After a strong start, the share market weakened in the back half of the month, with President Trump’s actions very much the focus of attention. Our portfolios followed the market, finishing marginally down.
In our first review for the year, we look at how the portfolios performed in January. On a relative basis, the income portfolio underperformed the index in January by 0.42%, while the growth portfolio outperformed the index by 0.55%. This largely reflected their exposure to stocks in the materials sector.
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 Oriented Portfolio’ (see here [1] and here [2]).
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 are our predominant investment themes for 2017, which we expect to be:
- Interest rates remaining at low levels, although some upward movement in bond rates;
- The US Fed likely to increase US interest rates by 0.75%, but probably no move in Australia by the RBA;
- The Australian dollar at around 0.70 to 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity prices remaining reasonably well supported;
- A positive lead from the US markets and President Trump;
- 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 January is down by 1.21% and the growth-oriented portfolio is down by 0.24% (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 underperformed the index by 0.42% and the growth-oriented portfolio has outperformed by 0.55%.
[3]
Healthcare and materials lead in January
While the ASX finished with a small loss of 0.8% and most sectors were in the red, the healthcare and materials sectors posted strong gains in January.
Led by the major miners such as BHP (BHP), Rio (RIO), Fortescue (FMG) and South32 (S32), the materials sector added 4.7% in January, as commodity prices continued to firm. The energy sector also finished with a small gain of 0.5%.
Recovering from a tough final quarter of 2016 and on the back of a positive lead from the USA, the healthcare sector added 4.8%. The largest stock by market weight, CSL (CSL), advised the market of an upgraded profit forecast.
On the negative side, the largest sector by market weight, financials, which makes up 37.8% of the index, posted a loss of 2.1%. The real estate sector slipped by 4.8%.
[4]
Income Portfolio
The income portfolio is underweight materials stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small. We have avoided real estate (potential impact of higher interest rates, plus lack of franking on real estate investment trusts), and health care (low dividends and pricing multiples).
The income portfolio is forecast to generate a yield of 4.90% in 2017, franked to 87.3%. The inclusion of Transurban (TCL) and Sydney Airport (SYD), 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.
Apart from the underweight position in materials, the other factor that impacted performance in January was the profit downgrade for Brambles. It advised the market that its first half result (sales and profit) would be less than previous guidance. The stock lost 16.1% over the month. The plus side included the performances of Boral (BLD) and AGL (AGL).
Overall, the portfolio lost 1.21% in January. No changes to the portfolio are contemplated at this point in time.
The income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 January 2017) is as follows:
[5]
Growth Portfolio
A critical construction decision with the growth portfolio has been to take a neutral sector bias in the materials sector. This has led to the inclusion of Rio (along with BHP and Boral).
Overall, the sector biases are relatively small. Despite healthcare underperforming in 2016 and many of the stocks trading on high multiples, we believe that the tailwinds are so strong that our sector position is materially overweight.
The other overweight position is in telecommunications, the only negative performing sector in 2016. This sector now looks cheap on a multiple basis. The major underweight positions are in real estate and consumer staples.
The stock selection is 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 January, the portfolio lost 0.24%. It benefitted from the strong performance of the material stocks, as well as a profit upgrade for CSL, which rose by 11.8%. Offsetting this was the performance of Brambles (see above). No 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 January 2017) 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 regards to your circumstances.