Last Monday, we updated our income stock portfolio. Today, 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 year 2013, the growth-oriented portfolio returned 27.55% — an outperformance of 7.35% compared to the index. In calendar year 2014, the portfolio returned 3.39% — an underperformance of 2.22%. In calendar year 2015, the portfolio returned 6.67% — an outperformance of 4.11%, while in 2016, it returned 9.82% for an underperformance of 1.98%. This takes the net outperformance to 1.50% p.a. for the past four years.
Critically, the purpose of the growth and income-oriented portfolios is to demonstrate an approach and methodology to portfolio construction that SMSFs could apply.
We have made some small changes to the growth portfolio, which include sector and stock rebalancing, the addition of Rio and TPG, and the deletion of BT Investment Management.
One of the big issues for 2017 is how to play the resources sectors. Given the almost totally unexpected rebound in coal, iron ore and metal prices in 2016, our sense is that you need to play these sectors close to index weight and be prepared to jump quickly if circumstances change. This is why we have added Rio and thereby increased the exposure to the materials sector. The positives include China and the growth agenda of President-elect Trump, the negatives include a likely supply response if prices continue to hold at these levels. The energy and oil markets are probably clearer — we can’t yet see the case to go long these sectors.
In relation to this portfolio, we need to state some important caveats upfront. Firstly, recognising 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 150 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 2017 will be:
- Interest rates remaining at low levels, although some upward movement in bond rates;
- The US Fed likely to increase US interest rates by 0.75%, but probably no move in Australia by the RBA;
- The Australian dollar at around 0.70 to 0.75 US cents, but with risk of breaking down if the US dollar firms;
- Commodity prices remaining reasonably well supported;
- A positive lead from the US markets and President Trump;
- A moderate pick-up in growth in Australia, back towards trend levels; and
- No material pick up in domestic inflation.
This leads to a portfolio with only small sector biases. Despite healthcare underperforming in 2016 and many of the stocks trading on high multiples, we believe that the tailwinds are so strong that our sector position is materially overweight. We have selected stocks that will benefit from a lower Australian dollar.
The other overweight position is in telecommunications, the only negative performing sector in 2016. This sector now looks cheap on a multiple basis. The major underweight positions are in real estate and consumer staples.
On a sector basis, our portfolio compares to the market (S&P/ASX 200) as follows:
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 21 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 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 are expecting that the Aussie dollar will remain well supported and trade in a fairly narrow in the short term, the risk is that a strengthening US dollar causes it to break down.
In financials, we have stuck with two strong performers from 2016 in Macquarie and Challenger. With the major banks, the positions are largely index weighted, although there is a small bias towards National Australia Bank.
In healthcare, while the stocks are pricey, we have retained CSL, Ramsay and Resmed.
In materials, we continue to prefer the diversified exposure that BHP provides, we have added Rio to increase the weighting, and have retained Boral for exposure to the construction industry. In industrials, a very diverse sector where stock selection is much more important than sector weight, we have retained logistics company Brambles and online employment and education group Seek.
In telecommunications, we have marginally reduced the weighting of Telstra, and added David Teoh’s diversified telco TPG. It is trading on a multiple of 15.3 times FY 17 earnings.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 December 2016) is as follows:
Using consensus broker forecasts from FNArena, the portfolio has the following characteristics:
- Forecast Price Earnings multiple for 2017: 20.11
- Forecast Dividend Yield for 2017: 4.12%
- Franking: 82.81%
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.