble - a bit like holding onto a hand grenade with the pin pulled out.

Having said all that, my latest portfolio buy does yield over 10%. What could justify grabbing hold of this?

The share in question is the City of London Investment Group (LSE:CLIG), an operator of 'boutique' funds specialising in buying shares mainly in other 'closed-end' funds, when these appear (to them) to be underpriced. In particular the company offers its own funds in Emerging Markets and Frontier Markets as well as other market segments.

Bloomberg describes it succinctly:

City of London Investment Group PLC is an institutional asset manager. The Group primarily manages portfolios which invest in emerging markets via closed-end funds, together with mandates in natural resources equity, emerging markets equity and developed markets closed end funds. The Group operates from offices in London, the United States, Singapore and Dubai.

At first view (even at second view), the picture is not at all encouraging:

• the Funds Under Management have fallen considerably (losing a major institutional investor didn't help)
• consequently, profits have fallen
• then the company recently 'lost' its chief executive and finance director (a sure sign of 'trouble a't' mill')
• not surprisingly, the share price has fallen considerably (hence the high yield)
• dividend cover is low (only a shade above 1)
• (and there's probably more)

So, what are the redeeming factors? The main 'positive' is that the dividend has been maintained, on the basis of an improving situation (in the view of the 'refreshed' management) and significant cash resources.  As the June 2013 Trading Update noted:

As a result of both falls in Emerging Markets, and client redemptions during the first half of the financial year, earnings cover will be reduced this year but given the Group's strong cash position and optimism with regard to the future, the Board is recommending a final dividend of 16p per share (2012: 16p). This would bring the total for the year to 24p (2012: 24p), making cover 1.04 times earnings per share (2012: 1.41 times).

Second, this purchase continues the theme of developing a portfolio that is more geographically diversified.

Third, the p/e ratio is quite low: undet 7 - indicating that it is quite 'cheap', in terms of the net income you are getting for the price.

Finally - and more importantly - I know from my own experience with my Emerging Market ETFs that this segment of the world market has been performing particularly poorly. My guess is that these markets have just gone out of fashion temporarily and that they could 'revert to mean' quite rapidly the minute there is some sustained good economic news (e.g. when the pace of QE tapering in the US is appreciated to be glacial, rather than avalanche-ial).

But that's just a guess, isn't it? Wise investors will follow the teachings of Armaments Chapter 2 and stick to more 'holy' yields. Otherwise run the risk of having it blow up in your face.

[Purchase price: £2.305]

Update 20/1/14: Half-year results are generally positive and the management plan to retain the dividend.



I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.