With company reporting season in full swing in August, our portfolios largely held their gains. This was despite the overall market softening towards the end of the month, as global equity markets started to factor in the prospect of an earlier increase in US interest rates.
Our income portfolio increased its relative outperformance, while our growth portfolio reduced its relative underperformance. Year-to-date, the income portfolio has outperformed the index by 2.86%, while the growth portfolio has underperformed by 2.36%.
The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we have also provided a quick recap on these.
Portfolio Recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth-Oriented Portfolio’ (see here [1]).
To construct the income portfolio, the processes we applied included:
- we used a ‘top down approach’ looking at the industry sectors;
- so that we are 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;
- 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 150;
- we have avoided stocks from industries where there is a high level of exogenous risk, such as airlines;
- for the income portfolio, we prioritised stocks that pay fully franked dividends and have a strong earnings track record; and
- within a sector, the stocks are broadly weighted to their respective index weight, although there are some biases.
The growth-oriented portfolio takes a different approach in that it introduces biases that favour the sectors that we judge to have the best medium term growth prospects. Critically, it also confines the stock universe to the ASX 150 (there are many great growth companies outside the top 150).
Overlaying these processes were our predominant investment themes for 2016, which we expected to 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.
Performance
The income-oriented portfolio to the end of August is up by 8.64% and the growth-oriented portfolio by 3.42% (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 outperformed the index by 2.86% and the growth-oriented portfolio has underperformed by 2.36%.
Top 20 still sluggish in August
With many ASX 200 companies releasing either half year or full year earnings reports in August, market action was focused around individual stocks, rather than strong industry or sector themes. Towards the end of the month, the prospect of an increase in US interest rates crept back onto the agenda, pushing the market to finish 1.6% lower for the month.
Reflecting some underwhelming profit results by majors such as CBA, Telstra, IAG, AMP, QBE and CSL, the top 20 stocks lost 2.0% over the month to be down 0.4% for the calendar year. The midcap 50 stocks, which represent stocks ranked 51st to 100th by market capitalisation, finished almost flat for the month but are up by 18.3% this year. Smaller companies, as represented by the Small Ordinaries index, are up this year by 14.3%.
In the sectors, the largest by market capitalisation, financials, which makes up 36.7% of the overall S&P/ASX 200 index, slipped by 1.4% in August. Weighed down by the underperformance of the major banks, it is down by 5.4% this calendar year and is the only sector in the red.
The materials sector added 0.3% in August and continues to be the best performing sector this year, up by 25.4%. Higher metal and ore prices have helped companies such as BHP, RIO, Fortescue and South32, while a stronger gold price has seen the price of some of the gold miners double this year.
One notable feature in August was the profit taking that crept into two of the defensive sectors that have benefited tremendously from lower interest rates, property trusts (A-REITs) and utilities. The former lost 2.8%, while utilities lost 5.2%, reducing it year-to-date gain to13.0%.
Income portfolio
The income portfolio is underweight materials stocks and overweight financial stocks. Otherwise, the sector biases are relatively small.
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 stock selection being more defensive, and conversely in a bear market, it should moderately outperform.
Strong performances from some of the more defensive stocks such as Medibank (realised), Sydney Airport and Dexus are offsetting the losses on our holdings in the major banks. JB Hi-Fi has also performed strongly, helping the portfolio to outperform the index by more than 2%.
At the end of May, we crystalized the gain on Medibank and re-invested the proceeds into $2,442 BHP and $5,000 ASX Limited. The BHP purchase reduced the underweight position in materials by lifting the sector exposure to around 11.6%.
The portfolio is forecast to generate a yield of 5.26% in 2016, franked to 84.2%. Currently, it has generated an income return of 3.56%, franked to 86.3%. We expect that the forecast will be met.
No portfolio changes are contemplated at this point in time. Stocks that have done well and are getting expensive are JB Hi-Fi and Dexus, however replacement stocks (without changing the sector weights) are not obvious.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 August 2016) is as follows:
* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis
** Sale of Medibank at $3.20 on 31/5/16. Proceeds of $7,742 reinvested in $2,242 BHP @ $19.08 per share and $5,000 ASX @ $44.51.
Click here [2] to download portfolio charts.
Growth portfolio
The growth portfolio, when set up, was marginally overweight the sectors that should benefit from increased consumer consumption or a lower Australian dollar; 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 best performing sector over the last three years, we elected to maintain an overweight position as the demographic factors are so strong.
At the end of May, we crystalized the loss on our Flight Centre holding and re-invested the net proceeds of $3,170 into $2,000 BHP shares (which lifted the weighting in material stocks to 10.8%), and $1,170 into Macquarie.
While in August the portfolio improved its relative performance compared to the index, it is still down by 2.4%. This is partly due to its bias with top 20 stocks. Also, the stock selection of BT Investment Management, Flight Centre (realised), Macquarie (until very recently) and Westfield (compared to the traditional A-REITS) has impacted performance.
No changes are proposed at this point in time. Stocks that have performed strongly and are expensive are JB Hi-Fi and Ramsay Health Care, however replacement stocks (without changing the sector weights) are not obvious.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 August 2016) is as follows:
* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis
** Sale of Flight Centre at $31.61 on 31/5/16. Proceeds of $3,170 reinvested in $2,000 BHP @ $19.08 per share and $1,170 Macquarie @ $74.87 per share.
Click here [2] to download portfolio charts.
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.