Our growth portfolio added 4.7% in October. This came as a resurgent local sharemarket outperformed the US markets for the first time in several months, with the S&P/ASX 200 adding 4% in the month. Year-to-date, the overall market return (with dividends included) is 8.0%.
Our model portfolios, which have a preponderance of major cap (top 20) stocks, had positive returns. The growth portfolio outperformed the index and reduced its gap to the benchmark to 0.65%, while the income portfolio lagged the index, with the gap widening to 3.35%.
This is our tenth monthly portfolio review.
The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we provide a quick recap on these.
Portfolio Recap
In January, we made some adjustments to our Australian share ‘Income Portfolio [1]’ and ‘Growth Oriented Portfolio [2].’
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’ve 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 2017, which we expected to be:
- Interest rates remaining at low levels, although some upward movement in bond rates;
- The US Fed likely to increase US interest rates by 0.75%, but probably no move in Australia by the RBA;
- The Australian dollar at around 0.70 to 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity prices remaining reasonably well supported;
- A positive lead from the US markets and President Trump;
- A moderate pick-up in growth in Australia back towards trend levels; and
- No material pick up in domestic inflation.
Performance
The income portfolio to 31 October is up by 4.68% and the growth oriented portfolio by 7.38% (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 underperformed the index by 3.35% and the growth oriented portfolio by 0.65%.
Sharemarket saws in October
A decisive breakout from a very narrow trading range around 5,700 led the Australian sharemarket to finish at 5909 in October. It recorded a gain of 4.0% for the month, taking the year-to-date return (with dividends included) to 8.0%.
All sectors finished in the black. The smallest sector, Information Technology, which accounts for only 1.5% of the overall market, followed the lead of the USA markets and led the gains with a return of 8.8%. The Energy sector received a boost as the oil price remained firmly over US$50 per barrel. This sector returned 6.5% in October to be up 11.3% for the year.
The largest sector on the ASX, Financials, which makes up 37.2% of the index, continues to lag the overall market. The return in October of 3.2% took the year-to-date gain to 4.7%, well below the overall market of 8.0%.
Heath Care remained the best performing sector this year, with a return of 23.3%. On the other side of the ledger, the Telecommunications sector has lost 24.2%.
The ‘top 20’ stocks finished with a positive return of 3.1% in October, but remain laggards with a year to date return of 4.2%. Midcap stocks, which are measured by the Midcap 50 index (an index tracking stocks ranked 51st to 100th by market capitalisation) lead the way with a return of 15.5%.
Sector returns for the month of October and since the start of the calendar year are set out in the following table.
Income Portfolio
The income portfolio is underweight material stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small. We have avoided real estate (potential impact of higher interest rates, plus lack of franking on real estate investment trusts), and health care (low dividends and pricing multiples).
In a bull market, we expect that the income biased portfolio will underperform relative to the S&P/ASX200 due to the underweight position in the more growth oriented sectors and the stock selection being more defensive, and conversely in a bear market, it should moderately outperform.
It is forecast to generate a yield of 4.90% in 2017, franked to 87.3%. After the first ten months, it has returned as income $4,052 or a yield of 4.05%, franked to 91.0%. With further dividends to come in from the three major banks, Transurban and Sydney Airport, it should now marginally exceed the forecast.
Year-to-date, the income portfolio has returned 4.68% (including dividends) compared to the accumulation index return of 8.03%. This is a credible performance given that the portfolio has no health stocks (the best performing sector), and has a heavy concentration of top 20 stocks (the top 20 index has returned 4.2%). In what is proving to be a market of individual stocks rather than a stock market, the strong performances of Sydney Airport, Transurban and Boral are offsetting the performances of Telstra and JB Hi-Fi.
A change to the portfolio (exit of Brambles, replaced by additional ANZ) was made at the end of August. No further changes to the portfolio are contemplated at this point in time.
The income biased portfolio per $100,000 invested (using prices at the close of business on 31 October 2017) is as follows:
¹ Position in Brambles (FV $4,000) realised on 31 August at $9.31 per share, loss of $997. Balance of $3,003 re-invested in ANZ at $29.40 per shares
Growth Portfolio
A critical construction decision with the growth portfolio has been to take a neutral sector bias in the materials sector. This has led to the inclusion of Rio (along with BHP and Boral).
Overall, the sector biases are relatively small. Despite healthcare underperforming in 2016 and many of the stocks trading on high multiples, we believe that the tailwinds are so strong that our sector position is materially overweight.
The other overweight position was in telecommunications, the only negative performing sector in 2016. The major underweight positions are in real estate and consumer staples.
The stock selection is biased to companies that will benefit from a falling Australian dollar – either because they earn a major share of their revenue offshore, and/or report their earnings in USD. While we were not surprised to see the Aussie dollar test 80 US cents due to the strength in commodity prices and less aggressive tightening stance by the US Federal Reserve, this assumption is clearly under pressure at the moment and may need to be re-assessed.
Year-to-date, the portfolio has returned 7.38% (including dividends) compared to the accumulation index return of 8.03%. Similar to the income portfolio, this is a credible performance given the weighting in top 20 stocks. An overweight position in telecommunications has also materially impacted performance, offset largely by the overweight position in healthcare stocks.
In what is proving to be a market of individual stocks rather than a stock market, losses on stocks such as JB Hi-Fi are compensated by gains on stocks such as Boral and Seek.
Changes to the portfolio were made at the end of May (exit of Westfield, replaced by Link) and at the end of August (exit of Telstra and Brambles, replaced by additional CSL and ANZ). No further changes to the portfolio are contemplated at this point in time.
Our growth oriented portfolio per $100,000 invested (using prices at the close of business on 31 October 2017) is as follows:
¹ Position in Westfield realised on 31 May at $8.48 per share, leaving loss of $384. Balance of $3,616 invested in Link at $7.75 per share.
² Link 4:11 entitlement issue at $6.75 per share. Entitlements sold through institutional tender at $1.10 per entitlement.
³ Portfolio not able to participate in TPG 1:11.13 non renounceable entitlement offer at $5.25 per share
⁴ Position in Brambles (FV $4,000) realised on 31 August at $9.31 per share, loss of $997. Position in Telstra (FV $4,000) realised on 31 August at $3.67 per share, loss of $1,122. Balance of $4,000 invested in ANZ at $29.40 per share, $1,881 in CSL at $128.52 per share.
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