Market on a high – portfolios up in July

Co-founder of the Switzer Report
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The Australian share market closed at a six-year high on Thursday, bringing an end to a very strong month. In a little bit of a rarity, all sectors of the market finished in the black in July, with the market as a whole up by 4.4%. This calendar year, it has put on 7.6% on a total return basis.

Our portfolios ended higher in July, largely tracking the market’s gains during the month. In this, our seventh review for the year, we look at their composition and performances. Our high-income portfolio is up by 9.0% and has outperformed the S&P/ASX 200 this calendar year by 1.4%, while our growth-oriented portfolio is up by 4.5% and has underperformed by 3.1%.

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 that 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 it 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 9.03% and the growth-oriented portfolio is up by 4.45% (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 1.46% and the growth oriented portfolio has underperformed by 3.12%.

Yield still rules

While the ‘materials’ sector bounced back with a gain of 7.7% to be the best performing sector in July as iron ore prices stabilised, 2014 continues to reflect the theme of 2013 in that the market is largely being driven by the search for yield. ‘Property trusts’ with a total return of 18.4%, ‘utilities’ at 13.5% and ‘financials’ at 8.9% are among the sectors leading the way on a year-to-date basis.

‘Financials’ is the largest sector on the ASX, representing 39.1% of the S&P/ASX 200. Whilst its monthly return at 3.6% was marginally less than the return for the S&P/ASX 200, its year to date return is 1.3% higher than the market overall. This comes despite repeated calls from the so-called experts and analysts saying that Australian banks are over-valued.

Other sectors that have done well include the tiny ‘IT’ sector (which comprises the three stocks of Computershare, Carsales.com and Iress) which is up this calendar year by 14.3%, and the ‘energy’ sector, which has benefitted from higher oil and gas prices and has returned 9.4%.

The laggards include the more growth-oriented sectors, such as ‘healthcare’, ‘consumer discretionary’ and ‘industrials’. With the Aussie dollar now starting to move lower, these sectors might start to see a renewed flow of funds in the coming months.

The table below shows the sector weights (as a proportion of the S&P/ASX 200), and performances (total return) for the month of July 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 seven 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 stock such as Toll and Primary. AGL also took a hit in July, following its update on earnings for 2014 and a more sobering outlook for 2015.

The income portfolio is forecast to generate a yield of 5.01% in 2014, franked to 90.4%. With dividends payable in the second half of the calendar year typically higher than those paid in the first half, we expect that 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 31 July 2014) is as follows:

* Income includes dividends declared payable. Assumes 37.5% Leighton shares sold in partial offer at $22.50, repurchased on 30/4 at $19.08.

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 3.1%. Clearly, our sector biases are a little out of step with the market and our changes in May haven’t yet returned any dividends. Also, with the Aussie dollar still sitting higher than where it started the year at, stocks that were selected to benefit from a fall in the currency have faired relatively poorly. 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 31 July 2014) is as follows:

* Income includes dividends declared and payable. Prices of Crown (new), JB Hi-Fi (new) and Resmed (new) as at 30 May.

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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