Did The DGI Newbie's 2014 Portfolio Fail Like High Yield Failed?

|
Includes: ETW, HRZN, MCC, NMFC, OCSL, PNNT, UHT, WMC
by: Steve Condie
Summary

Previous articles tracked how portfolios composed of high-yield CEFs, BDCs, MLPs and mREITs "failed" by underperforming the market significantly since 2014.

I've been challenged to demonstrate how my own investments held up over that time because comparing portfolios to SPY is "unfair."

A static portfolio based on my holdings in August 2014 would have returned 97% of the annual yield of the S&P 500.

My actively traded portfolio matched the performance of the index despite withdrawals in the past year.

Both outcomes significantly exceed the analyzed and reported performance of 2014 portfolios managed by high-yield advocates.

I have written a series of articles analyzing the performance of high-yield portfolios composed of CEFs, mREITs, MLPs and BDCs. Studied from multiple angles, I found that high-yield portfolios have consistently underperformed the market as a whole over the past 4 1/2 years. [Study #1: Model High-Yield Portfolios Holding BDCs, MREITs And CEFs Fail Multi-Year Performance Tests, Study #2 High-Yield Investment Strategy Fails and Study #3: High Yield Strategy Fails Again]

Although the high-yield investments recommended by several SA writers in 2014 pay out high dividends, that income is offset by erosion of both share value and dividend payments over time. My studies concluded that a diverse group of dozens of recommended high-yield investments have produced less than 70% of the yield of the market as a whole since the beginning of 2014. And that appears to be true of those that have been actively managed by skilled investors as well as those held in a static "buy and hold" portfolio.

One insistent refrain from the comments by readers of my articles is that using index funds as a comparison is "unfair," and that my studies had no credibility because I hadn't shown my own investments for comparison to the high-yield portfolios I was studying. I don't agree with that assessment, as I don't consider myself an expert investor and I'm not advancing a theory of investing for anyone to emulate.

I felt that my own portfolio's performance was unexceptional and would not add to the knowledge of the SA readers. My intent in writing the articles was to try to peel back the layer of confusion I perceived regarding what high-yield investments do and don't achieve.

Nonetheless, I am responding to the demands that I disclose the investments I made during the time period under review. As it happens, I made the transition from being primarily an index fund investor to 100% individual stock holdings in 2014. That transition was completed in August 2014. At the time, I considered myself a newbie DGI investor, and my portfolio was a mix of legacy stocks I'd owned for a long time and new ones I was picking with the information I had garnered more recently.

These are the 28 stocks I held in my "DGI newbie" portfolio as of August 31, 2014: Apple, Inc (AAPL), Analog Devices, Inc. (ADI), Automatic Data Processing, Inc. (ADP), Baxter International, Inc. (BAX), Carnival Corporation (CCL), Emerson Electric Co. (EMR), General Dynamics Corporation (GD), General Mills, Inc. (GIS), Hasbro, Inc. (HAS), The Home Depot, Inc. (HD), Hawaiian Electric Industries, Inc. (HE), H&R Block, Inc. (HRB), Intel Corporation (INTC), International Paper Company (IP), Johnson & Johnson (JNJ), Leggett & Platt, Incorporated (LEG), Eli Lilly and Company (LLY), Mattel, Inc. (MAT), PG&E Corporation (PCG), The Procter & Gamble Company (NYSE:PG), PPL Corporation (NYSE:PPL), Royal Caribbean Cruises Ltd. (RCL), Raytheon Company (RTN), Tupperware Brands Corporation (TUP), Texas Instruments Incorporated (TXN), Universal Health Realty Income Trust (UHT), Verizon Communications Inc. (VZ), Waste Management, Inc. (WM)

I put that set of stocks to the same tests I had applied to the dozens of high yield investments I had culled from the writings of some of the high yield advocates on Seeking Alpha in 2014-2016, which included investments such as Oaktree Specialty Lending Corp (OCSL), New Mountain Finance Corp. (NMFC), Resource Capital Corp. (RSO) Medley Capital Corp. (MCC), Horizon Technology Finance Corporation (NASDAQ:HRZN), Eaton Vance Tax Mgd Global Buy Write Fund (ETW), Western Asset Mortgage Capital Corporation (WMC), and Pennant Park Investment Corp. (PNNT).

First, I analyzed how the DGI newbie portfolio would have performed on a static, "buy and hold" basis, and compared that to how the index fund SPDR S&P 500 ETF (NYSEARCA:SPY) performed over the same time period. Then, I compared how my actively managed portfolio actually performed compared to SPY. Finally, I compared how my DGI newbie portfolio compared to the high-yield portfolios.

The results are fairly dramatic:

  • While the static high-yield portfolios returned less than half of SPY's yield from May 2014 to July 2018, [see High-Yield Investment Strategy Fails], the static DGI newbie portfolio returned 97% of SPY's yield from August 31, 2014 to July 1, 2018.
  • During the time period when two expertly-managed high-yield portfolios produced only two-thirds of the yield generated by SPY, the actively-managed DGI newbie portfolio exactly matched SPY's return - despite withdrawing funds instead of reinvesting them in the final year.

Static Portfolio:

Here's the chart of the DGI newbie portfolio and the performance of its components from August 31, 2014 to July 1, 2018:

Annual % August 2014 to July 2018 SPY annual % August 2014 to July 2018 Relative performance
TXN 27.51 10.49 162.2%
HD 24.76 10.49 136.0%
RTN 22.46 10.49 114.1%
ADI 21.31 10.49 103.1%
ADP 19.88 10.49 89.5%
BAX 19.05 10.49 81.6%
HAS 18.69 10.49 78.2%
AAPL 18.54 10.49 76.7%
WM 18.45 10.49 75.9%
RCL 15.53 10.49 48.0%
UHT 15.36 10.49 46.4%
CCL 14.21 10.49 35.5%
GD 13.66 10.49 30.2%
INTC 13.14 10.49 25.3%
HE 12.38 10.49 18.0%
LLY 10.81 10.49 3.1%
LEG 9.56 10.49 -8.9%
JNJ 7.12 10.49 -32.1%
IP 5.59 10.49 -46.7%
EMR 5.3 10.49 -49.5%
VZ 4.96 10.49 -52.7%
PPL 1.93 10.49 -81.6%
PG 1.56 10.49 -85.1%
PCG 0.07 10.49 -99.3%
GIS -6.26 10.49 -159.7%
HRB -6.62 10.49 -163.1%
TUP -9.59 10.49 -191.4%
MAT -14.1 10.49 -234.4%
10.19 10.49 -2.9%

Those are the results from a static, "buy and hold" portfolio. I like to use that analysis because once you start trading your portfolio, the results are likely to be more of a reflection of your skill in knowing when to buy or sell than of the type of investment you're trading. I feel that a comparison of static portfolios of recommended stocks better demonstrates the validity of the theory used to select them in the first place.

Actively Managed Portfolios:

Still, folks want to know the outcome of actively-traded portfolios of different types of investments. I found a couple of data points for high-yield theories:

High Yield Investor reports that his "50-50" mREIT/BDC portfolio grew 41% in the 4 1/2 years from 2014 to July 1, 2018. [See First Half Of 2018 Review: 10% Yield, Bull Or Bear (BDC, mREIT) Portfolio.] That works out to an average of about 8% per year, compounded annually, and is about 66% of the return from SPY over that same time period (62%).

Steven Bavaria has reported that his high-yield "Savvy Senior Income Factory" portfolio saw these results through July 10, 2018: 2014, +3.8%, 2015 -5.7%, 2016 +21.01%, 2017 +20.6, [see blog post] and January 1-July 10, 2018 was +4.1% [see 'Income Factory' Re-Invests At 12% Rate]. I get a net of approximately +46% from those numbers, which averages out to about 8.6% per year compounded annually. SPY's return from January 1, 2014 through July 10, 2018 was 66.7%, so the Income Factory's return appears to have been about 69% of SPY's return over that period.

I don't maintain a model portfolio. I was, however, able to generate a "Portfolio Performance" report from my broker showing the annualized percentage growth of my portfolio (excluding inflows and outflows) from August 31, 2014 to July 1, 2018: 10.49% per year. As it happens, that exactly matches SPY over that period of time, with one caveat: SPY's performance is calculated with all dividends reinvested.

I retired last year, and I have been withdrawing a sum equal to all of my current gains over the past twelve months. (This is part of a plan to maximize my long-term income by overdrawing my savings for a couple of years before triggering my social security benefits.) So I haven't had any compounding for the past year.

In fact, because my situation has changed from being in the accumulation phase of a retirement portfolio to being in the distribution phase, I started adopting a much more conservative approach to investing in the year prior to my retirement, and now 50% of my portfolio is currently in fixed income and cash.

Comments:

I'm not here to tell you how to invest your retirement savings. I've made the decisions I've made at the time I made them based on my personal circumstances, my best judgment, and the information I had available to me. Much of that information came from reading articles written by more knowledgeable investors here on Seeking Alpha.

But when I was in the thick of refining my strategy back in 2014, I kept bumping into articles about high-yield investing. The overall impression I got was that this was a sensible strategy for retirees and the soon-to-be-retired, and it would allow one who had retired without having "saved enough" to maintain a higher standard of living than other investment strategies - specifically, dividend growth investing, which "does not produce enough income."

But it was hard to follow the logic. There were lots of moving parts - cash paid out, then reinvested, dividend cuts and eliminations, share value erosion, etc. In the articles I read, it seemed like the holdings were constantly changing, with limited information about those transactions.

I read more than once that the underlying value of the holdings was "irrelevant" because it was just a "paper loss" until you sold it. (But still, if you sell it at a loss, that has to be deducted from the amount you "earned" through dividends, doesn't it?)

So I designed a study based on twenty stocks recommended by writers on SA. It was criticized because it was "buy and hold." It was explained to me (with varying degrees of politeness) that it was pointless to design such a study because it's necessary to constantly buy and sell your holdings.

Read those last two paragraphs again. On the one hand, share price is irrelevant unless you sell it. On the other hand, you have to buy and sell on an ongoing basis. Sure sounds to me like share price is "relevant."

That makes one data point from my second study particularly significant: of the high-yield investments, which I studied because they were listed as being held in high-yield proponents' portfolios in 2014, 95% lost share value between May 2014 and July 2018. The aggregate loss of share value of the five dozen investments (as well as the average reduction in annual dividend payments) in that 50-month period was over 22%.

Conclusion

I think the significant, chronic underperformance of high-yield investments of the type I have studied is obscured by the flurry of moving parts. That's why I tried to pin some of those parts down to see if they measured up.

When that was met with scorn, I took to analyzing the performance over that same time period of the actively-managed portfolios of two SA authors - Steven Bavaria and High Yield Investor. I know that they did not enjoy the results of my studies. It was not my intention to offend them or attack them personally. Indeed, I feel indebted to them, since they have had the integrity to publish their portfolios and disclose their results, which enabled me to study and compare their actively-managed portfolios to "the market." Other writers advocating a high-yield strategy have not been so transparent.

But facts are facts. The high-yield strategy of investing in CEFs, BDCs, MLPs and mREITs has, for the past 4 1/2 years, badly underperformed index funds, and even underperformed the portfolio of a newbie DGI wannabe, whether approached as a "buy and hold" exercise or based on the actual results of two savvy investors.

Disclosure: I am/we are long AAPL, VZ, PPL, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.