Our high income portfolio is up! Time to rebalance

Co-founder of the Switzer Report
Print This Post A A A

If you are overweight the major banks, Telstra (TLS) and the likes of Woolworths (WOW) and Wesfarmers (WES), your portfolio should be doing well in this market, where high yielding defensives are all the rage

Throw in a healthcare superstar stock like Ramsay (RHC), subtract a couple with fleas such as David Jones (DJS) and UGL (UGL), so it isn’t altogether surprising that our income portfolio is performing strongly! We’re up 8.3% since December and 12.3% if you include dividend income.

Expectations

It is worth restating our expectation that this portfolio should moderately underperform in a rising market, and moderately outperform in a falling market. After all, we have constructed it for tax-effective income and are underweight the typical ‘growth’ sectors.

To recap, last December we introduced our ‘income biased’ portfolio of stocks. The portfolio is forecast to generate a dividend yield of 5.82% per annum (pa) and given it is 97% franked, this translates into a forecast 6.87% pa after-tax income return in accumulation, and for a fund in pension phase, 8.08% pa.

Some of the key construction rules we applied:

  • a ‘top down approach’ to the sectors, with biases that favour lower PE, higher yielding sectors;
  • in the major sectors, our sector biases are not more than 33% away from index;
  • to balance the “diversification need” and “monitoring effort”, we sought 15 to 20 stocks; and
  • we confined our stock universe to the ASX 100, avoided chronically underperforming industries and looked for companies that pay franked dividends and have a strong record of earnings consistency.

Our income biased portfolio (per $100,000 invested) and its performance from 15 December 2011 to 31 August 2012 is as follows:

 

* Income includes dividends declared and payable, as the Accumulation Index assumes that this is re-invested the date the stock goes ex-dividend. Assume AGL 1:6 rights issue at $11.60 taken up – net amount shown in portfolio value. Brambles Entitlement Offer not taken up, proceeds of $0.25 per share.

All stocks have paid an interim dividend, and nine of the 17 have declared their final dividend. With the exception of David Jones, all were in line with forecast and there were no (negative) surprises. When the dividend income of $4,037 is added to the nominal profit of $8,252, the portfolio is up $12,289, or 12.3% from the start.

So, how is it doing on a relative basis? As it is income we are after, we track the performance against the S&P/ASX 200 Accumulation index rather than the normal price index. Further, as the accumulation index doesn’t take into account the taxation benefits to a SMSF from fully franked stocks, we have included the value of the portfolio “grossed up” for this benefit.

Rebalancing and stock changes

As the table below illustrates, our portfolio sector weights (using current market price) have changed since the portfolio was established. Our core portfolio rule (biases for the major sectors not to be more or less than 33% away from the index) is in danger of being breached, so it’s time for some re-balancing.

Exiting Ramsay and replacing with Primary Heath Care is just about “relative value”. Ramsay has delivered fantastic results over many, many years – it must be just about the best stock in the market. Deservedly so, it is trading on a pretty high 2013 PE of 19.5 (the Directors have forecast EPS growth of 10% to 12%), and while the Company has a habit of beating its own forecasts, Primary (on a forecast PE of 13.5) looks cheap. The risk – Primary doesn’t have the same track record, and is carrying a fair degree of debt.

These changes won’t have any material effect on the portfolio’s forecast income return. Our new income biased portfolio from 31 August is:

*Assume AGL 1:6 rights issue at $11.60 taken up – net amount shown in portfolio value. Brambles Entitlement Offer not taken up, proceeds of $0.25 per share.

Important information: 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. Anyone should consider the appropriateness of the information in regards to their circumstances.

Also in the Switzer Super Report

Also from this edition