The ‘Retain A Quality Of Life’ Investment Portfolio

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In this week's Weekly Insights:
 

– The 'Retain A Quality Of Life' Investment Portfolio
– Commodities: A Smaller Bonanza?
– China: About Growth And Properties
– More Equities, Please!
– Rudi On Tour Visits Brisbane In September

The 'Retain A Quality Of Life' Investment Portfolio

By Rudi Filapek-Vandyck, Editor FNArena

Two weeks ago, subscriber Bill send me a message explaining how keeping up to date with information while maintaining his investment portfolio in good stead has become a real burden on his life as a full-time retiree. Asking for my personal thoughts about his problem, Bill's message ended with the plea: "I would like to have a life away from researching".

I have little doubt Bill's not the only one struggling to match quality of life with regular requirements stemming from his desire to retain full control over investments and strategies. Hence the decision to share my thoughts with a wider audience.

Part of the solution to Bill's problem, I believe, can be achieved by narrowing down one's focus and spending all attention on a smaller group of stocks. Nobody can genuinely monitor the whole share market, day-in, day-out, and never miss anything and every time pick the right stocks at the most opportune times. This can only be a constant source of frustration.

For years, during my on-stage presentations to investors, I referred to the example of one professional fund manager who once explained to me his process of elimination which ultimately ends with 70-odd stocks, of which half are overvalued, thus leaving circa 35 stocks to concentrate on. Bottom line: not even this professional, with staff available working full time from Monday to Friday, having access to sophisticated data and tools for market analysis, tries to oversee the full suite of 2000 listed entities on the ASX.

Focus is key and a smaller selection of targets helps with achieving just that.

How to start? For a retail investor who manages his own funds, I believe the key lies with the basics of constructing a long-term investment portfolio. My personal view is every long-term portfolio needs a solid backbone and access to both income and growth. For the purpose of this exercise, I am only zooming in on the equities part of the investment portfolio. It goes without saying that a solid long term strategy also involves exposure to real estate and bonds and -depending on one's risk appetite and world views- precious metals and alternatives. In the equities department, my suggestion for investors is to create three baskets of stocks:

– income providing dividend stocks
– wealth protection providing All-Weather Stocks
– cyclicals and other growth stocks

To keep things simple and non-complicated (we will look into adjustments and variations further down) let's start off with the basic premise that all three categories represent one third of our portfolio, consisting of 4-5 stocks each. This means our total portfolio will contain between 12 and 15 stocks.

The first category -dividend stocks- seems rather straightforward. Most portfolios in Australia own bank stocks, and Telstra ((TLS)), and probably Woolworths ((WOW)), Wesfarmers ((WES)), Insurance Group of Australia ((IAG)), Woodside Petroleum ((WPL)) and BHP Billiton ((BHP)) too. All pay dividends twice per year, but yields differ -a lot- and that's not even mentioning many of the other characteristics that makes each of them different in their own right. This variety also shows the many options available to investors to play the dividend theme with different levels of risk and growth avenues. Not every dividend payer offers full franking credits either.

Observation number one: Australian investors, on average, own too much exposure to the local banking sector, and this applies to professional funds managers too (as most stay as close as possible to the index and this pretty much forces them into buying more banks as the sector's popularity grows – crazy stuff). Our basket of dividend paying stocks contains a maximum of 5 stocks so 4x Big Banks plus Telstra would do the job, but it also immediately reveals its weakness: too many banks.

Taking a rather traditional approach to the dividend theme, I suggest choosing 2x banks from either one of three mini-selections: Westpac ((WBC)) & Commonwealth Bank ((CBA)), ANZ Bank ((ANZ)) & National Australia Bank ((NAB)) and Bendigo and Adelaide Bank ((BEN)) & Bank of Queensland ((BOQ)). The options available are: domestic oriented, higher priced versus international exposure at lower price versus higher risk through regional, smaller operations.

Other popular options include Telstra ((TLS)), infrastructure exposures such as Sydney Airport ((SYD)), Transurban ((TCL)) and APA Group ((APA)), property owners and REITs including Westfield ((WDF)), Scentre Group ((SCG)) and Lend Lease ((LLC)), retailers including Myer ((MYR)) and Premier Investments ((PMV)), and IT stocks, especially after they've been beaten down.

The list above shows the variety in risk and sustainability that can be applied. For the purpose of this exercise, and with the knowledge that the third basket allows for a lot of risk taking, let's take a more old fashioned, conservative approach: Westpac and ANZ Bank among the banks, plus Telstra on top.

If you are a rather conservative investor, and you need the income, you are more likely to add dividends from names such as Ale Property Group ((LEP)), BWP Trust ((BWP)), Duet ((DUE)) or SP Ausnet ((SPN)). If you are a little more growth oriented, and don't mind the larger weighting of financials in your portfolio, you can choose from the insurers or even Macquarie Group ((MQG)).

One step further away from the traditional concept of dividend paying stocks, and two steps higher on the risk scale, we can now even consider Woodside Petroleum ((WPL)). Other options available from the suite of stocks that are constantly on my personal market radar include Ardent Leisure ((AAD)) and the small cap Count Plus ((CUP)). The latter board has promised to pay out 12c in four quarterly installments suggesting some 7% yield near the bottom of its pricing range. One other, higher risk, option available is through out-of-favour printing services provider CSG Ltd ((CSV)) whose shares stand to yield more than 8% next year. Another lesser known alternative is Asia Pacific Data Centres ((AJD)), a spin-off from cloud champion NextDC, which offers some 8.7% next year.

Let's just say we keep a lid on our enthusiasm to introduce too much risk (we can always re-consider some of the riskier propositions in the third basket) and we add Transurban and Ardent Leisure on top of Westpac, ANZ Bank and Telstra. This implies our average yield for the basket is around 5.5% but only three out of these five are fully franked. While investing in listed equities always carries a certain risk (never let anyone tell you differently), it's probably more than just fair to say that once you've made your four or five choices, and you stick to a lower risk profile, this part of the portfolio does not require intense scrutiny on a permanent basis, which is one reason as to why we are going through this exercise.

The second basket consists of All-Weather Performers; stocks that are not reliant on the economic cycle to continue creating value for shareholders. Regular readers of my market comments and analyses would be familiar with my research on this subject. FNArena has just updated the share price performances of my list of All-Weather Stocks. Subscribers can send an email to info@fnarena.com to request a copy.

Popular stocks on this list include Woolworths ((WOW)) and Wesfarmers ((WES)), CSL ((CSL)) and Ramsay Healthcare, Seek ((SEK)) and Carsales.com ((CRZ)). Again, we have the option to play with levels of risk as some of these All-Weather Performers have seen PEs expand significantly over the years past because solid and sustainable growth seemed rare and investor enthusiasm does not always listen to limits of valuation.

I suggest we move towards a little more risk, but not too much as we still have the third basket. Let's choose Woolworths, Invocare ((IVC)) and Amcor ((AMC)). Among the high PE stocks we choose Veda Group ((VED)), using the opportunity offered by recent share price weakness, and either Flight Centre ((FLT)) or Carsales.com ((CRZ)) for strong growth prospects at a higher risk profile (because of elevated valuation). Woolworths, of course, can be replaced with Wesfarmers. And we can always choose CSL ((CSL)) or Ramsay Healthcare ((RHC)) instead in the high PE department.

Note: in both baskets we are establishing a nice balance between domestic exposure and access to international growth. Also note: all five selected stocks pay out dividends and all are expected to pay out more in the future. The average yield for our first three stocks is 4%, but Amcor falls short on the franking side, while Flight Centre still offers 3.7% next year, and Carsales still 3.3% despite the elevated PEs.

Similar to the first basket, one can choose to add a little more risk by picking Coca-Cola Amatil ((CCL)) given its troubled status and this year's sell-off, but a yield of 5.2% might compensate for this and limit further downside (without guaranteeing it). REA Group ((REA)) and Domino's Pizza ((DMP)) are higher risk options too, but because of PEs at significant premia to the rest of the market.

In terms of ongoing research and the need for constant attention, I surmise stocks like Woolworths, Invocare and Veda Group require less, but with Amcor, Flight Centre and Carsales.com the requirement to keep up to date has stepped up, without giving us too many headaches.

Before we move to the next basket: I have reconsidered my choices and opted for both Flight Centre and Carsales.com. Unfortunately Veda Group misses the boat as a result.

The third basket is where our appetite for risk and for daily research can be stretched as far as we like it to be. Are we going to include loss-making exploration companies and/or eternally fluid young biotech ventures?

I am still assuming we refrain from going overboard, but allow for another step-up on the risk scale nevertheless. Large sized mining conglomerates are less risky and come with more options to provide shareholder benefits. The same applies to the upper echelon of energy companies that shall see a wall of cash flows coming their way over the next 1-3 years. I suggest we pick either BHP Billiton ((BHP)) or Rio Tinto ((RIO)) and one from the four largest energy companies: Oil Search ((OSH)), Santos ((STO)), Woodside Petroleum ((WPL)) or Origin Energy ((ORG)).

Personally, I'd prefer BHP Billiton, given less impact from iron ore weakness, while Woodside would be the higher yield, lower risk option available, but probably with the lowest growth options in the medium term. Origin Energy seems like the next best choice on the risk ladder given better times ahead for its electricity retailing and its relatively high dividend yield (circa 3.5%).

We don't have to stay inside the resources space. Both Orica ((ORI)) and Incitec Pivot ((IPL)) remain somewhat out of favour and their immediate prospects look less than exciting, but both are offering dividends of 4.6% and 4.0% respectively while we sit on the register and await more prosperous times.

The healthcare sector offers some riskier propositions too, from out-of-favour Cochlear ((COH)) -dividend yield 4%- to not well known Virtus Health ((VRT)), to Sirtex Medical ((SRX)), to acquisitive Mayne Pharma ((MYX)) and disruptive minnow Pro Medicus ((PRM)). We can recycle our IT idea since we didn't pick CSG Ltd in our first basket; or try to pick the bottom for mining services providers. I can add one of the popular small cap growth stories such as Greencross ((GXL)), iProperty ((IPP)), Donaco International ((DNA)) or Liquefied Natural Gas Ltd ((LNG)).

All in all, let's pick the following five stocks to complete the exercise: BHP Billiton, Origin Energy, Nine Entertainment ((NEC)) -whose dividend yield is projected to jump to 4.4%- Flexigroup ((FXL)) and Transpacific Industries ((TPI)). I admit. I am showing my colours: I prefer industrial stocks above miners and energy plays. As a side note: all of these stocks are paying a dividend. None of these options is so high on the risk scale that I should expect large losses on at least one of them. (A good night's sleep is one big luxury I do not wish to trade in).

Now that I have finished my list, it's time for regret to kick in. There are at least half a dozen stocks I would have liked to see included -I am thinking Hills Industries ((HIL)) and Hansen Technology ((HSN)), possibly G8 Education ((GEM))- but nothing needs to stop me from adding extra time and reconsidering some of my choices.

For now, let's assume we stick to our fifteen, which means:

In the first basket: WBC, ANZ, TLS, TCL and AAD

In the second basket: WOW, IVC, AMC, FLT and CRZ

In the third basket: BHP, ORG, NEC, FXL and TPI

And still our work is not done. Next decision to make is whether we stick to one third weightings for each basket. For this decision we probably best take guidance from the overall macro-picture. Prior to this year, earnings growth in Australia was low and scarce and volatile and commodity prices, outside of a few exceptions, were in a broad downturn. During this period, our portfolio would have benefited significantly from increased weightings to baskets one and two. Even though geopolitical risk is back on the agenda, and the Chinese property sector is still looking uncomfortably wobbly, global growth it seems, is poised for a mild acceleration in the years ahead.

Feel free to disagree, but I might stick to 33/33/33 and leave the extra 1% to the rounding of the actual numbers.

Next thing to do is to spend some additional time in weighing up the vulnerabilities of the portfolio in case of calamities and events. Are we not overexposed to AUD-weakness? To rising interest rates? To a prolonged property downturn in China? To a possible escalation of the conflict in the Ukraine or in Israel? Only after I have gone through several scenarios, and I am still comfortable with my three baskets of stocks, should I proceed.

Outside of my 12-15 stocks, I keep a list of somewhat equal length for potential replacements, but any changes will largely depend on whether any of my choices disappoints. Partial profit taking is part of the process, to prevent certain stocks from gaining too much weight. On final consideration, I might skip Flexigroup in the third basket and keep the cash at hand instead, for the next opportunity to come along.

Most of all, I now have two lists to concentrate on, and while none is immune to future adjustment, I don't feel like I am still caught inside a full-time investment job.

(All feedback welcome and appreciated at info@fnarena.com)

Commodities: A Smaller Bonanza?

When it comes to making predictions, investors should always heed the wise words spoken by Nobel laureate in Physics, Nils Bohr: "Prediction is very difficult, especially if it's about the future". Undeterred, commodity analysts at Goldman Sachs have attempted to pin down price forecasts for key commodities by 2019, or five years out from today.

If, and this remains a Big If, the work done by Goldman Sachs proves to be anywhere near prescient in years to come, the Big Three for the Australian share market -crude oil, copper and iron ore- are all staring at lower price levels by then as to where prices are today. The good news is that projected declines remain rather benign, in particular if one considers these projections are five years out as well as the usual volatility that comes with commodities and pricing.

More good news comes from the fact that commodities that have been in the doldrums in years past, such as thermal coal and aluminium, are finally forecast to enjoy better times ahead. Bottom line: the coming upturn for commodities and resources stocks won't be a repeat of the 2003-2008 bonanza, or even of the 2009-2010 bounce. But there seems to be something for everyone in it. On the assumption these forecasts can actually withstand the changing and shifting global dynamics in the years ahead.

China: About Growth And Properties

The "surprise" GDP growth statistic for the June quarter delivered by government statisticians in Beijing was due to rounding of some particular data, reported economists at Westpac. Bless those economists who are not afraid of embarking on tedious and unglamorous journeys to put a few dots and commas in the right places while virtually nobody cares, really. But nice to know and thanks for pointing that out. Good to realise that even Chinese data releases have come to the point where rounding lower or higher now makes the difference between meeting or beating market forecasts.

China's economy has continued growing at 7.5% in the second quarter, but investors should not be surprised to see a lower number for the current quarter, say economists at CBA and Macquarie. The problem seems to be of stronger growth in the third quarter from last year, which this year creates the problem of adding the same growth momentum on top. Regardless, economists at ANZ Bank decided to lift their forecasts to 7.5% for the full calendar year and this suggests the Chinese economy will start next year on a positive blaze. Economists at Deutsche Bank predict the December quarter will record annualised growth of no less than 8%.

8% makes sense, if we first see a dip towards 7% this quarter. All this on the assumption that Beijing's 7.5% target for the year is to remain sacrosanct. For how long will at some point become the market's new focus, one presumes, with ANZ Bank suggesting the Chinese government is looking for the opportune moment to announce a new target of 7%. It'll happen by early next year, predicts ANZ.

Meanwhile, price surveys for China's property markets continue to show declines in more and more regions. New home prices fell in 55 of the 70 major cities monitored by the National Bureau of Statistics, against 35 in May. This is what keeps local economists awake at night, at least those fearing a profound downturn and certainly not everyone is of the same view when it comes to China, debt and properties.

The same goes for Huatong Road & Bridge and Jiangsu Hengshunda Bio-Energy who's likely to become the second corporate default in the Chinese corporate bonds market this month. So far, investors seem to largely ignore the event, despite some market watchers feeling quite uncomfortable about it. Never a dull moment when conversations turn to China nowadays…

More Equities, Please!

The latest global fund managers' survey by BA-Merrill Lynch shows up some interesting observations. While cash levels remain elevated, at 4.5%, the industry's allocation to equities sits at the highest Overweight level since February 2011, making it the second highest level in 13 years. Not surprisingly, the Underweight positioning for bonds is currently the largest for the year to date and 1.2 standard deviation from its long term average, approaching the low allocation levels last seen in 2007.

According to the survey, fund managers see better global growth ahead and they are most worried about geopolitical escalation and Chinese debt. The irony comes with the observation that stocks are seen as the most expensive since May 2000, but just about everyone is looking to add additional exposure. In the view of BA-ML analysts, all of the above translates into a probable "melt-up" for global equities in the months ahead, to be followed by -finally!- that long anticipated correction during the Northern Hemisphere's autumn. Which takes us to September-October, the usual time to have corrections, so tells us history.

Rudi On Tour Visits Brisbane In September

I have yet to book accommodation and flights, but on Wednesday, September 3, I will be presenting in Brisbane twice, in the afternoon and in the evening, on behalf of the local chapters of the Australian Investors' Association (AIA) and the Australian Technical Analysts Association (ATAA)) respectively. More details to follow.

(This story was written on Monday, 21 July 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of June available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms