Our high-income stock portfolio for 2015

 

The objective of our high-income stock portfolio is to deliver tax-advantaged income, whilst broadly tracking the S&P/ASX 200.

Following above market performances in 2013 and 2014 (24.36% in calendar year 2013 for outperformance of 4.16%, and 8.13% in 2014 for outperformance of 2.52%), we have made some changes to the income portfolio. These changes reflect our view on the dominant investment themes for 2015, which we expect to be:

• Continued low interest rates (yield sectors will continue to perform);
• Lower Aussie dollar – moving down towards 75 US cents;
• Positive lead from the US markets;
• No pick up in commodity prices;
• Growth running slightly below trend in Australia;
• Impact of lower oil prices will lead to a rise in consumer spending in Australia.

The changes to our portfolio include:

•  We have exited our positions in Orora and Leighton (both now looking fully priced), and Origin;
• While still biased towards the yield sectors (financials, utilities, property trusts, consumer staples), these biases have been reduced. In fact, we have gone to neutral weight on the banks by introducing AMP into the portfolio and reducing our exposure to Commonwealth and Westpac;
• We have added JB Hi-Fi, which after a horror 2014, stacks up now as a yield proposition (we think the consumer discretionary sector will benefit from the impact of lower oil prices);
• We have neutralised many of our sector biases. For example, we have maintained positions in Woodside and BHP despite the considerable uncertainty in regard to oil prices;
• Our stock selections are, in the main, relatively defensive, with a bias to stocks that are trading on lower multiples.

The portfolio is forecast to generate a yield of 5.14%, franked to 88.7%. Importantly, we expect that this portfolio will moderately underperform relative to the benchmark price index in a strong bull market, and moderately outperform in a bear market.

Construction rules

Before detailing the portfolio, let’s recap on the construction rules that have been applied to develop the portfolio. These 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 and materials), 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 15.0%, and under this rule, our possible weighting is in the range from 10% to 20% (i.e. plus or minus one third or 5.0%);
• As discussed below, we are marginally underweight the index in materials, energy and health care stocks; broadly index weight financials and property trusts; and marginally overweight consumer staples and utilities;
• 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 have avoided stocks from industries where there is a high level of exogenous risk, such as airlines or general insurance;
• We prioritise stocks that pay fully-franked dividends and have a strong track record; and
• 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, NAB is now overweight relative to the Commonwealth and in consumer staples, Woolworths is overweight relative to Wesfarmers.

On a sector basis, our portfolio compares to the S&P/ASX 200 as follows:

^[1]* ASX 200 index weights as at 31 December 2014

Portfolio

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 December 2014) is as follows:

^[2]

Forecast returns

Using consensus analyst forecasts from FN Arena (and making a couple of adjustments for the commodity based stocks), the portfolio has the following characteristics:

Forecast PE for 2015: 14.91
Forecast Dividend Yield for 2015: 5.14% pa
Franking: 88.7%

For an SMSF in the accumulation phase, the 5.14% dividend yield will translate to an income return of 6.12% per annum (after tax), and for a fund in pension phase, the income return will increase to 7.09% per annum.

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, and conversely in a bear market, it should moderately outperform.

We will monitor the portfolio and report back each month in the Switzer Super Report on its performance.

Next week, our growth-oriented portfolio.

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.

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