A surge in iron ore, copper and oil prices helped the ASX add 3.4% in April. Despite being underweight resource stocks, our income portfolio continued to perform strongly and is now firmly in the black.

Year-to-date, our income portfolio has outperformed the index by 2.74%, while the growth portfolio has underperformed by 2.27%.

The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we have also provided a quick recap on these.

Portfolio Recap

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

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 have 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 were our predominant investment themes for 2016, which we expected to be:

• Continued low interest rates (yield sectors will continue to perform);
• The US Fed will be very cautious about further US interest rate rises;
• Australian dollar at around 0.70 US cents, but with risk of breaking down;
• Commodity prices remaining weak;
• A positive lead (or at least not a negative lead) from the US markets; and
• Growth running below trend in Australia.

Performance

The income-oriented portfolio to end April is up by 3.27% and the growth-oriented portfolio is down by 1.74% (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 2.74% and the growth-oriented portfolio has underperformed by 2.27%.

Resource sectors lead in April

The S&P/ASX 200 added 3.4% in April to move into the black on a year-to-date basis. With dividends included, it has returned 0.5%. The increase in April was driven by a surge in commodity prices.

Largely on the back of an improvement in iron ore, copper and the gold price, the materials sector rose by 14.2% in April to push the year-to-date return to a market leading 19.5%. The energy sector also performed strongly on the back of a firmer oil price, returning 7.7% in April and a positive year-to-date return of 6.8%.

The biggest sector financials, which by market weight represents 38.5% of the index, built on the positive momentum in March and recorded a gain in April of 1.3%. However, reflecting ongoing market concerns about capital and credit provisioning with the major banks, this sector is still the worst performing sector this year, with a return of -8.4%.

Property trusts continued to be well bid, adding 2.8% in April for a year-to-date return of 9.4%. Going against the trend were the consumer discretionary and utilities sectors, which finished with small losses in the month.

Income Portfolio

The income portfolio is underweight materials stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small.

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 stock selection being more defensive, and conversely in a bear market, it should moderately outperform.

Strong performances from some of the more defensive stocks, such as Medibank, Sydney Airport and Dexus are offsetting the losses on our holdings in the major banks. At this point in time, we don’t propose to change the sector weightings or stock mix of the portfolio, although we may need to consider increasing the weighting to material stocks. Further, the gain on the Medibank holding is beyond all expectations – and it may be appropriate to realise this at some point.

The portfolio is forecast to generate a yield of 5.26% in 2016, franked to 84.2%. The inclusion of Dexus and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.

By face value, approximately 66% of companies have paid a first half dividend, generating just under 1.5% in income, franked to 96.7%. Despite the greater than expected cut by BHP to its dividend, the portfolio is on track to meet its dividend forecast.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 29 April 2016) is as follows:

* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis

Click here to download an Excel file of both portfolios

Growth Portfolio

The growth portfolio is marginally overweight the sectors that should benefit from increased consumer consumption or a lower Australian dollar; 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 best performing sector over the last three years, we have elected to maintain an overweight position, as the demographic factors are so strong.

In April, the growth portfolio underperformed relative to the index, in part due to its underweight position in materials and energy, and also due to stock selection issues with Macquarie and BT Investment Management. Despite gains by financial stocks in the month, Macquarie retreated from $66.09 to $63.50. Macquarie is due to report full year earnings this Friday, which we will be watching with keen interest.

BT Investment Management has lost almost 25% this year as the negative sentiment on equity markets in the early part of the year hit fund managers, who earn part of their remuneration through performance fees. Despite the recovery in equity markets in March and April, the market hasn’t re-priced BT.

While the underperformance of the portfolio against the ASX 200 index is disappointing, it is in part a function of the top 20 stock bias of the portfolio. With a number of companies reporting in May, we have elected to keep the portfolio unchanged for the time being. However, we may need to consider a sector re-balancing at the end of May, which may result in increasing the exposure to the materials sector, and reducing our exposure to the financials sector.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 April 2016) is as follows:

* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis

Click here to download an Excel file of both portfolios

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.