Although the Australian sharemarket lost 0.7% in November, both portfolios outperformed relative to the benchmark accumulation index. Gains in healthcare and financial stocks made up for the continuing weakness in resource stocks, with BHP alone down 21.5% in the month.
The income portfolio has marginally underperformed the index by 0.3%, while the growth portfolio has outperformed the index by 3.6%.
The purpose of the income and growth oriented portfolios is to demonstrate an approach to portfolio construction.
To construct the income portfolio, the processes we applied included:
- using a ‘top down approach’ and introducing biases that favour lower PE, higher yielding industry sectors;
- to minimise the market tracking risk, adopting a rule that says that our sector biases in the major sectors (financials and materials) will not be more than 33% away from index;
- identifying 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), with a stock universe confined to the ASX 100;
- within a sector, weighting the stocks broadly to their respective index weights, although there are some biases; and
- looked for companies that pay franked dividends and have a consistent earnings record.
The growth-oriented portfolio takes a different approach to the sectors in that it introduces biases that favour the sectors that we judge to have the best medium term growth prospects. Critically, it also confines the stock universe to the ASX 100 (there are many great growth companies outside the top 100).
The income portfolio is down by 0.50% this calendar year and the growth-oriented portfolio is up by 3.43% (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 0.34% and the growth oriented portfolio has outperformed by 3.59%.
Health care and financials lead the market in November
Health care, financials and industrials made up for the continuing weak performance of the resource sectors (materials and energy) in November. Although information technology was the best performing sector with a gain of 7.0%, it is also the smallest sector by market capitalisation, accounting for only 0.9% of the S&P/ASX 200.
The health care sector added 5.3% in the month, while financials (led by Commonwealth Bank and Westpac) added 2.5%. Materials lost 12.4%, with BHP being impacted by the incident at Samarco and its share price falling from $23.02 to $18.09. Energy stocks were also pressured due to weaker oil prices, with the sector slipping by 1.2%.
Over the course of 2015, the story is very much the same as that seen in November. Health care at 15.2% and industrials at 17.1% are positive standouts, while materials is down 16.7% and energy has lost 21.4%. Two of the more defensive sectors are also doing well, the A-REIT (property trust) sector at 9.9% and the small utilities sector, which shows a return of 19.4%.
Looking at the composition of the S&P/ASX 200, the top 20 stocks are underperforming – down 4.5% this year compared to the index’s 0.2%, while the midcap 50 (stocks ranked 51 to 100 by market capitalisation) are up 9.2%.
The table below shows the returns for the 11 sectors, plus their weighting (as at 30 November) of the S&P/ASX 200.
The income portfolio at the start of the year was overweight consumer staples, utilities and telecommunications; underweight materials and energy, and broadly index-weight the other sectors. Reflecting an expectation that the banks will, over time, have to raise more capital, we neutralized our exposure to financials. Further, following a stellar performance in 2014, our exposure to property trusts (the A-REIT sector) is also neutral.
With these sector allocations, we would expect this portfolio to moderately underperform relative to the benchmark accumulation index in a strong bull market, and moderately outperform in a bear market.
At the end of March, we made some changes to the portfolio. We crystallized our profit on Toll Holdings following the announcement of its takeover by Japanese Post; cut our exposure in consumer staples to go back to index weight by selling (for a small loss) 50% of our position in Woolworths; and reinvested those proceeds in Woodside, Telstra, Commonwealth Bank and AMP.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share. As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading. Commonwealth Bank and Westpac also had rights issues in August and October.
In November, the income portfolio moderately outperformed against the index. BHP lost 21.5% in value, while Primary Health Care issued an earnings downgrade. On the upside, the banks picked up as the temporary indigestion from the capital issues cleared. Westpac and Commonwealth Banks were strong performers.
We don’t propose to make any changes to the portfolio at this point in time.
The income portfolio is forecast to generate a yield of 5.14% in calendar 2015, franked to 88.7%. With all companies except Dexus having declared their final dividend, this target should be moderately exceeded. Currently, the portfolio sits at yield of 5.03%, franked to 92.30%.
Our income-biased portfolio per $100,000 invested (using prices as at the close of business on 30 November 2015) is as follows:
* On 31 March, reduced original $6,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $1,901 reinvested in Woodside, $2,000 in AMP, $3,000 in CBA and $2,000 in Telstra.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50, assume sold on last day of trading at $2.01. Westpac 1: 23 rights at $25.50, assume sold on last day of trading at $4.83
With our growth-oriented portfolio, we based our sector exposure on what we expected to be the predominant investment themes in 2015, which are:
- Continued low interest rates (the yield sectors will continue to perform);
- Lower AUD – moving down towards 0.70 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 AUD 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 maintained an overweight position, as the demographic factors are so strong.
With stock selection, we biased the portfolio to companies which should benefit from a falling Australian dollar – either because they earn a major share of their revenue offshore, and/or report their earnings in USD, such as CSL, Resmed, Brambles and Computershare.
In the Financials, we pared back our exposure to the major banks, biased NAB, and included for growth Macquarie and Challenger. We added online employment and education group Seek, and stuck with Crown and JB Hi-Fi from the Consumer Discretionary sector.
At the end of March, the portfolio realized the profit on its investment in Toll Holdings and like the income portfolio, cut its exposure in Woolworths. These proceeds were reinvested in Santos and Westfield.
Further changes to the portfolio occurred in May with the demerger of South32 from BHP (which we decided to keep), and a 2:25 rights issue to subscribe for new NAB shares at $28.50 per share.
As this model portfolio does not have access to cash (unless another share is sold), we assumed that the rights were sold and used the closing price ($4.99) on their last day of trading. This approach was also applied to rights issues from the Commonwealth bank and Westpac.
At the end of August, we cut our exposure to Santos (for a loss of $1,109) and re-invested the net proceeds of $2,913 into National Australia Bank.
In November, the portfolio outperformed the index, increasing its year to date outperformance to 3.6%.
Continued gains in health care stocks CSL, Ramsay and Resmed, along with strong support for Macquarie and Challenger, more than offset the price drop in BHP shares. Computershare and Seek also rebounded – the former in part due to the success of the Link IPO.
Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 30 November) is as follows:
* On 31 March, reduced original $4,000 holding in Woolworths by 50%, and sold original $4,000 holding in Toll. $3,939 reinvested in Santos and $4,000 in Westfield.
** South32 demerged from BHP on a 1:1 basis. NAB 2:25 rights issue – assume sold on last day of trading at $4.99. CBA 1:23 rights issue at $71.50, assume sold on last day of trading at $2.01. Westpac 1: 23 rights at $25.50, assume sold on last day of trading at $4.83.
*** Santos acquired on 31 March at $7.14 sold for $5.13 on 31 August. Net amount of $2,830 reinvested in NAB at $31.17
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