With the virus curves starting to flatten, the Australian share market rebounded strongly in April to post a rise of 8.8%. Although the best monthly gain for some years, the market is still down more than 16% in 2020.

Our model portfolios (income and growth) also gained ground, although their returns were tempered by exposure to financial stocks. In our fourth review for the year, we look at how they 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.

It is important to note that these portfolios are designed as “long only”. They don’t allocate to “cash” and don’t represent a view about the outright direction of the market.

Portfolio recap

In January, we adjusted our Australian share ‘Income Portfolio’ and ‘Growth Portfolio’ (see https://switzersuperreport.com.au/our-portfolios-for-2020/)

The construction rules for the portfolios are:

• We use a ‘top down approach’ looking at the prospects for each of the industry sectors;
• For the income portfolio, we introduce 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 19.1%, and under this rule, our possible portfolio weighting is in the range from 12.8% to 25.4% (i.e. plus or minus one third or 6.3%);
• We require 15 to 25 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.

The portfolios were developed after applying a number of assumptions about economic growth, interest rates, demand for commodities including oil, and international investment markets. The outbreak of Covid-19 and its impact as a “black swan” event negated some of these assumptions, and at the end of March, we made some further portfolio adjustments.

Performance

The income portfolio to 30 April has lost 19.19% and the growth-oriented portfolio has lost 16.95% (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 by 2.84% and the growth portfolio by 0.60%.

All sectors in the green energy and IT roar back

All industry sectors recorded gains in April, but the differences between the top performing and the worst performing were quite marked.

Putting the energy sector to one side (the best performing sector in the month but the worst in 2020), strong gains were recorded in information technology, consumer discretionary, materials and real estate. Rises in information technology companies followed a very strong lead from the USA.

Fears of increasing bad debts held back the major banks, and as a result, the financial sector only rose by 2.8%. The largest sector on the ASX 200 by market capitalization with a weight of 26.4%, it is the second worst performing sector in 2020 with a loss of 25.9%.

Defensive sectors (consumer staples, communication services, utilities and health care) enjoyed modest gains in April. Year to date, they are performing best, with health care the only sector with a positive return in 2020. This is largely due to market leader CSL.

Performances of the 11 industry sectors, together with their respective market weights, are set out in the table below.

Income portfolio

The objective of the income portfolio is to deliver tax advantaged income whilst broadly tracking the S&P/ASX 200.

On a sector basis, the biases are fairly minor. It is moderately overweight financials and underweight health care (where there are no medium or high yielding stocks in the ASX 100).

In the expectation that interest rates in Australia are staying at record low levels, it has a defensive orientation and a bias to yield style stocks.

The income portfolio was originally forecast to generate a yield on its opening value of 4.65%, franked to 78%. This will now not be achieved in the Covid-19 environment, as profits erode and companies preserve capital. ANZ and Westpac have deferred their interim dividends, NAB has cut its interim dividend by 64% and IAG has said that it is unlikely to pay a final dividend in September. A yield closer to 3% is now more likely. After four months, the portfolio has delivered an income return of 1.15% (franked at 90.2%).

In April, the income portfolio returned 5.32% for a relative underperformance of 3.46%. This is measured on a total return basis which includes dividends. Apart from the major banks, underperformers in the month were Telstra, IAG, Woolworths, Medibank and Dexus (the latter going marginally backwards despite the real estate sector rebounding by 14.2%). The only stocks to materially outperform were Woodside and JB Hi-Fi.

Following changes in February and March, no further portfolio changes are proposed at this at this point in time.

The income biased portfolio per $100,000 invested (using prices as at the close of business on 30 April 2020) is as follows:

Growth portfolio

The objective of the growth portfolio is to outperform the S&P/ASX 200 market over the medium term, whilst closely tracking the index.

The growth portfolio in 2020 is moderately overweight health care, energy, consumer discretionary and information technology. It is underweight consumer staples, real estate and utilities. Overall, the sector biases are not strong.

On a stock selection basis, it also has a bias to companies that earn revenue outside Australia and should benefit from a weaker Australian dollar.

In April, the growth portfolio returned 8.04% for a relative underperformance of 0.74%.

This is measured on a total return basis which includes dividends. Strong performers included Aristocrat, JB Hi-Fi, Woodside, Macquarie, Seek, Xero and Bluescope. Apart from the major banks, underperformers included Ramsay, Resmed, Reliance and Orora. Ramsay conducted a discounted institutional placement and share purchase plan (which the model portfolio is not able to participate in).

Following changes in February and March, no further portfolio changes are proposed at this at this point in time.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 April 2020) is as follows:

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.