The basic idea behind the DIY Income Investor is to take advantage of Mr Market's manic-depressive reaction to bad news - whilst collecting a nice income for your trouble. In other words, I buy high-yield securities that the market has marked down because there is a potential problem that may, or may not materialise.
The difficulty, of course, is judging whether the risk is worth it...
High yield is an indicator that the market thinks something is wrong. If you are a contrarian investor (like me) it is one of the most valuable signals available. It is a clear flashing red light that says (to me anyway) "have a look at me!"
However, going against market sentiment has it's risks, of course. The market is composed of dozens - or even hundreds - of investors, most of whom I assume are better informed than I am. Sometimes they are right and the company bombs - leaving me with a capital loss.
Bearing in mind that I can get a 6+% return on cash (with Ratesetter 5-years peer-to-peer lending) with little-to-no risk means that yields have to be quite tasty to get me to take a big risk.
In this latest purchase for the DIY Income Investor portfolio I stumbled across a sad story: a Building Society that has hit hard times: Manchester Building Society. The society reported a loss for 2015 and the long-term future of the society is in question. Indeed the 2015 Annual Accounts do not paint a pretty picture:the Group had negative accounting reserves of £5.6.
The news caused a 40% drop in market price of the 8% Permanent Interest-Bearing Shares (PIBS), meaning that the yield on them shot up to around 12%. This is an almost unheard-of yield in the current market and is twice my cash yield.
So what happens if the Society goes bust or is taken over?
I couldn't find the prospectus for the 8% PIBS but the one for the 6 3/4% PIBS shows some of the legal options - I'm assuming the conditions for the 8% PIBS are similar. [The link - provided by a reader - is here.] I think it is most unlikely that the Society will be allowed to fail, so a takeover is the most likely outcome. This could have the following result for the PIBS:
- no change: unlikely, as this would represent very expensive capital for the new owner
- cessation or reduction of interest payment: probably not legal
- repurchase at face value (i.e. £1): possible, but unlikely, because of the cost
- offer of repurchase at a premium to the market price: the most likely option in my opinion
So there you have it: a huge yield with a possibility of a capital gain. Or a loss. You decide.
[Purchase price: £0.69]
Update 11/8/16; Danger indeed! PIBS payments will not be made in October 2016.
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.