Last Thursday, we updated our income stock portfolio. Today, we look at our growth-oriented portfolio.

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

In calendar 2013, the growth-oriented portfolio returned 27.55% – an outperformance of 7.35% compared to the index. In calendar 2014, the portfolio returned 3.39% – an underperformance of 2.22%. And in calendar 2015, the portfolio returned 6.67% – an outperformance of 4.11%, taking the net outperformance to 2.85% pa for the past three years.

Critically, the purpose of the growth and income-oriented portfolios is to demonstrate an approach and methodology to portfolio construction that SMSFs could apply.

We have made some changes to the growth portfolio, which include sector and stock rebalancing, base-lining for the start of the year, the replacement of South32 (which came from the BHP demerger), Crown, Computershare and Woolworths, and the inclusion of Flight Centre and BT Investment Management.

The critical issue in 2016 is how to position in the beaten up resources sectors – energy and materials. We have chosen to stay underweight these sectors at the moment, recognising that there is no sign yet that commodity prices have bottomed. However, these sectors will rebound at some stage – and at some point in 2016, it may pay to go overweight these sectors.

In relation to this portfolio, we need to state some important caveats upfront. Firstly, recognizing the importance of tax effective income from dividends to the overall portfolio return, and a general aversion by many SMSFs to taking excessive risk, our sector biases are not strong. While there is an orientation to the sectors and stocks that we believe will grow over the medium term, our aim is to design a portfolio that will also track reasonably closely the overall market as measured by the S&P/ASX 200 Accumulation Index. It is a bias only towards growth.

Secondly, our universe of stocks to select from is confined to the top 150 stocks. More often than not, the stocks with the best medium term growth prospects will come from outside this group, in particular, the so called ‘small’ caps.

With these caveats decked, let’s move on to the portfolio construction.

Sector Biases

Similar to our approach to the high income portfolio, we applied a ‘top down’ approach to the industry sectors and introduced biases that favour the sectors that we think have the best medium term growth prospects.

Overlaying this is a view that the predominant investment themes in 2016 will 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.

This leads to a portfolio with only small sector biases. We are marginally overweight the sectors that will 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 third best performing sector last year with a return of 15.8% and over the last three years, the best performing sector with a return of 22.1% pa, we have elected to maintain an overweight position, as the demographic factors are so strong. Recognising that a number of the healthcare stocks are very pricey, we have selected stocks that should benefit from a lower Australian dollar.

On a sector basis, our portfolio compares to the market (S&P/ASX 200) as follows:

Stocks

Working on the basis that we need at least 10 stocks for diversification and that once you get over 25, it becomes pretty hard to monitor, we have selected 21 stocks. This is more than the income portfolio, reflecting in part the increased risk in stock selection.

Critically, we have biased the stock selection to companies that should 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.

In the ‘consumer discretionary’ sector, we have replaced Crown (CWN) with Flight Centre (FLT). With the former, an exogenous risk has been introduced with speculation about re-privatisation impacting the share price.

Flight Centre has been a strong performer over a number of years, and is forecasting underlying operating profit to grow by between 4% and 8% this year.

In financials, we have stuck with two strong performers from 2015 in Macquarie (MGQ) and Challenger (CGF), and added the fund management company BT Investment Management (BTT). This business has been expanding strongly offshore, and is priced at a more attractive multiple to its competitors such as Magellan (MFG) and Platinum (PTM).

With the major banks, the positions are largely index weighted, although there is a small bias towards the Sydney based banks.

In health care, while the stocks are getting very pricey, we have retained CSL (CSL), Ramsay (RHC) and Resmed (RMD).

In materials, we continue to prefer the diversified exposure that BHP Billiton (BHP) provides, and have retained Boral (BLD) for exposure to the construction industry. In industrials, a very diverse sector where stock selection is much more important than sector weight, we have retained logistics company Brambles (BXB) and online employment and education group Seek (SEK).

Portfolio

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 December 2015) is as follows:

Forecast Returns

Using consensus broker forecasts from FN Arena, the portfolio has the following characteristics:

Forecast Price Earnings multiple for 2016: 18.22
Forecast Dividend Yield for 2016: 4.55%
Franking: 81.1%

As a growth-oriented portfolio, our investment timeframe is in the three to five year range, and while short-term investment performance (including dividends) is important, our aim is to deliver slightly above market performance over that timeframe. We will keep a close eye on the growth-oriented portfolio, and report back in coming editions of the Switzer Super Report.

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.