Key points
- Year to date the income portfolio has outperformed the index by 2.65%, while the growth portfolio is 3.65% higher than the benchmark return.
- Major bank stocks continued to weigh on the market in May following a fairly uninspiring set of half-year results, although their performances improved in the second half of the month.
- In a fairly quiet month, the industrials, IT and property trust (A-REIT) sectors led the gains.
Our portfolios made small gains in May, despite the share market largely standing still. Overall, the S&P/ASX 200 lost 0.22% during the month in price terms, but added 0.40% when dividend returns are included.
Year-to-date, both the income and growth portfolios are outperforming the market. The income portfolio has outperformed the index by 2.65%, while the growth portfolio is 3.65% 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 [1]’ and ‘Growth-oriented Portfolio [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 ASX 100 (there are many great growth companies outside the top 100).
Performance
The income portfolio is up by 11.53% this calendar year and the growth-oriented portfolio is up by 12.53% (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 2.65% and the growth oriented portfolio has outperformed by 3.65%.
[3]Financials still under pressure in May
Major bank stocks continued to weigh on the market in May following a fairly uninspiring set of half-year results, although their performances improved in the second half of the month. Consumer staples and the telecommunications sectors also slipped, with the performance of Woolworths in particular impacting the former.
In a fairly quiet month, the industrials, IT and property trust (A-REIT) sectors led the gains.
Year to date, all sectors (if dividends are included) are in positive territory. The utilities sector leads the return at 18.1%, followed by consumer discretionary at 16.5% and industrials at 15.9%. The table below shows the returns for the 11 sectors, plus their weighting (as at 29 May) in 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.
In May, the new South32 company was demerged from the BHP group, on a 1:1 basis. For both portfolios for the short term, we will hang on to this position, however will probably look to dispose of it at some stage. National Australia Bank conducted 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 have assumed, again for both portfolios, that the rights were sold and have used the closing price ($4.99) on their last day of trading.
No changes were made to the portfolio in May, and apart from the exposure to the property trust sector through Dexus, which looks pretty fully priced, don’t see any immediate need to make any changes in the short term.
The income portfolio is forecast to generate a yield of 5.14% in 2015, franked to 88.7%. With all companies except Dexus having declared a half-year distribution, we can be fairly confident that this target should be moderately exceeded. Currently, it is running at 2.39%, franked to 97.4%.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 29 May 2015) is as follows:
[5]Click here to download as an excel file [6]
* 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 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 Australian dollar – 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 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 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 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.
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.
In May, the portfolio moderately outperformed the market. A lower Australian dollar towards the end of the month helped stocks such as CSL, Brambles, Computershare, Macquarie and Westfield, which offset some earlier share price weakness in Resmed and Crown.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 May 2015) is as follows:
[7]Click here to download as an excel file [6]
* 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.