Growth Portfolio performs

‘Even if you’re on the right track,’ warns actor Will Rogers, ‘you’ll get run over if you just sit there.’ In The Buy and Sell strategy, we explained why investors would need to be more active as share prices became more volatile in a world of pygmy interest rates and unconventional monetary policies.

While the model Growth Portfolio has been quite active over the past year (see Table 1), its performance is on the right track, having returned 22.1% for the year to 30 June 2013, ahead of the 20.7% return of the All Ordinaries Accumulation index.

The outperformance was, however, skewed to the second half, with the portfolio returning 9.2% compared to the index’s 4.4% return.

Clear themes

There are some clear themes behind the performance. Resources businesses and the companies that service them have been hammered. The decision to largely avoid them – other than some very small speculative positions – has been vindicated.

Although Tap Oil and Silver Lake Resources have suffered a 25% and 82% fall in their respective share prices over the past six months, we sold some Silver Lake at much higher prices and the small position sizes means the damage has been minimal. Speculative Buys only make up 4% of the portfolio, which is sensible for a conservative portfolio.

We sold Billabong International after its share price had fallen 73% from our initial purchase. With a duo of shrewd US hedge funds recently buying the company’s debt the situation remains unpredictable. We also finally sold the tiny Elders Hybrids position. The share price has fallen a further 70% since as Elders holds out for a superior bid for its remaining assets. All up, the portfolio is now more concentrated in our best ideas.

Cochlear was the only other stock to fall. The share price fell 22% over the past six months as sales growth dramatically slowed. With customers wait for the launch of the Nucleus 6, Mr Market’s pessimism produced an upgrade on 3 June 13, though you had to be quick.

The big winners over the past six months were the stocks with large US operations. In order of performance they are QBE Insurance (up 38%), Platinum Asset Management (38%), Aristocrat Leisure (36%), 21^st Century Fox [formerly NewsCorp] (rising 30%), ResMed (27%) and Macquarie Group (18%).

QBE’s chief executive John Neale is implementing a sensible strategy to reduce costs and improve the company’s underwriting results. If interest rates and premiums in the US keep rising, then QBE could be a $20 stock once more. Aristocrat, Platinum and Macquarie remain core holdings but we’ve got one eye on the exit for Fox and the ‘new’ Newscorp. Look out for full reviews of these two demerged companies soon.

It’s been said that as your island of knowledge grows larger, so too does the coastline of mystery. So rather than discuss recent changes to the portfolio, we’ve produced a matrix to show you how the portfolios are prepared for various risks. Green indicates when a company benefits from a risk, red means it would be adversely affected and blue indicates no meaningful effect.

The table reveals just how well positioned the growth portfolio is to profit from a decline in the Australian dollar. It may have already fallen more than 17% since reaching $1.108 on 27 July 2011 as China’s economy slows and mining investment tails off but it could fall far more. The recently published special report Stocks to profit from a lower Aussie dollar will tell you more.

We also own a large swag of dominant, high quality businesses with pricing power to protect earnings and dividends from inflation, should it eventuate. Computershare, Carsales.com, CSL and Sydney Airport are good examples.

Not rocket surgery

Many of the companies are also less sensitive to a recession than a typical listed stock. Whilst reliable and high-dividend paying companies have been bid up by investors, cyclical businesses that have been recently punished are largely indistinguishable from junk.

The potential returns are not compensating for the risks and we won’t lower our standards to acquire them. Whilst we’re not buying mining services companies (for now), Worley Parsons offers a good example.

Of course, the risk matrix doesn’t cover all the potential risks. We recognise that it’s often the risks you don’t see coming that can hurt the most. Higher valuations and the opportunity to profit from events such as NewsCorp’s phone hacking scandal are why we’ve got 9% of the portfolio in cash despite earning interest of just 2.75%.

As I discussed at last year’s national roadshow, formulating a robust portfolio is not ‘rocket surgery’ if you favour cheap and high quality businesses. But it does require patience and the ability to act quickly as opportunities to buy low and sell high present themselves.

We’ve done a good job of that over the past year and I’m sure we’ll get plenty of opportunities over the coming year to put our cash to work.

Note: From 1 July we’ll include franking credits in the performance of the portfolio and the All Ordinaries Accumulation Index. That won’t make much difference in comparing the two, but as we’ll have to reinvest the dividends the portfolio’s cash levels could increase, particularly if more companies reach our assessment of fair value.