Weighed down by fears of trade war and the opening of the Banking Royal Commission, the Australian sharemarket had a pretty poor run in March, with all sectors finishing in the red. It lost 3.8% in the month (after adding back dividends) in the month to be down by 3.9% in 2018.
Our model portfolios, which are weighted towards the major stocks, suffered falls of around 4.4%. The income portfolio now lags the index by 0.9%, while the growth portfolio has underperformed by 0.2%.
In our third review for the year, 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 here [1]).
The construction rules applied were:
- A ‘top down approach’ that looks at the prospects for each of the industry sectors;
- For the income portfolio, we introduced 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 18.0%, and under this rule, our possible portfolio weighting is in the range from 12.0% to 24.0% (i.e. plus or minus one third or 6.0%);
- 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 S&P/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 2018, which we expect to be:
- Synchronised growth in the USA, Europe, China and Japan;
- The US Fed likely to increase US interest rates by 0.75%;
- Interest rates in Australia to remain at historically low levels, with the RBA unlikely to move rates higher until the final quarter of 2018. Some upward movement in bond rates;
- AUD around 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity and energy prices remaining reasonably well supported;
- A positive lead from the US markets;
- A moderate pick-up in growth in Australia, back towards trend levels; and
- No material pick up in domestic inflation.
Performance
The income portfolio to 29 March is down by 4.76% and the growth-oriented portfolio by 4.04% (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 underperformed the index by 0.90% and the growth-oriented portfolio by 0.18%.
All sectors in the red in March
All ASX industry sectors finished in the red in March (see table below). The largest sector by market weight, financials, accounting for 34.8% of the S&P/ASX 200, was one of the poorer performers, losing 5.9% as the Banking Royal Commission got underway.
In a relative sense, real estate was the “best” performing sector with a loss of 0.2% as bond yields in the USA stabilised. Year to date, it remains a laggard with a return of -5.3%.
Health care is the best performing sector in 2018, up 6.9%, largely due to the performance of CSL and Cochlear. Telecommunications continues its horror run of 2016 and 2017 with a return of -11.0% so far in 2018.
Income portfolio
On a sector basis, the income portfolio is moderately overweight financials, and index-weight materials. Exposure is being taken through the major banks (to the former), and the major miners (to the latter).
It is underweight health care, consumer staples and real estate.
In a bull market, we expect that the income-biased portfolio will underperform relative to the standard S&P/ASX200 price index, 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 generate a yield of 5.13% in 2018, franked to 88.8%. The inclusion of Transurban and Sydney Airport, while adding to the defensive qualities of the portfolio, drags down the franking percentage.
In March, the income portfolio returned -4.20%, taking its year to date return to -4.76%. It now lags the accumulation index by 0.90%. The portfolio was impacted by weakness in the major banks and the relative overweight position in ANZ, and a guidance “downgrade” from Fortescue.
From an income point of view, the portfolio has returned 1.61%, franked to 98.2%. This is tracking to plan and we remain confident that the forecast above will be met.
No changes to the portfolio are contemplated at this point in time.
The income-biased portfolio per $100,000 invested (using prices as at the close of business on 29 March 2018) is as follows:
* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
Growth portfolio
The growth portfolio is moderately overweight materials, financials and consumer discretionary. It is underweight consumer staples, industrials and real estate. Overall, the sector biases are not strong.
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. While we expect that the Aussie dollar will remain well supported, and trade in a fairly narrow range in the short term, the risk is that a strengthening US dollar causes it to break down.
In March, the growth portfolio returned -4.60% which took its year to date return to -4.04%. It has now underperformed the index by 0.18%.
The performance in March was impacted by the overweight positions in financials and materials, and underweights in sectors that performed “better”. Pullbacks by Seek, Fortescue and further pressure on Challenger also detracted.
No changes to the portfolio are contemplated at this point in time, although we are keeping a close watch on Challenger.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 29 March 2018) is as follows:
* Closing price 29/12/17
¹ Woodside 1:9 entitlements at $27.00 per share. Assume sold on last day of trading.
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.