Income portfolio delivers steady returns
It takes a rare investing talent to impress Joel Greenblatt, Jeremy Grantham, Seth Klarman, and Warren Buffett, but Howard Marks, co-founder and chairman of Oaktree Capital Management, has done just that. Over forty-odd years in the market, Marks has forged a reputation as an original and insightful investor, garnering the respect of the best in the business.
Careful portfolio management is one of the keys to Marks's success and we've taken many of his lessons to heart in the management of our Income portfolio, which aims to provide a steady, reliable stream of income from companies with minimal risk of bankruptcy.
As Marks puts it: 'Superior investment performance is not our primary goal, but rather superior performance with less-than-commensurate risk ... Thus, rather than merely searching for prospective profits, we place the highest priority on preventing losses."
Marks believes that a skilfully managed, risk-averse portfolio should aim to match the performance of the market when it rises and do better than the market when it does poorly. If you can achieve this then, over time, your portfolio should significantly outperform the market.
Key Points
- Income portfolio returned 4.0% and paid $3,912 in dividends in the six months to 30 June
- Long-term outperformance of the market, returning 13.0% a year since inception in 2001
- Changes to portfolio reflect a focused, disciplined approach to risk
So how do we stack up against Marks’s yardstick? Over the past six months the Income portfolio returned 4.0% compared to 2.9% for the All Ordinaries Accumulation Index. And since inception in 2001 the portfolio has returned 13.0% a year, well clear of the index's 6.3% (see Chart 1).
Let’s look at the principal drivers of the portfolio’s performance and the changes we’ve made over the past six months.
Income lower as cash balance rises
One of the most important things for an income-focused portfolio, is, well, income. In the six months to 30 June the portfolio generated $3,912 in dividends, giving it a running yield of 4.7% a year. This is lower than the same period in 2011 and well short of the $7,492 received in six months to December 2006 (see Chart 2).
Lower income is a direct result of the increased cash in the portfolio, which at 30 June was $30,777 or 18.4% of the portfolio (including US dollars).
We are keenly aware of the need to boost the portfolio’s income, but as we suggested in The five secrets of tough-times investing on 25 Jun 12, ‘Simply buying stocks with the fattest yield ... would be a mistake. Just ask anyone that invested in A-REITs in the lead up the GFC.’
Given the choice, we’ll always forego a slight increase in yield to avoid excessive risk, which explains why we’ve avoided the recent spate of income securities. Increasing our cash holdings when opportunities are scarce leaves the portfolio well placed to act when bargains emerge. (see The case for cash).
Stable performance reflects low-risk holdings
Turning to performance, there were a couple of notable winners that helped boost returns. Westfield Group rose 22% as investors became more excited with its overseas expansion strategy. Westfield is trading around fair value and we remain comfortable with our holding.
Challenger Infrastructure Fund rose 17% after announcing the sale of its assets: Inexus and LBC Tank Terminals (see CIF: Risk reduced, upside improved from 06 Jun 12 (Long Term Buy – $1.18) and CIF: Inexus sale boost from 26 Jun 12 (Hold – $1.29)). Challenger is now in wind-up mode and we patiently await the pending capital return.
STW Communications, Platinum Asset Management, Sydney Airport, Abacus Property Group, Woolworths and Westpac all outperformed the market over the past six months reflecting their stable, high-quality nature (see Chart 3).
On the other side of the ledger, Metcash’s share price fell 17% following a weak result from its core grocery wholesaling business and a $325m capital raising. Since the 30 June balance date, we've downgraded the company to Hold and sold our holding, chalking up a 11.8% loss (see Red flags waving for Metcash from 10 Jul 12 (Hold – $3.25)).
Risk first, then reward
Recent transactions reflected our focus on risk before reward. Over the past six months we have sold shares in Perpetual, Westfield Retail Trust, Insurance Australia Group and Spark Infrastructure following reassessments of their businesses (see Table 1). Australand was also sold to reduce our exposure to the property sector and Treasury Wine Estates got the chop following its recent price rise.
Stock (ASX code) | Buy/Sell | Shares (no.) | Price ($) | Value ($) | Date |
---|---|---|---|---|---|
Westfield Retail Trust (WRT) | Sell | 2,343 | 2.51 | 5,881 | 30/01/12 |
Perpetual (PPT) | Sell | 400 | 24.43 | 9,772 | 24/02/12 |
WHK Group (WHG) | Buy | 4,000 | 0.84 | (3,360) | 03/04/12 |
Treasury Wine Estate (TWE) | Sell | 417 | 4.155 | 1,733 | 03/04/12 |
Spark Infrastucture (SKI) | Sell | 7,000 | 1.42 | 9,940 | 20/04/12 |
Insurance Australia Group (IAG) | Sell | 2,150 | 3.36 | 7,224 | 16/05/12 |
ASX (ASX) | Buy | 200 | 29.87 | (5,974) | 08/06/12 |
Australand (ALZ) | Sell | 3,060 | 2.45 | 7,497 | 29/06/12 |
ASX (ASX) | Buy | 80 | 29.26 | (2,341) | 29/06/12 |
Computershare (CPU) | Buy | 780 | 7.38 | (5,753) | 29/06/12 |
ALE Notes 2 (LEPHC) | Buy | 60 | 100.50 | (6,030) | 28/06/12 |
Betashares US Dollar ETF (USD) | Buy | 750 | 9.90 | (7,425) | 29/06/12 |
These transactions increased the focus of the portfolio, with the total number of holdings decreasing from 21 at 31 December 2011 to 19 at 30 June 2012 (including US dollar ETF). For this type of portfolio, we're very happy with around 15 to 20 holdings, which should offer most of the benefits of diversification without overly muting the effect of our winners.
Portfolio eyes opportunities abroad
Additions to the portfolio have broadly fitted into three categories.
First, as we’ve discussed extensively, now is a great time to invest overseas (see Why now is a great time to invest abroad, Ripe for the picking: Eight overseas stocks to buy now and Overseas stock opportunities – Pt 1).
‘Howard Marks publishes regular memos on Oaktree’s website, which are available free here. He has also written a book, ‘The Most Important Thing’, a distilled version of the best of his client letters.' |
The Income portfolio only invests in ASX-listed stocks so we’ve increased our overseas exposure by investing in share registry Computershare, which generates 81% of its sales offshore. This complements our existing internationally focused holdings, Westfield Group and QBE Insurance. We have also diversified our currency holdings by placing about 20% of the portfolio’s cash in a US dollar exchange traded fund (see Topping up model portfolios from 29 Jun 12).
Secondly, we’ve added some high-quality, blue-chip stocks. Computershare has already been mentioned and also fits this category. We've also purchased some ASX. ASX has a quasi-monopolistic position as the owner of our main securities exchange, helping it generate large licks of free cash, which translate into a fat fully-franked dividend yield of 6.2%.
Stock (ASX code) | Price movement since 31/12/11* (%) | Current yield (%) | Most recent reco. | Shares (no.) | Price ($) | Value ($) | % of portfolio |
Abacus Property Group (ABP) | 7.4 | 8.1 | Hold – $1.90 (13 Jun 12) | 2,350 | 2.04 | 4,794 | 2.9 |
ALE Notes 2 (LEPHC) | 0.0 | 8.1 | Buy for Yield – $100.50 (28 Jun 12) | 60 | 100.50 | 6,030 | 3.6 |
Australand ASSETS (AAZPB) | -2.2 | 9.3 | Hold – $93.10 (09 May 12) | 100 | 89.00 | 8,900 | 5.3 |
ASX (ASX) | -0.2 | 6.2 | Long Term Buy – $29.87 (08 Jun 12) | 280 | 29.82 | 8,350 | 5.0 |
Challenger Infra. Fund (CIF) | 17.0 | n/a | Hold – $1.29 (26 Jun 12) | 3,600 | 1.31 | 4,716 | 2.8 |
Computershare (CPU) | 2.9 | 3.8 | Long Term Buy – $7.82 (14 Jun 12) | 780 | 7.58 | 5,916 | 3.5 |
Metcash (MTS)~ | -16.6 | 8.3 | Hold – $3.25 (10 Jul 12) | 2,500 | 3.37 | 8,425 | 5.0 |
Platinum Asset Mmt (PTM) | 10.5 | 5.9 | Hold – $3.69 (11 Jul 12) | 1,500 | 3.89 | 5,835 | 3.5 |
QBE Insurance (QBE) | 3.1 | 6.4 | Buy – $14.09 (05 Apr 12) | 700 | 13.70 | 9,587 | 5.7 |
Servcorp (SRV) | 1.5 | 5.7 | Long Term Buy – $2.85 (22 Feb 12) | 1,800 | 2.65 | 4,770 | 2.9 |
Seven Net. TELYS4 (SVWPA) | -8.2 | 10.6 | Hold – $82.50 (18 May 12) | 93 | 77.99 | 7,253 | 4.3 |
STW Communications (SGN) | 12.5 | 8.4 | Hold – $0.92 (21 Jun 12) | 7,000 | 0.95 | 6,615 | 4.0 |
Sydney Airport (SYD) | -13.2 | 7.2 | Long Term Buy – $2.61 (27 Feb 12) | 3,280 | 2.90 | 9,512 | 5.7 |
Washington H Soul Patts. (SOL) | -0.3 | 3.1 | Hold – $13.40 (12 Jul 12) | 700 | 13.79 | 9,653 | 5.8 |
Westfield Group (WDC) | 21.6 | 5.1 | Hold – $9.18 (16 May 12) | 1,086 | 9.50 | 10,317 | 6.2 |
Westpac Banking Corp. (WBC) | 5.7 | 7.7 | Hold – $22.93 (04 May 12) | 320 | 21.13 | 6,762 | 4.1 |
WHK Group (WHG) | 1.8 | 8.3 | Long Term Buy – $0.83 (23 Feb 12) | 9,500 | 0.84 | 7,980 | 4.8 |
Woolworths (WOW) | 6.8 | 4.6 | Long Term Buy – $26.44 (01 Jun 12) | 400 | 26.80 | 10,720 | 6.4 |
^Held via US dollar ETF at current market prices | Cash (AUD) | 23,442 | 14.0 | ||||
*Since purchase for new additions | Cash (USD)^ | 7,335 | 4.4 | ||||
~Sold post 30 June | Total portfolio value ($) | 166,912 | |||||
Current annualised yield (%) | 4.6 | ||||||
Return since inception (p.a) | 13.0 |
Finally we've purchased two high-yielding second liners. WHK Group, an existing investment, was doubled to a 4.8% weighting, whilst a new position was taken in ALE Notes 2, an income security we purchased on an attractive nominal yield of 8.1% secured by ALE Property Group’s 87-strong pub network.
Overall, these were modest changes, reflecting our steady, risk-averse approach to building and managing an income portfolio.
The Income portfolio is a dynamic, practical demonstration of how we think about investing, and is designed to complement our stock research, helping you build and manage your portfolio. The results, especially over the longer-term, demonstrate the value of our approach.
Note: For more on portfolio management check out Building and managing an income portfolio - Part 1 or dive into our back catalogue of model portfolio reviews. Look out for a Growth portfolio update next week.