A very strong first quarter has resulted in double digit gains for our portfolios. Led by a recovery on Wall Street and an expectation that interest rates could possibly fall, our income portfolio has returned more than 11.5%.
In the third review for 2019, we look at how our income and growth portfolios performed in March.
The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we provide a quick recap on these.
Portfolio recap
In January, we made some adjustments to our Australian share ‘Income Portfolio’ and ‘Growth Portfolio’ (see https://switzersuperreport.com.au/here-are-our-portfolios-for-2019/ [1] )
The construction rules for the portfolios are:
- we use a ‘top down approach’ looking at the prospects for each of the industry sectors;
- for the income portfolio, we introduce biases that favour lower PE, higher yielding sectors;
- so that we are not overly exposed to a market move, in the major sectors (financials and materials), our sector biases will not be more than 33% away from index. For example, the weighting of the ‘materials’ sector on the S&P/ASX 200 is currently 18.9%, and under this rule, our possible portfolio weighting is in the range from 12.6% to 25.2% (i.e. plus or minus one third or 6.3%);
- we require 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), and have set a minimum stock investment size of $3,000;
- our stock universe is confined to the ASX 100. This has important implications for the growth portfolio, because the stocks with the best medium term growth prospects will often come from outside this group (the so called ‘small’ caps);
- we avoid stocks from industries where there is a high level of exogenous risk, such as airlines;
- for the income portfolio, we prioritise stocks that pay fully franked dividends and have a consistent record of paying dividends; and
- within a sector, the stocks are broadly weighted to their respective index weights, although there are some biases.
Overlaying these processes are our predominant investment themes for 2019, which we expect to be:
- Economic growth to slow in the USA, Europe, China and Japan, but not into recession territory;
- The US Fed moving to a more neutral stance on US interest rates. If not pausing, only one or two more hikes in 2019;
- Interest rates in Australia to remain at historically low levels, with the RBA unlikely to move rates higher;
- Australian dollar around 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Oil price remaining well supported around US$50 per barrel. Base metal and iron ore prices to soften;
- A positive lead from the US markets;
- Growth in Australia to ease to around 2.5%, with no real pick-up in domestic inflation;
- Housing prices in Australia to ease moderately, but not collapse; and
- A federal election in May, which may limit any market gains in the first half.
Our performance
The income portfolio to 29 March is up by 11.57% and the growth oriented portfolio by 9.71% (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 0.68% and the growth oriented portfolio has underperformed by 1.18%.
Iron ore miners and property trusts support market in March
The somewhat unusual combination of the major iron ore miners (BHP, Rio and Fortescue) and a buoyant property trust sector supported the share market in March, allowing it to post a small gain for the month of 0.7% and round out a very strong first quarter of 10.9%. The former followed the disruption to supply from the tragic accident in Brazil, while lower interest rates saw property trusts and other defensive stocks being bid strongly.
Against this was weakness in the energy sector and waning support for the financial sector. The largest sector on the ASX by market capitalisation with a weighting of 31.5%, the financial sector dipped by 2.7% in March. In 2019, it has returned 6.0%, the weakest of any sector.
All industry sectors are positive for the year. Information technology tops the list with a return of 20.7%, followed by the materials sector (which includes the major miners) with a return of 17.8%. In the main, defensive sectors and stocks that will benefit from lower interest rates (such as property trusts, utilities, consumer staples, and selected industrials) are outperforming.
Returns of the 11 industry sectors for March and calendar 2019, plus their respecting weighting as part of the ASX 200, are shown in the table below.
Income portfolio
On a sector basis, the income portfolio is moderately overweight financials and utilities, and underweight materials and health care (where here are no medium or high yielding stocks in the ASX 100). Otherwise, the sector biases are reasonably minor.
On paper, it is roughly index weight in industrials. However, this exposure is being taken through toll road operator Transurban which is not your typical industrial stock.
In the expectation that interest rates in Australia are staying at record low levels and that a federal election is due in May, it has a defensive orientation and a bias to yield style stocks. In a bull market, we expect that the income portfolio will underperform relative to the broader market due to the underweight position in the more growth oriented sectors and the stock selection being more defensive, and conversely in a bear market, it should moderately outperform.
The portfolio is forecast to yield 5.78%, franked to 82.3%. The forecast yield is higher than would normally be expected due to the payment by BHP of a special dividend of $1.42 per share. When this is excluded, the yield drops back to 5.49%.
In March, the income portfolio returned 1.29% for a relative outperformance of 0.56%. Year to date, it has returned 11.57% for an outperformance of 0.68%.
The return includes both capital and income. On the income side, the return (which takes into account dividends that the portfolio is contractually entitled to) is currently 2.08%, franked at 97.4%.
Helping in March was the strong performance of defensives Dexus and Transurban, and the major miners BHP and Rio. This offset the underperformance of the major banks, particularly ANZ, which slipped by 7.0% in the month.
No changes to the portfolio are contemplated at this point in time although we note that both Transurban and Dexus look very fully priced.
The income biased portfolio per $100,000 invested (using prices as at the close of business on 29 March 2019) is as follows:
Growth portfolio
The growth portfolio is moderately overweight financials and energy, and underweight materials, consumer staples and real estate. Overall, the sector biases are not strong.
On paper, it is overweight consumer discretionary. Part of this exposure is through Aristocrat Leisure (which is servicing the gaming and gambling markets) and through conglomerate Wesfarmers.
The stock selection is marginally biased to companies that will 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.
In March, the portfolio was flat for a relative underperformance of 0.73%. Year to date, it has returned 9.71% for an underperformance of 1.18%.
Holding the performance of the portfolio back in March was the absence of defensive stocks, and a weak performance from its midcap stocks. Seek, Reliance, Orora, Aristocrat, Ramsay and Link posted losses. While BHP and Rio rose on the back of firmer iron ore prices, weakness in the major banks put a drag on the portfolio.
No changes to the portfolio are contemplated at this point in time.
Our growth oriented portfolio per $100,000 invested (using prices as at the close of business on 29 March 2019) is as follows:
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 regard to your circumstances.