Portfolios perform well in torrid market

'May you live in interesting times' goes the Chinese saying, and it's certainly been an interesting start to our Growth and Equity Income portfolios' existence as separately managed accounts.

Established on the 1^st of July, the portfolios have run the usual gauntlet of reporting season, alongside some heightened volatility due to fears of a slowdown in China and over a possible rise in US interest rates.

After peaking at 5,711 at the beginning of August (already down from a high of 5,963 in April), the benchmark All Ordinaries index fell 14% to 4,936 in three torrid weeks, before closing out the first quarter with a 7% loss at 5,059. Including dividends, the index logged a total loss of 5.8%. This doesn't do justice to the volatility, however, with barely a day going by over the past few weeks without a swing of a percentage point or more.

The Chinese saying is meant as a curse, of course, but such volatility is the friend of disciplined value investors, because it can help bring stocks into buying territory. The more difficult environment is when the market's biggest sectors – notably banks and miners – are surging higher, making it hard to keep up. It's safe to say that over the past few months there has been little sign of that – indeed, smaller and medium-sized companies have tended to perform better than their larger peers.

Outperformance

In a benign environment, then, our portfolios performed relatively well, with the Growth Portfolio slipping just 0.3% and the Equity Income Portfolio returning a positive 1.0% – 5.5 and 6.8 percentage points ahead of the index, respectively. Since inception in 2001, the Growth Portfolio has returned 9.8% a year, while the Equity Income Portfolio has returned 13.3% a year, compared to 7.4% a year for the index.

Not surprisingly, the smaller companies in the portfolios chipped in some of the best returns in the September quarter, with Servcorp returning 21% thanks to a strong final result and outlook statement and OzForex gaining 19% after its new chief executive outlined plans to double revenue by 2019. Plans are all they are at this stage, but we like the greater focus on lower value transactions and the U.S., not to mention marketing.

Hansen Technologies was next in line with a 14% return, but the biggest dollar contributor to both portfolios was Sydney Airport, which also returned 14% and was the largest holding in both portfolios for much of the quarter. We took some profit on the stock on 22 September, reducing its weighting from about 8% to 5% in each portfolio, giving them both a cash weighting of around 6%.

Transactions

During the quarter we also took advantage of price weakness to start new holdings in Seek and increase Computershare in both portfolios. We also added to our holding in GBST in the Equity Income Portfolio. All three stocks delivered downbeat guidance on short-term earnings, but we remain confident of their long-term prospects.

In the Equity Income Portfolio, we also sold our holding in BWP Trust following its strong result and reinvested the proceeds into BHP Billiton. Initially the switch was in respect of 3.4% of the portfolio, although this had shrunk to 2.9% by the end of September due to BHP's underperformance. That represents a weighting in the stock of about half that of the All Ordinaries index.

Both portfolios' worst-performing investment, though, in percentage and dollar terms was Origin Energy, which was pummeled by persistently low energy prices. We view these as unsustainable over the long term, but short-term prices do matter for Origin due to its substantial debts – something it's trying to mitigate with its recently announced capital raising.

Overall, it was a pleasing start for both portfolios, although it may be harder to beat the index in the current quarter, with the big banks and miners off to a flier.