July 2016 was a great month for the Australian share market, as fears of Brexit faded and we joined a global rally in equities. All industry sectors finished in the black as the market added 6.29%, to be up 7.45% this calendar year. Our portfolios followed the market higher, with our income portfolio increasing its relative outperformance.
Year-to-date, our income portfolio has outperformed the index by 2.23%, while the growth portfolio has underperformed by 3.95%.
The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we have also 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 [1]).
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 July is up by 9.68% and the growth-oriented portfolio by 3.50% (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 2.23% and the growth-oriented portfolio has underperformed by 3.95%.
All sectors up in July
All sectors finished in the black in July, as the market surged by 6.3%. Consumer discretionary and consumer staples topped the list, the latter benefitting from a strong performance by Woolworths, which put on 12% in the month.
Energy was the weakest sector, returning a modest 0.2% for the month. This took its year-to-date rise to 4.6%.
The largest sector by market capitalisation, financials, which makes up 37.9% of the overall S&P/ASX 200 index, rose by 6.0% in July, just marginally behind the overall index gain of 6.3%. However, weighed down by the underperformance of the major banks, it is still down 4.0% this calendar year.
Property trusts continued to be bid up as the yield crunch continued. Overall, it is the second best performing sector this year, up by an astonishing 22.6%. The best performing sector is materials, which is up by 25.0%. Higher metal and ore prices have helped companies such as BHP, RIO, Fortescue and South32, while a soaring gold price has seen the price of some of the gold miners double this year.
Other strong performers include industrials and healthcare, both sectors up over 16% this year.
Income Portfolio
The income portfolio is underweight materials stocks and overweight financial stocks. Otherwise, the sector biases are relatively small.
In a bull market, we expect that the income biased portfolio will underperform relative to the standard S&P/ASX200 price index due to the underweight position in the more growth oriented sectors and stock selection being more defensive, and conversely in a bear market, it should moderately outperform.
Strong performances from some of the more defensive stocks such as Medibank (realised), Sydney Airport and Dexus are offsetting the losses on our holdings in the major banks. JB Hi-Fi has also performed strongly, helping the portfolio to outperform the index by more than 2%.
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 11.3%.
The portfolio is forecast to generate a yield of 5.26% in 2016, franked to 84.2%. At a little over the half way point, the portfolio has generated an income return of 2.52%, franked to 81.2%. Although on a run-rate basis this is below the forecast, with second half dividends typically higher than the first half, we expect that the forecast will be met.
No portfolio changes are contemplated at this point in time.
Our income biased portfolio per $100,000 invested (using prices as at the close of business on 29 July 2016) is as follows:
Click here [2] to download an Excel version.
* 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.
Growth Portfolio
The growth portfolio, when set up, was marginally overweight the sectors that should benefit from increased consumer consumption or a lower AUD; 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 3 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 10.8%), and $1,170 into Macquarie.
In July, the portfolio marginally underperformed relative to the index, increasing the year to date gap to 3.95%. This is partly due to its bias with top 20 stocks. Year to date, the S&P/ASX 20 is up by 1.63%, compared to the S&P/ASX 200’s gain of 7.45, a difference of 5.8%. Stock selection is also impacting, with the selection of Flight Centre, BT Investment Management, Macquarie and Westfield. The last three have been affected to some extent by the Brexit decision.
Despite the ongoing performance, no changes are proposed at this point in time.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 July 2016) is as follows:
Click here [2] to download an Excel version.
* 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.
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.