With the Greeks agreeing to the inevitable deal to stay in the Euro, the Australian share market started the financial year on a high note, adding 4.4% in July and making up for most of June’s loss. Lower commodity prices and a weaker Australian dollar (AUD) were the dominant investment themes.
Our portfolios powered ahead, performing better than the market to increase their relative outperformance.
For the first seven months of the calendar year, the income portfolio has outperformed the index by 2.78%, while the growth portfolio is 4.18% higher than the benchmark return.
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 10.42% this calendar year and the growth-oriented portfolio is up by 11.82% (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 2.78% and the growth-oriented portfolio has outperformed by 4.18%.
[3]Industrial sectors lead the market higher
Putting the resources sectors to one side, the rest of the market performed strongly in July. Healthcare led the way with a gain of 9.6%, followed by consumer staples at 7.5% and industrials at 6.5%. Falling commodity prices impacted the materials sector, which lost 1.1%, while a lower oil price limited any gains in the energy sector to just 0.3%.
Over the course of 2015, the yield sectors continue to lead the way. Utilities at 17.1%, A-REIT (property trusts) at 12.8% and telecommunications (which is largely Telstra) at 12.4% are amongst the best performing sectors. Notwithstanding the pressure on the banks in regard to capital, the largest sector by ASX weighting, financials, continues to perform strongly having added 8.6% this year compared to the index’s 7.6%.
Healthcare and industrials are the other standout sectors, with a lower AUD acting as a tailwind for both sectors. The energy sector is in the red on a year to date basis, while materials has only added 1.0%.
The table below shows the returns for the 11 sectors, plus their weighting (as at 31 July) of the S&P/ASX 200.
[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.
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.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
In July, the portfolio marginally outperformed the index. Stock specific issues seemed to play a more important role than sector or industry issues, with strong performances from Boral, Telstra and AGL offsetting weakness in Primary Healthcare following a profit downgrade. Going into the earnings season in August, sector weightings are broadly in line with where we want them to be, and there are no stocks where we have any material concerns. Accordingly, no changes are proposed at this time.
The income portfolio is forecast to generate a yield of 5.14% in 2015, franked to 88.7%. With final dividends typically higher than the interim dividends, we are confident that the forecast target should be moderately exceeded.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 July 2015) is as follows:
[5]Click here to download 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.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99.
Growth portfolio
With our growth-oriented portfolio, we based our sector exposure on what we expected to be the predominant investment themes in 2015, which are:
- Continued low interest rates (the yield sectors will continue to perform);
- Lower AUD – 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 AUD 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 maintained an overweight position as the demographic factors are so strong.
With stock selection, we 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 USD, such as CSL, Resmed, Brambles and Computershare. In the Financials, we pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We added online employment and education group Seek, and stuck with Crown and JB Hi-Fi from the Consumer Discretionary sector.
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.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
In July, the portfolio outperformed the index by 0.6%, increasing in value by around 5.0%. The healthcare stocks (CSL, Ramsay and Resmed) performed strongly, as did Westfield, Boral, Telstra, Crown and AGL.
Going into the August company earnings season, sector weightings are broadly in line and we are comfortable with our stock selections. Accordingly, we don’t propose any changes to the portfolio at this point in time.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 July 2015) is as follows:
[7]Click here to download 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.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99.
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