Outperformance relative to the index is interesting but when the whole market falls by 5.5%, it’s not really something to shout from the rafters. In this our first review for the year, we look at how our portfolios performed in January.

The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we have also provided a quick recap on these.

Portfolio recap

In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth-oriented Portfolio’ (see here and here).

To construct the income portfolio, the processes we applied included:

• we used a ‘top down approach’ looking at the industry sectors;
• so that we are not overly exposed to a market move, we have determined that in the major sectors (financials and materials), our sector biases will not be more than 33% away from index;
• we require 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), and have set a minimum stock investment of $3,000;
• we confined our stock universe to the ASX 150;
• we have avoided stocks from industries where there is a high level of exogenous risk, such as airlines;
• for the income portfolio, we prioritised stocks that pay fully franked dividends and have a strong earnings track record; and
• within a sector, the stocks are broadly weighted to their respective index weight, although there are some biases.

The growth-oriented portfolio takes a different approach in that it introduces biases that favour the sectors that we judge to have the best medium-term growth prospects. Critically, it also confines the stock universe to the ASX 150 (there are many great growth companies outside the top 150).

Overlaying these processes are our predominant investment themes for 2016, which we expect to be:

• Continued low interest rates (yield sectors will continue to perform);
• The US Fed will be very cautious about further US interest rate rises;
• AUD at around 0.70 US cents, but with risk of breaking down;
• Commodity prices remaining weak;
• A positive lead (or at least not a negative lead) from the US markets; and
• Growth running below trend in Australia.

Performance

The income-oriented portfolio to 29 January is down by 3.13% and the growth-oriented portfolio is down by 4.81% (see tables at the end). Compared to the benchmark S&P/ASX 200 Accumulation Index (which adds back income from dividends), the income portfolio has outperformed the index by 2.3% and the growth-oriented portfolio has outperformed by 0.7%.

Defensive sectors perform best in January

While most ASX sectors finished in the red in January, defensive sectors such as property trusts and utilities finished with small gains. Largely on the back of a small increase in the price of Telstra, the telecommunications sector added 0.7%.

With oil and commodity prices under pressure, particularly in the early part of the month, the energy sector lost 6.2% while the materials sector shed 9.5%. The largest sector by market capitalisation, financials, which makes up 40.5% of the index, lost 9.0% in January. Some of this loss may have been in response to the very steep run up in the price of bank stocks that occurred in the last two weeks of December.

Income portfolio

The income portfolio is underweight materials stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small.

The income portfolio is forecast to generate a yield of 5.26% in 2016, franked to 84.2%. The inclusion of Dexus and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.

In a bull market, we expect that the income-biased portfolio will underperform relative to the standard S&P/ASX200 price index due to the underweight position in the more growth-oriented sectors and the stock selection being more defensive. Conversely in a bear market, it should moderately outperform

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 29 January 2016) is as follows:

Click here to download an Excel version 

Growth portfolio

The growth portfolio is marginally overweight the sectors that will benefit from increased consumer consumption or a lower AUD; marginally underweight or index-weight the yield sectors (financials, utilities, telecommunications and consumer staples); and underweight the commodity-exposed sectors (materials and energy). Despite healthcare being the best performing sector over the last three years, we have elected to maintain an overweight position, as the demographic factors are so strong. Recognising that a number of the healthcare stocks are very pricey, we have selected stocks that should benefit from a lower Australian dollar.

In regards to the performance of some of the stocks in January, JB Hi-Fi benefitted from the demise of Dick Smith, while BT Investment Management (and its peer fund managers) came under pressure as global equities slumped. Macquarie also got caught up in this sentiment, and lost 13.5% in January. At this stage, we don’t propose to exit these positions.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 January 2016) is as follows:

Click here to download an Excel version 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.