Despite a sideways market in March, our portfolios continued to make positive headway and extended their outperformance. The growth portfolio has outperformed by almost 4.0%, while the income portfolio has exceeded the benchmark so far this year by 3.4%.

We have made some changes to both portfolios at quarter’s end, including reducing our exposure to Woolworths and realising the gain on Toll Holdings.

The purpose of the income and growth-oriented portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we have 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:

• 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 that 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 ASX100;
• 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 ASX100 (there are many great growth companies outside the top 100).

Performance

The income portfolio so far this calendar year is up by 13.70% and the growth-oriented portfolio is up by 14.26% (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 3.37% and the growth-oriented portfolio has outperformed by 3.93%.

Market sideways in March

The market finished marginally lower in March, not being able to crack through the 6000 level. When dividends are added back, it basically finished flat (a loss of -0.1%).

Most sectors finished with small gains or losses in March. The exceptions being materials and energy, where softer commodity and oil prices saw these sectors lose 4.5% and 5.9% respectively.

The largest sector by market weighting, financials, added 2.0% in March to be up 14.1% this calendar year. Profit taking in the property trust (A-REIT) sector saw it go against the ongoing enthusiasm for yield stocks and suffer its first loss in many months. Year-to-date, the sector still boasts a healthy gain of 9.4%.

The table below shows the returns for the 11 sectors.

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.

The income portfolio is forecast to generate a yield of 5.14% in 2015, franked to 88.7%.

In March, with the market largely moving sideways, the portfolio benefitted from its underweight position in materials and energy, and bias towards the major banks in the composition of its financial sector stocks.

With the takeover of Toll Holdings by Japan Post now certain to complete, we have elected to dispose of our holding and use these funds to invest in other areas. Also, with the market taking such a negative view on the outlook for Woolworths in particular and consumer staples in general, we have gone back to index weight by cutting our position in Woolworths in half.

The net $8,901 has been used to top up our position in financials by investing a further $3,000 in Commonwealth Bank and $2,000 in AMP, and to invest $2,000 in Telstra and $1,901 in Woodside. With Woodside, while it is likely to do it tough in the short to medium term, the forecast yield remains very attractive.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 March 2015) is as follows:

Click here to download portfolios in excel format

*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.

Growth portfolio

With our growth-oriented portfolio, we have based our sector exposure on what we expect to be the predominant investment themes in 2015, which are:

• Continued low interest rates (the yield sectors will continue to perform);
• Lower Aussie dollar – moving down towards 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 have maintained an overweight position as the demographic factors are so strong.

With stock selection, we have 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 have pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We have also added online employment and education group Seek, and stuck with two of the laggards in 2014 from the consumer discretionary sector in Crown and JB Hi-Fi.

In March, the portfolio added over 1%, boosted by the performance of stocks that benefit from a lower Australian dollar, such as Resmed, Brambles and Computershare.

Like the income portfolio, we have pared back our exposure to Woolworths and realised the gain on the investment in Toll Holdings. The net $7,939 has been invested in Westfield ($4,000) and Santos $3,939.

While the investment in Santos may be a little premature, we feel that over the medium term, the stock at round $7.00 will prove to be a good entry point.

Westfield is a global business with strong growth prospects. Further, the stock will also benefit from a lower Aussie dollar.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 March 2015) is as follows:

Click here to download portfolios in excel format

* 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.

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.