Managing Sequence of Risk

ColdIron

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

I have separate portfolios for growth, I like to keep them separate as it allows me to focus on the job in hand and take advantage of different charging regimes

Audaxer

MK62 said:

tacpot12 said:

To the people who pointed out that there had not really been a poor sequence of returns during the pandemic, would agree with this, but I would also point out that the nature of the risk is that we don't know whether one poor return is the start of a sequence or not.

My contention is that by taking my income from the natural yeild of the portfolio, I am less exposed to any sequence of return risk. I might have a poor return, or I might have a sequence of poor returns, but it only affects my income during  the period of the poor return, when the returns return to normal, all my assets return to normal. Someone whose plan is to sell assts for their retirement income will not have their assets return to normal as they have sold some of them (and done so at low prices, so had to sell more. I only sell when the markets have not just crashed. 

I know that this smacks of trying to time the markets, but I'm willing to risk that a recovery follows a crash.  

 

It sounds good in theory, but as recent events have shown, relying on the natural yield of your portfolio carries it's own SORR.

Fair enough, if you are very heavy in bonds, this might have less effect, but for equities, many dividends have been slashed during the pandemic......if you have to sell assets to make up that income shortfall, you are back to square one on SORR. Investment Trusts have an advantage here of course, as they can "smooth" their payouts, but even then, the cash reserves needed to do that may not last as long as you might like.

I'm not saying that such a plan is "wrong" of course, just that it won't really avoid SORR.......

I agree you could end up with a lower capital balance over time by just selecting funds or ITs for natural yield. However if it is a portfolio of the ITs that have increased their dividends over many decades, and IF that continues over the next few decades (and I know it's a big IF), that could provide a SWR of over 4% per annum increasing with inflation, without the need to sell capital. 

MK62

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

Audaxer

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

masonic

Audaxer said:

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

There's no reason someone couldn't manage their portfolio in the same way as one of those ITs, i.e. hold back some income as reserves to supplement their income during cuts.

Audaxer

masonic said:

Audaxer said:

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

There's no reason someone couldn't manage their portfolio in the same way as one of those ITs, i.e. hold back some income as reserves to supplement their income during cuts.

But if someone bought the IT and fund at the same time, say at the start of 2020, they are going to be 42% down on their income. The fund's dividends might be back up to equal of the ITs dividends now, but the retiree is still going to be 42% down in income. If he sold capital to make up for that loss of income, that will surely result in lower dividends in future?

  

masonic

Audaxer said:

masonic said:

Audaxer said:

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

There's no reason someone couldn't manage their portfolio in the same way as one of those ITs, i.e. hold back some income as reserves to supplement their income during cuts.

But if someone bought the IT and fund at the same time, say at the start of 2020, they are going to be 42% down on their income. The fund's dividends might be back up to equal of the ITs dividends now, but the retiree is still going to be 42% down in income. If he sold capital to make up for that loss of income, that will surely result in lower dividends in future?

When you buy an investment trust with retained cash reserves, then part of your capital is going into purchasing those cash reserves. That means if you instead buy an OEIC and wish to invest on a like for like basis, you must keep some of your capital in cash. If you do so, you will not need to sell capital to make up for the loss of income, you use those cash reserves, just like the IT would. Let's say, for sake of example, that an IT was holding back 5% of its assets in cash, which might cover them for 2-3 years of dividend cuts. Then you would invest 95% of your cash in an equivalent OEIC and put 5% in a savings account.

masonic

I suppose the other thing to consider with ITs is that if you are relying on their cash reserves, these prove insufficient to weather a prolonged downturn, and the trust decides to cut its dividend, you could become a forced seller of the IT's shares both at depressed underlying asset prices and at a greater discount to NAV to when you purchased. It would therefore be prudent to have some other assets to fall back on (cash, bonds, as a last resort equity OEICs trading at NAV, etc) should you have this issue. Probably not something anyone in decumulation wouldn't have considered as it is key to avoid being a forced seller of equities during a crash.

Audaxer

masonic said:

Audaxer said:

masonic said:

Audaxer said:

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

There's no reason someone couldn't manage their portfolio in the same way as one of those ITs, i.e. hold back some income as reserves to supplement their income during cuts.

But if someone bought the IT and fund at the same time, say at the start of 2020, they are going to be 42% down on their income. The fund's dividends might be back up to equal of the ITs dividends now, but the retiree is still going to be 42% down in income. If he sold capital to make up for that loss of income, that will surely result in lower dividends in future?

When you buy an investment trust with retained cash reserves, then part of your capital is going into purchasing those cash reserves. That means if you instead buy an OEIC and wish to invest on a like for like basis, you must keep some of your capital in cash. If you do so, you will not need to sell capital to make up for the loss of income, you use those cash reserves, just like the IT would. Let's say, for sake of example, that an IT was holding back 5% of its assets in cash, which might cover them for 2-3 years of dividend cuts. Then you would invest 95% of your cash in an equivalent OEIC and put 5% in a savings account.

Okay, fair point about checking how much cash the IT holds. As an example, I've just looked at Merchants IT on the AIC website and it shows Cash as -11.7%, which I would assume is down to gearing as that is showing as 12%? The dividend cover shows as 0.64 years. So if you had say £10k to invest, what percentage would you hold back as cash if investing in the fund rather than the IT?

masonic

Audaxer said:

masonic said:

Audaxer said:

masonic said:

Audaxer said:

MK62 said:

ColdIron said:

One of my income portfolios is 100% ITs and the other is about 70% ITs and a ETF and 30% OEICs. No company shares. Some of the ITs do use capital for distributions (HFEL, BIPS and HDIV) but most of them have adequate dividend cover and a more modest yield

I'm comfortable with the lower capital prospects of the income generating accounts and it was the plan from the outset, the principal objective was steady and reliable dividends which I am pleased to see it has achieved over the last 2 years despite talk of 'slashed' dividends. It's one thing to theorise about what should happen and another to see it play out. Dividends are far less volatile than share prices

Fair enough if you've been invested in income producing assets which have maintained their payouts (ie investment trusts)........However, there is no theorising here....cuts happened, even if you personally didn't see that in your own portfolio.

Many Income funds reduced their payouts........eg, Royal London UK Equity Income cut it's dividend by 42% from TY19/20 to TY20/21, Franklin UK Equity Income by 28%, JOHCM UK Equity Income by 50%, Threadneedle UK Equity Income by 30%, Vanguard UK Equity Income Index by 36%........these are pretty mainstream funds, nothing exotic.......Global Income funds fared a bit better, but the cuts were there, just not as large......

Not quite per UK  tax year, but this report suggests a 12.2% cut in global dividends during calendar 2020 (remember, the pandemic didn't really hit until calendar Q2 2020)

https://www.cnbc.com/2021/02/22/220-billion-of-global-dividends-cuts-in-2020-janus-henderson-says.html

Nobody is arguing that investment trusts don't give you a smoother ride as far as dividend payouts go (though if you look under the hood, there is no free lunch....or magic sauce), but is dismissing dividend cuts as "theorising" not just ignoring facts as they don't happen to directly affect you? (at least not yet anyway.. ).

If a retiree absolutely needed the dividend income in the last few years, then I think it is better to have had an IT that continued paying the full dividend rather than a similar equity income fund that cut it's dividend by 42%. I know the IT would have had to dip into reserves, but surely that is better for the retiree than having to decide whether to sell some capital from their fund to make up for the 42% dividend cut.

There's no reason someone couldn't manage their portfolio in the same way as one of those ITs, i.e. hold back some income as reserves to supplement their income during cuts.

But if someone bought the IT and fund at the same time, say at the start of 2020, they are going to be 42% down on their income. The fund's dividends might be back up to equal of the ITs dividends now, but the retiree is still going to be 42% down in income. If he sold capital to make up for that loss of income, that will surely result in lower dividends in future?

When you buy an investment trust with retained cash reserves, then part of your capital is going into purchasing those cash reserves. That means if you instead buy an OEIC and wish to invest on a like for like basis, you must keep some of your capital in cash. If you do so, you will not need to sell capital to make up for the loss of income, you use those cash reserves, just like the IT would. Let's say, for sake of example, that an IT was holding back 5% of its assets in cash, which might cover them for 2-3 years of dividend cuts. Then you would invest 95% of your cash in an equivalent OEIC and put 5% in a savings account.

Okay, fair point about checking how much cash the IT holds. As an example, I've just looked at Merchants IT on the AIC website and it shows Cash as -11.7%, which I would assume is down to gearing as that is showing as 12%? The dividend cover shows as 0.64 years. So if you had say £10k to invest, what percentage would you hold back as cash if investing in the fund rather than the IT?

According to its annual report, it was holding £10.7m in 'cash' (including shares repurchased for cancellation) with net assets of £555m, which equates to 1.9% on 31st Jan 2021 (down from 2.4% in the year to 31/01/2020, and 4.5% in the year to 2019). Suggests around 4% could be used as an upper limit, with excess dividends reinvested or used to top up previously depleted reserves, assuming you'd want a 2-3 year buffer. I'd recommend surveying a few different trusts to get a better understanding of real-world use of cash reserves during the previous wave of cuts, with the caveat that was rather shorter than might be the case next time. I've just taken a cursory look at one trust, so please don't take this as a considered opinion.

Beyond that it would be something to be tailored to your personal circumstances, which is possible if managing yourself. Either way, it is necessary to plan for what you would do in a prolonged and/or more severe situation of reduced yields, but cash reserves held by the investments in your portfolio should be considered when deciding your own level of personal cash reserves. Personally, I wouldn't let a trust's cash reserves tempt me to hold none of my own.