In the ninth review for 2019, we look at how our model income and growth portfolios performed in September.
The purpose of these portfolios is to demonstrate an approach to equity portfolio construction. As the rule sets applied are of critical importance, we provide a quick recap on these. Also, it is important to note that these portfolios are designed as “long only”. They don’t allocate to “cash” and don’t represent a view about the outright direction of the market.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth Portfolio’ (see https://switzersuperreport.com.au/here-are-our-portfolios-for-2019/ [1] )
The construction rules for the portfolios are:
- we use a ‘top down approach’ looking at the prospects for each of the industry sectors;
- for the income portfolio, we introduce biases that favour lower PE, higher yielding sectors;
- so that we are not overly exposed to a market move, in the major sectors (financials and materials), our sector biases will not be more than 33% away from index. For example, the weighting of the ‘materials’ sector on the S&P/ASX 200 is currently 18.9%, and under this rule, our possible portfolio weighting is in the range from 12.6% to 25.2% (i.e. plus or minus one third or 6.3%);
- 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 size of $3,000;
- our stock universe is confined to the ASX 100. This has important implications for the growth portfolio, because the stocks with the best medium term growth prospects will often come from outside this group (the so called ‘small’ caps);
- we avoid stocks from industries where there is a high level of exogenous risk, such as airlines;
- for the income portfolio, we prioritise stocks that pay fully franked dividends and have a consistent record of paying dividends; and
- within a sector, the stocks are broadly weighted to their respective index weights, although there are some biases.
Overlaying these processes were our predominant investment themes for 2019, which we expected to be:
- Economic growth to slow in the USA, Europe, China and Japan, but not into recession territory;
- The US Fed moving to a more neutral stance on US interest rates. If not pausing, only one or two more hikes in 2019 (but no expectation of rate decreases);
- Interest rates in Australia to remain at historically low levels, with the RBA unlikely to move rates higher (but again, no expectation of rate decreases);
- Australian dollar around 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Oil price remaining well supported around US$50 per barrel. Base metal and iron ore prices to soften;
- A positive lead from the US markets;
- Growth in Australia to ease to around 2.5%, with no real pick-up in domestic inflation;
- Housing prices in Australia to ease moderately, but not collapse.
Performance
The income portfolio is up by 20.91% and the growth-oriented portfolio by 20.14% (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 1.65% and the growth oriented portfolio by 2.42%.
Financials and resources lead in September
The largest sector by market weighting, financials, led the market higher in September. Comprising 32.4% of the S&P/ASX 200 index, financials added 4.1% in September which took its year to date gain to 21.2%. The second largest sector, materials, returned 3.1% whilst the other “resources” sector, energy, put on 4.7% on the back of a surge in the oil price.
In somewhat of a mean reversion, sector stars healthcare and information technology eased a touch in September. For calendar 2019, these sectors still lead with returns of 25.9% and 31.3% respectively.
All sectors are positive for the year. Interestingly, the performance of the sectors is relatively even, with the gap between the best performing sector (information technology at 31.3%) and the worst performing sector (utilities at 14.4%) relatively narrow by historical standards.
Returns for the 11 industry sectors in September and calendar 2019, plus their respecting weighting as part of the ASX 200, are shown in the table below.
Income portfolio
On a sector basis, the income portfolio is moderately overweight financials and utilities, and underweight materials and health care (where there are no medium or high yielding stocks in the ASX 100). Otherwise, the sector biases are reasonably minor.
On paper, it is roughly index weight in industrials. However, this exposure is being taken through toll road operator Transurban which is not your typical industrial stock.
In the expectation that interest rates in Australia are staying at record low levels, it has a defensive orientation and a bias to yield style stocks. In a bull market, we expect that the income portfolio will underperform relative to the broader market 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.
The portfolio is forecast to yield 5.78%, franked to 82.3%. The forecast yield is higher than would normally be expected due to the payment by BHP of a special dividend of $1.42 per share. When this is excluded, the yield drops back to 5.49%.
In September, the income portfolio returned 1.81% (essentially the same as the market’s 1.84%). Year-to-date, it has returned 20.91% for a relative underperformance of 1.65%.
The return includes both capital and income. On the income side, the return (which includes dividends that the portfolio is contractually entitled to) is currently 4.94%, franked to 84.7%. When final dividends from the 3 major banks, Macquarie, Transurban, Dexus and APA are received, the income return should be very close to the forecast above.
No changes to the portfolio are contemplated at this point in time. Woolworths and Wesfarmers are very expensive (the portfolio is a ‘long-only’ portfolio – if not, we would probably take some profits and move to cash), and we continue to monitor the position in Link closely.
The income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 September 2019) is as follows:
¹Does not include the tax benefit of accepting the Woolworths off-market share buyback
Growth portfolio
The growth portfolio is moderately overweight financials and energy, and underweight materials, consumer staples and real estate. Overall, the sector biases are not strong.
The stock selection is marginally 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.
In September, the portfolio returned 3.76% for a relative outperformance of 1.92%. Year-to-date, it has returned 20.14% for an underperformance of 2.42%.
Assisting the performance in September were the strong gains made by the financial and resource stocks, as well as a rebound in TPG and Link. Bluescope, CSL and Ramsay were the only stocks in the portfolio to slip in September.
Most of the underperformance in 2019 is due to 4 stocks – Link, Reliance, AGL and Challenger. In the case of Link, we continue to monitor closely. No changes to the portfolio are proposed at this point in time.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 September 2019) is as follows:
¹ Aristocrat ($4,000) purchased 1/1/19 @ $21.84, sold 31/5/19 @ $29.12 for profit of $1,333
² Challenger ($4,000) purchased 1/1/19 @ $9.49, sold 31/5/19 @ $8.07 for loss of $599
³ Following sale of Aristocrat and Challenger, proceeds re-invested on 31/5/19 into $3,734 NAB @ $26.49, $2,000 CSL @ $205.49 and $3,000 Bluescope @ $10.54.
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 regard to your circumstances.