Despite Brexit, our income portfolio performed strongly in June and increased its relative outperformance to almost 2%. For the year, it is up by a touch over 3%. The same cannot be said for our growth portfolio, which suffered due to weakness with stocks that have exposure to the UK.
Year to date, our income portfolio has outperformed the index by 1.96%, while the growth portfolio has underperformed by 3.48%.
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 [1] and here [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 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;
- AUD 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 June is up by 3.05% and the growth oriented portfolio is down by 2.39% (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 1.96% and the growth oriented portfolio has underperformed by 3.48%.
Defensives lead in June
In a month dominated by Brexit, the S&P/ASX 200 lost 2.5%. With the fear index up, interest rates staying very low and bond yields being crunched, the defensive sectors led the market. Property trusts added 3.5%, while the utilities sector returned 6.2%.
The largest sector by market capitalization, financials, which represents about 38.1% of the index, lost 6.0% in June. With interest rates staying lower for longer, margins under pressure and ongoing capital concerns, the major banks followed leads from Europe and the USA and were sold down. The financials sector continues to be the major drag on the index in calendar 2016, down 9.4%.
Contributing to the pressure in June on the financials sector was the Brexit vote, which impacted a number of Australian companies in this sector with UK exposures, including BT, Henderson, Macquarie, QBE, CYBG and Westfield.
For the first six months, the healthcare sector continues to perform strongly, up 8.7%. It has been joined by a recovering material sector. Despite a horrific January and February, the latter is now up 16% as iron ore and other metal prices (including copper and gold) have moved higher.
Income Portfolio
The income portfolio is underweight materials stocks and 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 the end of May, we crystalized the gain on Medibank and re-invested the proceeds into $2,442 BHP and $5,000 ASX Limited. The BHP purchase reduced the underweight position in materials by lifting the sector exposure to around 11.2%. The investment into ASX was somewhat defensive, as it ASX is a relatively low beta stock, trading on a multiple of just over 20 times FY16 earnings and yielding 4.2% (fully franked).
No further changes are contemplated at this point in time.
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.
All companies have now declared a dividend for the first half, generating an income return of 2.52%, franked to 81.2%. Although on a run-rate basis this is marginally below the forecast, with second half dividends typically higher than the first half, we expect that the forecast will be met.
Our income biased portfolio per $100,000 invested (using prices as at the close of business on 30 June 2016) is as follows:
[3]* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis
** Sale of Medibank at $3.20 on 31/5/16. Proceeds of $7,742 reinvested in $2,242 BHP @ $19.08 per share and $5,000 ASX @ $44.51.
Growth Portfolio
The growth portfolio is marginally overweight the sectors that should benefit from increased consumer consumption or a lower AUD; 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 3 years, we have elected to maintain an overweight position as the demographic factors are so strong.
At the end of May, we crystalized the loss on our Flight Centre holding and re-invested the net proceeds of $3,170 into $2,000 BHP shares (which lifted the weighting in material stocks to 10.8%), and $1,170 into Macquarie.
In June, the portfolio underperformed relative to the index, increasing the year to date gap to 3.48%. This is partly due to its bias with top 20 stocks. Year to date, the S&P/ASX 20 index has lost 3.9% compared to the S&P/ASX 200’s gain of 1.1%, a difference of 5.0%.
Stock selection is also impacting. In June, the portfolio was hit by the Brexit decision, which negatively impacted stocks with UK exposures. On a relative basis, BT Investment Management, CYBG, Macquarie and Westfield underperformed compared to their sector peers.
Despite the performance in June, no changes are proposed at this point in time. With regard to BT Investment Management and Macquarie, our sense is that the Brexit related pain is over for these stocks, with both looking quite oversold.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 June 2016) is as follows:
[4]* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis
** Sale of Flight Centre at $31.61 on 31/5/16. Proceeds of $3,170 reinvested in $2,000 BHP @ $19.08 per share and $1,170 Macquarie @ $74.87 per share.
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.