We have made some changes to our high-income stock portfolio for 2014. These include sector and stock rebalancing, base lining for the start of the year, and the replacement of Coca Cola Amatil, Rio Tinto and UGL with Dexus, Leighton Holdings and Orora.
Importantly, we have marginally reduced our overall exposure to the “yield” based sectors (through stocks such as the major banks and Telstra) and marginally increased our exposure to some of the cyclical industries that may benefit from a recovering economy.
With the S&P/ASX200 increasing by 15.1% in 2013, and company earnings (particularly for banks and Telstra) growing at a much lower rate, forecast dividend yields have fallen. Our income-biased portfolio is forecast to generate a yield of 5.01% pa in 2014, franked to 90.4%.
Construction rules
The construction rules we applied are:
- We used a ‘top-down approach’ looking at the industry sectors, and introduced biases that favour lower PE, higher yielding sectors;
- So that we are not overly exposed to a market move, we have determined that in the major sectors (financials, materials and consumer staples), our sector biases will not be more than 33% away from index. For example, the ‘materials’ sector weighting on the S&P/ASX 200 is 17.8%, and under this rule, our possible weighting is in the range from 11.9% to 23.7% (i.e. plus or minus one third or 5.9%);
- While property trusts have limited tax advantages to an SMSF, the sector has underperformed and is now looking reasonable value – so we have included an exposure in the portfolio. Consumer discretionary, which was the best performing sector in 2013, is in the main low yielding, and as a very diverse sector, is extremely difficult to replicate without introducing massive single stock risk. Accordingly, we have taken a little more exposure to the “cyclicals” through the selection of stocks from the industrial sector. Our portfolio is thus overweight financials, consumer staples, utilities and telecommunications; underweight materials and consumer discretionary; and broadly index-weight the other sectors
With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark price index in a strong bull market, and moderately outperform in a bear market.
On a sector basis, our portfolio compares as follows:
* ASX 200 index weights as at 31 December, 2013
Stock rules
The stock rules are:
- 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 100;
- We avoided stocks from industries where there is a high level of exogenous risk, such as airlines or general insurance;
- Within a sector, the stocks are broadly weighted to their respective index weight. That said, we have applied some biases – in the financials sector, for example, we favour the Sydney Head Office banks CBA and Westpac over ANZ, and to a lesser extent NAB; and
- Of course, we looked for companies that pay (where possible) franked dividends and have a consistent earnings record.
Portfolio
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 December 2013) is as follows:
Forecast returns
Using consensus analyst forecasts from FN Arena, the portfolio has the following characteristics:
- Forecast PE for 2014: 14.73
- Forecast dividend yield for 2014: 5.01% pa
- Franking: 90.41%
For an SMSF in the accumulation phase, the 5.01% dividend yield will translate to a return of 5.98% pa (after tax), and for a fund in pension phase, the income return will increase to 6.95% pa.
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 oriented “growth” sectors, and conversely in a bear market, it should moderately outperform.
We will keep a close eye on the portfolio, and report back in coming editions of the Switzer Super Report.
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.
Click here to download an excel spreadsheet of the income portfolio. [1]
Also in the Switzer Super Report:
- Peter Switzer: Do I see a secular bull market looming? [2]
- Gary Stone: Charts promise life for Invocare [3]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [4]