Our portfolios for 2018

Co-founder of the Switzer Report
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The purpose of our model portfolios (income and growth) is to demonstrate an approach to portfolio construction that SMSFs or personal investors could apply.

We have made some changes to our portfolios for 2018 to take into account the dominant investment themes that we expect to apply. We have also rebalanced the portfolios.

Recap on portfolio objectives and performance

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

In a bull market, we expect that the income 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.

In calendar 2013, the income portfolio returned 24.36% – an outperformance of 4.16% compared to the index. In calendar 2014, the portfolio returned 8.13% – an outperformance of 2.52%. In calendar 2015, the portfolio returned 1.95% – an underperformance of 0.61%, while in 2016, it returned 14.48% for an outperformance of 2.68%. In 2017, it returned 8.36% for an underperformance of 3.17%. Compared to the 5-year return of the S&P/ASX 200 of 10.23% pa, the income portfolio has returned 11.20% per annum for a net outperformance of 0.97% per annum.

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

In calendar 2013, the growth 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%. In calendar 2015, the portfolio returned 6.67% – an outperformance of 4.11%, while in 2016, it returned 9.82% for an underperformance of 1.98%. In 2017, it returned 11.26% for an underperformance of 0.54%. Compared to the 5-year return of the S&P/ASX 200 of 10.23% pa, the growth portfolio has returned 11.44% per annum for a net outperformance of 1.21% per annum.

Portfolio construction rules

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 17.9%, and under this rule, our possible portfolio weighting is in the range from 12.0% to 23.8% (i.e. plus or minus one third or 5.9%);
  • 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.

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;
  • Australian 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 US markets;
  • a moderate pick-up in growth in Australia, back towards trend levels; and
  • no material pick up in domestic inflation.

Sector outlook

Our sector views were detailed in the following article (click here https://switzersuperreport.com.au/how-to-play-the-australian-stockmarket-in-2018/). In summary, these are:

* ASX 200 index weights as at 29 December, 2017

The major callouts are for a moderately overweight position in financial stocks and to be at least index-weight in the resource sectors.

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. 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:

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% per annum (after tax), and for a fund in pension phase, the income return will increase to 7.1% per annum.

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.

Changes from 2017 include the removal of Resmed and down weighting of the health care sector, the replacement of Boral with Orora (the former looking fully priced), and the inclusion of Aristocrat Leisure and Fortescue.

Our growth portfolio per $100,000 invested (using prices as at the close of business on 29 December 2017) is as follows:

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

Forecast Price Earnings multiple for 2018:       20.11
Forecast Dividend Yield for 2018:                       4.12%
Franking:                                                                  82.8% (estimated)

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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