After a horrific March, the sharemarket bounced back in April, to recover almost all of the previous month’s loss. While all sectors rose, financial stocks were materially impacted by revelations at the Royal Commission.
Our model portfolios, which are overweight financials, were therefore affected too. Although both portfolios generated positive returns in April, the income portfolio now lags the index by 2.4% while the growth portfolio has underperformed by 0.4%.
In our fourth review for the year, we look at how our income and growth portfolios performed in April. The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we provide a quick recap on these.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth Portfolio’ (see https://switzersuperreport.com.au/our-portfolios-for-2018/ [1]).
The construction rules applied were:
- A ‘top down approach’ that looks at the prospects for each of the industry sectors;
- For the income portfolio, we introduced biases that favour lower PE, higher yielding sectors;
- So that we are not overly exposed to a market move, in the major sectors (financials and materials), our sector biases will not be more than 33% away from index. For example, the weighting of the ‘materials’ sector on the S&P/ASX 200 is currently 18.0%, and under this rule, our possible portfolio weighting is in the range from 12.0% to 24.0% (i.e. plus or minus one third or 6.0%);
- 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 size of $3,000;
- Our stock universe is confined to the ASX 100. This has important implications for the growth portfolio, because the stocks with the best medium term growth prospects will often come from outside this group (the so called ‘small’ caps);
- We avoid stocks from industries where there is a high level of exogenous risk, such as airlines;
- For the income portfolio, we prioritise stocks that pay fully franked dividends and have a consistent record of paying dividends; and
- Within a sector, the stocks are broadly weighted to their respective index weights, although there are some biases.
Overlaying these processes are our predominant investment themes for 2018, which we expect to be:
- Synchronised growth in the USA, Europe, China and Japan;
- The US Fed likely to increase US interest rates by 0.75%,
- Interest rates in Australia to remain at historically low levels, with the RBA unlikely to move rates higher until the final quarter of 2018. Some upward movement in bond rates;
- Aussie dollar around 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity and energy prices remaining reasonably well supported;
- A positive lead from the US markets;
- A moderate pick-up in growth in Australia, back towards trend levels; and
- No material pick up in domestic inflation.
Performance
The income portfolio to 30 April is down by 2.49% and the growth-oriented portfolio by 0.48% (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 underperformed the index by 2.38% and the growth-oriented portfolio by 0.37%.
[2]
All sectors up in April, but financials lag badly
All ASX industry sectors finished in positive territory in April (see table below). The two standouts were the strong returns from the commodities sectors (energy and materials) as the “synchronised world economic growth” theme gained favour, and the relative underperformance of the financials sector.
The largest sector on the S&P/ASX 200, with a market weighting of 33.5%, the financials sector, managed a return of 0.2% as the major banks and AMP came under fire at the Royal Commission. Year to date it lags badly, with a return of -5.8% compared to the overall market at -0.1%.
Health care remains the best performing sector this year, with a return of 14.8%. In April, it added 7.4%. Telecommunications, following a very poor 2016 and 2017, is the laggard with a return of -9.3%.
[3]
Income portfolio
On a sector basis, the income portfolio is moderately overweight financials and index-weight materials. Exposure is being taken through the major banks (to the former), and the major miners (to the latter).
It is underweight health care, consumer staples and real estate.
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.
The portfolio is forecast to generate a yield of 5.13% in 2018, franked to 88.8%. The inclusion of Transurban and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.
In April, the income portfolio returned 2.38%, taking its year to date return to -2.49%. It now lags the accumulation index by 2.38%. The portfolio was impacted by weakness in the major banks and the debacle of AMP, which faces the prospect of criminal charges. Link also underperformed, following an institutional placement at $8.50 per share.
We have elected to exit the position in AMP and realise a loss of $886. We plan to maintain the exposure to the financials sector by investing the balance of $3,114 into ANZ, which has a strong focus on cutting costs and is arguably now the least risky of the major banks.
From an income point of view, the portfolio has returned 1.61%, franked to 98.2%. This is tracking to plan and we remain confident that the forecast of 5.13% will be met.
No other changes to the portfolio are contemplated at this point in time.
The income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 April 2018) is as follows:
[4]* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
² AMP shares sold on 30 April @ $4.04, loss of $886 realised. Balance of $3,114 invested in ANZ @ $26.84
Growth portfolio
The growth portfolio is moderately overweight materials, financials and consumer discretionary. It is underweight consumer staples, industrials and real estate. Overall, the sector biases are not strong.
The stock selection is marginally biased 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. While we expect that the Aussie dollar will remain well supported and trade in a fairly narrow range in the short term, the risk is that a strengthening US dollar causes it to break down.
In April, the growth portfolio returned 3.71%, which took its year to date return to -0.48%. It has underperformed the index by 0.37%.
The performance in April was impacted negatively by the overweight positions in financials and positively by the marginal overweight in materials. The strong performance of Aristocrat offset weakness in Challenger and Link, with the latter suffering indigestion pains following an institutional placement at $8.50.
No changes to the portfolio are contemplated at this point in time, although we are keeping a close watch on Challenger.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 April 2018) is as follows:
[5]* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
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 regard to your circumstances.