Portfolios bounce back after Brexit

Sterling’s flash crash shows we’re not yet out of the woods on Brexit, but the threat of a Trump presidency seems to be receding.

What a difference a few months makes. Markets took a hammering right at the end of the 2016 financial year thanks to the Brits’ decision to leave the European Union – and took our portfolios down with them – but three months of mostly sober reflection have reassured investors that the world is not about to end.

Last week’s ‘flash crash’ – where sterling fell 6% against the US dollar in a matter of minutes – shows that the UK isn’t out of the woods yet, but markets are taking the view that any damage is likely to be contained. Meanwhile, the greater threat to global stability – a Trump presidency – appears to be receding.

Key Points

  • Portfolios outperform strongly

  • Reporting season favourable

  • Well placed for long term

The All Ordinaries Index returned 5.3% for the three months to 30 September, but our portfolios came in well ahead of that, with the Growth Portfolio gaining 13.1% and the Equity Income Portfolio gaining 11.4%.

Since they opened their doors to investment in July 2015, they have generated annualised returns of 21.7% and 19.6% respectively, compared to 5.9% for the All Ords; and since inception as model portfolios 15 years ago they have returned 11.0% a year and 13.7% a year respectively, compared to 7.9% a year for the All Ords.

Growth Portfolio

The Growth Portfolio’s top performer for the September quarter was South32, which gained 57% as investors anticipated and were delivered an excellent full-year result. Although the headline loss was a whopping US$1.6bn it was mostly due to asset writedowns and operating cash flow actually jumped more than 50% to over US$1bn.

Nanosonics was also up strongly, gaining 55% after delivering its first annual profit. Management reported that sales of its Trophon probe sterilisers jumped 74% in the key North American market and noted that it is now being used in 48 of the top 50 US hospitals. The installed base is particularly important because it drives recurring sales of high-margin disinfection cartridges.

Hansen Technologies is another fast grower, and it duly delivered a 40% rise in revenue for 2016 and a 43% rise in earnings per share. It was enough to push the stock up 39% for the quarter and it has now tripled since it was added to the (then model) portfolio two years ago.

Other notable performers were Monash IVF and Amaysim, with gains of 38% and 33% respectively.

Set against these high-fliers was a horrible performance from iCar Asia. At the end of June it had been plodding along nicely towards its targeted breakeven in 2018, at what now looks like a very distant share price of 85 cents. Then receipts for the June quarter fell short of expectations, before the company warned on 2016 losses, abandoned its breakeven target and raised capital. All that knocked the stock down to 29 cents at the end of September, handing us a 66% loss.

The only good news is that we began all this with a weighting of only 3%, so the damage has been limited. With the path to profitability now much less clear, iCar has become decidedly more speculative and that’s discouraged us from buying more, although we’re content to hang onto what we have.

Table 1: Growth Port. transactions
Date Stock % bought
/(sold)
Price
1 Sep 16 Trade Me (TME) (1.0) $5.32
1 Sep 16 Amaysim (AYS) 1.0 $2.04

OFX Group (formerly OzForex) was another significant faller, losing 18% as investors fretted over increased competition in international payments – including an agreement between Commonwealth Bank and the UK’s Barclays Bank – and potential disruption from ‘blockchain’ technology. The stock looks cheap at current prices but, again, given the risks involved we’re content to sit on our hands.

The Growth Portfolio’s only disposal in the quarter was the one percentage point reduction of Trade Me on 1 September at $5.32; and the only purchase was the use of those funds to increase our holding in Amaysim at $2.04.

We remain very comfortable with Trade Me, but its weighting (at 8.5%) had moved well beyond our 6% recommended maximum and we were keen to increase our investment in Amaysim after an excellent full-year result showed that our investment case is on track, with subscribers growing strongly and margins expanding.

You can see a full list of holdings on the Growth Portfolio’s homepage.

Equity Income Portfolio

Our Equity Income Portfolio’s best performer was also South32, which benefited from an excellent result, as described above.

South32’s former parent, BHP Billiton, also performed well, returning 21% despite a headline loss for 2016 of US$6.4bn. As with South32, the loss was due to writedowns forced by past mistakes of capital allocation, but the underlying net profit of US$1.2bn was a decent effort given weak commodity prices. New management continues to make strides at recuperating the big miner.

The portfolio’s other top performers were Monash IVF and Ansell, with gains of 38% and 28% respectively. Both companies reported full-year results that suggested past difficulties were behind them.

Monash saw a 12% increase in IVF cycles in Australia, increasing its market share from 23% to 24%, and a 10% increase in cycles in its nascent Malaysian business. Price rises meant that revenue rose 25%, while a slower rate of cost growth meant that net profit increased by 35%.

Ansell, on the other hand, saw profits go backwards, with revenue falling 4% and net profit down 15%. That was, however, at the upper end of the guidance provided in February, which caused the stock to fall 20% and prompted us to buy. Growth is expected to return this year and the market also cheered plans to sell the company’s condoms division to focus on its other operations (mostly gloves) that sell to businesses rather than consumers.

Table 2: Income Port. transactions
Date Stock % bought
/(sold)
Price
1 Sep 16 Trade Me (TME) (2.0) $5.32
1 Sep 16 ASX (ASX) (1.0) $51.51
1 Sep 16 Virtus Health (VRT) (1.0) $7.92
1 Sep 16 CBA (CBA) 3.0 $71.60
1 Sep 16 Westpac (WBC) 1.5 $29.55

The only significant faller in the quarter was OFX Group (formerly OzForex), which lost 18% as described above.

On 1 September we reduced some of our largest holdings – Trade Me by 2.0 percentage points to 6.6% (at $5.32), and ASX (at $51.51) and Virtus Health (at $7.92) each by 1.0 percentage points, to 6.3% and 4.3% respectively. The funds (and some cash) were used to increase our holdings in Commonwealth Bank by 3.0 percentage points to 5.2% (at $71.60) and Westpac by 1.5 percentage points to 3.8% (at $29.55).

We remain comfortable with Trade Me, ASX and Virtus, but wanted to bring their weightings down after share price increases. Commonwealth Bank and Westpac are both Holds, but were (and still are) close to their Buy prices and are particularly well suited to an income-focused portfolio due to their high fully franked dividend yields.

You can see a full list of holdings on the Equity Income Portfolio’s homepage.

Greatest threat

In spite of the excitement (or perhaps horror) around Brexit and Trump, the greatest short-term threat to our portfolios – as for markets generally – is that interest rate expectations rise. That would force investors to raise the ‘opportunity cost’ they put into their valuation models and knock down their valuations accordingly.

The good news is that any increase in rate expectations is likely to be accompanied by improved prospects for growth. Both our portfolios are largely comprised of stocks that add value and enjoy plenty of pricing power, and that should enable them to take their share of any growth that eventuates.

As ever, the sharemarket could see some sharp movements in the short term as investors adjust their expectations for rates and growth. But that’s the penalty for being in an asset class that tends to outperform others over the long term. We see no reason for that to change.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in many of the stocks mentioned. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Amaysim, iCar Asia, OFX Group, Trade Me, ASX, Woolworths and GBST.

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