Last week, we updated our high-income stock portfolio. This week, we look at our growth-oriented portfolio.
The objective of the growth-oriented portfolio is to outperform the S&P/ASX 200 market over the medium term, whilst closely tracking the index.
In calendar 2013, the growth-oriented portfolio returned 27.55% – an outperformance of 7.35% compared to the index. In calendar 2014, the portfolio returned 3.39% – an underperformance of 2.22% – taking the net outperformance to 2.16% per annum for each of the past two years.
Critically, the purpose of the growth and income portfolios is to demonstrate an approach and methodology to portfolio construction that SMSFs could apply.
We have made some changes to the growth portfolio, which include sector and stock rebalancing, base-lining for the start of the year, the replacement of Amcor, Origin and Orica, and the inclusion of Boral, Challenger, Macquarie and Seek.
In relation to this portfolio, we need to state some important caveats upfront. Firstly, recognizing the importance of tax effective income from dividends to the overall portfolio return, and a general aversion by many SMSFs to taking excessive risk, our sector biases are not strong. While there is an orientation to the sectors and stocks that we believe will grow over the medium term, our aim is to design a portfolio that will also track reasonably closely the overall market as measured by the S&P/ASX 200 Accumulation Index. It is a bias only towards growth.
Secondly, our universe of stocks to select from is confined to the top 100 stocks. More often than not, the stocks with the best medium-term growth prospects will come from outside this group, in particular, the so called ‘small’ caps.
With these caveats decked, let’s move on to the portfolio construction.
Similar to our approach to the high-income portfolio, we applied a ‘top down’ approach to the industry sectors and introduced biases that favour the sectors that we think have the best medium-term growth prospects.
Overlaying this is a view that the predominant investment themes in 2015 will be:
- Continued low interest rates (the yield sectors will continue to perform);
- Lower Aussie dollar – moving down towards 75 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 Aussie 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. Recognising that a number of the healthcare stocks are very pricey, we have marginally reduced our sector exposure and selected stocks that should benefit from a lower Aussie dollar.
The property trust sector starred last year and we think that this sector is fully priced. Further, as this sector is not traditionally a growth sector, we plan to take no exposure.
On a sector basis, our portfolio compares to the market (S&P/ASX 200) as follows:
Click here to download an excel version of the portfolio
Working on the basis that we need at least 10 stocks for diversification and that once you get over 25, it becomes pretty hard to monitor, we have selected 22 stocks. This is more than the income portfolio, reflecting in part the increased risk in stock selection.
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, and/or report their earnings in US dollars.
In the ‘consumer discretionary’ sector, we have stuck with two of the laggards in 2014 – Crown and JB Hi-Fi. While both are somewhat out of favour with the market, we like the underlying businesses and the management teams, and the stocks are reasonably priced.
In financials, the portfolio continues to pare back on its exposure to the major banks. While it is now broadly around index, we have introduced two stocks to increase the growth flavour – Macquarie and Challenger. Both stocks are off their 2014 highs, with the latter off by some 21% and likely to benefit in the medium term, as moves to introduce deferred annuities gain traction. With the major banks, we have oriented the position towards NAB (a 27% premium to the Commonwealth Bank is historically looking cheap), and away from Westpac (new CEO taking over).
In healthcare, while the stocks are getting very pricey, we have retained CSL, Ramsay and Resmed. While CSL and Resmed will benefit from a lower Aussie dollar, on track record, it is impossible to dump Ramsay (despite its lofty PE of 29.5). Although Computershare is classified as ‘information technology’, its global registry business provides exposure to buoyant global stock markets and the resultant increase in primary market issues.
In materials, we continue to prefer the diversified exposure that BHP provides, notwithstanding that Rio has some form of takeover premium built into its price. We have included Boral at the expense of Amcor (fully priced), with the former to benefit from construction and infrastructure spending in Australia, and a continuing strong outlook in the US. In industrials, a very diverse sector where stock selection is much more important than sector weight, we have retained logistics companies Toll and Brambles, and added one of the strongest market performers over the last five years, online employment and education group Seek.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 December 2014) is as follows:
Click here to download an excel version of the portfolio
Using consensus broker forecasts from FN Arena, the portfolio has the following characteristics:
Forecast Price Earnings multiple for 2015: 16.11
Forecast Dividend Yield for 2015: 4.52%
As a growth-oriented portfolio, our investment timeframe is in the three to five year range, and while short-term investment performance (including dividends) is important, our aim is to deliver slightly above market performance over that timeframe. We will keep a close eye on the growth-oriented portfolio, and report back in coming editions of the Switzer Super Report.
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.