Key points

• All sectors finished in the red in June, but the financials sector was one of the better performing sectors on a relative basis (only down 2.9%), as major bank stocks rallied from a way oversold position.
• Consumer discretionary and materials were the worst performing sectors, falling by 11.2% and 8.3% respectively.
• The income portfolio has outperformed the index by 2.74%, while the growth portfolio is 3.60% higher than the benchmark return.

June was a “red ink” month for the market, with fears about Grexit causing the S&P ASX 200 to lose 5.3%. So much seems to have happened since 30 June – just last Tuesday – that it may be cold comfort to know that our portfolios exactly tracked the market lower in June. Hence, they continue to outperform the market on a year to date basis.

The income portfolio has outperformed the index by 2.74%, while the growth portfolio is 3.60% 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’.

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
• Looking 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 is up by 5.84% this calendar year and the growth-oriented portfolio is up by 6.70% (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 2.74% and the growth-oriented portfolio has outperformed by 3.60%.

All sectors in the red, major banks bounce off lows

While all sectors finished in the red in June, the financials sector was one of the better performing sectors on a relative basis (only down 2.9%), as major bank stocks rallied from a way oversold position. Commonwealth Bank, for example, hit a low of $79.19 on June 10, before rallying to close on June 30 at $85.13 – 4 cents higher than where it finished at the end of May. Other “yield” sectors such as telecommunications (which is dominated by Telstra) and property trusts (A-REITs) also performed relatively better.

Consumer discretionary and materials were the worst performing sectors, falling by 11.2% and 8.3% respectively.

Year to date (since 1 January), most sectors (if dividends are included) are in positive territory. The utilities sector leads the returns at 10.8%, followed by A-REITs at 6.7%. Both energy and consumer staples are in the red, the latter impacted by the supermarket wars and share price weakness for Woolworths, Wesfarmers and IGA.

The table below shows the returns for the 11 sectors, plus their weighting (as at 30 June) in the S&P/ASX 200.

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 June, the portfolio tracked the index almost to a tee. Sector weightings are broadly in line with where we want them to be, and there are no stocks where we have any material concerns. Accordingly, no further changes are proposed at this time.

The income portfolio is forecast to generate a yield of 5.14% in 2015, franked to 88.7%. At the halfway point, it has generated a return of 2.61% franked to 89.4%. With final dividends typically higher than the interim dividends, we can be confident that the forecast target should now be moderately exceeded.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 June 2015) is as follows:

Click here to download an excel version

* 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.

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 Australian dollar – moving down towards 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 Aussie 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 maintained an overweight position as the demographic factors are so strong.

With stock selection, we biased the portfolio to companies, which 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. It also decided to keep the South32 shares and like the income portfolio, for the NAB rights issue assumed that the rights were sold and used the closing price ($4.99) on their last day of trading.

Despite Seek falling 17% during June on the back of a profit downgrade, the portfolio very closely tracked the overall market, losing 5.2% in value. With Seek, it is somewhat of a line ball call whether to hold or sell. As the earnings issue relates to its secondary education business (rather than the mainline online employment business), we have decided to hold for the time being – however, we will monitor very closely.

Sector weightings are broadly in line and while some of our stock selections are underperforming, we don’t propose any further changes to the portfolio at this point in time.

Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 June 2015) is as follows:

Click here to download an excel version

* 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.

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.