Managing Sequence of Risk

bostonerimus

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.

My thinking exactly. There's is no great magic to ITs, they are just PLCs that own investments and pay you a dividend that comes from reserves, and investment interest, dividends and capital gains etc. They are allowed to use tools like borrowing, but basically they don't do anything you couldn't do with your own portfolio. And guess what, SWR strategies are all about paying yourself an index linked income and having reserves to manage down turns and you can do that with or without ITs.

Audaxer

masonic said:

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.

It's an interesting point, but I still think for those that have confidence a particular IT will continue to pay an increasing level of income each year, would still prefer the IT. I agree with also holding a decent cash buffer of my own.

masonic

Audaxer said:

masonic said:

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.

It's an interesting point, but I still think for those that have confidence a particular IT will continue to pay an increasing level of income each year, would still prefer the IT. I agree with also holding a decent cash buffer of my own.

There are other reasons one might prefer an IT, but their ability to hold cash reserves alone should not sway someone. The long term income sustainability is more a factor of manager performance, and it may or may not be true that the best managers operate within the IT space. Over half my portfolio is in ITs, but I don't have any interest in their ability to pay a sustained level of income.

Audaxer

bostonerimus 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.

My thinking exactly. There's is no great magic to ITs, they are just PLCs that own investments and pay you a dividend that comes from reserves, and investment interest, dividends and capital gains etc. They are allowed to use tools like borrowing, but basically they don't do anything you couldn't do with your own portfolio. And guess what, SWR strategies are all about paying yourself an index linked income and having reserves to manage down turns and you can do that with or without ITs.

I know you have a straightforward system with two or three well diversified index funds, and income can be taken easily on a Total Return basis, especially if you only need a low level of income. I'm not sure it's as easy to manage a portfolio of equity income funds to provide the same smooth level of increasing income as those equity income ITs that have a long history of increasing dividends.

masonic

Audaxer said:

...income ITs that have a long history of increasing dividends.

Mentioned a few times now, so worth clarifying. The increase is in relation to nominal dividend per share, which must increase as the share price increases, otherwise the yield would fall. I don't think they have a log history of increasing dividend yield, unless I'm mistaken?

Audaxer

masonic said:

Audaxer said:

...income ITs that have a long history of increasing dividends.

Mentioned a few times now, so worth clarifying. The increase is in relation to nominal dividend per share, which must increase as the share price increases, otherwise the yield would fall. I don't think they have a log history of increasing dividend yield, unless I'm mistaken?

The yield can still fall if the dividend per share is increasing. A lot of the UK equity income ITs had big falls during the Covid crash which resulted in very decent yields for those brave enough to buy into them at or near the bottom. For example Merchants IT share price dropped to as low at £3.03 in March 2020, which would have given anyone buying in at that point a yield of nearly 9%. At close of play Friday the share price was up to £5.74 and the yield is down to 4.74% for anyone buying in now, but the actual dividends paid out are still increasing.

Thrugelmir

Audaxer said:

masonic said:

Audaxer said:

...income ITs that have a long history of increasing dividends.

Mentioned a few times now, so worth clarifying. The increase is in relation to nominal dividend per share, which must increase as the share price increases, otherwise the yield would fall. I don't think they have a log history of increasing dividend yield, unless I'm mistaken?

The yield can still fall if the dividend per share is increasing. A lot of the UK equity income ITs had big falls during the Covid crash which resulted in very decent yields for those brave enough to buy into them at or near the bottom. For example Merchants IT share price dropped to as low at £3.03 in March 2020, which would have given anyone buying in at that point a yield of nearly 9%. At close of play Friday the share price was up to £5.74 and the yield is down to 4.74% for anyone buying in now, but the actual dividends paid out are still increasing.

Reading the annual accounts for the year ended 31st Januay 2021. Of the total dividends paid out of 27.2p, 9.9p was drawn from existing reserves. Yield may have looked attractive in March 2020, but has been mentioned previously.  A sizable chunk of the dividend received would have been a return of ones own capital. 

Audaxer

Thrugelmir said:

Audaxer said:

masonic said:

Audaxer said:

...income ITs that have a long history of increasing dividends.

Mentioned a few times now, so worth clarifying. The increase is in relation to nominal dividend per share, which must increase as the share price increases, otherwise the yield would fall. I don't think they have a log history of increasing dividend yield, unless I'm mistaken?

The yield can still fall if the dividend per share is increasing. A lot of the UK equity income ITs had big falls during the Covid crash which resulted in very decent yields for those brave enough to buy into them at or near the bottom. For example Merchants IT share price dropped to as low at £3.03 in March 2020, which would have given anyone buying in at that point a yield of nearly 9%. At close of play Friday the share price was up to £5.74 and the yield is down to 4.74% for anyone buying in now, but the actual dividends paid out are still increasing.

Reading the annual accounts for the year ended 31st Januay 2021. Of the total dividends paid out of 27.2p, 9.9p was drawn from existing reserves. Yield may have looked attractive in March 2020, but has been mentioned previously.  A sizable chunk of the dividend received would have been a return of ones own capital. 

Yes, but if you had been lucky or brave enough to invest in Merchants at near the bottom in March 2020, you would still be getting a yield of up to 9% on your initial investment, have increasing dividends, and have seen your capital value almost double.

I invested in it just before the crash unfortunately, but I'm happy with the 5.2% yield I bought in at and the fact the dividends are still increasing. I was concerned when I saw how fast the share price was falling during Covid, but pleased that it has recovered really well.

masonic

Deleted_User said:

masonic said:

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.

Let's be careful not conflate an IT's cash reserves with its dividend reserves. By not paying out 100% of the income on the investments it holds, an IT can build up dividend reserves, which will allow it to pay out to pay out a higher dividend in a future year than the investments it holds generate in that year. But it does not have to hold the dividend reserves in cash; it may, and often does, reinvest those reserves in more shares. If that's what it's doing, then the IT may be selling off investments in order to maintain its dividend.

Personally, I would class reinvestment of those reserves in shares that could later be sold to be equivalent to not having those reserves. In a bad sequence of returns example, they could be valued at a market peak when the investor buys in, then sold after a subsequent crash. IT's that sell their own investments to maintain their dividends would be in the same situation as an investor who draws down their capital to supplement a reduced yield. Of course if you take an extreme hypothetical example of an IT being very conservative and paying out 50% of dividends received, then if its portfolio yield falls 50%, it would not have to sell shares, merely pay out all of its dividends received in those years. If 'dividend reserves' means dividends that can be expected, but that are not normally distributed, then point taken.

A trust that wishes to court a reputation of year on year increases in dividend would need to hold back (and reinvest) a reasonable proportion of its dividends in order to account for natural fluctuations in the dividends received, so its yield would trail its income by some margin. The downside being they need to pay a sufficiently attractive and competitive yield for their target investors. Reinvesting a proportion of dividends during the good time is another behaviour that could be replicated by a non-IT investor. Cash reserves can be held in addition to this.

I suppose you also make a good point that investors buying IT's on the assumption that they are maintain dividends using reserves should make sure those reserves are what they think they are. This might be easier said than done.

Thrugelmir

Audaxer said:

Thrugelmir said:

Audaxer said:

masonic said:

Audaxer said:

...income ITs that have a long history of increasing dividends.

Mentioned a few times now, so worth clarifying. The increase is in relation to nominal dividend per share, which must increase as the share price increases, otherwise the yield would fall. I don't think they have a log history of increasing dividend yield, unless I'm mistaken?

The yield can still fall if the dividend per share is increasing. A lot of the UK equity income ITs had big falls during the Covid crash which resulted in very decent yields for those brave enough to buy into them at or near the bottom. For example Merchants IT share price dropped to as low at £3.03 in March 2020, which would have given anyone buying in at that point a yield of nearly 9%. At close of play Friday the share price was up to £5.74 and the yield is down to 4.74% for anyone buying in now, but the actual dividends paid out are still increasing.

Reading the annual accounts for the year ended 31st Januay 2021. Of the total dividends paid out of 27.2p, 9.9p was drawn from existing reserves. Yield may have looked attractive in March 2020, but has been mentioned previously.  A sizable chunk of the dividend received would have been a return of ones own capital. 

Yes, but if you had been lucky or brave enough to invest in Merchants at near the bottom in March 2020, you would still be getting a yield of up to 9% on your initial investment, have increasing dividends, and have seen your capital value almost double.

I invested in it just before the crash unfortunately, but I'm happy with the 5.2% yield I bought in at and the fact the dividends are still increasing. I was concerned when I saw how fast the share price was falling during Covid, but pleased that it has recovered really well.

That was a one off event. By the 3rd week of February 2020 my entire portfolio was 65% cash. Subsequently reinvesting before the end of April.  I returned 39.1% in 2020 calender year. Unlikely to achieve this level of performance again in my investing lifetime.