The objective of the high-income stock portfolio is to deliver tax advantaged income, whilst broadly tracking the S&P/ASX 200.
Following above market performances in 2013, 2014 and 2016, and marginal underperformance in 2015 (24.36% pa in calendar year 2013 for outperformance of 4.16%, 8.13% pa in 2014 for outperformance of 2.52%, 1.95% pa in 2015 for underperformance of 0.61%, and 14.48% pa in 2016 for outperformance of 2.68%), we have made some changes to the income portfolio. These changes reflect our view on the dominant investment themes for 2017, which we expect to be:
- Interest rates remaining at low levels, although some upward movement in bond rates;
- The US Fed likely to increase US interest rates by 0.75%, but probably no move in Australia by the RBA;
- The Australian dollar at around 0.70 to 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity prices remaining reasonably well-supported;
- A positive lead from the US markets and President Trump;
- A moderate pick-up in growth in Australia, back towards trend levels; and
- No material pick up in domestic inflation.
The changes to our portfolio are fairly minor and are:
- A general re-balancing within sectors, with minor changes to some of the individual stock weights;
- A marginal reduction in the financial sector, with the effective weight falling from 50.4% to 47%;
- The addition of Tabcorp to the portfolio.
The portfolio is forecast to generate a yield of 4.90%, franked to 87.4%. Importantly, we expect that this portfolio will moderately underperform relative to the benchmark price index in a strong bull market, and moderately outperform in a bear market.
Construction rules
Before detailing the portfolio, let’s recap on the construction rules that have been applied to develop the portfolio. These are:
- we used a ‘top down approach’ looking at the industry sectors, and introduced biases that favour lower PE, higher yielding sectors;
- so that we’re not overly exposed to a market move, we have determined that in the major sectors (financials and materials), our sector biases will not be more than 33% away from index. For example, the ‘materials’ sector weighting on the S&P/ASX 200 is currently 16.2%, and under this rule, our possible weighting is in the range from 10.8% to 21.69% (i.e., plus or minus one third or 5.4%);
- 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 of $3,000;
- we confined our stock universe to the ASX 100;
- we have avoided stocks from industries where there is a high level of exogenous risk, such as airlines;
- we prioritise stocks that pay fully-franked dividends and have a strong track record; and
- within a sector, the stocks are broadly weighted to their respective index weight, although there are some biases.
Investment themes for 2018
We expect these 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;
- AUD around 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.
* ASX 200 index weights as at 29 December, 2017
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. On paper, it is overweight industrials, however exposure here is being taken through Transurban and Sydney Airport (not “typical” industrial stocks).
Changes from 2017 include the removal of Tabcorp, IAG and Boral (all looking fully priced), and the inclusion of Fortescue and Rio to boost the exposure in materials, particularly to ferrous materials. Link and Suncorp have also been added to the portfolio, the former to provide a measure of exposure to a stock with strong growth prospects.
Our income portfolio per $100,000 invested (using prices at the close of business on 29 December 2017) is:
Forecast returns
Using consensus analyst forecasts from FN Arena, the portfolio has the following characteristics:
Forecast Price Earnings (PE) for 2018: 18.0 (14.8 if Sydney Airport and Transurban are excluded)
Forecast Dividend Yield for 2018: 5.13% pa
Franking: 88.8% (estimated)
For an SMSF in the accumulation phase, the forecast 5.13% dividend yield will translate to an income return of 6.1% pa (after tax), and for a fund in pension phase, the income return will increase to 7.1% pa.
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.