SSR portfolio update – “dollar” stocks make ground

Co-founder of the Switzer Report
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Nervousness on Wall Street and a plunging Aussie dollar led to a 6% fall in the share market in September, wiping away most of the gains that have been made this year. When dividends are added back in, the S&P/ASX 200 has returned 2.42% this calendar year.

Our portfolios followed the market down, closely tracking the overall move. In our ninth review for the year, we look at their composition and performances. Our high-income portfolio is up by 3.8% and has outperformed the S&P/ASX 200 this calendar year by 1.3%, while our growth-oriented portfolio is fractionally down and has underperformed by 2.7%.

Portfolio recap

In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth-Oriented Portfolio’.

The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets are of critical importance, we always commence a review by briefly recapping the key portfolio construction processes applied.

The income portfolio is forecast to generate a yield of 5.01%, franked to 90.4%. The construction rules applied include:

  • 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 our sector biases in the major sectors (financials, materials and consumer staples) 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
  • Of course, we looked for companies that pay franked dividends and have a consistent earnings record.

The growth-oriented portfolio takes a very 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-oriented portfolio is up by 3.76% and the growth-oriented portfolio is down by 0.30% (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 1.34% and the growth-oriented portfolio has underperformed by 2.72%.

Financials take a beating as “dollar” stocks make ground

The big banks got clobbered in September, with the financials sector finishing in the red with a return of -6.5%. On a year-to-date basis, however, the sector is keeping pace with the market, with an overall return of 2.4%.

All sectors, with the exception of healthcare, were weaker. Depressed iron ore prices continued to impact the major miners, such as BHP and RIO, with the materials sector giving up 6.3%. On a year-to-date basis, it is down by 6.2%.

The ‘healthcare’ sector held its ground, with a number of stocks that will benefit from a weaker Aussie dollar, such as CSL, Resmed and Ramsay performing relatively strongly. This was also the case in the ‘industrials’ sector, where stocks set to improve earnings from a lower Aussie dollar made some headway.

Year-to-date, the best performing sectors are property trusts with a return of 13.9%, utilities at 12.6% and healthcare at 9.2%.

The table below shows the sector weights (as a proportion of the S&P/ASX 200), and performances (total return) for the month of September and for the 2014 calendar year.

Income portfolio

The income portfolio is overweight ‘financials’, ‘consumer staples’, ‘utilities’ and ‘telecommunications’; underweight ‘materials’ and ‘consumer discretionary’; and broadly index-weight the other sectors. It also includes an allocation to ‘property trusts’ (formally called the A-REIT sector), and somewhat more exposure to the “cyclicals” through the selection of stocks from the ‘industrial’ sector.

With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark price index in a strong bull market, and moderately outperform in a bear market.

For the first nine months of the year, the portfolio is marginally outperforming the index. This is now largely due to stock selection, rather than sector biases. The inclusion of stocks such as Leighton, Orora and Dexus is compensating for the poor performance of stocks such as Primary and AGL. A slight bias to stocks that will benefit from a weaker Aussie dollar, such as Brambles, is also assisting.

The income portfolio is forecast to generate a yield of 5.01% in 2014, franked to 90.4%. With most companies now having declared their final dividend for the year, we can now confidently predict that the realised yield on the portfolio should marginally exceed the original target.

Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 September 2014) is as follows:

Income includes dividends declared and payable.
*AGL rights following 1:5 renounceable issue at $11.00, assumed sold on last day of rights trading at $2.62. **Assumes 37.5% Leighton shares sold in partial offer at $22.50, repurchased on 30/4 at $19.08.

Growth portfolio

Similar to our approach to the income portfolio, we applied a ‘top down’ approach to the industry sectors and introduced biases that favour the sectors that we feel have the best medium-term growth prospects. The growth-oriented portfolio is overweight ‘healthcare’, ‘consumer discretionary’ and ‘industrials’; underweight ‘financials’ and ‘property trusts’; and largely index weight the other sectors, including ‘materials’.

Critically, we have biased the stock selection to companies that should benefit from a falling Australian dollar – either because they earn a major share of their revenue offshore, or report their earnings in US dollars – such as CSL, Amcor, Brambles, Computershare and BHP. Other biases include Woolworths over Wesfarmers; CBA and Westpac over ANZ and to a lesser extent NAB; and the selection of Crown and JB Hi-Fi.

At the end of May we decided to make some changes to the portfolio. We reduced our exposure to the ‘materials’ sector by selling our holding in Rio for a loss of $391, exited our holding in Primary Health Care for a loss of $291 and replaced this with Resmed, and increased our exposure to the ‘consumer discretionary’ sector through additional holdings in Crown and JB Hi-Fi.

The portfolio is lagging the index by 2.7%. While this is an improvement on the relative position at the end of August, the market clearly doesn’t agree with our exposures to Crown and JB Hi-Fi. We remain confident that both these companies have sound medium-term growth prospects and are reasonably priced. However, with the short sellers in control of JB Hi-Fi, there may not be much relief in the short term.

During September, we started to see some return from our stock selections favouring a lower Aussie dollar – with relatively strong performances from CSL, Brambles, Resmed, Amcor and Computershare.

At this point, we are going to hold with the portfolio and continue to monitor it closely. Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 September 2014) is as follows:

Income includes dividends declared and payable.
*Prices of Crown (new), JB Hi-Fi (new) and Resmed (new) as at 30 May. ** AGL rights following 1:5 renounceable issue at $11.00, assumed sold on last day of rights trading at $2.62.

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.

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