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 minor changes to our portfolios for 2020 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. Typically, it has delivered an income return of around 5% pa, with the balance of the return comprising capital gain or loss.
The table below shows the total performance of the income portfolio and that of the benchmark S&P/ASX 200. Over the seven years since 2013, it has delivered an annualized total return of 10.14% and outperformed the index by 0.08% pa. This figure doesn’t include the benefits of franking credits or from participating in off-market share buybacks.
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 table below shows the performance of the growth portfolio and that of the benchmark S&P/ASX 200. Over the seven years since 2013, it has delivered an annualized return of 10.84% and outperformed the index by 0.82% pa.
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 18.1%, and under this rule, our possible portfolio weighting is in the range from 12.1% to 24.2% (i.e. plus or minus one third or 6.1%);
- 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.
Investment themes for 2020
We expect these to be:
- A positive lead from the US markets. While the gains of 2019 are unlikely to be repeated, the US election in November means that President Trump will favour market supportive policies;
- Trade tensions between the USA and China to ease (or at least be put on hold);
- Modest economic growth in the USA, with Europe remaining relatively moribund and growth in China moderating;
- In Australia, economic growth to ease to around 2%, with no real pick up in domestic inflation;
- Interest rates in Australia to remain ultra low, while in the USA, the Fed will delay any hike until 2021;
- The oil price to be well supported above US$50 per barrel as OPEC “manages” production to meet demand;
- Iron ore and metal prices to soften;
- The aussie dollar to remain range bound around 70c but with some risk of breaking down;
- Ultra low interest rates to continue to support the recovery in the Australian housing market; and
- Following on from 2018 and 2019, quality stocks with both top and bottom line growth will get even more expensive.
Sector Outlook
Our sector views were detailed in our ‘2020 Investment Outlook’ and the article ‘How to play the Australian Stockmarket in 2020” (see https://switzersuperreport.com.au//assets/InvestmentOutlook2020.pdf). These are summarized in the table below.
* ASX 200 index weights as at 31 December 2019
Overall, our sector views are not particularly strong and so the biases will be relatively small.
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 for the income portfolio in 2020 are fairly minor. It is moderately overweight financials and underweight health care (where here 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. In a bull market, we expect that the income portfolio will underperform relative to the broader market 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 biggest change for this year is to include a (below index) weighting to CSL, Australia’s second largest stock by market capitalization. While the yield on CSL is just a tiny 1%, a portfolio without CSL faces tracking challenges as it is now such a significant weight.
Other changes include the inclusion of Amcor and Santos, the exclusion of AGL, and relative downweightings for JB Hi-Fi and Woolworths. Within the banks, we have biased away from CBA to the other cheaper major banks.
Using consensus analyst forecasts from FN Arena, the income portfolio has the following characteristics:
Forecast Price Earnings (PE) for 2020: 19.8 times
Forecast PE for 2019 (excluding Transurban and APA): 17.0 times
Forecast Dividend Yield for 2020: 4.65% pa
Franking: 77.5% (estimated)
The forecast dividend yield of 4.65% is considerably down on the yield of 6.17% achieved in 2019, due to the absence of special dividends from the resource companies, reduced payouts from the major banks, and the impact of higher share prices. The franking percentage has been reduced by the inclusion of stocks such as Dexus, Transurban and APA.
For an SMSF in the accumulation phase, the forecast 4.65% dividend yield will translate to an income return of 5.4% pa (after tax), and for a fund in pension phase, to 6.2%.
Our income portfolio per $100,000 invested (using prices at the close of business on 31 December 2019) is:
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 staplers, 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.
Changes from 2019 are the inclusion of Aristocrat Leisure, a2 Milk, Resmed, Xero and Amcor. AGL has been excluded from the portfolio, with relative downweightings for JB Hi-Fi, TPG, CSL and Seek. Within the major banks, the 3 cheaper major banks have been biased ahead of CBA.
Using consensus broker forecasts from FN Arena, the portfolio has the following characteristics:
Forecast Price Earnings multiple for 2020: 46.5 times
Forecast PE multiple for 2020 (excluding Xero): 19.9 times
Forecast Dividend Yield for 2020: 3.73%
Franking: 85.2% (estimated)
Our growth portfolio per $100,000 invested (using prices as at the close of business on 31 December 2019) 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.
