Market on a high – portfolios finish up in August

Co-founder of the Switzer Report
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The Australian share market closed at close to a six-year high on Friday. Although the S&P/ASX 200 gave up 0.12% over the month of August, when dividends are included, the market returned 0.62%. This took the total return this calendar year to 8.25%.

August was reporting season for those companies with June/December balance dates, and as a result, there was considerable movement in some stock prices. BHP, for example, gave up more than 5%, while CSL added just on 9%.

Our portfolios ended higher in August, largely tracking the market. In this, our eighth review for the year, we look at their composition and performances. Our high-income portfolio is up by almost 10% and has outperformed the S&P/ASX 200 this calendar year by 1.6%, while our growth-oriented portfolio is up by 4.8% and has underperformed by 3.5%.

Portfolio recap

In January, we made some adjustments to our Australian share ‘Income portfolio’ and ‘Growth-oriented portfolio’.

The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets are of critical importance, we always commence a review by briefly recapping the key portfolio construction processes applied.

The income portfolio is forecast to generate a yield of 5.01%, franked to 90.4%. The construction rules applied include:

  • Using a ‘top down approach’ and introducing biases that favour lower PE, higher-yielding industry sectors;
  • To minimise the market tracking risk, adopting a rule that says our sector biases in the major sectors (financials, materials and consumer staples) will not be more than 33% away from index;
  • Identifying 15 to 20 stocks (less than 10 is insufficient diversification, over 25 is too hard to monitor), with a stock universe confined to the ASX 100;
  • Within a sector, weighting the stocks broadly to their respective index weights, although there are some biases; and
  • Of course, we looked for companies that pay franked dividends and have a consistent earnings record.

The growth-oriented portfolio takes a very different approach to the sectors 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 100 (there are many great growth companies outside the top 100).

Performance

The income-oriented portfolio is up by 9.83% and the growth-oriented portfolio is up by 4.76% (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 1.58% and the growth-oriented portfolio has underperformed by 3.49%.

Financials still strong – healthcare makes a comeback

Despite all the naysayers, the largest sector in the market ‘financials’ (which includes the major banks) continued to perform, marginally exceeding the market return. On a year-to-date basis, the total return of 9.6% compares favourably to the overall market at 8.25%. Highlighting the ongoing demand for yield by investors, ‘property trusts’ still lead the way on a year-to-date basis with a total return of 20.4%.

After a very slow start to the year, the ‘healthcare’ sector bounced back, with a return of 6.6% in August. This was very much a function of some strong earnings reports from companies such as CSL, Ramsay and Cochlear.

Iron ore prices fell, and as a result, the ‘materials’ sector finished down 3.7% to take its calendar year return to only 0.1%. Heavyweights such as BHP led the decline with a fall of 5.2%. ‘Consumer staples’ also fell, with Woolworths and Coca Cola Amatil finishing in the red.

The table below shows the sector weights (as a proportion of the S&P/ASX 200), and performances (total return) for the month of August and for the 2014 calendar year.

Income portfolio

The income portfolio is overweight ‘financials’, ‘consumer staples’, ‘utilities’ and ‘telecommunications’; underweight ‘materials’ and ‘consumer discretionary’; and broadly index-weight the other sectors. It also includes an allocation to ‘property trusts’ (formally called the A-REIT sector), and somewhat more exposure to the “cyclicals” through the selection of stocks from the ‘industrial’ sector.

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.

For the first eight months of the year, it is outperforming the index. An overweight exposure to the four major banks, in particular CBA and Westpac, together with the inclusion of stocks such as Leighton and Orora, is compensating for the poor performance of stocks such as Primary and AGL. On the back of a more encouraging outlook (it had been heavily sold down), Toll Holdings bounced back to life in August, adding 9.3% in the month.

The income portfolio is forecast to generate a yield of 5.01% in 2014, franked to 90.4%. With a number of companies now having declared their final or second dividend for the year, we can now confidently predict that the realised yield on the portfolio should marginally exceed the original target.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 29 August 2014 is as follows:

Click here for a larger image

* Income includes dividends declared and payable. Assumes 37.5% Leighton shares sold in partial offer at $22.50, repurchased on 30/4 at $19.08. AGL rights (AGKRA) following 1:5 renounceable offer.

Growth portfolio

Similar to our approach to the income portfolio, we applied a ‘top down’ approach to the industry sectors and introduced biases that favour the sectors that we feel have the best medium-term growth prospects. The growth-oriented portfolio is overweight ‘healthcare’, ‘consumer discretionary’ and ‘industrials’; underweight ‘financials’ and ‘property trusts’; and largely index weight the other sectors including ‘materials’.

Critically, we have biased the stock selection 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 US dollars – such as CSL, Amcor, Brambles and Computershare and BHP. Other biases include Woolworths over Wesfarmers; CBA and Westpac over ANZ and to a lesser extent NAB; and the selection of Crown and JB Hi-Fi.

At the end of May we decided to make some changes to the portfolio. We reduced our exposure to the ‘materials’ sector by selling our holding in Rio for a loss of $391, exited our holding in Primary Health Care for a loss of $291 and replaced this with Resmed, and increased our exposure to the ‘consumer discretionary’ sector through additional holdings in Crown and JB Hi-Fi.

The portfolio is lagging the index by 3.5%. Clearly, our sector biases are a little out of step with the market and our changes in May haven’t yet returned any dividends. While we remain confident that both Crown and JB H-Fi represent good growth companies at reasonable prices, the market doesn’t presently agree with our assessment. The short sellers are in control of JB Hi-Fi, and this looks unlikely to change in the short term.

We also haven’t yet seen the benefit of a weaker Aussie dollar on our stock selections, as it remains stubbornly at a higher level than where it started the year.

On a positive note, our overweight position (and stock selection) in the health care sector was rewarded with strong gains during the month in CSL, Ramsay and Resmed.

At this point, we are going to hold with the portfolio and continue to monitor it closely. Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 August 2014) is as follows:

Click here for a larger image

* Income includes dividends declared and payable. Prices of Crown (new), JB Hi-Fi (new) and Resmed (new) as at 30 May. AGL rights (AGKRA) following 1:5 renounceable issue.

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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