After I posted an article on the historical performance of the Dogs of the Dow somebody asked me whether these kinds of strategies would apply to non-US equities as well. More specifically they wanted to know whether it would work with the FTSE 100.
At the time I answered that it should, with my reasoning being that its basically a universal value strategy whereby the dividend yield is a loose proxy for value. When the market falls investors panic but, crucially, forward returns also look more attractive as a consequence. To paraphrase one investment fund manager, the stock market is the only market where people run away when things go on sale.
That basically sums the theory up in a nut shell; the Dogs strategy being a little algorithm that, in the grand-scheme of things, gets you decent bargains. It’s not perfect in that it doesn’t beat the benchmark every year, and it throws up a lot of cases where the sell-offs were completely justified, but over a stretch of five or six decades it has totally crushed the Dow Jones Industrial Average. The equivalent strategy for the S&P 500 also significantly outperformed over that time frame.
Okay so it worked well for the famous American indices, now let’s test it for the FTSE 100 firms. The process will be exactly the same as for the Dogs of the Dow. At the start of each trading year the ten highest yielding stocks are purchased in equal amounts and held for the duration of that year. At the beginning of the next year the portfolio is rebalanced; those stocks no longer making the top ten are sold and the new entrants are purchased. This is done regardless of whether the investments were profitable or not.
Let’s look at a fifteen year stretch going back to 2001. At the start of the year you open up your copy of the Financial Times and mark out the ten highest yielding stocks of the FTSE 100. You deposit a lump sum of £100,000 into your broker account and place the appropriate buy orders.
- That sees you obtain a starting portfolio containing equal £10,000 chunks of Bass, British American Tobacco, Boots, Imperial Tobacco, Invensys, PowerGen, Royal & Sun Alliance, Scottish and Southern Energy, Scottish Power and United Utilities.
Now if you’re reading from the States, or actually anywhere outside of the United Kingdom, then there’s a good chance you won’t be familiar with them in the same way you would be with the Dow 30 stocks. British American Tobacco is the one you’ve most likely heard of after it recently bid to acquire the 58% of Reynolds American it doesn’t already own. The other one you may also recognize is Imperial Tobacco, now known as Imperial Brands, which is the world’s fourth largest tobacco company and third by market share in the United States.
The others are probably less well known outside the U.K. but it doesn’t much matter since the composition of the portfolio changes from year to year. What’s more interesting is that it shows what kind of stocks might have been relatively cheap at the time. 60% of the above portfolio is comprised of tobacco or utility stocks for example (and we know big tobacco was exceptionally cheap at the time). Today the comparable figure would only be 20%, with neither big tobacco company making the list as the hunt for yield has made them less attractive. Granted the dividend yield is only a very rough guide to value, but it gives you an idea of how the strategy is meant to work.
Now at the time the average yield for this miniature portfolio would’ve been approximately 5.75%. On its own that might sound quite attractive compared to today’s average blue chip yields, but remember this was still near the peak of the dot-com bubble. I mean you only have to consider that “risk-free” 10-year UK government bonds were yielding around the 5% mark to see that it’s not a particularly great deal. The flip side is that as a value strategy you might also expect this to outperform in periods of high equity valuation, which is pretty much exactly what happened. In the first year a £100,000 investment in a FTSE 100 tracker fund would’ve been reduced to around £87,000 once you include dividends. The portfolio of the Dogs on the other hand would’ve actually generated positive returns of just over 10%.
By the end of year two the FTSE had crashed even further, to the point where that initial £100,000 investment in the tracker fund would now only show a value of £63,000 including dividends. Following the Dogs strategy however would have basically just put you back at square one in nominal terms (it would have shown a gain of 0.5% to be precise).
Over the entire fifteen year period a £100,000 investment in the FTSE 100 would’ve been worth just under £162,000 by early 2016 including dividends. That’s equivalent to compounded total returns of 3.25% a year; pretty pathetic considering most of that gets eaten up by inflation but that’s the consequence of starting during bubble like valuations. In comparison an annually rebalanced portfolio of the Dogs would have been worth £272,000 at the beginning of this year. That’s equal to compounded returns of 6.90% a year.
Obviously an extra £100,000 in total returns over a fifteen year period represents a massive outperformance compared to the benchmark. If you tucked that away in a high quality diversified portfolio of U.K. dividend stocks you’d be looking at anywhere between an extra £3,000 to £4,000 in annual income every year. What was more interesting though was the distribution of returns. Let’s say we start in 2003 instead of 2001. In that case you miss the entire fallout from the bubble, which in terms of total returns would’ve meant almost no differentiation between the benchmark and the Dogs. To be precise a £100,000 investment made in 2003 would have been worth around £256,500 if it had been invested in the FTSE 100 and £270,000 had it followed the Dogs strategy.
There’s probably two things I’d take away from that. The first is that, whilst there’s plenty of evidence that high yield strategies work for the reasons already discussed, something like the Dogs the Dow/FTSE is pretty volatile. In the 2008/2009 period for example the Dogs would’ve lost 63% before rebounding 86.5% the next year. The second point is that you need to be prepared to stick it out for a long enough period of time to see the gains, and when it comes to investing that’s going to be the kicker for an awful lot of people.
Finally for those that are interested here’s a current list of the Dogs of the FTSE 100 along with their approximate dividend yields: