As we head out of the rather late summer towards winter it’s time for me to review the UKVI defensive value model portfolio once again.
The first thing I have to point out, as always, is that investors should start with the end in mind which means they should know what they are trying to achieve, i.e. what their goals are.
In the case of this model portfolio the goals are defined as:
- A high dividend yield, defined as 110% of the FTSE All-Share yield
- Higher total returns than the FTSE All-Share
- Lower risk than the FTSE All-Share (measured using beta and maximum drawdown)
- Low effort, requiring no more than a few hours to maintain each month
And this is no mere virtual portfolio as I have just about every penny of my (and my wife’s) pension pot invested in exactly the same stocks as this portfolio.
So, now that we know what the portfolio is aiming at, let’s have a look at how it’s getting on.
Recent slowdown reflects the state of the UK stock market
It’s been a quiet time for the UK stock market in recent months. The FTSE 100 has fallen to 6,623, down 3% from the 6,820 level it held at the start of September. Year to date the index is down 2% from 6,749.
This pause in the market’s rate of growth is entirely reasonable and well within the bounds of what investors should expect. The stock market does not go up in a straight line and so we must expect years where returns are low and even negative.
Like the general market, the model portfolio has had a slow year too.
So far in 2014 it’s up by just 0.3% with dividends included. In comparison the FTSE All-Share tracking investment trust which I use as a benchmark is up by just 0.1% with dividends included.
You can see how this recent slowdown looks in the chart below:
Note: The average and bad investor in the chart underperform the market by 3% and 6% respectively each year, which is based on various estimates of average private investor underperformance.
In relation to the goals I set out at the top, the model portfolio so far has:
- Historic dividend yield of 6%, including large special payouts from Vodafone. The FTSE All-Share yield is also high at 4.2% for the same reason.
- Total returns over 1 and 3 years and also from inception of 6.3%, 48.2% and 41.8% respectively. The FTSE All-Share in comparison has returned 5.4%, 47.3% and 31.5%.
- Annualised returns from inception of 10.2% compared to 7.9% for the All-Share.
- Beta over 3 years of 0.58 relative to the FTSE All-Share (below 1 means lower risk).
- Maximum drawdowns to date are 8% for the model portfolio and 13.5% for the All-Share.
On all measures so far the portfolio is on track. It has always had a higher dividend yield than the All-Share, as well as higher total returns while being less risky (if risk is measured by beta and drawdown).
Of course this comparison takes place over a period of just 3 years and 7 months, which is far too short to make any meaningful conclusions about how a portfolio and its underlying investment strategy have performed.
According to some academics (PDF) it can take 22 years to be 90% sure that a fund manager’s outperformance is skill rather than luck.
In the real world we have little else to go on other than the performance history that we have accumulated so far, and so far I’m reasonably pleased with the portfolio’s 10.2% annualised return from 2011.
Dividend growth is more important than capital gains
While it’s interesting to look at total returns, as a long-term investor I’m more interested in the ability of the portfolio’s underlying companies to generate cash returns rather than how their share prices or the aggregate value of the whole portfolio is doing.
In the long-run it is dividends that determine share prices rather than the fickle opinion of Mr Market, so growing the portfolio’s total dividend is priority number one.
As you can see in the dividend history chart below, both the model portfolio and the All-Share tracker have produced record dividends this year (my definition of dividends includes all payouts, whether cash dividends, shares “gifted” to investors like those of Verizon when Vodafone sold it off, and also any cash from the sale of nil-paid-rights in a rights issue).
However, dividends from both portfolios were also boosted by the huge one-off Vodafone payout earlier this year. Because of that, I would expect cash returns to be lower next year, although of course the goal is to see them climb in the longer-term.
I’ve also included a second dividend chart below which shows dividend income on a monthly basis. Hopefully it shows how a portfolio of shares can pay out a reasonably consistent stream of dividends every month.
It’s easy to see how that dividend income could be used to boost income from a company pension for example, unlike the All-Share which would be a bit more fiddly as it only pays a dividend twice a year.
You can see the Vodafone income spike in the All-Share’s income as a very large second dividend payment in 2014. For the model portfolio it shows up as very large dividend payments in both February and March 2014.
Happiness is a growing dividend
Warren Buffett has long used Berkshire Hathaway’s book value rather than its share price as his main measure of progress over time.
Berkshire’s book value is a better measure of progress than its share price because its book value is less affected by Mr Market’s mood swings. In other words, its book value grows more or less in line with the company’s ability to generate cash returns today and in the future.
In much the same way I would rather use annual dividends as a guide to the progress of the model portfolio and its FTSE All-Share tracker benchmark, rather than their market value.
I know that in the long-run, if dividends keep rising at a decent pace over a number of years then the intrinsic value of the portfolio is very probably rising as well. That will be more than enough to keep me happy, regardless of what happens to share prices in the short-term.