Friday 11 November 2016

Investors Chronicle High Yield System

Investor Chronicle's writer James Norrington has been trialling a new High Yield System - with mixed results.

It's interesting to have a look at how this system differs from the DIY Income Investor approach and how well the two strategies have worked.
The Investors Chronicle High Yield (iCHY) strategy is described in a recent article, which details the rules, portfolio composition and results over the 6 months April-October 2016.

The iCHY rules are quite detailed and were designed (it seems) to be mechanical - removing the need for much decision-making:
  • Stocks are selected from the FTSE All-Share:
  • Positive 12-month price momentum.
  • Market capitalisation in the top 40 per cent of the universe.
  • Dividend yield not in the top 10 per cent of the universe (this is a quality measure).
  • Dividend cover above 1.5.
  • Remaining shares ranked on dividend yield.
(There are other restrictions to ensure diversification.)

Companies are sold if they combine negative 12-month price momentum with a dividend yield below the portfolio average; or, if the dividend is passed.

The difference between the iCHY and DIYII approaches can be summarised as follows:
  • iCHY consists of only 15 high-yield dividend companies - about the same as DIYII (although not the same holdings) but DIYII also invests in fixed-income securities and diversified ETFs, more than doubling the number of holdings
  • DIYII is based much more on yield and a subjective assessment of sustainability of that yield (even the quite high yields that iCHY would not consider)
  • DIYII tends to hold on to losers (until they turn good - or the bitter end) 
  • iCHY looks for positive price momentum; DIYII is looking for price drops that might be market over-reactions given the business fundamentals

A good objective case can be made for all the iCHY rules. However, the strategy has not really been successful and has under-performed the market and other passive income strategies over the 6 months 11/04/16 to 10/10/16 (comparing Total Return):

FTSE 350 15.4%
FTSE All Share15.3%
SPDR UK Dividend Aristocrats ETF (UKDV)10.4%

My estimate for the DIY Income Investor portfolio return for the similar period April to September 2016 is around 16.4% - so in-line (a little better, in fact) with the market.

The author of the iCHY system recognises that all is not well and suggests more diversification and making the application of rules much more flexible, although this will require more subjective decision-making.

"The reason for adopting a passive approach is to remove the emotion from buy and sell decisions. However, when selecting just 15 companies we are not achieving the diversification which is one of the main benefits of passive strategies when these encompass a whole index. Choosing such a narrow slice of the universe of stocks is an emotional leap of faith in itself. Therefore, why not use the high-yield screen as just the starting point and then actively manage the decision of which companies to buy and sell? This would certainly save on dealing costs and avoid replacing shares we would be happy to hold on to."

So, is there something we can take away to improve the DIY Income Investor strategy?

I don't think so...

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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