With the market rallying by more than 4% in March, February seems almost a little like ancient history. More so because so much of what we saw last week was a reversal of what happened in February, with the banks and large caps back in favour as utilities, property trusts and industrials stood still.

Notwithstanding their bias towards major cap stocks, our portfolios largely kept pace with the broader market in February. And this is despite the large cap S&P/ASX 20 index losing 4.7% in the month compared to the broader market’s (S&P/ASX 200) loss of 1.8%. Year to date, our income portfolio has outperformed the index by 1.2%, while the growth portfolio has underperformed by 0.5%.

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 and here).

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 is our predominant investment themes for 2016, which we expect 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 29 February is down by 5.99% and the growth oriented portfolio is down by 7.64% (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 1.15% and the growth oriented portfolio has under performed by 0.50%.

Financials take a beating in February

While the S&P/ASX 200 lost 1.8% in February, the narrow large cap S&P/ASX 20, which is dominated by financial stocks, got belted and lost 4.7%.

The financials index lost 7.0%, as negative leads from Europe and the USA, together with speculation about increased short selling and disruption in the property market, hit the share prices of the major banks.

The consumer staples and telecommunications sectors also went backwards, with the latter losing 5.5%.

On the flip side, defensive sectors such as utilities and property trusts finished with gains, while institutions continued to chase industrial stocks, with this sector up 6.2% for the month and 3.4% for the year.

After a horrid January, firming iron ore, copper and gold prices helped to push the materials sector to a 9% gain.

The energy sector finished flat, as oil prices moved firmly back over US $30 per barrel.

Income Portfolio

The income portfolio is underweight materials stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small.

The income portfolio is forecast to generate a yield of 5.26% in 2016, franked to 84.2%. The inclusion of Dexus and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.

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.

Many of the companies reported either half year or full year earnings in February. JB Hi Fi, Brambles, Boral, AGL, Medibank and AMP reported better than the market had expected, while Wesfarmers, Woodside, CBA, BHP, Telstra, Sydney Airport and Dexus were largely in line with expectations. There weren’t any disasters, although BHP’s cut to its dividend was more than we were expecting and may put a little bit of pressure on whether the portfolio can achieve its target yield of 5.26%.

At this point in time, we don’t see any compelling reasons to change the sector weightings or stock mix of the portfolio.

Our income biased portfolio per $100,000 invested (using prices as at the close of business on 29 February 2016) is as follows:

Click here to download an Excel document of the Portfolios

* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis

Growth Portfolio

The growth portfolio is marginally overweight the sectors that will benefit from increased consumer consumption or a lower AUD; 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 3 years, we have elected to maintain an overweight position as the demographic factors are so strong. Recognising that a number of the healthcare stocks are very pricey, we have selected stocks that should benefit from a lower AUD.

Many of the companies reported either half year or full year earnings in February.

JB Hi Fi, Brambles, Boral, Challenger, Ramsay, Seek, Westfield and AGL reported better than the market had expected, while Flight Centre, Wesfarmers, Woodside, CBA, CSL, BHP and Telstra were largely in line with expectations. Importantly, there weren’t any disasters.

BT Investment Management has lost 29% this year as the negative sentiment on equity markets has hit fund managers who earn part of their remuneration through performance fees. Macquarie has also got caught up in this sentiment, losing 22% in price.

At this stage, we don’t propose to exit these positions.

Further, we don’t see any compelling reasons yet to change the sector weightings or stock mix of the portfolio.

Our growth oriented portfolio per $100,000 invested (using prices as at the close of business on 29 February 2016) is as follows:

Click here to download an Excel document of the Portfolios

* CYBG Plc demerged from National Australia Bank in Feb 16, on 1:4 basis

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.