One small portion of my invested portfolio is run as a ‘Dividend Growth Portfolio’ (DGP). I kicked off this portfolio in early 2013, and have run it pretty consistently ever since. It’s time for my first ever ‘deep dive’ into how this portfolio has been performing.
The strategy: buy growing dividends
I didn’t document my exact strategy for this portfolio at the time, but it has been something along the line of this:
To own Dividend Champions, and their ilk, with a strong likelihood of growing their dividend over the short and long term.
I have been a longtime admirer of the Dividend Champions, who are the ~100 publicly listed US companies that have raised their dividend for 25+ years in a row. The UK has hardly any companies that can boast of this track record, and the UK approach to paying dividends (interim + final, rather than 4 equal quarterly instalments) makes the UK fiddlier to monitor for shallow analysts like me. I will certainly consider shorter track records than 25 years, such as the Dividend Achievers, Dividend Contenders etc, but for true quality you need Champions.
You will note that there is nothing in this approach that prioritises high yield payers. In fact US companies tend to have lower yields than UK companies. Much as I like dividend income, for this strategy I am prioritising predictable growth in dividends, not the level of dividend itself.
Leverage: a changing approach
This portfolio was one of my early uses of leverage, though in a very modest way: I used to leverage up the portfolio by one to two year’s worth of dividends (i.e. 2-5%). In late 2015 this approach changed as I leveraged up across the board to buy my Dream Home and by 2016 my leverage for this portfolio had risen to over 40%. As rates have risen, I have reduced my leverage, so right now the Loan to Value is around 30%, and I am in fact paying almost as much interest (~3%) as the after tax dividend yield of the portfolio.
How the stock lineup has expanded over time
My initial set of about a dozen holdings comprised stocks like AXP, CAT, KO, MCD, T, VZ, WFC, with a smattering of IBM, GE in there too. Sizing my positions has been very ad hoc.
Doesn’t October feel like a long time ago? Here in the UK it does, at any rate.
In the USA we saw Trump lose the House (which follows population closely) but gain in the Senate (which follows land/space more closely). He’s here to stay, folks, and he represents a sizeable portion of the USA – like it or not.
Likewise in the UK, while the polls have shifted slightly in favour of Remain, despite everything, a sizeable portion of the UK (over 40%) appears to still prefer to Leave the EU, almost whatever happens. We have a messed up political situation, like it or not.
In the meantime markets have been rumbling around. At one point mid month I breached my maximum drawdown, and was mentally preparing a blog post about it. But in the end the US markets had a last minute jump up, for no particular reasons, with some of the most bruised stocks from Ouch-tober showing the sharpest gains.
As it turns out, my diversified portfolio’s large exposure to the USA has helped me turned in a positive performance this month – though it could easily have gone the other way.
Australia deserves a mention. I haven’t been following it closely this month but its currency gained over 3% on the pound, but its equity index lost almost the same value. I assume this is a pure currency move, with overseas investors holding the value of the equity markets stable in USD/etc terms. I haven’t been following Oz closely this month so any additional insights (from @grasmi, perhaps?) would be helpful.
UK bonds also took something of a tumble. The ‘index’ I track is the corporate bond benchmark, but in fact my fixed income exposure is now more Treasuries than corporates so I should revisit this soon. In any case, both were hit – my Index Linked Gilt holding was a significant drag on my portfolio.
Longstanding readers will know that I have been an avid user of leverage, ever since I used it to buy my Dream Home in January 2016. At that point I was able to borrow funds, very flexibly, secured on my portfolio. And rates were well under 2% in all major currencies.
When I started my leverage journey, I was borrowing over GBP1m, in a ratio of 3:2 GBP:USD. The rates on both were, from memory, between 1% and 1.5%. At this point the interest is more than covered by the after-tax dividend income on the securities, leaving any capital gains or untaxed income as leveraged upside. My main concern from having debt was not the financing cost, but the leveraged exposure it left me with – a 10% drop in markets would have hit my portfolio’s value by around 15%, and potentially left me vulnerable to the bank calling in some of the debt (via ‘margin calls’).
Since January 2016, base rates have started to climb – for the first time since the Global Financial Crisis in 2008. This change was long heralded and a long time coming.
I’ve been aware of the change in rates posture, but not been paying too much attention. After all UK base rates have risen to only 0.75%. Euro rates haven’t changed. But I must admit I had somewhat missed the fact that US base rates have risen above 2%. Two per cent! That’s becoming a proper base rate.
In the meantime, I’ve succeeded in reducing my leverage very significantly. In debt terms, by around half. In loan-to-value terms, by more than that – because my portfolio has grown as my debt has shrunk.
I recently reviewed the rates I’m paying for my margin loan and finally clocked that now my USD debt is costing me over 3.25%. IB’s rates start at 3.7% and then drop to 3.2% up to $1m of loan. This much higher interest rate has made me reconsider my target leverage.
With USD rates over 3%, but my loan to value being around 15%, my main concern now is the financing cost / spread, not the level of exposure/risk. Paying interest of over 3.25% out of after-tax income now requires yields of 6% or more, which is getting into ‘high yield’ securities only – something that I know from experience tend to deliver pretty poor total returns. Of course capital gains may yet deliver an overall gain, even after tax and interest costs, but that is much more of a gamble than I faced two years ago, especially with October’s correction still a very recent memory.