Key points
- The income portfolio is up by 1.54% this calendar year and the growth-oriented portfolio is up by 1.87%.
- The income portfolio has outperformed the S&P/ASX 200 Accumulation Index by 2.29% and the growth-oriented portfolio has outperformed by 2.62%.
- Financials lost 10.6% in August, with both ANZ and Commonwealth Bank announcing capital raisings. Energy finished 13.9% down, and the smallest sector, IT, which accounts for only 0.7% of the S&P/ASX 200, was the worst performing sector.
Fears about the strength of the Chinese economy and a fairly ordinary company reporting season saw the Australian share market give back all of the gains it made in July and more, to finish 7.8% lower in August. While our portfolios continued to outperform the market, they tracked the market lower as selling emerged with the most liquid stocks the most impacted.
For the first eight months of the calendar year, the income portfolio has outperformed the index by 2.29%, while the growth portfolio is 2.62% higher than the benchmark return.
The purpose of the income and growth oriented portfolios is to demonstrate an approach to portfolio construction.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth-oriented Portfolio’ (see here [1] and here [2]).
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 S&P/ASX 100 (there are many great growth companies outside the top 100).
Performance
The income portfolio is up by 1.54% this calendar year and the growth-oriented portfolio is up by 1.87% (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 2.29% and the growth-oriented portfolio has outperformed by 2.62%.
[3]Red ink everywhere!
All sectors finished in the red in August. Financials was one of the most impacted sectors, losing 10.6%, with both ANZ and Commonwealth Bank announcing capital raisings. Energy was hit hard as the oil price plunged with the sector finishing 13.9% down. The smallest sector, IT, which accounts for only 0.7% of the S&P/ASX 200, was the worst performing sector. Largely as a result of a disappointing earnings report (and outlook statement) from Computershare, the sector shed 15.1%.
Over the course of 2015, the yield sectors by and large continue to lead the way. Utilities at 17.0%, A-REIT (property trusts) at 8.2% and telecommunications (which is largely Telstra) at 3.1% are among the best performing sectors.
The other clear take is that the sectors with companies that are more likely to do better from a lower A$, such as Industrials and arguably consumer discretionary, are also doing relatively better.
Healthcare also continues to be a standout sector, with the ageing population/demand for health services/lower $A acting as tailwinds for this sector.
The table below shows the returns for the 11 sectors, plus their weighting (as at 31 August) of the S&P/ASX 200.
[4]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.
At the end of March, we made some changes to the portfolio. We crystallized our profit on Toll Holdings following the announcement of its takeover by Japanese Post; cut our exposure in consumer staples to go back to index weight by selling (for a small loss) 50% of our position in Woolworths; and reinvested those proceeds in Woodside, Telstra, Commonwealth Bank and AMP.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
In August, the income portfolio largely followed the index down, with capital raisings affecting performance of the major banks. Earnings results and outlook statements also impacted – on the negative side in particular from Boral and Primary Healthcare, while AGL and JB Hi-Fi were on the positive side.
With sector weightings broadly in line and there being no stocks where we have any material concerns, we don’t propose to make any changes at this point in time.
The income portfolio is forecast to generate a yield of 5.14% in calendar 2015, franked to 88.7%. With most companies now having declared their final dividend, this target should be moderately exceeded. Currently, the portfolio sits at 3.69%, franked to 86.6%. Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 August 2015) is as follows:
[5]Click here to download an Excel file
* 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.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50.
Growth portfolio
With our growth-oriented portfolio, we based our sector exposure on what we expected to be the predominant investment themes in 2015, which are:
- Continued low interest rates (the yield sectors will continue to perform);
- Lower A$ – moving down towards 0.70 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 A$ 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 maintained an overweight position as the demographic factors are so strong.
With stock selection, we 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 pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We added online employment and education group Seek, and stuck with Crown and JB Hi-Fi from the consumer discretionary sector.
At the end of March, the portfolio realized the profit on its investment in Toll Holdings and like the income portfolio, cut its exposure in Woolworths. These proceeds were reinvested in Santos and Westfield.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.
In August, the portfolio gave up some of its earlier outperformance to fall slightly harder than the market. Earnings results and outlook statements figured prominently, with Crown, Computershare, Seek and Boral disappointing. On the positive side were Ramsay, Challenger and AGL.
We propose to make one change to the portfolio, mainly because it has reached our pain threshold and the stock remains under material market pressure. We propose to exit Santos (for a loss of $1,109) and re-invest the proceeds of $2,913 into National Australia Bank. This will take our weighting in financials back to 40.2% (very close to index weight), and we will move back to underweight energy.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 August) is as follows:
[6]Click here to download an Excel file
* 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.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50
*** Santos acquired on 31 March at $7.14 sold for $5.13 on 31 August. Net amount of $2,830 reinvested in NAB at $31.17
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