YIELD INVESTING

There are many (variable) comments on yield investing on retail sites, having managed a couple of yield funds, I thought it may be of some help in couching the argument and pointing out some pro and cons.

First things first what is the definition of yield investing? In professionally managed money, (if you don’t own the firm), it relies, in reality, on what the sales team can sell. First and fore most funds management is a business not an investing think tank. In my case the instruction was quite clear, a 4% fully franked yield was required to sell the product as an attractive yield product. Adding the 1% mgt fee meant that the portfolio needed to yield 5% (80% franked).

For reasons I wont go into here, the franking was never really an impediment, so the franking target was easily achieved.

The portfolio yield of 5% could also be achieved but having this “constraint” as they are known in the trade, came with a price. Constraints can be of many forms and are usually consciously chosen, say risk or quality as examples. As the name implies they put some constraints on the structure of the portfolio.

After many theoretical iterations the yield portfolio had almost a set structure between growth and yield. As a simple example, say there are 2 stocks in the market CSL yielding 1% and WBC yielding 6%. To get 5%, assuming you want as much CSL as you can in the portfolio, gives you an 80/20 mix WBC/CSL. This is simple maths. Of course, there a range of WBC and CSL style stocks you can choose from but the broad structure split is set basically around 80/20.

What are the ramifications of this? My opinions are;

The yield portfolio could play a part of a broader strategy, but should not be of interest to a swathe of investors for various reasons (wealth (higher), age (lower), risk tolerance (higher) etc etc).

The portfolio appeals to a certain client. They are usually much older, not interested in capital growth, have a lower risk profile, want/need cash in the next year, not in 10 years. Like a TD with extra yield and franking but willing to wear some variability.

The portfolio cant really be compared to the broader market given that the constraints have a significant impact on the structure of the portfolio. I find is point is not understood, even by professionals.

The sales guys wanted yield and outperformance of the broader market (of course don’t we all). Having dual outcomes can be tricky and in the short to medium term at least, depends on what style the market favours, eg growth or value. We have seen stark examples of that over the last 5 years or so. Value imo being closely related to yield. Over the very LT (whatever that is) it should even itself out. In reality, imo, comparing a constrained portfolio with the broader market is not useful, you are trying to get something for free and to achieve it puts an unreasonable strain on stock picking (hit rate).

When I soke to yield clients, and I spoke to hundreds of them, the overwhelming investment question was, is the distribution secure and is it franked?, that was it. As I said the average client was a definitely pensioner vintage. If I had said we were planning to increase the returns but the cost was extra volatility and extra risk, I don’t think it would have gone down well at all.

Of course, managing these funds is like fighting with one hand tied behind your back which can be frustrating. The only way I could reconcile it is that it is a niche product, sitting in a different part of the risk/return spectrum. Now someone will tell me if you bought CSL 20 year ago the yield on cost now would be very high, how many times have I heard that…. :)

Hope this explains the yield case to some extent.