Key points
- ASX/S&P 200 was up 4.5% in October, reversing most of September’s 5.4% loss.
- Income portfolio is up 9.13% year to date, helped by moderately overweight positions in financials and telecommunications and stock selection is playing a key role.
- Growth-orientated portfolio is up by 3.79% year to date. Bias away from the yield sectors is hurting, and stock selections in the consumer discretionary sector are yet to show gains.
A strong lead from the US led to local stock market gains of 4.5% in October, reversing most of September’s 5.4% loss. The top 20 stocks, in particular the major banks, led the market higher. For the first 10 months of the year, the market has put on 3.3% – or almost 7% when dividends are included.
Our portfolios followed the market up, with our high-income portfolio continuing to perform strongly as “yield” stocks roared back into favour. In this, our tenth review for the year, we look at the composition and performances of the portfolios. Our high-income portfolio is up by 9.1% and has outperformed the S&P/ASX 200 this calendar year by 2.2%, while our growth-oriented portfolio is up by 3.8% and has underperformed by 3.2%.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth Oriented Portfolio’.
The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets are of critical importance, we always commence a review by briefly recapping the key portfolio construction processes applied.
The income portfolio is forecast to generate a yield of 5.01%, franked to 90.4%. The construction rules applied include:
- 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, materials and consumer staples) 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
- Of course, we looked for companies that pay franked dividends and have a consistent earnings record.
The growth-oriented portfolio takes a very 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-oriented portfolio is up by 9.13% and the growth-oriented portfolio by 3.79% (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 2.17% and the growth-oriented portfolio has underperformed by 3.17%.
Yield sectors roar back into life
Who said the “yield” trade was dead? Continuing the theme that has driven the market over the last few years, the yield sectors put in stellar performances. The largest sector, financials, with a weighting in the S&P/ASX 200 of 39.7%, added 6.9% in October to take its year to date gains to 9.5%. Property trusts added 6.8%, telecommunications (which is largely Telstra) 6.0%, consumer staples 5.0% and utilities 2.3%.
Healthcare was a standout sector rising by 6.2%, with strong gains from stocks such as CSL, Cochlear and Sirtex.
Energy stocks fell as the oil price headed south, and although iron ore prices stabilised, the major miners in the materials sector made little headway.
Interestingly, the top 20 stocks led the market, with a gain of 5.27% in October. At the other end of the scale, the Small Ordinaries index (which represents stocks ranked from 101 to 300 by market capitalisation), fell by 0.51%.
Year to date, the best performing sectors are property trusts with a return of 21.7%, healthcare at 16.2% and utilities at 15.2%. Materials is the only sector in the red at -6.2%.
The table below shows the sector weights (as a proportion of the S&P/ASX 200), and performances (total return) for the month of October and for the 2014 calendar year.
Income portfolio
The income portfolio is overweight ‘financials’, ‘consumer staples’, ‘utilities’ and ‘telecommunications’; underweight ‘materials’ and ‘consumer discretionary’; and broadly index-weight the other sectors. It also includes an allocation to ‘property trusts’ (formally called the A-REIT sector), and somewhat more exposure to the “cyclicals” through the selection of stocks from the ‘industrial’ sector.
With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark price index in a strong bull market, and moderately outperform in a bear market.
For the first 10 months of the year, the portfolio is outperforming the index. While sector selection is helping, through the moderately overweight positions in financials and telecommunications, stock selection is playing a key role. The inclusion of stocks such as Leighton, Orora and Dexus is compensating for the poor performance of stocks such as Primary and AGL. A slight bias to stocks that will benefit from a weaker Aussie dollar, such as Brambles, is also assisting.
The income portfolio is forecast to generate a yield of 5.01% in 2014, franked to 90.4%. With most companies now having declared their final dividend for the year, we can now confidently predict that the realised yield on the portfolio should marginally exceed the original target.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 October 2014) is as follows:
Income includes dividends declared and payable.
*AGL rights following 1:5 renounceable issue at $11.00, assumed sold on last day of rights trading at $2.62. **Assumes 37.5% Leighton shares sold in partial offer at $22.50, repurchased on 30/4 at $19.08.
Growth portfolio
Similar to our approach to the income portfolio, we applied a ‘top down’ approach to the industry sectors and introduced biases that favour the sectors that we feel have the best medium-term growth prospects. The growth-oriented portfolio is overweight ‘health care’, ‘consumer discretionary’ and ‘industrials’; underweight ‘financials’ and ‘property trusts’; and largely index weight the other sectors, including ‘materials’.
Critically, we have biased the stock selection to companies that should benefit from a falling Australian dollar – either because they earn a major share of their revenue offshore, or report their earnings in US dollars – such as CSL, Amcor, Brambles, Computershare and BHP. Other biases include Woolworths over Wesfarmers; CBA and Westpac over ANZ and to a lesser extent NAB; and the selection of Crown and JB Hi-Fi.
At the end of May we decided to make some changes to the portfolio. We reduced our exposure to the ‘materials’ sector by selling our holding in Rio for a loss of $391, exited our holding in Primary Health Care for a loss of $291 and replaced this with Resmed, and increased our exposure to the ‘consumer discretionary’ sector through additional holdings in Crown and JB Hi-Fi.
The portfolio is lagging the index by 3.2%. Our bias away from the yield sectors (for example, no property trusts) is hurting, and the performance of our stock selections in the consumer discretionary sector (Crown and JB Hi Fi) has been very disappointing. While the market doesn’t presently agree with our selections, we remain confident that both these companies have sound medium-term growth prospects and are reasonably priced
Our stock selections that favour a lower Aussie dollar – CSL, Brambles, Resmed, Amcor and Computershare – continued to perform relatively strongly.
At this point, we are going to hold with the portfolio and continue to monitor it closely. Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 October 2014) is as follows:
Income includes dividends declared and payable.
*Prices of Crown (new), JB Hi-Fi (new) and Resmed (new) as at 30 May. ** AGL rights following 1:5 renounceable issue at $11.00, assumed sold on last day of rights trading at $2.62.
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.
