Key points
- The S&P/ASX 200 Accumulation Index (which adds back income from dividends) is down by 3.68% for the year-to-date.
- Amongst a sea of red for most sectors, utilities are up 13.5% and A-REITs (property trusts) are ahead by 7.9% for the year to the end of September.
- Despite underperforming in September, Healthcare also continues to be a standout and is up 3.1% this year.
The Australian share market lost a further 3.0% in September, as a ‘non decision’ by the US Fed and fears about Chinese growth pressured world stock markets. While our model portfolios continue to outperform the market, both were impacted by the selling that emerged in the most liquid stocks, and are now in the red for the calendar year.
The income portfolio has outperformed the index by 1.09%, while the growth portfolio is 2.44% higher than the benchmark return.
The purpose of the income and growth-oriented portfolios is to demonstrate an approach to portfolio construction.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income portfolio’ and ‘Growth-oriented portfolio’ (see here [1] and here [2]).
To construct the income portfolio, the processes we applied included:
- Using a ‘top down approach’ and introducing biases that favour lower PE, higher yielding industry sectors;
- To minimise the market tracking risk, adopting a rule that says our sector biases in the major sectors (financials and materials) will not be more than 33% away from index;
- Identifying 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), with a stock universe confined to the ASX 100;
- Within a sector, weighting the stocks broadly to their respective index weights, although there are some biases; and
- Looked for companies that pay franked dividends and have a consistent earnings record.
The growth-oriented portfolio takes a different approach to the sectors 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 100 (there are many great growth companies outside the top 100).
Performance
The income portfolio is down by 2.59% this calendar year and the growth-oriented portfolio is down by 1.24% (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 1.09% and the growth-oriented portfolio has outperformed by 2.44%.
[3]The red ink continues
Following a horrid August, most sectors finished in the red again in September. The exceptions were the smallest sector by ASX weighting, information technology, which was largely due to a rebound in the price of an oversold Computershare, and the industrials sector, which added 2.1%.
The resources sectors were the most impacted, with energy losing 12.2% to take the sector to a year-to-date loss of 26.4%, while materials (which includes stocks like BHP, Rio and Amcor) lost 4.9%. The largest sector financials lost 3.3%, with the impact of capital raisings continuing to pressure the major banks.
Over the course of 2015, the defensive yield sectors continue to lead the way. Utilities at 13.5% and A-REITs (property trusts) at 7.9% are amongst the best performing sectors. The other clear take is that the sectors with companies that should benefit from a lower Australian dollar, such as industrials and arguably consumer discretionary, are doing relatively better.
Despite underperforming in September, Healthcare also continues to be a standout and is up 3.1% this year.
The table below shows the returns for the 11 sectors, plus their weighting (as at 30 September) of the S&P/ASX 200.
[4]Income portfolio
The income portfolio at the start of the year was overweight consumer staples, utilities and telecommunications; underweight materials and energy, and broadly index-weight the other sectors. Reflecting an expectation that the banks will, over time, have to raise more capital, we neutralized our exposure to financials. Further, following a stellar performance in 2014, our exposure to property trusts (the A-REIT sector) is also neutral.
With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark accumulation index in a strong bull market, and moderately outperform in a bear market.
At the end of March, we made some changes to the portfolio. We crystallized our profit on Toll Holdings, following the announcement of its takeover by Japanese Post; cut our exposure in consumer staples to go back to index weight by selling (for a small loss) 50% of our position in Woolworths; and reinvested those proceeds in Woodside, Telstra, Commonwealth Bank and AMP.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
In September, the income portfolio underperformed against the index, with capital raisings affecting performance of the major banks, BHP under pressure due to concerns about China, and Woodside being punished for its proposed offer for Oil Search.
With sector weightings broadly in line, we don’t propose to make any changes at this point in time.
The income portfolio is forecast to generate a yield of 5.14% in calendar 2015, franked to 88.7%. With most companies now having declared their final dividend, this target should be moderately exceeded. Currently, the portfolio sits at 4.3%, franked to 86.2%.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 September 2015) is as follows:
[5]
* On 31 March, reduced original $6,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $1,901 reinvested in Woodside, $2,000 in AMP, $3,000 in CBA and $2,000 in Telstra.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50, assume sold on last day of trading at $2.01.
Growth portfolio
With our growth-oriented portfolio, we based our sector exposure on what we expected to be the predominant investment themes in 2015, which are:
• Continued low interest rates (the yield sectors will continue to perform);
• Lower Australian dollar – moving down towards 0.70 US cents;
• Positive lead from the US markets;
• No pick up in commodity prices;
• Growth running slightly below trend in Australia; and
• Low oil prices will lead to a rise in consumer spending in Australia.
This leads to a portfolio with only small biases. We are marginally overweight the sectors that will benefit from increased consumer consumption, a lower Australian dollar or lower oil prices – mainly the so called “cyclicals” (consumer discretionary and industrials); 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 second best performing sector last year, we maintained an overweight position as the demographic factors are so strong.
With stock selection, we biased the portfolio to companies that should 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, such as CSL, Resmed, Brambles and Computershare. In the financials, we pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We added online employment and education group Seek, and stuck with Crown and JB Hi-Fi from the Consumer Discretionary sector.
At the end of March, the portfolio realized the profit on its investment in Toll Holdings and, like the income portfolio, cut its exposure in Woolworths. These proceeds were reinvested in Santos and Westfield.
Further changes to the portfolio occurred in May, with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. We assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
At the end of August, we cut our exposure to Santos (for a loss of $1,109) and re-invested the net proceeds of $2,913 into National Australia Bank.
In September, the portfolio tracked the market lower, but still retained its relative outperformance. Positive performances from Westfield, Macquarie, Challenger and a rebound in Computershare, helped to cushion the share price falls with the major banks, BHP, Boral and Crown.
With sector weightings broadly in line, we don’t propose to make any changes at this point in time.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 September) is as follows:
[6]
* On 31 March, reduced original $4,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $3,939 reinvested in Santos and $4,000 in Westfield.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50, assume sold on last day of trading at $2.01.
*** Santos acquired on 31 March at $7.14 sold for $5.13 on 31 August. Net amount of $2,830 reinvested in NAB at $31.17.
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.