On the back of a company-reporting season that largely met expectations, the Australian share market added 1.4% in August, as it pushed towards 10-year highs. Smaller and mid-cap companies did relatively better than large-cap companies, and one of the laggard sectors this year, telecommunications, was the best performing sector in the month.
Our model portfolios recorded gains of around 1% to 2% in August. Year-to-date, our model income portfolio, which is overweight financials and telecommunications, has underperformed the index by 4.1%, while our model growth portfolio has outperformed the index by 0.9%.
In our eighth review for the year, we look at how our income and growth portfolios performed in August. 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.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth Portfolio’ (see https://switzersuperreport.com.au/our-portfolios-for-2018/ [1]).
The construction rules applied were:
- A ‘top down approach’ that looks at the prospects for each of the industry sectors;
- For the income portfolio, we introduced 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%, and under this rule, our possible portfolio weighting is in the range from 12% to 24% (i.e. plus or minus one third or 6%);
- 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 S&P/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.
Overlaying these processes are our predominant investment themes for 2018, which we expect 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;
- Aussie 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 the US markets;
- A moderate pick-up in growth in Australia, back towards trend levels; and
- No material pick up in domestic inflation.
Performance
The income portfolio to 31 August is up by 3.10% and the growth-oriented portfolio is up by 8.15% (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 the index by 4.13% and the growth-oriented portfolio has outperformed the index by 0.92%.
Major sectors struggle as telco surges
With company reporting season in full swing, the two major sectors, financials and materials, struggled in August. The largest sector on the ASX, financials, with a market weighting of 32.8%, finished flat, while materials lost 4.8%.
Telecommunications, which has been the worst performing sector this year, surged by 13.1%, as Telstra found favour and TPG announced a “merger of equals” with Vodafone Australia.
On the back of a string of positive company earnings reports, the information technology sector added 12.7%, to be up by 25.7% this year. The health care sector leads the market over the first eight months. The performance of stocks such as CSL, Resmed and Cochlear has driven the sector’s return to 40.6%.
Individual sector returns (for August and 2018) are set out in the table below.
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.
In a bull market, we expect that the income-biased 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.
The portfolio is forecast to generate a yield of 5.13% in 2018, franked to 88.8%. The inclusion of Transurban and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.
In August, the income portfolio returned 0.89%, which took its year-to-date return to 3.10%, 4.13% below the accumulation index return. It benefitted in August from the performance of JB Hi-Fi, Wesfarmers and Telstra, and suffered from the underperformance of the major banks and major resource companies.
With trade tremors still very much in the news, we are proposing to reduce our weighting in materials and exit the holding in Fortescue. This will be re-invested in the new Transurban entitlement issue (10 for 57 @ $10.80) and additional shares in Westpac.
From an income point of view, the portfolio has returned 3.94%, franked to 92.79% this year. This is tracking to plan and we remain confident that the full-year forecast of 5.13% will be met.
The income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 August 2018) is as follows:
* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
² AMP shares sold on 30 April @ $4.04, loss of $886 realised. Balance of $3,114 invested in ANZ @ $26.84
³ Fortescue shares sold on 31 August @ $3.84, loss of $639 realised. Balance re-invested in Transurban Entitlement issue (10 for 57 @ $10.80) and $1,446 Westpac @ $28.54.
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.
The stock selection is marginally biased to companies that will 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. While we expect that the Aussie dollar will remain well supported and trade in a fairly narrow range in the short term, the risk is that a strengthening US dollar causes it to break down.
In August, the growth portfolio returned 1.62%, which took its year-to-date return to 8.15%. It has outperformed the accumulation index by 0.89%.
Strong performances by CSL, JB Hi-Fi and TPG (the latter following its announced merger with Vodafone) offset weakness with Challenger and Ramsay.
With trade tremors still in the news and some weakness in commodity prices, we propose to realise the loss on Fortescue and decrease the weighting in materials. The balance of $3,148 will be invested into Westpac shares. No other changes to the portfolio are contemplated at this point in time.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 August 2018) is as follows:
* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
² Fortescue shares sold on 31 August @ $3.84, loss of $852 realised. Re-invested in $3,148 Westpac @ $28.54.
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.