The takeover of Toll Holdings by Japan Post and a buoyant share market saw our portfolios surge in February, with each adding gains in excess of 8%. While early days, both portfolios are outperforming the benchmark index.

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

Performance

The income portfolio to 27 February is up by 12.37% and the growth-oriented portfolio is up by 12.95% (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 1.98% and the growth-oriented portfolio has outperformed by 2.56%.

Materials and energy rebound

The thirst for yield took a little bit of a breather in February, with the resource-based sectors (Materials and Energy) leading the market higher. While all sectors finished in the black, on the back of some impressive earnings results from (in particular) Rio and BHP, the Materials sector put on 11.9% during the month. Oil prices stabilised, which helped the Energy sector add 9.2%.

With reporting season in full swing in February, the Consumer Discretionary sector added 7.7% to be up 14.4% this year, the best performing sector. A very close second is the Utilities sector. All sectors are showing gains on a year-to-date basis.

Woolworth’s disappointing half-year result, which was announced last Friday, hit the Consumer Staples sector. It was the second worst performing sector during the month, and has only returned 4.6% so far this year, compared to the S&P/ASX 200 return of 10.4%.

Income Portfolio

The income portfolio is 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 have 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 price 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 February, sector exposures worked against the portfolio’s return relative to the market. Sectors where the portfolio is underweight (materials and energy) performed strongest, whereas sectors where the income portfolio is overweight (consumer staples and telecommunications) were the weakest performers. Offsetting this was stock selection.

The takeover of Toll Holdings by Japan Post added almost 2% to the income portfolio’s return. AGL, AMP, Boral and JB Hi-Fi performed impressively as their half-year results were received favourably by the market, and compensated for the performance of Woolworths. Interestingly, all stocks except Woodside have made a positive contribution this year.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 27 February 2015) is as follows:

Click here to download in excel format

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 AUD – moving down towards 0.75 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 who 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 February, apart from Toll Holdings, which added almost 2% to the portfolio’s performance, the other standouts were Macquarie and Crown Holdings. BHP added 15% as its share price rose from $29.26 to close the month at $33.65.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 27 February 2015) is as follows:

Click here to download in excel format

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.