Income portfolio plods along
For the model Income portfolio, 2012 was a bit like the banker who took delight in a $1m bonus until he found out his colleague got $2m.
On 1 January 2012, we would have been delighted to know that the Income portfolio would return 10.9% for the year. But with the All Ordinaries Accumulation Index increasing 18.8%, it doesn’t feel quite as good now.
Of course, measuring your performance over one year against an index with a 22% weighting to the big four banks, which themselves produced a stellar average annual total return (capital gains plus dividends) of 29%, is foolhardy. The portfolio’s aim is to preserve capital, produce a reliable stream of dividends (preferably fully franked) and outperform the index over a long period.
Key Points
- Total returns of 10.6% for 2012
- Happy with performance, despite lagging index
- Equities still a good bet
As you can see in Chart 1, you could drive a lorry between the performance of the Income portfolio and the index since inception in July 2001, though we expect the gap to fall somewhat over time as the portfolio is managed more conservatively these days.
Performance envy
So we won’t be suffering any short-term performance envy, a malady that can lead to excessive risk taking and permanent losses of capital.
China’s economy remains highly unbalanced and sits aloft a mountain of (potential) ‘non-performing loans’. The US, Europe, UK, Japan and many other nations are involved in a currency war to stimulate exports, investment and employment by printing money, while avoiding reforms that could produce a long-term solution to consumer and sovereign debt burdens.
With valuations also increasing considerably in 2012, we’re still prepared to hold a decent amount of cash for future opportunities (the portfolio assumes all dividends are spent), avoid the resources sector and highly cyclical industries that feed off it, and maintain the conservative 6% combined bank weighting, split fairly evenly between Commonwealth Bank and Westpac. If their respective share prices fell significantly, we’d potentially top up their combined weighting to a maximum of 10%.
Stock performance
Every stock in the portfolio produced a positive return in 2013 (see Chart 2), except QBE Insurance. QBE’s performance would be close to flat if you took the current price, which we believe undervalues the company.
Two cyclical companies were amongst the top three performers: advertising group STW Communications and virtual office provider Servcorp. Often it pays to have some higher growth companies in an income or conservative portfolio to help fight inflation, though these two stocks aren’t particularly suited to such a conservative portfolio.
Westfield Group produced a 42% total return, showing that the stockmarket is not always rational, as concerns about the impact of the internet on discretionary retailers and retail rents gave way to the hunt for reliable income stocks due to falling interest rates.
It’s hard to believe that Sydney Airport (then Macquarie Airports) reached a low of $1.68 in March 2009 given the record number of passengers passing through Sydney Airport. It produced a 35% total return in 2012 and from here it is capable of at least producing high single-digit annual returns, which are also protected against inflation by regulated airport and landing charges.
Poorer performers
Amongst the poorer performers, several were relatively recent inclusions (see Table 1 for a full list of transactions) such as the ALE Notes 2 income securities, ASX and Commonwealth Bank. We regret not selling the Seven Network TELYS4 at higher prices, and Washington H Soul Pattison has suffered due to lower gas prices which could reduce demand for coal. Half of Soul Patts’ value resides in New Hope Coal.
Stock | BUY/SELL | Shares (no.) | Price ($) | Value ($) | Date |
---|---|---|---|---|---|
Westfield Retail | Sell | 2,343 | 2.51 | 5,881 | 30/01/12 |
Perpetual | Sell | 400 | 24.43 | 9,772 | 24/02/12 |
WHK | Buy | 4,000 | 0.84 | (3,360) | 03/04/12 |
Treasury Wine | Sell | 417 | 4.155 | 1,733 | 03/04/12 |
Spark Inf. | Sell | 7,000 | 1.42 | 9,940 | 20/04/12 |
IAG | Sell | 2,150 | 3.36 | 7,224 | 16/05/12 |
ASX | Buy | 200 | 29.87 | (5,974) | 08/06/12 |
Australand | Sell | 3,060 | 2.45 | 7,497 | 29/06/12 |
ASX | Buy | 80 | 29.26 | (2,341) | 29/06/12 |
Computershare | Buy | 780 | 7.38 | (5,753) | 29/06/12 |
ALE Notes 2 | Buy | 60 | 100.50 | (6,030) | 28/06/12 |
Betashares USD ETF | Buy | 750 | 9.90 | (7,425) | 29/06/12 |
Metcash | Sell | 2,500 | 3.25 | 8,125 | 10/7/2012 |
ALE Property | Buy | 2,800 | 2.09 | (5,852) | 27/7/2012 |
Westpac | Sell | 120 | 25.74 | 3,089 | 15/10/2012 |
Comm. Bank | Buy | 100 | 57.05 | (5,705) | 15/10/2012 |
Challenger Inf. | Capital return | 3,600 | 1.16 | 4,176 | 27/11/2012 |
We also sold Insurance Australia Group too early, as it recently sold its lousy UK divisions and has been pushing though premium increases and raising its dividend (although selling is a fine art, see Sold out early? The one that got away). It’s currently on the cusp of a downgrade.
The portfolio collected $8,033 in dividends, which is down significantly from the peak of the boom when dividends were unsustainably high (see Chart 3), and 16% of the portfolio is currently held in cash for future opportunities (the figure increases to 20% if you include the US dollar ETF). In 2013 we’ll begin earning interest on these amounts calculated monthly, conservatively using the official cash rate rather than much higher term deposit rates.
What now?
Many investors that have held firm since the global financial crisis are wondering if they should be cashing in their gains. In response, Steven Johnson, Chief Investment Officer of the Intelligent Investor Value Fund emphatically says Don’t sell your stocks just yet.
We agree that stocks are still a good bet given the dearth of favourable investment alternatives, but we would say that wouldn’t we. We’d be satisfied with a high single-digit return from the Income portfolio in the current environment, particularly given the portfolio’s defensive settings, such as the large cash weighting. As always, individual stock valuations will guide our decisions.
Just in case you’re missing the days of regular double-digit returns, François Sicart of Tocqueville Asset Management offers solace in Short-term Gratification and Long-term Return: ‘In my observation,’ says Sicart, ‘more capital is lost or wasted as a result of poor life choices than because of inadequate investment performance.’
Note: Look out for an update on the Growth Porfolio over the next few weeks.