Banks drag portfolios lower in April but still ahead of market

 

Weakness in major bank stocks over the last couple of days of April dragged the share market down and impacted on the performance of our portfolios. Our growth portfolio largely mirrored the market’s fall of 1.7%, while our income portfolio lost 2.7%. On a year-to-date basis, however, both portfolios continue to outperform the market, with the income portfolio 2.2% above the benchmark and the growth portfolio outperforming by 3.5%.

The purpose of the income and growth-oriented portfolios is to demonstrate an approach to portfolio construction.

Portfolio recap

In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth-oriented portfolio’ (see here ^[1] and here ^[2]).

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

• Using a ‘top down approach’ and introducing biases that favour lower PE, higher yielding industry sectors;
• To minimise the market tracking risk, adopting a rule that says that our sector biases in the major sectors (financials and materials) will not be more than 33% away from index;
• Identifying 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), with a stock universe confined to the ASX 100;
• Within a sector, weighting the stocks broadly to their respective index weights, although there are some biases; and
• Looked for companies that pay franked dividends and have a consistent earnings record.

The growth-oriented portfolio takes a different approach to the sectors 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 100 (there are many great growth companies outside the top 100).

Performance

The income portfolio is up by 10.67% this calendar year and the growth-oriented portfolio is up by 11.95% (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 2.22% and the growth-oriented portfolio has outperformed by 3.50%.

^[3]Dollar strength hurts market in April

Still unable to crack through the 6000 level, the market ended up losing 1.7% in April. A higher Aussie dollar (weaker US dollar), higher oil prices and lower confidence about the imminence of a further cut in interest rates impacted the market.

On the back of higher oil prices, energy was the best performing sector – up 8.5% during the month. Healthcare, which contains companies such as CSL, Cochlear and Resmed that benefit from a lower Aussie dollar, was amongst the worst performing sectors, shedding 4.0%.

The largest sector by ASX market weighting at 40.4%, financials, lost 4.7% as renewed speculation about the timing of higher capital ratios impacted on sentiment, and the odds of a further rate cut receded marginally. Despite its performance in April, the sector is still outperforming on a year-to-date basis – up 8.8%.

Interestingly, all sectors have made a positive contribution to the market this year, and the difference between the best performing sector (utilities at 15.9%) and the worst performing sector (IT at 2.9%) is by historical standards not that marked.

The table below shows the returns for the 11 sectors.

^[4]Income portfolio

The income portfolio at the start of the year was overweight consumer staples, utilities and telecommunications; underweight materials and energy, and broadly index-weight the other sectors. Reflecting an expectation that the banks will, over time, have to raise more capital, we neutralized our exposure to financials. Further, following a stellar performance in 2014, our exposure to property trusts (the A-REIT sector) is also neutral.

With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark accumulation index in a strong bull market, and moderately outperform in a bear market.

The income portfolio is forecast to generate a yield of 5.14% in 2015, franked to 88.7%.

At the end of March, we made some changes to the portfolio. We crystallized our profit on Toll Holdings following the announcement of its takeover by Japanese Post; cut our exposure in consumer staples to go back to index weight by selling (for a small loss) 50% of our position in Woolworths; and reinvested those proceeds in Woodside, Telstra, Commonwealth Bank and AMP.

Although only marginally overweight financials, the portfolio was impacted in April by the performance of the major bank shares, and its relative underweight position in energy and materials.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 April 2015) is as follows:

 

^[5]

Click here to download as an Excel file ^[6]

* On 31 March, reduced original $6,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $1,901 reinvested in Woodside, $2,000 in AMP, $3,000 in CBA and $2,000 in Telstra.

Growth portfolio

With our growth-oriented portfolio, we have based our sector exposure on what we expect to be the predominant investment themes in 2015, which are:

• Continued low interest rates (the yield sectors will continue to perform);
• Lower Australian dollar – moving down towards 0.70 US cents;
• Positive lead from the US markets;
• No pick up in commodity prices;
• Growth running slightly below trend in Australia; and
• Low oil prices will lead to a rise in consumer spending in Australia.

This leads to a portfolio with only small biases. We are marginally overweight the sectors that will benefit from increased consumer consumption, a lower Aussie dollar or lower oil prices – mainly the so called “cyclicals” (consumer discretionary and industrials); 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 second best performing sector last year, we have maintained an overweight position as the demographic factors are so strong.

With stock selection, we have biased the portfolio to companies that should benefit from a falling Australian dollar – either because they earn a major share of their revenue offshore, and/or report their earnings in US dollars, such as CSL, Resmed, Brambles and Computershare. In the financials, we have pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We have also added online employment and education group Seek, and stuck with two of the laggards in 2014 from the consumer discretionary sector in Crown and JB Hi-Fi.

At the end of March, the portfolio realised the profit on its investment in Toll Holdings and like the income portfolio, cut its exposure in Woolworths. These proceeds were reinvested in Santos and Westfield.

In April, the portfolio largely kept track with the market – losing 2.02% compared to the market’s 1.70%. The Santos purchase paid off immediately (up 16% during the month), while Westfield held its ground. A higher Australian dollar impacted on the portfolio’s stock selection of companies exposed to a weaker currency – in particular, CSL, Brambles and Computershare.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 April 2015) is as follows:

^[7]

Click here to download as an Excel file ^[6]

* On 31 March, reduced original $4,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $3,939 reinvested in Santos and $4,000 in Westfield.

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.