The purpose of our model portfolios (income and growth) is to demonstrate an approach to portfolio construction that SMSFs or personal investors could apply.
We have made some changes to our portfolios for 2019 to take into account the dominant investment themes that we expect to apply. We have also rebalanced the portfolios.
Recap on portfolio objectives and performance
The objective of the income portfolio is to deliver tax advantaged income whilst broadly tracking the S&P/ASX 200.
The table below shows the performance of the income portfolio and that of the benchmark S&P/ASX 200. Over the six years since 2013, it has delivered an annualized return of 8.57% and outperformed the index by 0.64% pa. This figure doesn’t include the benefits of franking credits or from participating in off-market share buybacks.
The objective of the growth portfolio is to outperform the S&P/ASX 200 market over the medium term, whilst closely tracking the index.
The table below shows the performance of the growth portfolio and that of the benchmark S&P/ASX 200. Over the six years since 2013, it has delivered an annualized return of 8.91% and outperformed the index by 0.98% pa.
Portfolio construction rules
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 18.2%, and under this rule, our possible portfolio weighting is in the range from 12.1% to 24.3% (i.e. plus or minus one third or 6.1);
- 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.
Investment themes for 2019
We expect these 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;
- AUD around 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 will limit any market gains in the first half.
Our sector views were detailed in our ‘2019 Investment Outlook’ and the article ‘How to play the Australian Stockmarket in 2019” (see https://switzersuperreport.com.au/investment-outlook-for-2019/  . These are summarized in the table below.
* ASX 200 index weights as at 31 December 2018
The major callout is for a slightly more defensive orientation (which is in keeping with slowing economic growth and interest rates on hold), with a moderately overweight position in financial stocks and yield sensitive sectors such as utilities, and a moderately underweight position in materials.
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.
Changes from 2018 include the removal of ASX (which looks fully priced), Sydney Airport, Suncorp and the “inherited” position in Coles. Additions include Dexus (for exposure to the Sydney commercial office market), insurer IAG, Woolworths, Macquarie and pipeline owner APA.
Our income portfolio per $100,000 invested (using prices at the close of business on 31 December 2018) is:
Using consensus analyst forecasts from FN Arena, the portfolio has the following characteristics:
Forecast Price Earnings (PE) for 2019: 17.0
Forecast PE for 2019 (excluding Transurban and APA): 13.9
Forecast Dividend Yield for 2019: 5.78% pa
Franking: 82.3% (estimated)
The forecast yield is higher than would normally be expected due to the payment by BHP in January of a special dividend of $1.42. When this is excluded it drops back to 5.49%.
For an SMSF in the accumulation phase, the forecast 5.78% dividend yield will translate to an income return of 6.8% pa (after tax), and for a fund in pension phase, to 7.8% pa.
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 only omission from the 2018 portfolio is the removal of the inherited position in Coles. Additions to the portfolio are oil and gas producer Santos and plumbing and tap fitting manufacturer Reliance Worldwide. Holdings in the major banks have been re-balanced to bias ANZ and Westpac.
Our growth portfolio per $100,000 invested (using prices as at the close of business on 31 December 2018) is as follows:
Using consensus broker forecasts from FN Arena, the portfolio has the following characteristics:
Forecast Price Earnings multiple for 2019: 15.4
Forecast Dividend Yield for 2018: 4.79%
Franking: 89.1% (estimated)
The forecast yield is higher than would normally be expected due to the payment by BHP in January of a special dividend of $1.42. When this is excluded, the yield drops back to 4.50%.
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.