Friday 10 January 2014

Investing by Numbers (Portfolio Buy)

The goal of any investment strategy is to have a set of 'rules' ("more in the nature of guidelines" according to Captain Barbossa) that guide you towards the right purchase for sustainable long-term growth of your wealth. To completely automate the process is by all the evidence available an unachievable aspiration - but I think you can get quite a long way with a handful of rules.

But, like the instructions from a dodgy Satnav, always double-check your route through the stock market - it is probably good to sleep on any big decision and review it with a fresh mind.

So, onto today's rule-based purchase decision:

1) Look for high and sustainable yield, making sure (as far as it possible) that the capital value will be safeguarded. (High yield is defined as a real annual return - i.e. after inflation - of above 2-4%, depending on risk levels.) 

2) Split the portfolio evenly between dividend shares and fixed-income (such as bonds and preference shares).

3) Limit any single security to 5% of the portfolio; also diversify by market sector as much as possible.

4) Build up 50% of the portfolio in geographically diversified (i.e. non-UK) ETFs investing in high-yield securities, consistent with maintaining reasonable overall portfolio yield.

OK, so today I need to top up the fixed-income side of the portfolio - what to buy?

5) Look at the possibility of topping up with available geographically-diversified ETFs.

I'm pretty well invested in all the ETF options that I've been able to find, although I could top up one at around 5% yield.

6) If ETFs do not seem to be attractive, review the current market for UK fixed-income securities.

My first port of call for these securities is Fixed Income Investments.

7) Given the current negative outlook for fixed-income (due to the withdrawal of QE), look for securities with a medium-term maturity (ISAs require a minimum of 5 years) selling below par (i.e. under £1.00 per unit)  with a yield greater than the portfolio average (currently around 5.7%)

Hmmm. Here's a Lloyds Bank security LLPG 6.3673% Non-Cumulative Preference Share - maturing in 2019 (or is it 2020?) with an income yield of 7.3% and a yield-to-call of 9.5%. It is familiar, at least - I held the similar security, LLPE, and I sold it at a profit last year.

8) Check for any potential downsides or risks

I still have a big (negative) holding of Lloyds Bank shares, so I would be taking a larger position in Lloyds than is perhaps desirable. However, Lloyds seems to have settled down (and its share price is climbing). I feel reasonably confident about its future (and I bank there).

However, a bigger risk is what happens in 2019 (according to the prospectus): instead of being redeemed, the interest rate may be reset to 1.36% per annum above three-month Sterling LIBOR. This is currently running at only around 0.52% - implying a return of less than 2%; however, this is artificially low due to QE. Is LIBOR likely to be higher in 2019? Almost certainly - but how much higher is anyone’s guess. Hence the current price and high yield, I suppose, remembering that high yield is usually the bedfellow of high risk.
So, overall, this security ticks all my boxes.  although I have to bend my diversification rule a little and take maybe a little more risk than I like.


[Purchase price: £0.92]

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.


  1. Hi
    I was thinking of moving too from LLPE to LLPG to benefit from the slightly increased on-going yield and yield to call. What worries me slightly is the reset in 2019 to libor + 1.36%. Could be a shrewd move though if interest rates start to rise

    1. Anon

      Thanks for pointing that out - I've added to the text. Not sure if it is shrewd or not - a bit of a gamble, in any case!

  2. Have you ever considered investing in Investment Trusts? I know that you focus on buying into specific companies and/or ETFs for the equity part of your portfolio, but surely Investment Trusts (or Unit Trusts/OEICs) should also be considered. Personally I prefer Investment Trusts. I also saw that they don't figure in your "Income Pyramid" either.

    For example, you could get exposure to infrastructure assets through 3i's Infrastructure Investment Trust (trading at a Net Dividend Yield of 7.35% according to Trustnet) or pick up 7.26% via Invesco's Perpetual Enhanced Income Investment Trust. Both have shown pretty good share price performance over the last couple of years. There are also real estate investment trusts yielding between 6.5% and 7% as well as well as a raft of others to choose from.

    Yes, before you say it, Investment Trusts can trade at a premium (3i Infrastructure) or a discount (Invesco Perpetual Enhanced income) which puts many people off, but who is to say that the company you have invested in will not see a PE multiple contraction which is the same sort of risk?

    I've not invested in these funds but they do look attractive to give access to areas that I could not reach (not sure I can build much of a road with a few thousand pounds to set up my infrastructure investments!) or good diversification.

  3. Andrew

    Maybe - but as a rule I don't like to nuy the 'suits' their yachts. There is a lot of 'smoke and mirrors' sometimes (e.g. ramping up debt to improve performance) and hidden charges. But maybe, if I find one with a similar philosophy - I haven't really looked that hard up to now...

    1. I agree to some extent, but are you not biting off your nose to spite your face by denying the "suits" their fees? If you are getting 7%+ after they've taken their fees then is it really an issue that they are taking 1%+ in fees? Yes, that does mean you could be getting 8%+, but surely if it is offering a better yield compared to other alternative investments it should be seriously considered. And, to get cut out the fees you'd have to be in a position to be able to build up this portfolio yourself, whcih very few of us can do in some of the more exotic/interesting sectors.

      I agree that there may be hidden charges. I's assume that an investment trust issued by, say, JP Morgan, would only deal through JP Morgan, have custodian relationship with JP Morgan and pay JP Morgan for any advice (research, corporate advice, etc.). However, some Investment Trusts have very stable portfolios (how often can you trade into and out of a school investment?) so there is little dealing charges. I'm not so sure about ramping up debt, if it's a high-trading investment trust then this could be an issue but if it is a stable high-yield investor then I don't see this as too much of an issue.

      Your comment encouraged me to look at 3i's Infrastructure trust a bit closer. 3i (as investment adviser) take 1.5% of the opening asset value and value of any investments made during the year which looks to be in the IMA's typical range of fees (1.25% to 1.75%). 3i themselves hold 34% so it would seem that interests are aligned between shareholders and investment adviser.

      I think it still looks like an interesting sector that should definitely be investigated for gaining yield - I'm not just pushing 3i! (As a disclaimer I don't work for 3i or any company that has/runs an investment trust)

  4. Why do Prefs defy "the benefits of scale" . Ask for a 20k get quoted 95p. Ask for 2k get 93p. I have seen this before but I remain puzzled.

  5. The news "Labour will split banks" is an important lesson for the DIY investor. "Sentiment" will wipe out 10% of these Prefs. If you possibly can - place these sorts of buys in a pension drawdown account where the yield is everything and the capital value less important.

    On the other hand - these Prefs are now a "bargain"!

    We have had "fix the energy price", "Failed (regulation) at COOP bank", "split the banks" - what is next?

    1. PH

      Yes, no matter how careful you are, there are random factors that can knock you sideways. Hence my diversification rule!

  6. Yes but what about IPE ? Andrew Hardy mentioned above.