Using leverage for higher dividend yields

25th May '23 by Phil Ton

14 comments 1416 reads

Basic strategy is to use leverage to live off dividends in retirement.

Using Vodafone (LON:VOD) VOD as an example - say it was trading at 100p/share and paying an annual dividend of about 7.5p/share, so 7.5%.

Buying shares: I've got £40000 to invest so I buy 40000 shares at 100p/share gives me an income of £3000/year.

But using a spread betting account, you buy at £1000/point which, means you need a margin of £20000 but I've got £40000 in my account so that's fine.

Buying at £1000/point give me a notional value of 100000 shares which would generate £7500/year in dividends which works out to 18.75% on my £40000.

It's not quite that good because you can't use a DFB, you got to use a Forward. The interest rate charge on a DFB is quite hight due to the base rate being high.

You use a 9 month Forward you have the cost of the spread to include every 9 months. Spread at the moment is about 1.23% to that equates to about 1.64% annually. So instead of getting 18.75% you're getting 17.11%. Sill significantly better than 7.5%.

What's even better is Vodafone (LON:VOD) VOD is currently about 84p which means, for the same margin, you can go up to £1200/point giving you about £9000/year in dividends.

Can you see a flaw?

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ISAallowance

25th May '23

Nice idea.

The first flaw is that your 9 month forward will auto-roll into a 3-month forward when it expires, so if you're holding for the long term you'll pay more spread than in your calc.

The obvious risk is that if the share price goes down then you have leveraged exposure to it. You might counter that you're only interested in the dividends, but if a dividend cut precipitates a share price collapse then leverage will amplify your pain.

On the flip side, if the share price rises to moderate the dividend yield then leverage can also amplify your gain.

I have done this in the recent past, albeit only with a small proportion of my predominately non-leveraged portfolio, and in fact leveraged tobacco and banks were my best performing sub-portfolio last year. Personally I prefer to max out my ISA subscription each year though, which currently doesn't really give me any left over for leveraged accounts.

I don't really see the attraction of Vodafone (LON:VOD) either, it's way too complicated for a simpleton like me to understand if the dividend is truly covered or not after their capex requirements to stay ahead of competitors. Certainly the share price graph since 2015 looks dismal. I'd also want to know how increasing interest rates are going to affect their interest payments, given that their total debt looks to be about 30 times their net profit, at a first glance going purely off the Stocko pages and not their accounts. Goes in the too-difficult bucket for me I'm afraid.

Phil Ton

It's cheaper to close the trade manually and then open another one. Never let it roll over.

I know, easier said than done, but ideally what you want is a portfolio that doesn't move in terms of share price. I don't think the price of individual shares matter as long as the overall value of the portfolio doesn't move too much.

I have a number of buy to let properties and I think the analogy is the same - I don't care if the house is worth 30% less than I paid, or 30% less. Doesn't matter as long as I'm still receiving the rent.

KevinS1

26th May '23

I would avoid SBing in hindsight.

It is great when you are winning, but so easy to magnify your losses and lose thousands when the market turns against you.

Paul Scott himself will tell you about the millions he has made, and the millions he has lost through S.Betting. He has now stopped all forms of SB.

Personally my experiences are tiny compared to Paul's, but it has been a painful lesson for me. I recently was well on the way to making back my losses but had a relatively small SB move against me which took me back again.

You could say it is my methods; did I have a Stop Loss, was I over leveraged etc etc, but in my experience its too difficult and too risky. I would rather invest over the long-term and let compounding do its thing.

I still have a dabble with a small bit of fun-money, but TBH its way too risky and I sure am not good enough to make a consistent return.

I know there are many others out there who use it effectively, but when the SB companies have to tell you on their websites that 80-90% of people lose money SBing then that in itself tells you a story.

Good luck in whatever you choose.

Unfortunately I think the forward spreads are much larger than you think they are. I've logged into IG, cash DFB for VOD was 78.53 - 78.73, and DEC 23 was 80.35 - 81.35 at the same instant. The actual spread for DEC 23 is DEC 23 buy to cash sell, i.e. 78.53 - 81.35. That's a 3.59% spread for 7 months (actually a little under 7 months now since we're past the 18th of May), which is 6.16% annualised.

Those figures mean that even when taking the risk of being 2x geared, your effective post-interest dividend yield will actually be reduced unless it's greater than about 12.5% ungeared.

Maybe you have a provider with lower forward to cash spreads, or maybe you're making the mistake of simply taking the headline spread on the forward contract, and not comparing forward buy back to current sell as the real spread.

Dragon

27th May '23

I have run some high yielding spreadbets for a while and basically the yield covers the overnight or spread costs but at the expense of turning them into low yielding holdings. You can compensate that by placing the remainder of the exposure into a high yielding savings account. So If you wanted to buy £5000 of Vodafone (LON:VOD) with 20% margin you put £1000 in the spread and £4000 into a savings account, but you are not leveraging then. So you might get an extra 3.5% on the savings.

jjis

The flaw might be that you have would have lost £4000 to £4800 of capital in 2 days based on the numbers you quoted perhaps? Chances are that it will go down a similar amount when it goes XD 4,5c on 8/6/23. So potentially you might have wiped out your expected income for the year in about 10 days and a quarter of your available margin. Unless I have mis-understood ( as I don't use them personally) the maths on spread bets and your £1000-£1200 a point position size suggestion. Of course anything could happen and it could go back up again afterwards on a deal with 3 or something else. Or they could end up cutting the dividend again as the cover is pretty thin & trading they suggest is quite tough with their updated guidance for 2024 of flat to slightly down EBITDAaL (?) & reduced free cash flow of "around" £3.3bn vs. around £5bn in 2023. Finally the shares rank pretty average on Stockopedia & my work based on income paying share. Hope this helps and good luck if your are doing this.

29th May '23

Isn't that the same as if I held the £100000 of shares? The share price drops by the values of the dividend on XD date?

Rusty2

30th May '23

Not always, a few recently have dropped considerably more than the dividend, such as Legal & General (LON:LGEN).

That's just a dividend adjustment added to a down day. Sometimes you get the dividend adjustment and an up day.

My point is that the same thing applies if your exposure if via shares or a spread bet.

Sorry, I'm a bit confused about "DEC 23 buy to cash sell i.e. 78.53-81.35"

When you've bought a forward you don't sell at the cash sell price, you sell at the forward sell price.

I've just done a little test:

The cash price at the time of the trade above was 78.76/78.95.

Or have I misunderstood?

The shares have still not recovered, even to pre dividend price less the dividend. The dividend was April 27. I have noticed this on other high dividend shares recently.

The point is that the forward sell price will decay to the cash sell price over the 9 months, which is the point at which you will have to sell it. Basically both the forward buy and sell prices contain a time weighting relative to cash prices that roughly approximates the cash DFB overnight funding, albeit with a small discount for the longer holding periods.

For example, you buy Dec-23 now at 81.52. On the 17th Dec you have to sell this, or you'll get rolled-over on the 18th. Assuming the cash price of VOD has not changed and is still 78.76/78.95, on the 17th Dec the Dec-23 price will probably also be 78.76/78.95, i.e. it will have decayed to the cash price. Hence in addition to the 0.2p spread that's always present, you will have paid another 2.57p in time-based premium in order to hold for 6.5 months, which works out at around 6% p.a. funding cost. This compares favourably with a DFB at 2.5% + 1 month LIBOR (about 6.7% p.a. at present), but unfavourably with the unlevered 8% dividend yield you could obtain.

shipoffrogs

Looks like high dividend shares are being sold off now because of rising interest rates.

Ahhhhh, now I understand, thanks for explaining that.

So the spread I need to include in the calculations is the difference between the forward buy price and the cash sell price.

As you say, I think that would wipe away all the benefits of the leverage, unless you leveraged more aggressively but that is a recipe for disaster.

Back to the drawing board and thanks again for sharing your knowledge.

Using leverage for higher dividend yields

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Phil Ton

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