A surprise victory by Donald Trump led to a rally in global share markets in November, as investors sensed that he would invest in infrastructure and defence while cutting company taxes to stimulate the US economy. Bond yields soared, gold fell and the US dollar rallied. In Australia, our share market largely followed suit, adding just on 3% during the month.

Both our income and growth-oriented portfolios performed better than the market in November. The income portfolio has increased its relative outperformance to 3.25% and has returned 10.36% this year, while the underperformance of the growth portfolio has narrowed to 0.79%. It has returned 6.32%.

The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we also 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 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 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 November is up by 10.36% and the growth-oriented portfolio by 6.32% (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 3.25% and the growth-oriented portfolio has underperformed by 0.79%.

Financials lead in November

The biggest sector by market weight, financials, led the market higher with a gain of 6.1% in November. With bond yields rising and concerns about the prospect of further dilutive capital raisings fading, each of the major banks posted strong gains.

The materials sector continued to set the pace. On the back of firmer base metal prices, including iron ore, copper, nickel and coal, the sector put on 2.5% during the month. On a year-to-date basis, the sector has added 37.5%. No other sector is in double figures.

Elsewhere, most other sectors lagged the market’s overall monthly return of 3.0%, with either small gains or small losses. Healthcare, one of the best performing sectors over the last five years, continued to be hit by profit taking and momentum driven switching. Following a loss of 8.3% in October, it dropped by another 1.4% in November to be barely in the black on a year-to-date basis.

The telecommunications sector also struggled, with highflyers Vocus and TPG coming under pressure, and Telstra out of favour due to concerns about an NBN earnings hole in FY2022.  Year-to-date, it is the worst performing sector, with a loss of 7.5%.

Income portfolio

The income portfolio started the year underweight materials stocks and overweight financial stocks. Otherwise, the sector biases were relatively small.

Strong performances from some of the more defensive stocks, such as Medibank and Dexus (now both realised), as well as from the exposure to the materials sector through BHP, have offset the losses on our holdings in Westpac and CBA. JB Hi-Fi has also performed strongly, helping the portfolio to outperform the index by more than 3%.

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 12.0%.

At the end of October, in anticipation that we are moving into a period of higher interest rates and that property trusts are fully priced, we realised our profit on Dexus. The net sum of $8,344 was reinvested into $5,000 Transurban and $3,344 National Australia Bank.

No other changes are contemplated at this point in time. In keeping with usual practice, the Boral entitlements will be divested on the last day of trading (2 December).

The portfolio was originally forecast to generate a yield of 5.26% in 2016, franked to 84.2%. Currently, it has generated an income return of 4.74% franked to 91.4%. With final dividends outstanding for Sydney Airport and Transurban, the portfolio is now expected to generate an income return in 2016 of 5.0%, franked to 87%.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 November) is as follows:

To view a larger version of this table, click here.

* 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.

*** JB Hi-Fi entitlements on 1:6.6 basis, assumed to be sold on last day of trading (23/9) at $3.02

**** Sales of Dexus at $8.94 on 31/10/16. Proceeds of $8,344 reinvested in $3,344 NAB @ $28.00 per share (cum-dividend), and $5,000 Transurban at $10.39 per share.

***** Boral 1:2.2 renounceable entitlement at $4.80 per share.

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 11.7%), and $1,170 into Macquarie.

During September, JB Hi-Fi completed an entitlement issue to fund the purchase of the Good Guys retailing chain. As the model portfolio is fully invested and doesn’t hold cash, we assume that the entitlement was sold on the last trading day.

While the portfolio has improved its relative performance compared to the index, it is still down by 0.8%. This is partly due to its bias with top 20 stocks. Also, the stock selection of BT Investment Management, Flight Centre (realised) and Westfield (compared to the traditional A-REITS) has impacted performance.

No changes are proposed at this point in time. In keeping with usual practice, the Boral entitlements will be divested on the last day of trading (2 December).

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 November 2016 is as follows:

To view a larger version of this table, click here.

* 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.

*** JB Hi-Fi entitlements on 1:6.6 basis, assumed to be sold on last day of trading (23/9) at $3.02

**** Boral 1:2.2 renounceable entitlement @ $4.80 per share

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.