UK SIPP Income Factory

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Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

UK SIPP Income Factory

Post by WillEndure »

I was intrigued by Steven Bavaria: "The Income Factory" book. There was another post on this forum about it here: viewtopic.php?t=390936

That post summarizes the approach as:
"Instead of using no-load mutual funds or ETFs, Bavaria recommends Closed-End-Funds (CEFs). Two critical rules for portfolio construction are: 1) Look for CEFs that are throwing off a dividend in excess of 8%. 2) Find CEFs that are priced below their Net Asset Value (NAV). A third, and less important rule is to find CEFs that are leveraged below 25%."

That said, there is no reason to stick purely with CEFs with this approach, and my recollection of the book is that he makes use of CEFs and ETFs. The essential idea as I see it is to cover a range of possible income sources with funds that provide a solid yield but at a lower risk than trying for growth through equities. Candidate sources include: senior loans, high yield, preffereds, convertible bonds, real estate, infrastructure, energy MLPs, dividend stocks and CLOs.

One helpful aspect of the book is Bavarias recommendations of a specific list of funds, which have generally been good long term income performers.

Unfortunately, my investment vehicles is a UK SIPP or ISA, and the major brokers in the UK will not allow "foreign" investment funds to be purchased. Unless of course, I am mistaken on that? Would certainly be interested to hear if there are ways to do this within a SIPP.

It would have been helpful to take Bavarias fund list as a starting point for my own research, but now that I am aware of the above, it is useless to me! Does anyone have any good sources on income factory style investing in the UK that I could use as a starting point?
Valuethinker
Posts: 51479
Joined: Fri May 11, 2007 11:07 am

Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Fri Jan 24, 2025 9:50 am I was intrigued by Steven Bavaria: "The Income Factory" book. There was another post on this forum about it here: viewtopic.php?t=390936

That post summarizes the approach as:
"Instead of using no-load mutual funds or ETFs, Bavaria recommends Closed-End-Funds (CEFs). Two critical rules for portfolio construction are: 1) Look for CEFs that are throwing off a dividend in excess of 8%. 2) Find CEFs that are priced below their Net Asset Value (NAV). A third, and less important rule is to find CEFs that are leveraged below 25%."

That said, there is no reason to stick purely with CEFs with this approach, and my recollection of the book is that he makes use of CEFs and ETFs. The essential idea as I see it is to cover a range of possible income sources with funds that provide a solid yield but at a lower risk than trying for growth through equities. Candidate sources include: senior loans, high yield, preffereds, convertible bonds, real estate, infrastructure, energy MLPs, dividend stocks and CLOs.

One helpful aspect of the book is Bavarias recommendations of a specific list of funds, which have generally been good long term income performers.

Unfortunately, my investment vehicles is a UK SIPP or ISA, and the major brokers in the UK will not allow "foreign" investment funds to be purchased. Unless of course, I am mistaken on that? Would certainly be interested to hear if there are ways to do this within a SIPP.

It would have been helpful to take Bavarias fund list as a starting point for my own research, but now that I am aware of the above, it is useless to me! Does anyone have any good sources on income factory style investing in the UK that I could use as a starting point?
1. Closed End Funds are called Investment Trusts in the UK.

2. There are plenty of them and some with a strong dividend income orientation. Some have been holding or growing their dividends every year for decades.

3. Generally "high income" funds and ETFs are oriented towards particular sectors like utilities. You pay for the higher income in less growth prospects- less capital gain. And for example financials were a big income sector - banks and insurance companies. Then we hit the 2008/9 Crash and they stopped paying dividends. So you can't guarantee that the dividends will be paid.

https://www.ishares.com/uk/individual/e ... rough=true

HSBA HSBC HOLDINGS PLC Financials Equity 6.21
RIO RIO TINTO PLC Materials Equity 5.30 4
BATS BRITISH AMERICAN TOBACCO Consumer Staples Equity 5.15
LGEN LEGAL AND GENERAL GROUP PLC Financials Equity 4.93
IMB IMPERIAL BRANDS PLC Consumer Staples Equity 4.73
BP. BP PLC Energy Equity 4.27
NWG NATWEST GROUP PLC Financials Equity 3.94
LLOY LLOYDS BANKING GROUP PLC Financials Equity 3.89
VOD VODAFONE GROUP PLC Communication Equity 3.70
AV. AVIVA PLC Financials Equity 3.58

You will find pretty much those holdings and weightings at the top of any given UK dividend fund or ETF. They are blue chip, but many of them are not likely to grow that fast - certainly not faster than the market as a whole. Note there's no technology exposure in the entire ETF. Nor any Property companies (REITs) I don't think? Which kind of surprised me (usually one owns REITs for income, since by law they have to pay out the majority of their earnings as dividends).

Preference shares are like high yield bonds, but issued primarily by financial companies as capital required by regulators. If the bank gets into trouble, they can, and do, suspend the dividend. If the issuing company is wound up (insolvency), then preference shareholders rank behind creditors for repayment. They likely will get nothing.

4. We have discussed all these types of assets on the boards, if you do a search by term. Many posters here have professional experience related to these. The bottom line is there is no secret sauce or free lunch: higher returns or income come with more equity-like risk. You can see that with High Yield bonds v Investment Grade bonds, for example.

5. You might read Monevator.com blog for a BH style look at investing in the UK. Good articles & sensible. Bottom line: investors should look at Total Return = income + capital gains rather than trying to maximise either. By the Modigliani & Miller theorems, a dividend is irrelevant to setting the value of a share - that's one of the most durable and empirically tested results in corporate finance academia.

Example: Apple and Microsoft pay dividends. Berkshire Hathaway (Warren Buffett), Alphabet (Google), Meta (FB), Amazon do not. Nvidia pays a tiny dividend. So of the world's 7 largest companies, should you own 2 but not the other 5? Why?

6. BTW "8% or above". You are in the land of very high risk investments (a good UK dividend yield stock like those above pays sort of 3.5%-4.5% annual Dividend/ Stock Price). Or leveraging the investment (which increases volatility). Or companies which are distributing capital as well as income. You will find a few in the UK, but don't bet the ranch on it --these things pay high yields for a reason (ie risk).
Valuethinker
Posts: 51479
Joined: Fri May 11, 2007 11:07 am

Re: UK SIPP Income Factory

Post by Valuethinker »

https://www.theaic.co.uk/research-tools Association of Investment Companies allows one to compare Investment trusts.

The difference is tax related. An IT is just a passive holding company and so can pass through dividends to investors without paying tax twice. A Real Estate Investment Trust is an example.

An IC is a broader concept and can (I believe) take larger stakes in companies and exert influence etc. But there is double taxation on profits from any investments it makes.
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Sat Jan 25, 2025 5:59 am HSBA HSBC HOLDINGS PLC Financials Equity 6.21
RIO RIO TINTO PLC Materials Equity 5.30 4
BATS BRITISH AMERICAN TOBACCO Consumer Staples Equity 5.15
LGEN LEGAL AND GENERAL GROUP PLC Financials Equity 4.93
IMB IMPERIAL BRANDS PLC Consumer Staples Equity 4.73
BP. BP PLC Energy Equity 4.27
NWG NATWEST GROUP PLC Financials Equity 3.94
LLOY LLOYDS BANKING GROUP PLC Financials Equity 3.89
VOD VODAFONE GROUP PLC Communication Equity 3.70
AV. AVIVA PLC Financials Equity 3.58
Thanks for your response.

I do not particularly want to invest in UK companies, the UK does not seem like it is doing particularly well right now and I don't see how that gets turned around in the short to medium term. I am hoping to find UK based funds that will let me invest mostly in non-UK assets, but that can also be held in a SIPP. It seems strange to me that through a SIPP I can buy shares in companies on NYSE, NASDAQ and many other major exchanges worldwide. Yet non-uk investment trusts are somehow excluded by the major SIPP providers.

On your point about income vs growth investment - yes I agree. I am looking into Bavaria's income investing strategy but not with a view to making it 100% of my portfolio. I think the risk in growth stocks is particularly high right now. The AI future will eventually arrive, just like the promise of the Internet has arrived today. But in the dotcom era the promise of the internet was already priced in and then some. I think that is about where we are with the Mag7 today.
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Sat Jan 25, 2025 8:25 am https://www.theaic.co.uk/research-tools Association of Investment Companies allows one to compare Investment trusts.
Excellent, thank you for the link.
jg12345
Posts: 817
Joined: Fri Dec 11, 2020 12:03 pm

Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Sun Jan 26, 2025 3:29 pm
Valuethinker wrote: Sat Jan 25, 2025 5:59 am HSBA HSBC HOLDINGS PLC Financials Equity 6.21
RIO RIO TINTO PLC Materials Equity 5.30 4
BATS BRITISH AMERICAN TOBACCO Consumer Staples Equity 5.15
LGEN LEGAL AND GENERAL GROUP PLC Financials Equity 4.93
IMB IMPERIAL BRANDS PLC Consumer Staples Equity 4.73
BP. BP PLC Energy Equity 4.27
NWG NATWEST GROUP PLC Financials Equity 3.94
LLOY LLOYDS BANKING GROUP PLC Financials Equity 3.89
VOD VODAFONE GROUP PLC Communication Equity 3.70
AV. AVIVA PLC Financials Equity 3.58
Thanks for your response.

I do not particularly want to invest in UK companies, the UK does not seem like it is doing particularly well right now and I don't see how that gets turned around in the short to medium term. I am hoping to find UK based funds that will let me invest mostly in non-UK assets, but that can also be held in a SIPP. It seems strange to me that through a SIPP I can buy shares in companies on NYSE, NASDAQ and many other major exchanges worldwide. Yet non-uk investment trusts are somehow excluded by the major SIPP providers.

On your point about income vs growth investment - yes I agree. I am looking into Bavaria's income investing strategy but not with a view to making it 100% of my portfolio. I think the risk in growth stocks is particularly high right now. The AI future will eventually arrive, just like the promise of the Internet has arrived today. But in the dotcom era the promise of the internet was already priced in and then some. I think that is about where we are with the Mag7 today.
The usual suggested strategy here for your stocks/risky assets is FTSE all world or MSCI ACWI ETFs.

Dividends aristocrats and similar limit diversification and might not return more than the market.

In addition, if "bavaria income investing" is returning in dividends/income 8%, seems a bit too much and I would stay away (meaning 0% of portfolio)
Trying to stay the course
Valuethinker
Posts: 51479
Joined: Fri May 11, 2007 11:07 am

Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Sun Jan 26, 2025 3:29 pm
Valuethinker wrote: Sat Jan 25, 2025 5:59 am HSBA HSBC HOLDINGS PLC Financials Equity 6.21
RIO RIO TINTO PLC Materials Equity 5.30 4
BATS BRITISH AMERICAN TOBACCO Consumer Staples Equity 5.15
LGEN LEGAL AND GENERAL GROUP PLC Financials Equity 4.93
IMB IMPERIAL BRANDS PLC Consumer Staples Equity 4.73
BP. BP PLC Energy Equity 4.27
NWG NATWEST GROUP PLC Financials Equity 3.94
LLOY LLOYDS BANKING GROUP PLC Financials Equity 3.89
VOD VODAFONE GROUP PLC Communication Equity 3.70
AV. AVIVA PLC Financials Equity 3.58
Thanks for your response.

I do not particularly want to invest in UK companies, the UK does not seem like it is doing particularly well right now and I don't see how that gets turned around in the short to medium term. I am hoping to find UK based funds that will let me invest mostly in non-UK assets, but that can also be held in a SIPP. It seems strange to me that through a SIPP I can buy shares in companies on NYSE, NASDAQ and many other major exchanges worldwide. Yet non-uk investment trusts are somehow excluded by the major SIPP providers.

On your point about income vs growth investment - yes I agree. I am looking into Bavaria's income investing strategy but not with a view to making it 100% of my portfolio. I think the risk in growth stocks is particularly high right now. The AI future will eventually arrive, just like the promise of the Internet has arrived today. But in the dotcom era the promise of the internet was already priced in and then some. I think that is about where we are with the Mag7 today.
It is the country of domicile of the fund or ETF that matters.

If the fund does not meet PRIIP rules (EU financial regulation) then a UK broker cannot sell them to you. Most of the things you can buy are either domiciled legally in the UK, or Ireland/ Luxembourg. They have the proper documentation for a retail investor.

US Closed End Funds have far far higher expense ratios than UK Investment Trusts, on average. At least last time I looked.

(I don't think there's an HMRC issue, ie the very strong warning against investing in funds which are not "reporting" from an HMRC classification. That can be a painful experience in a taxable account).
I do not particularly want to invest in UK companies, the UK does not seem like it is doing particularly well right now and I don't see how that gets turned around in the short to medium term.
The good news is, if you look at that list of companies, they are pretty multinational. 60-70% of the profits of the FTSE 100, itself c 85% of the FTSE All-Share, are sourced from outside the UK. That's why when the GBP goes down, the FTSE tends to go up (when the pound dropped 15% after Brexit vote, you definitely saw that effect).

The problem is the UK stockmarket's tilt towards "the old economy". US has far, far more tech stocks. And particularly the "Magnificent 7" which have had all the recent outperformance.
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Mon Jan 27, 2025 2:52 am The good news is, if you look at that list of companies, they are pretty multinational. 60-70% of the profits of the FTSE 100, itself c 85% of the FTSE All-Share, are sourced from outside the UK. That's why when the GBP goes down, the FTSE tends to go up (when the pound dropped 15% after Brexit vote, you definitely saw that effect).

The problem is the UK stockmarket's tilt towards "the old economy". US has far, far more tech stocks. And particularly the "Magnificent 7" which have had all the recent outperformance.
Thanks for that analysis. I can also see that there is plenty scope for international exposure even outside of UK listed companies in the funds available to buy in the UK.

I'm ok leaving off the Mag7 currently. Wish I had gotten in years ago, of course, but I like to think I would be taking profit now if I had. Happy to wait for the AI bubble to burst and think about tech stocks when no-one wants them!
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

jg12345 wrote: Sun Jan 26, 2025 7:32 pm In addition, if "bavaria income investing" is returning in dividends/income 8%, seems a bit too much and I would stay away (meaning 0% of portfolio)
Lets take an example. Here is Cohen & Steers Ltd Duration Pref & Inc:LDP, which is one of the funds he suggests looking at:

https://www.cefconnect.com/fund/LDP

That website is a little primitive, I cannot link exactly to it but if you click the Distributions tab and then selection Distribution History Since Inception, you see that the roughly 7.2% annualized dividend has been maintained all the way back to 2012. Would screenshot but linking an image seems a faff on here.

I picked that one more-or-less at random, because its the first one I could remember and don't have the book with me right now. Ok maybe not random, but I didn't pick it out because its the best performer in the book, seems quite typical of his selection. There are some with longer histories than 12+ years.

Is that too good to be true?
jg12345
Posts: 817
Joined: Fri Dec 11, 2020 12:03 pm

Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Tue Jan 28, 2025 5:24 pm
jg12345 wrote: Sun Jan 26, 2025 7:32 pm In addition, if "bavaria income investing" is returning in dividends/income 8%, seems a bit too much and I would stay away (meaning 0% of portfolio)
Lets take an example. Here is Cohen & Steers Ltd Duration Pref & Inc:LDP, which is one of the funds he suggests looking at:

https://www.cefconnect.com/fund/LDP

That website is a little primitive, I cannot link exactly to it but if you click the Distributions tab and then selection Distribution History Since Inception, you see that the roughly 7.2% annualized dividend has been maintained all the way back to 2012. Would screenshot but linking an image seems a faff on here.

I picked that one more-or-less at random, because its the first one I could remember and don't have the book with me right now. Ok maybe not random, but I didn't pick it out because its the best performer in the book, seems quite typical of his selection. There are some with longer histories than 12+ years.

Is that too good to be true?
thanks for sharing.

1) there's a premium price vs NAV price, and I am not sure I understand it. seems due to debt, but still.

2) the share price and NAV did -20% from inception in 2012 (it was 25US$ at inception, now 20$ - roughly if I am not mistaken). add back the 7% / year, you are probably at +60-70% from from 2012. this seems high yield (so not so sensitive to interest rate?) and decline in nav is sustained over time, so not just the recent interest rates hike.

I feel the decline might be the fees, which seem massive: 1% for management, and then 3% for cost of capital, total ER of 4.5%, under fund basics.
then again, unclear to me whether returns are gross or net of fees.

3) over the same time period the MSCI world did almost +500%. ACWI probably a bit less but surely similar, you can check yourself. sure, you probably want to compare one of these funds with inception say in 2005 to include 2008-2009, but I really doubt they beat the market, even including the 2008-2009 crash.

at first glance, this is not too good to be true, it's too bad to be true. Seems like you'd be (way) better off with the market.
Trying to stay the course
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

jg12345 wrote: Wed Jan 29, 2025 6:12 am 1) there's a premium price vs NAV price, and I am not sure I understand it. seems due to debt, but still.

2) the share price and NAV did -20% from inception in 2012 (it was 25US$ at inception, now 20$ - roughly if I am not mistaken). add back the 7% / year, you are probably at +60-70% from from 2012. this seems high yield (so not so sensitive to interest rate?) and decline in nav is sustained over time, so not just the recent interest rates hike.

I feel the decline might be the fees, which seem massive: 1% for management, and then 3% for cost of capital, total ER of 4.5%, under fund basics.
then again, unclear to me whether returns are gross or net of fees.
The premium/NAV thing is the current price to the net asset value of the fund holdings. Its currently running at a strong discount. The fund is mainly in bonds and the decline in price coincides with the last few years decline in bond prices. The price is at a discount probably for that reason - the bond market has been ugly, and investors scared off and more excited by tech stocks.

But when the tech bubble bursts there will be capital rotation and more steady options might become more popular again.

The idea is to pick these things up when trading at a discount, sell them when trading at a premium, or just hold till your dead.

7% for 12 years would be compounded, because the idea is to plow all the income back into buying more. So +130%. Minus the 20% if you are selling, but the idea is to hold into a pension as income. Its not very sexy, but it is steady.

Its wonderful that MCSI did 500% in the same time. Will it be doing 500% in the next 12 years? It could do. The idea of this fund is to produce a steady and reliable 7% with risk somewhere between that of a treasury bond and an equity. Not so much about beating the market as tuning in to a particular risk/reward for the long haul, and lower volatility.

The idea is also to start income investing ahead of putting a pension portfolio into a higher amount of bonds and income mode during retirement. This style of investing is also about learning how to do that as a DIY investor - rather than buying an annuity or arriving at retirement and having no clue how to do income investing well.

For example, one way I could retire would be to put my capital into a commercial building, and rent it out at around 8% p.a. Could be nice. But I would have the hassle of finding tenants, setting up a lease. Also my 8% would not compound, I would constantly need to find more commercial properties to buy. So instead by a REIT and a bunch of other income funds in different sectors, and try to build that 8% portfolio in a way that spreads the risk and enable compounding.

I don't have a PDF of the book, but I will take a picture with my camera of the tables of funds and get AI to turn it into text for me, then I can post it here. There are some higher yielding funds in the book with correspondingly higher risk. The author suggests taking some of that risk to build a portfolio yielding up to 10% overall, or playing it safe with lower yields all the way down to around 7% or 6%. North of treasury bonds, but south of equities.

Many of the funds in the book survived the GFC (not this one since it started in 2012). Overall bond recovery rates were high for the ones that did have defaults during the GFC. Hopefully I can dig a few examples out once I create the list.
Valuethinker
Posts: 51479
Joined: Fri May 11, 2007 11:07 am

Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Wed Jan 29, 2025 10:29 am
jg12345 wrote: Wed Jan 29, 2025 6:12 am 1) there's a premium price vs NAV price, and I am not sure I understand it. seems due to debt, but still.

2) the share price and NAV did -20% from inception in 2012 (it was 25US$ at inception, now 20$ - roughly if I am not mistaken). add back the 7% / year, you are probably at +60-70% from from 2012. this seems high yield (so not so sensitive to interest rate?) and decline in nav is sustained over time, so not just the recent interest rates hike.

I feel the decline might be the fees, which seem massive: 1% for management, and then 3% for cost of capital, total ER of 4.5%, under fund basics.
then again, unclear to me whether returns are gross or net of fees.
The premium/NAV thing is the current price to the net asset value of the fund holdings. Its currently running at a strong discount. The fund is mainly in bonds and the decline in price coincides with the last few years decline in bond prices. The price is at a discount probably for that reason - the bond market has been ugly, and investors scared off and more excited by tech stocks.

But when the tech bubble bursts there will be capital rotation and more steady options might become more popular again.

The idea is to pick these things up when trading at a discount, sell them when trading at a premium, or just hold till your dead.

7% for 12 years would be compounded, because the idea is to plow all the income back into buying more. So +130%. Minus the 20% if you are selling, but the idea is to hold into a pension as income. Its not very sexy, but it is steady.

Its wonderful that MCSI did 500% in the same time. Will it be doing 500% in the next 12 years? It could do. The idea of this fund is to produce a steady and reliable 7% with risk somewhere between that of a treasury bond and an equity. Not so much about beating the market as tuning in to a particular risk/reward for the long haul, and lower volatility.

The idea is also to start income investing ahead of putting a pension portfolio into a higher amount of bonds and income mode during retirement. This style of investing is also about learning how to do that as a DIY investor - rather than buying an annuity or arriving at retirement and having no clue how to do income investing well.

For example, one way I could retire would be to put my capital into a commercial building, and rent it out at around 8% p.a. Could be nice. But I would have the hassle of finding tenants, setting up a lease. Also my 8% would not compound, I would constantly need to find more commercial properties to buy. So instead by a REIT and a bunch of other income funds in different sectors, and try to build that 8% portfolio in a way that spreads the risk and enable compounding.

I don't have a PDF of the book, but I will take a picture with my camera of the tables of funds and get AI to turn it into text for me, then I can post it here. There are some higher yielding funds in the book with correspondingly higher risk. The author suggests taking some of that risk to build a portfolio yielding up to 10% overall, or playing it safe with lower yields all the way down to around 7% or 6%. North of treasury bonds, but south of equities.

Many of the funds in the book survived the GFC (not this one since it started in 2012). Overall bond recovery rates were high for the ones that did have defaults during the GFC. Hopefully I can dig a few examples out once I create the list.
Really chasing after US funds won't help you much?

You'd have currency risk. Plus PRIIP means you probably couldn't buy them anyways. Unless you can upgrade your investor status to expert investor (I forget what the FCA term is - accredited?)?

Look through that list of UK Investment Trusts. There's quite a lot there. And generally in Investment Companies. And there's High Yield ETFs. You might find something on the riskier end of REITs (industrial property etc). If you can live with the volatility of the share prices, well, then you can get those kinds of yields (or sort of 6-8% anyways).

There was however the "Split Capital Trust" debacle. Supposedly the risk of that is near zero now. But some of these trusts do still have Preference Shares etc, so you want to understand that. Also some of these trusts are geared (many are).

(I have a personal view that Student Housing is likely to be a debacle in a world of tighter immigration restrictions. But there are various funds around and they were paying quite high yields). Certainly I had a colleague who was buying Social Housing properties in the North of England (ie tenants were social tenants) at yields that were sort of 8-12%, I believe he said.
jg12345
Posts: 817
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Re: UK SIPP Income Factory

Post by jg12345 »

1) what Valuethinker says on access and currency risk

2) ah yes sorry about the compounding, I was just making mental calculations. I see 7% for 12 years yields +125%, so minus 20% we get to 105%, roughly the same you mentioned.

when you say 'the stock market will drop', I think you are making forecasts about the market and tbh, no one knows. I don't know whether what you say will happen or not. Traders gets things wrong and they have the most expensive software and data, have been trained in super expensive schools, have PhD in quantitative finance and sophisticated AI working for them, work 100h / week, have incentives, etc etc. we can only join the ride, and hope the market will do - roughly - as it did for the past 100+ years. the US may be another Japan yes... hopefully those caught into it will have enough time to ride it out. Side note: if that happens, I doubt this fund will be saving your portfolio. high quality bonds, maybe, hopefully.

3) strictly linked to previous point. as we don't know that the MSCI will do 500% over next 12 years... do you know this fund will deliver 7% income and -20% value for the next 12 years? One thing we know for sure is that this fund will cost 4.5%, while an ETF will be 0.2% or less, so I'd guess I get a way better return/volatility with a low cost index linked ETF.

4) On pension, the debate to me is closed. if you prefer dividends for psychological reasons, so be it. Otherwise you have more flexibility and diversification with stocks/bonds and sell them as needed, which will not 'force' you to receive 7% dividends when you might not want them (of course they would still provide some dividends, but way below 7%). Any way, the point of total return vs. dividends is well known, and already mentioned in this thread.

5) I do not think the 4.5% TER is adequately considered. I am presuming the 7% is net of 4.5% fees. In any case, 4.5% seems a ton.

6) as mentioned by Valuethinker, there are HY ETFs, either in GBP and GBP hedged. Just picking one of the first coming up, GBP hedged, global HY: https://am.jpmorgan.com/gb/en/asset-man ... erformance did +5.3% total return since inception compounded over 12 years is around +85%, with a much smaller currency risk, and I would also bet much better liquidity (so lower bid-ask spread - I get it, you want to keep forever... but there's always a risk you _need_ to sell). You might find some in GBP with higher yields, and perhaps lower total returns.

I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily. you could use CEFs if that's your preference, but if I really wanted HY bonds in my portfolio I'd rather stick to a global, low cost, liquid and hedged ETF

Thanks for sharing in any case.
Trying to stay the course
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

jg12345 wrote: Thu Jan 30, 2025 9:48 am 6) as mentioned by Valuethinker, there are HY ETFs, either in GBP and GBP hedged. Just picking one of the first coming up, GBP hedged, global HY: https://am.jpmorgan.com/gb/en/asset-man ... erformance did +5.3% total return since inception compounded over 12 years is around +85%, with a much smaller currency risk, and I would also bet much better liquidity (so lower bid-ask spread - I get it, you want to keep forever... but there's always a risk you _need_ to sell). You might find some in GBP with higher yields, and perhaps lower total returns.

I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily. you could use CEFs if that's your preference, but if I really wanted HY bonds in my portfolio I'd rather stick to a global, low cost, liquid and hedged ETF
The US Investment Funds are accademic at this point, since I cannot buy them in my SIPP anyway! I do think your suggestion is correct, I should look first at ETFs valued in GBP, and then non-ETF funds valued in GBP secondary to that. It is the right path out of the options that are actually available to me.

> I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily.

The bond market is much larger than the equity market. There are also a large variety of different type of bonds that one can buy. So when you say stocks/bonds are sufficient in a portfolio, that isn't really narrowing it down much?

I don't want to invest just in HY bonds, I would like exposure to a wider spectrum of the bond market. That is the appeal of the US CEF funds (that I cannot buy), because of the variety available it is easier to find the combination of quality and targetting to specific sectors, in order to get a particular mix of bond types, and to maintain that mix over a long investment horizon. So high yield, prefereds, convertibles, mlps, reits, clos, direct lending, treasuries, and so on.

I am not purely investing in income funds. I do hold equities and precious metals also. I would like to increase my commodities exposure too, as an inflation hedge. By considering bonds and income funds - or bond funds that accumulate the income automatically - I am simply considering what to do for the bonds part of a stocks+commodities+bonds portfolio.
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Fri Jan 31, 2025 3:55 am
jg12345 wrote: Thu Jan 30, 2025 9:48 am 6) as mentioned by Valuethinker, there are HY ETFs, either in GBP and GBP hedged. Just picking one of the first coming up, GBP hedged, global HY: https://am.jpmorgan.com/gb/en/asset-man ... erformance did +5.3% total return since inception compounded over 12 years is around +85%, with a much smaller currency risk, and I would also bet much better liquidity (so lower bid-ask spread - I get it, you want to keep forever... but there's always a risk you _need_ to sell). You might find some in GBP with higher yields, and perhaps lower total returns.

I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily. you could use CEFs if that's your preference, but if I really wanted HY bonds in my portfolio I'd rather stick to a global, low cost, liquid and hedged ETF
The US Investment Funds are accademic at this point, since I cannot buy them in my SIPP anyway! I do think your suggestion is correct, I should look first at ETFs valued in GBP, and then non-ETF funds valued in GBP secondary to that. It is the right path out of the options that are actually available to me.

> I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily.

The bond market is much larger than the equity market. There are also a large variety of different type of bonds that one can buy. So when you say stocks/bonds are sufficient in a portfolio, that isn't really narrowing it down much?

I don't want to invest just in HY bonds, I would like exposure to a wider spectrum of the bond market. That is the appeal of the US CEF funds (that I cannot buy), because of the variety available it is easier to find the combination of quality and targetting to specific sectors, in order to get a particular mix of bond types, and to maintain that mix over a long investment horizon. So high yield, prefereds, convertibles, mlps, reits, clos, direct lending, treasuries, and so on.

I am not purely investing in income funds. I do hold equities and precious metals also. I would like to increase my commodities exposure too, as an inflation hedge. By considering bonds and income funds - or bond funds that accumulate the income automatically - I am simply considering what to do for the bonds part of a stocks+commodities+bonds portfolio.
So Modern Portfolio Theory (MPT) was built around 2 assets, the risk-free asset (90 day US T Bills) and the risky asset (what became the equity index fund, holding the whole market).

That gives you a straight, linear relationship between risk and expected return.

The question of the "Efficient Frontier" then looms. You can increase the curvature of that tradeoff by adding non-correlated assets.

Remembering that the correlation of return between the risk-free asset and the equity market index should be zero.

You should be wary of arguments that adding asset x or y improves the Efficient Frontier. If an asset has zero expected return (commodities) then adding it to the portfolio may not improve your overall returns. And that will hurt. Also there's a whole industry, both in academia and in asset management, of inventing new assets that will create fee revenue (or publishable academic papers).

Over time, the "risk free" asset has migrated to, say, the 10 year government bond yield. That's accepting new risks - interest rate risk, credit risk (potentially) in return for higher returns. The true risk free asset is probably the inflation linked government bond - assuming that has zero default risk. Investors in USD have TIPS, in GBP have index linked gilts. And you are subjecting yourself to high volatility - empirically that bond or bond fund moves around a lot.

What you are trying to do is blur the line between bonds and equities. "High yield" investments which in fact are equities, but pay out like bonds. That could well be de-worsification not diversification. You see that if you see what these things did in 2008/9 - they went off a cliff, just like stocks. Income trusts, REITs, the works.

There's no secret sauce in High Yield bonds. They behave like a combination of equities + bonds. They have equity risk. Without going into the detail, the original work on "Fallen Angel" bonds showed an asymmetry of risk-return there (because of the stricture of "Investment grade" ie BBB- or above -- many funds cannot hold below BBB-). But then the "Original Issue" high yield market grew up -- see Connie Bruck's The Predators Ball for detail. And OI bonds don't show that anomaly -- they are just bonds with equity risk.

The same is true of Preference Shares or Income Trusts etc.

If you hold Investment Grade corporate bonds - short maturities only - then there *was* (but still?) an anomaly where they seemed to give a bit higher yield than government bonds, but without a higher cost in defaults (relative to government). However 2008/9 might have shown that that's because there are, every so often, financial crashes when they show it in spades.

And by being short duration on the yield curve (bonds maturing early) you lose yield pickup from going longer. 1-2% pa compounded over 30 years is ... a lot of money. So that's why I suggest Intermediate Term government bond funds. But I am wary of the very long duration of the gilt index -- historically those long maturity bonds are bought by UK pension funds that are required to hold them, and I think that means they are overpriced/ lower yield. For that reason I tend to hold Global Govt Bond funds, sterling hedged. That has shorter duration (sensitivity to interest rate changes).

If you really want high yield, take a look at UK investment companies. There's quite a lot there. Some trading at substantial discounts to NAV.

I'd read Anti Illmanen's books for the most up to date view of these different asset classes, empirically.
minimalistmarc
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Re: UK SIPP Income Factory

Post by minimalistmarc »

Don’t separate income and capital growth mentally. It’s total return that matters. You generate your own income by spending dividends and selling capital if required. Stick with low cost global equity trackers.
Topic Author
WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

I know the theory. I used it to invest around about the early 2000s, and as I was young and prepared to take more risk, after running the numbers I went with a 100% equities portfolio with a global mix selected to achieve the efficient frontier. My only regret is that I did not go further and leverage it, because it did very well!

The 60/40 porfolio has worked extremely well during the period we call "the great moderation". This runs from the 1990s up to the GFC, or possibly beyond the GFC and up to the Covid era. Interest rates fell continuously during this period.

The US 10 year has more recently broken out of this continuosly falling trend line. The great moderation is done and dusted. In my view, the 60/40 portfolio is currently carrying a lot more risk some people think.

One of the reasons that passive investment is still continuing to push the market higher, is that in the USA they have had auto enrolement to pensions since about 2007. A very large number of employees just sign up to the default, which means a proportion of their earnings are trickling into equities. It all adds up to a flood, the so called "dumb money". It has made passive investment the only game in town, and today their is not so much scope for active stock picking or alternative thinking as there once was.

However... Do you not think that equity prices are very high at the moment? Historically speaking, things are at extreme levels right now, not just in terms of price, but market concentration, sector concentration and many other factors. With an eye to value investing, this is not the right time for me to buy equities. Or if I am buying equities I will use a service like ValuEngine to assist my search.

If we have equities as the risky investment and treasuries as the safe investment, it is not true to say that any bond except for treasuries should also be lumped into the risky category and regarded as an equity. For example, if I hold a senior bond in a company and that company goes bankrupt, as a bond holder I stand a good chance of getting at least some of my principal back, but the equity investors will lose all of their equity.

This happened to me this year. I made a high risk bet on some pre-IPO shares in an AI company called Graphcore. Graphcore failed and was bought out by Softbank. The deal involved Softbank paying off all of the bond holders but zeroing out the equity. :-( The good news is that I made my bet against a few AI companies, and the others are still in the race! But this is just a small consideration within my high risk pool of capital. I may lose it all, and got comfortable with that idea before parting with the money. On the other hand we are in the era of AI, and you need to be in the race to win it. If I get lucky, I could make a ton from it.

This is all covered in Bavarias book. For example the recovery rate for failed bonds during the GFC was something like 75%. If you held a fund which in turn held a wide portfolio of bonds, and some small %age of them failed, but still recovered on average 75%, the overall loss to the fund is well contained. The fund would also begin to trade at a discount, and Bavaria took advantage of that also and profitted when the discount went away. The whole book really, is about evaluating what the risk of these different bond asset classes really is, rather than blindly dismissing it.

The GFC did indeed result in defaults in the investment grade A+ corporate bonds! But not in spades. You certainly would not want to own bonds in any single company as an individual investor, but spread the risk through a fund.
Topic Author
WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

minimalistmarc wrote: Fri Jan 31, 2025 5:43 am Don’t separate income and capital growth mentally. It’s total return that matters. You generate your own income by spending dividends and selling capital if required. Stick with low cost global equity trackers.
Correct. But the point Bavaria makes is that if you have an 8% yield on an income fund, and you fully re-invest that buy buying more, your total return will be 8%. If you buy an equity growth fund and it happens to grow by 8% a year, you will also be making a total return of 8%. So the two things are exactly the same in terms of their total return. I am thinking about total return, just doing so in conjunction with thinking about risk.

The difference might be that the income fund returns a solid 8% every year, but the growth fund is likely to have a far higher volatility. Yes, the stock market has been insane recently, but also very high valuations compared with historical norms.

The question to ask when looking at the growth of an equity is to ask is its price simply extravagent or is it actually implausable? For example Tesla is currently priced like last years sales are going to continue to grow at 50% per year. In the next 10 years it would need to grow 55 times to justify a fair valuation of its current price. Amazon grew at 26%/year compounded for around 10 years (amazing), and grew by 11 times in that space of time. Is Teslas current price implausable? :)

Of course, none of us has a crystal ball. Its very hard to call a bubble when we are in one. Its almost impossible to time these things or determine what event is going to be the straw that breaks the camel. But overall, I think the macro environment and extreme levels of many different kinds of market indicators are strongly suggesting that your equity portfolio is accumulating risk right now.

I would be quite happy to park some money at a solid 8% right now. Or even a much more solid 5% in treasuries would be totally fine. I am risk off right now.

The money actually came from the sale of an AirBnb property, which for the last 10 years was yielding around 5%! Plus an accumulation in the property value. Unfortunately the property was purchased in 2007 right before the GFC, so it had a lot of catch up to do after prices crashed a bit in 2008, so the property value accumulation was somewhat damped by that. That is actually the reason that I kept on my ownership of it and converted to AirBnb from living there - when we moved house I borrowed more on the new house to keep it on otherwise I would have been selling at negative equity in around 2011. The AirBnb yield actually went up to close to 10% in its last year of operation. In part because some of the competition gave up during Covid and because I live in Scotland and they recently introduced strict licencing laws for AirBnb which also caused the competition to drop out.

By comparison the risk/reward of investing the money in financial assets seems pretty good to me, and without the hassle of maintaining the property and running the AirBnb account.
jg12345
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Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Fri Jan 31, 2025 3:55 am
The US Investment Funds are accademic at this point, since I cannot buy them in my SIPP anyway! I do think your suggestion is correct, I should look first at ETFs valued in GBP, and then non-ETF funds valued in GBP secondary to that. It is the right path out of the options that are actually available to me.
Sounds like a right approach that I'd follow even if I had access to US CEFs
Then you have to choose among the many HY ETFs in GBP (fallen angels, or broad)
WillEndure wrote: Fri Jan 31, 2025 3:55 am
> I think stock/bonds in a portfolio are sufficient, but I don't mind HY bonds in a portfolio necessarily.

The bond market is much larger than the equity market. There are also a large variety of different type of bonds that one can buy. So when you say stocks/bonds are sufficient in a portfolio, that isn't really narrowing it down much?
with 'stocks/bonds' I meant the usual portfolio we suggest here for a UK person: FTSE all world/MSCI acwi on equity side, and global bond aggregate hedged to GBP on the bond side

I am not entirely sure stocks are overvalued now.

I think the point of concentration is more straightforward.
Trying to stay the course
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Fri Jan 31, 2025 6:05 am I know the theory. I used it to invest around about the early 2000s, and as I was young and prepared to take more risk, after running the numbers I went with a 100% equities portfolio with a global mix selected to achieve the efficient frontier. My only regret is that I did not go further and leverage it, because it did very well!

The 60/40 porfolio has worked extremely well during the period we call "the great moderation". This runs from the 1990s up to the GFC, or possibly beyond the GFC and up to the Covid era. Interest rates fell continuously during this period.

The US 10 year has more recently broken out of this continuosly falling trend line. The great moderation is done and dusted. In my view, the 60/40 portfolio is currently carrying a lot more risk some people think.

One of the reasons that passive investment is still continuing to push the market higher, is that in the USA they have had auto enrolement to pensions since about 2007. A very large number of employees just sign up to the default, which means a proportion of their earnings are trickling into equities. It all adds up to a flood, the so called "dumb money". It has made passive investment the only game in town, and today their is not so much scope for active stock picking or alternative thinking as there once was.

However... Do you not think that equity prices are very high at the moment? Historically speaking, things are at extreme levels right now, not just in terms of price, but market concentration, sector concentration and many other factors. With an eye to value investing, this is not the right time for me to buy equities. Or if I am buying equities I will use a service like ValuEngine to assist my search.

If we have equities as the risky investment and treasuries as the safe investment, it is not true to say that any bond except for treasuries should also be lumped into the risky category and regarded as an equity. For example, if I hold a senior bond in a company and that company goes bankrupt, as a bond holder I stand a good chance of getting at least some of my principal back, but the equity investors will lose all of their equity.
The point being made is that if you hold a portfolio of riskless government bonds (default risk free) and stocks, you get to the same performance and potentially lower volatility.

Corporate bonds, whether Investment Grade or High Yield, carry equity risk. That's consistent with how academic theory looks at bonds.

If you read Swensen, he takes you through the issues with corporate bonds in terms of asymmetric information between the Board of the borrower, and the investor. He doesn't recommend them.

Anti Illmanen will tell you whether, empirically, there has been alpha worth having (ie separate from equity risk which is beta). One might argue that credit, or default risk, is orthogonal to equity risk - ie an independent factor in a Fama-French world. I think the jury's out on that: Larry Swedroe says no, Rick Ferri says yes.
This happened to me this year. I made a high risk bet on some pre-IPO shares in an AI company called Graphcore. Graphcore failed and was bought out by Softbank. The deal involved Softbank paying off all of the bond holders but zeroing out the equity. :-( The good news is that I made my bet against a few AI companies, and the others are still in the race! But this is just a small consideration within my high risk pool of capital. I may lose it all, and got comfortable with that idea before parting with the money. On the other hand we are in the era of AI, and you need to be in the race to win it. If I get lucky, I could make a ton from it.

This is all covered in Bavarias book. For example the recovery rate for failed bonds during the GFC was something like 75%. If you held a fund which in turn held a wide portfolio of bonds, and some small %age of them failed, but still recovered on average 75%, the overall loss to the fund is well contained. The fund would also begin to trade at a discount, and Bavaria took advantage of that also and profitted when the discount went away. The whole book really, is about evaluating what the risk of these different bond asset classes really is, rather than blindly dismissing it.

The GFC did indeed result in defaults in the investment grade A+ corporate bonds! But not in spades. You certainly would not want to own bonds in any single company as an individual investor, but spread the risk through a fund.
75% is far above any number i have heard -- if that number includes things like Irish banks, where the government took on essentially all their bond debt at par, then that's not likely to re-occur, ever, anywhere. Regulators have been clear about that*. Empirically, recoveries in default have been falling for decades, due to more leveraged corporate structures and weaker covenants. Edward Altman's research showed that.

You will be aware of the lawsuit against Switerland of the $18bn of AT1 (Alternative Tranche 1) CoCo (contingent convertible) bonds in Credit Suisse. Even the creator of CoCos acknowledges that what happened was a possible, legal outcome. I don't know if holders got anything, but I believe they were at least 99% diluted. Of course that was more than 10 years past the GFC.

It sounds like you have a very good handle on the risks and returns from your chosen strategy.

You should pursue it.

Do come back in 2-3 years, say, to tell us how it went/ to gloat.

* Pasche di Siena. Where there nearly was a wipeout of retail bondholders, until it was realised that would start a bank run (as well as the government of Italy falling). So they found a fudge - very Italian.
Topic Author
WillEndure
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Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Fri Jan 31, 2025 9:21 am Do come back in 2-3 years, say, to tell us how it went/ to gloat.
Really, the point will not be to gloat. Just to sleep well, preserve capital and make a modest but steady return.

On that note, is there a UK ETF that invests in US TIPS? I feel it would be worth taking some as an inflation hedge.
Topic Author
WillEndure
Posts: 17
Joined: Fri Jan 24, 2025 9:43 am

Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Fri Jan 31, 2025 9:21 am The point being made is that if you hold a portfolio of riskless government bonds (default risk free) and stocks, you get to the same performance and potentially lower volatility.
Potentially lower.

Google tells me:
"In the 20 years from September 2003 to June 2024 , the FTSE All-World index (in EUR) had a compound annual growth rate of 9.10%, a standard deviation of 13.06%, and a Sharpe ratio of 0.64."

Suppose the riskless treasury is sitting at 4.25% on the left of some graph we are imagining. The risky equities are sitting at 9.1% on the right. Modern portfolio theory says decide what your level of risk is, then pick the point on the line between, split your money into two baskets and keep it balanced that way. The risk level slides linearly from a standard deviation of 0% on the left to 13.06% on the right. lets pretend the 2022/23 bond rout didn't happen. Or perhaps we need a more realistic model that factors in inflation risk and assigns the treasury bond a non zero risk - or maybe we use TIPS for that part.

If you only consider these 2 asset classes, and consider them superior to all other asset classes, you are saying that there are no investments which might sit on our graph with a return somewhere between 4.25% to 9.1% that have a standard deviation lower than any point on the line between.

If there are investments that fall below the line, why not consider them when building your risky portfolio? They would have a positive impact on the efficient frontier, so should form a part of the risky asset mix if you are aiming to maximize your risk/return.

There is some equity risk in corporate bonds, for sure. But it is a sliding scale, with the equity tranch bearing the full risk, and bonds bearing a lower amount of risk in order of their seniority. That is not enough by itself to make them attractive investments. You would expect them to be priced so that they lie on our portfolio allocation line, but I think it is also often the case that they sell at a discount to that evaluation for various reasons.

What I am trying to say is, why just equities? FTSE all-world index is purely equities. Are you claiming that world equities completely dominate the efficient frontier to the extent that only equities should be considered for the risky side of the portfolio?
jg12345
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Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Fri Jan 31, 2025 9:38 am
Valuethinker wrote: Fri Jan 31, 2025 9:21 am Do come back in 2-3 years, say, to tell us how it went/ to gloat.
Really, the point will not be to gloat. Just to sleep well, preserve capital and make a modest but steady return.

On that note, is there a UK ETF that invests in US TIPS? I feel it would be worth taking some as an inflation hedge.
https://www.ishares.com/uk/individual/e ... -ucits-etf a quick search on google
Trying to stay the course
jg12345
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Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Fri Jan 31, 2025 9:54 am
Valuethinker wrote: Fri Jan 31, 2025 9:21 am The point being made is that if you hold a portfolio of riskless government bonds (default risk free) and stocks, you get to the same performance and potentially lower volatility.
Potentially lower.

Google tells me:
"In the 20 years from September 2003 to June 2024 , the FTSE All-World index (in EUR) had a compound annual growth rate of 9.10%, a standard deviation of 13.06%, and a Sharpe ratio of 0.64."

Suppose the riskless treasury is sitting at 4.25% on the left of some graph we are imagining. The risky equities are sitting at 9.1% on the right. Modern portfolio theory says decide what your level of risk is, then pick the point on the line between, split your money into two baskets and keep it balanced that way. The risk level slides linearly from a standard deviation of 0% on the left to 13.06% on the right. lets pretend the 2022/23 bond rout didn't happen. Or perhaps we need a more realistic model that factors in inflation risk and assigns the treasury bond a non zero risk - or maybe we use TIPS for that part.

If you only consider these 2 asset classes, and consider them superior to all other asset classes, you are saying that there are no investments which might sit on our graph with a return somewhere between 4.25% to 9.1% that have a standard deviation lower than any point on the line between.

If there are investments that fall below the line, why not consider them when building your risky portfolio? They would have a positive impact on the efficient frontier, so should form a part of the risky asset mix if you are aiming to maximize your risk/return.

There is some equity risk in corporate bonds, for sure. But it is a sliding scale, with the equity tranch bearing the full risk, and bonds bearing a lower amount of risk in order of their seniority. That is not enough by itself to make them attractive investments. You would expect them to be priced so that they lie on our portfolio allocation line, but I think it is also often the case that they sell at a discount to that evaluation for various reasons.

What I am trying to say is, why just equities? FTSE all-world index is purely equities. Are you claiming that world equities completely dominate the efficient frontier to the extent that only equities should be considered for the risky side of the portfolio?
[I think you meant above the frontier line, not below the line]

JPmorgan used to publish their long term capital market assumptions (LTCMAs) and within that an efficient frontier. now the report is available only to clients, or at the least I cannot access it easily. EM bonds and US HY bonds (hedged) in their 2021 report were coming out as dominating the efficient frontier (I don't know how to post an image here). not that one should base all their reasoning on LTCMAs, but this is just to say that the risk/return profile of HY bonds is potentially attractive, hence some HY bonds in a portfolio are potentially justified. However, I think this is true for a more sophisticated investor that understands risk/return of a portfolio, and wants to add them. you fall square into that category. for most people I think 1 FTSE all world ETF and 1 global aggregate bond ETF is enough.
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Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Fri Jan 31, 2025 9:38 am
Valuethinker wrote: Fri Jan 31, 2025 9:21 am Do come back in 2-3 years, say, to tell us how it went/ to gloat.
Really, the point will not be to gloat. Just to sleep well, preserve capital and make a modest but steady return.
It feels as if you have made your mind up, and that what we say will not shift you. All I can do is point you at what endless research says (but you'll have to look up the papers yourself). Also Larry Swedroe's books. And David Swensen - who gives you a pretty clear steer as to why you shouldn't go down this route. And Anti Illmanen (he might say there is something there).

At the risk of repeating myself. There's no secret sauce there. You won't get a lower risk alternative by throwing in high yielding assets. And that yield is usually bought at some cost (& often higher taxes, if in a taxable account).

You are sort of flirting with the Value premium, the idea that there might be stocks that are less volatile. There's also the Low Volatility anomaly. Now the problem is both anomalies were found in the data, but since they were found, they haven't really worked. But you might investigate Low Volatility funds - you will find they are weighted towards consumer staples etc -- and they *might* produce more stable returns in the future.

Value can be measured by high dividend yield. But it's never played out that well compared to other value metrics: Price/ Sales, Price/ Book etc. Price/Book is the one that Fama & French used, but there's at least some good evidence that modern accounting cannot cope with the increased value of intangibles on the corporate balance sheet, and so that relationship breaks down. Certainly Value funds tend to use a "secret sauce" to give you Value metrics.

I hold the ishares global value ETF in my ISA. It has not done well. But given the importance of the "Magnificent 7" to stockmarket performance particularly since 2021, that's not surprising. (Japan, generally, blows off scale on Value right now. But that's been true for many years).

I did hold an Emerging Market Value ETF. SEDY. Now that had an exciting portfolio (it was my proxy for value). However Feb 22nd 2022 happened-- 20% of the fund was in Russian stocks, and they dropped to zero :oops: :oops: . I finally sold it in disgust and went and bought some Investment Trust.

(I also had Terry Smith's Fundsmith Emerging Market Trust. I liked that a lot: companies with high returns on capital, exposed to EM growth in middle class consumers. So what happened? They underperformed the index so badly they liquidated. :oops: :oops: ).

So there are my adventures in "off index" investing.
On that note, is there a UK ETF that invests in US TIPS? I feel it would be worth taking some as an inflation hedge.
Or. You could hold Index Linked Gilts directly in a taxable account (*not* a fund). At which point you avoid UK tax on the inflation uplift (of the principal).

Swensen, again, talks you through why you don't want to hedge against inflation other than in your home currency. I think monevator.com might do similar (not sure).
Last edited by Valuethinker on Fri Jan 31, 2025 3:44 pm, edited 1 time in total.
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Fri Jan 31, 2025 9:54 am
Valuethinker wrote: Fri Jan 31, 2025 9:21 am The point being made is that if you hold a portfolio of riskless government bonds (default risk free) and stocks, you get to the same performance and potentially lower volatility.
Potentially lower.

Google tells me:
"In the 20 years from September 2003 to June 2024 , the FTSE All-World index (in EUR) had a compound annual growth rate of 9.10%, a standard deviation of 13.06%, and a Sharpe ratio of 0.64."

Suppose the riskless treasury is sitting at 4.25% on the left of some graph we are imagining. The risky equities are sitting at 9.1% on the right. Modern portfolio theory says decide what your level of risk is, then pick the point on the line between, split your money into two baskets and keep it balanced that way. The risk level slides linearly from a standard deviation of 0% on the left to 13.06% on the right. lets pretend the 2022/23 bond rout didn't happen. Or perhaps we need a more realistic model that factors in inflation risk and assigns the treasury bond a non zero risk - or maybe we use TIPS for that part.

If you only consider these 2 asset classes, and consider them superior to all other asset classes, you are saying that there are no investments which might sit on our graph with a return somewhere between 4.25% to 9.1% that have a standard deviation lower than any point on the line between.

If there are investments that fall below the line, why not consider them when building your risky portfolio? They would have a positive impact on the efficient frontier, so should form a part of the risky asset mix if you are aiming to maximize your risk/return.

There is some equity risk in corporate bonds, for sure. But it is a sliding scale, with the equity tranch bearing the full risk, and bonds bearing a lower amount of risk in order of their seniority. That is not enough by itself to make them attractive investments. You would expect them to be priced so that they lie on our portfolio allocation line, but I think it is also often the case that they sell at a discount to that evaluation for various reasons.

What I am trying to say is, why just equities? FTSE all-world index is purely equities. Are you claiming that world equities completely dominate the efficient frontier to the extent that only equities should be considered for the risky side of the portfolio?
You'd only get off the risk-return line if there was some other factor besides interest rate risk (which dominates for bonds) and equity risk. If the 3rd security is simply a weighted sum of those 2 factors, it will sit more or less on the straight line.

What we are saying is that there isn't some other factor. There's nothing super special about Preference Shares, or High Yield bonds. They are combinations of equity risk and fixed income risk. (The original work was Fallen Angels, and yes, there is (or at least was before a bunch of hedge funds started exploiting this) some anomaly around Fallen Angels, because institutional investors often cannot hold High Yield bonds -- so the price drops by too much as they get close to BBB-/ BB+).

Now if you think credit risk is some orthogonal factor that isn't correlated highly (or perfectly) with equity risk then there's some value, potentially, in throwing them into the mix. But I am not aware of any strong evidence that, for Original Issue HY bonds (the vast majority) there is such evidence.

On recovery rates: Altman showed that recovery and default rates are inversely correlated. Thus, when there are a lot of corporate defaults, recovery rates fall (makes sense as it is usually a recession).

I used to get excited by distressed debt funds. Michael Price's fund - Mutual Shares fund? However there was that distressed fund that imploded in the States a few years ago (it might even have been Price's own fund, many years after he stopped running it). Really grievous losses for investors.

Same goes for EM bonds. Although I'd be prepared to listen to an argument that "locals" have something**. But USD EM bonds? I think what they have is cyclicality. I don't think there's any net gain on risk-adjusted returns. See nickels & bulldozers, below.

Private Credit is all the rage. You can bet after 10 years of amazing returns and huge funds being raised, that the next 10 years won't be such an easy ride.


** This is the "nickels in front of bulldozers" thing in financial markets. You can make quite a lot of money running a fund that has a very frequent low payoff, with the occasional risk of total wipeout. See a paper by Andrew Lo called "Capital Decimation Partners". Principal-Agent problems come here (as they usually do in Finance) -- the hedge fund manager goes and gets another job. The investor? They are left with the wiped out investment.

So I wonder if "locals" (local currency, issued to local borrowers primarily) simply pay higher returns because capital markets are not perfect, but EM economies tend to be volatile, and so they will periodically slam you with devaluation - foreign exchange controls - soaring interest rates - default. Their higher returns are paid for by higher risk. It is just it doesn't show up every year.
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Fri Jan 31, 2025 2:44 pm It feels as if you have made your mind up, and that what we say will not shift you. All I can do is point you at what endless research says (but you'll have to look up the papers yourself). Also Larry Swedroe's books. And David Swensen - who gives you a pretty clear steer as to why you shouldn't go down this route. And Anti Illmanen (he might say there is something there).
I love to read books, especially if they are well written and engaging. Also, no massive rush to commit my money to any particular path, just so long as I make a start within the next 6 months or so. So I shall look these authors up and see what they have to say. Thanks for the recommendations.
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

Valuethinker wrote: Fri Jan 31, 2025 2:44 pm I did hold an Emerging Market Value ETF. SEDY. Now that had an exciting portfolio (it was my proxy for value). However Feb 22nd 2022 happened-- 20% of the fund was in Russian stocks, and they dropped to zero . I finally sold it in disgust and went and bought some Investment Trust.
This comes back to what I wrote earlier about the great moderation. The great moderation runs from early 90s up to GFC or perhaps the Covid period. Interest rates fell in a straight line pretty much over that entire period, if we take the US 10 year as the benchmark. Why did that happen? because the cold war ended, increasing political stability spread throughout the world, and globalisation and wider and deeper supply chains happened on the back of it. It ended the day Russian boots crossed into Ukraine.
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Sat Feb 01, 2025 12:51 pm
Valuethinker wrote: Fri Jan 31, 2025 2:44 pm I did hold an Emerging Market Value ETF. SEDY. Now that had an exciting portfolio (it was my proxy for value). However Feb 22nd 2022 happened-- 20% of the fund was in Russian stocks, and they dropped to zero . I finally sold it in disgust and went and bought some Investment Trust.
This comes back to what I wrote earlier about the great moderation. The great moderation runs from early 90s up to GFC or perhaps the Covid period. Interest rates fell in a straight line pretty much over that entire period, if we take the US 10 year as the benchmark. Why did that happen? because the cold war ended, increasing political stability spread throughout the world, and globalisation and wider and deeper supply chains happened on the back of it. It ended the day Russian boots crossed into Ukraine.
If we are talking the Great (Macroeconomic) Moderation (which is usually the term implied) then the broadly accepted answer is: the Global Financial Crisis of 2008-09. After that, you had the most severe recession of the postwar period, plus an unprecedented period of low growth in most major economies.

Of course the Ukraine War began in 2014 - when Russian boots crossed into Crimea, Luhansk and Donbass. This is merely the 2nd phase - which began with the Battle of Kiev, Mariopol etc.

Supply chains Russia was only peripheral - raw materials. China is the key, and the concerns re Chinese dominance of manufacturing supply chains started well before 22 September 2024. Biden's efforts to re-locate chip manufacture to the USA started well before that.
Why did that happen? because the cold war ended, increasing political stability spread throughout the world, and globalisation and wider and deeper supply chains happened on the back of it.
I think we should not ignore the role of Central Banking, from the early 1980s onwards. Inflation targeting became the accepted regime under which Central Banks operated, and with a high degree of independence from the political process. Countries that got out of line - such as the UK in 1992, got slammed back into line by the forces of markets.

The period of high economic growth was actually earlier: 1946-1972 roughly. That was about reconstruction from WW2, falling trade barriers, technological revolutions (such as the US Interstate Highway System, which transformed travel and logistics; air travel would be another), and very favourable demographics. Plus falling oil prices as the world economy switched from coal to oil as its largest energy source.

That came screeching to a halt around 1971 and particularly during the era of the 2 oil crises: 1973 and 1979-80. Stagflation. Places like Britain and Italy, inflation became embedded in the system, and it was a horrendous economic and human cost to squeeze it down again.

Aggressive Central Banking brought inflation down from c 1979 throughout the 1980s. The recession at the end of the 1980s was a relatively mild one. The 1990s *did* see the rise of Chinese manufacturing, which had a deflationary impact on prices, thus allowing more monetary stimulus without causing inflation**. You also finally saw some of the benefits of the computer and communications technology revolution dating from the 1960s, appearing in the productivity statistics - up to then, you couldn't see that.

The end of the Cold War gave a fiscal dividend. Countries in the west could deal with rising healthcare costs in an aging population, by shifting from defence spending to healthcare spending.

On political stability, the end of that was essentially 9-11. "The World Turned Upside Down" as the British band played at the surrender of Singapore in 1942 to Japan. There was plenty of instability before, but 9-11, and the subsequent intervention in Iraq, destabilised the Middle East (among other places). It was probably also the high water mark for Democracy - but that's another story.

** container shipping. Samuel Maclean launched the shipping container in the mid 1960s to serve the US buildup in Vietnam. In the next 25 years it more or less took over world trade, and that was a huge productivity jump, and made possible China being the "workshop of the world" on an unprecedented scale in the 1990s and early 00s.
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

Thanks for the history lesson.

What I am asking is, looking back at 30 years of constant declining interest rates - within that time frame passive investing and the 60/40 portfolio has become popular. Is there evidence that it would have been a good strategy prior to 30 years ago?

Do you not worry that we are entering an era of increasing de-globalisation and the next 30 years might be a bumpier ride than the last? Or do you think this barbell passive strategy of risk-free bonds and risky world equity balanced to your preferred risk profile is the best bet for the next 30 years?

Last year has been strange in that the S&P500 and Gold and the dollar all went up together. Liquidity is what drove that.
Last edited by WillEndure on Mon Feb 03, 2025 6:05 am, edited 2 times in total.
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

MCSI World or FTSE All World - these are world equity funds right? They market cap weighted, so very heavily made up of the top-US companies?

I think there are so many reasons the USA will still be on top in the next 30 years.
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

Do any of you have gold in your portfolio and if so how much? I am at 30% on gold.
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

[edited]
Last edited by Valuethinker on Mon Feb 03, 2025 9:38 am, edited 1 time in total.
Valuethinker
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Re: UK SIPP Income Factory

Post by Valuethinker »

WillEndure wrote: Mon Feb 03, 2025 5:58 am Thanks for the history lesson.

What I am asking is, looking back at 30 years of constant declining interest rates - within that time frame passive investing and the 60/40 portfolio has become popular. Is there evidence that it would have been a good strategy prior to 30 years ago?
It depends on your sub period. But, broadly, yes.
Do you not worry that we are entering an era of increasing de-globalisation and the next 30 years might be a bumpier ride than the last?
Could well be.
Or do you think this barbell passive strategy of risk-free bonds and risky world equity balanced to your preferred risk profile is the best bet for the next 30 years?
Yes.
jg12345
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Re: UK SIPP Income Factory

Post by jg12345 »

WillEndure wrote: Mon Feb 03, 2025 6:06 am Do any of you have gold in your portfolio and if so how much? I am at 30% on gold.
I usually suggest 0% on gold.

For people that really want it, no more than 5%.

So 30% seems like a lot to me.

(and I second everything else said by Valuethinker in the previous post)
Trying to stay the course
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WillEndure
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Re: UK SIPP Income Factory

Post by WillEndure »

30% gold is my current portfolio. If I take into account the money from the AirBnB sale, that would dilute it down to 3% - the overall size of my financial investment portfolio can grow by 10x now that I am out of property. 5% does sound pretty normal, I will probably go for 10%.
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