Saturday 14 March 2015

Know Your Strategy! (Portfolio Buy)

Contrarian Investing

My long-term strategy for the DIY Income Investor portfolio is to develop an investing style that doesn't require much skill or input. The objective is to pass on investment nest eggs that more-or-less manage themselves.

So, 'DIY' taken almost to an extreme - Do Very Little Yourself!

To my mind, the basic requirements for any investment strategy are that it should:
  • be based on a coherent and proven concept of how the investment market works (i.e. rather than a 'scattergun' approach) [this is probably the hardest part!]
  • produce a total return greater than
    • inflation, and
    • no-risk (or low-risk) cash investments (which I put currently at around 5-6%, available from Ratesetter).
  • minimise risk through diversification
  • be low cost (to keep as much of the gains as possible) - implying a DIY approach, to reduce fees
  • be easy to manage - using online accounts and not requiring daily attention

As regular readers will be aware, my 'concept' (such as it is) is that high yield can often be a sign of potential value. [It can also be a 'kiss of death' - the skill is in being able to judge the difference.] High yield usually indicates that the market is wary of a security (usually because of basic concerns about a company or the fixed-income security). And the market is basically manic depressive: over-reacting to good and bad news. This means that bad news is often not as bad as it originally seems.

My investment 'universe' includes only securities yielding an income; because if there is no yield, it is much more difficult to gauge market sentiment. Also having yield means that you receive some income while you wait (hopefully) for the price of the security to recover.

It may not be a 'perfect' approach (and do tell me if you discover such a mythical investment beast), but the DIY Income Investor portfolio has survived one of the greatest investment crashes of modern history and has demonstrated a total return comparable to the best of the managed UK equity income funds.

There have been a couple of refinements in the DIY Income Investor strategy:
  • Before discovering my 'high yield' approach, I invested fairly randomly, learning (to my cost) that Investors' Chronicle was not the path to riches that the editorials might suggest.
  • Initially the portfolio was based on a classic High Yield Portfolio, as advocated by Motley Fool's pyad - including only dividend shares;
  • The 2007/8 crash showed how vulnerable this approach was; consequently I started investing also in fixed-income securities - eventually ramping up their share to 50% of the portfolio. [Fortuitously, as it turned out - QE resulted in a boom in their prices.] 

The latest refinement of the strategy is to boost the proportion of Exchange Traded Funds (ETFs) - intended primarily to make the portfolio easier to manage, as effectively keeping track of 30-odd different securities is beyond me (and probably beyond most DIY investors). The downside of ETFs is that you are not going to get rich quickly from them (at least the ones I invest in) - but hopefully you won't get poor either.

The latest portfolio purchase is a top-up of an existing ETF. It is probably useful to explore the decision process. For diversification, I try to limit single investments to around 5% of the portfolio value. However a different rule should apply to ETFs, as they are already highly diversified - the risks in this case are not so much related to the individual components of the index but the meta-risks related to the overall sector or geographical area. So a maximum of around 7-8% of the portfolio in any single ETF (or similar ETFs) seems a reasonable cap. In addition, I try to diversify the ETFs in two ways:
  • 50/50 split between ETFs based on dividends and fixed-income
  • a geographical split between: UK, Euroland, USA, Asia Pacific, Emerging Markets
The available ETFs quoted on the LSE are fairly limited in number - and (I like to think) the 'best' of these are already included in the DIY Income Investor portfolio. When looking for the next ETF purchase I go back to the basic premise: high yield = out-of-favour. The task is therefore quite simple - top-up the ETF with the highest yield that is under-represented.

Which led to IAPD  (iShares Asia Pacific Select Dividend 30 UCITS ETF) which I already hold. The historic yield is 5.4%, the highest of the 'dividend' ETFs. To me it looks like the Asia Pacific region is going through a bad patch in the markets - but one that seems (to me at least) to be temporary. As always, at that kind of yield I don't mind holding on until it recovers.

This investment takes the proportion of ETFs in the portfolio to nearly 50% (I'm aiming for around 75% or more). The basic, simple future strategy for investing any generated cash: top-up the ETF with the highest yield that you don't have a lot of. Simples.

[Purchase price: £20.41]

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.

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