Portfolio Construction White Paper Thematic Approach
Staying Ahead Of The Game
Many clients may wonder about the reasoning behind our investment recommendations & how they come about. Well, wait no more, this White Paper is designed to help you better understand AAG investment philosophies.
Primarily we invest in themes for future macro investing. We endeavor to identify stocks likely to outperform, whatever the stock market trend. Different stocks are recommended to different clients, depending on your age, requirement for dividend income to support your lifestyle & your tolerance to risk.
Markets are generally fuelled by fear & greed, so while one sector may be hot & full of the “greedy”, other sectors may be unloved & full of “fear”. We like to invest in “fear” & sell when “greed” starts to appear (except where the dividend yield is compelling).
You can’t look at your shares on a daily basis. If you are investing for the longer term, then try not to micro-manage your positions. If someone told you the value of your home on a daily basis, it would drive you to distraction. So sit back, look at the bigger picture, & make decisions accordingly. Cashflow is king & is the backbone of all our investment strategies. As everyone knows, the AAG philosophy is to minimise tax & bank fees, whilst boosting returns.
Major Market Themes
The Big Four Banks
As mentioned earlier, cashflow is king, so we favour high dividend paying shares. With Term Deposit rates at historical lows, we prefer to invest in the institutions that pay these low rates, rather than the product itself. That is, we prefer to own the bank shares that pay dividends of 7.5% pa (before tax), rather than hold Term Deposits that pay 2.5% pa (before tax) at best.
If you think the banks are good enough to honour your Term Deposit, then it makes sense to purchase the underlying stock, as long as you can weather the ups & downs of stock market investing. Once again, understand why you have bought the banks & sit back & enjoy your dividends.
There is some market noise, suggesting that the banks may not be able to increase their dividends in the coming years. While this may be true, in the meantime, you are receiving 7.5% pa on your invested funds. Even if the banks were to cut their dividends by 25% (which would be corporate suicide), dividend income will still be over 5%, which is double the current Term Deposit rate.
When interest rates start rising, the banks’ revenues will also grow, reiterating their enviable position. Everybody likes to complain about the banks, so why not be on the other side & profit from their profits & enjoy years of tidy, tax effective income.
As we are an ageing population, this theme is growing in relevance. It offers long term growth, with some income; the free trade agreement with China will provide further opportunities.
Stocks like Sonic Healthcare, Primary Healthcare, Ramsay Healthcare & CSL provide exposure to this growing sector.
Diversified financials refer to those companies that provide services to the financial sector. Stocks like AMP, Platinum Asset Management & Perpetual Trustees derive their income from financial markets. They provide services & derive fees from managed funds, superannuation products & other related products. The superannuation industry is growing exponentially in Australia; 9.5% of all Australians’ incomes pour into this sector, so they have solid, legislated base, from which to grow.
“No one understands the cloud”….. but Telstra does. The Cloud will spawn tomorrow’s infrastructure stocks. Things are rapidly changing in the IT world. In future, all our networks will be housed in custom-built data centres, properly backed up, serviced, uninterrupted, protected, secure & temperature controlled environments. We will be paying for services & applications by the hour. Telstra will be the biggest player. Also they are paying 8.6% pa in dividends. NextDC is the other obvious player, but it does not pay dividends.
China is not all about infrastructure. The consumer class in China is growing rapidly. China’s retail markets are expected to almost double again by 2020 to US$9.8trillion. The resources boom has subsided, but the services boom is real. Financial services, tourism, healthcare & agriculture will be able to benefit. The free-trade agreement has opened up opportunities for many Australian companies. China, as a theme, is still in play, just skewed towards to consumer rather than resources.
Having said that about resources, we still believe it is a key theme. The boom may be over but there is still growth in world economies, albeit, at a much slower rate. Refineries, highways, freeways, dams, airports & other infrastructures, are still being built. Furthermore, as emerging economies pick up pace, particularly CHINDIA (China & India as it is colloquially known), essential services will need to be provided to the growing middle class, consumer sector.
Resources are cyclical, always have been, always will be; prices are depressed at the moment & we view this as an opportunity. It is only a matter of time before the cycle picks up again, so we are happy to accumulate major resource stocks such as BHP, Woodside & to a lesser extent RIO.
As previously stated, we are an aging population, so Aged Care is an emerging theme, but not one that we are prepared to submerge ourselves in just yet. The Department of Health (DoH) is tightening up on the nature & quantum of fees that the sector may charge residents. It is likely that the sector will experience increased audit scrutiny, on top of what was already going to occur under the Aged Care Funding Instrument changes.
It comes at a delicate time for the sector that is grappling with the real & perceived impact of the federal budgets c$1.8b in funding cuts, & subdued earnings guidance. The DoH is clamping down on the sector’s capacity to replace lost revenue from the funding changes. It is one thing for the Commonwealth to seek to find savings within a tight budgetary context, it is another thing entirely, when the Commonwealth appears to be seeking to stop the sector from charging fees to residents to recoup lost funding, when the Living Longer Living Better reforms, are specifically designed to compel the consumer to pay more. So what is going on?
Listed Property Trusts have been the best performing sector over the past two years. However, they were the sector to be hardest hit post GFC & have taken the longest to recover; some have still not reached their pre GFC levels. As most clients have property assets, we are not major investors in this sector. In addition, the distribution rates are generally 5-6% before tax & growth is linked to the rental market; we prefer franked dividends that provide greater income & opportunity for capital growth.
Exchange Traded Funds (ETFs)
The latest buzzword & fastest growing product sector in the market. Essentially, an ETF is an investment in an index, market or theme, so is more of a diversification strategy, that gives you exposure to markets that you would otherwise not have exposure to.
Gold, technology, cyber security, agriculture, fuel, currencies, yield, healthcare, …….you name it, there is an ETF for it. Although a portion of funds can be invested in ETFs, they lack the transparency of direct shares. There are the fund managers that create the ETF themselves, then they commission a market maker to ensure there is a buy & sell spread for the ETF…….the beat goes on & all of these management layers expect to be paid.
Proceed, but with caution.
ETFs & most managed funds can be traded like any other security on the stock exchange.
Portfolio construction & stock selection is an ongoing, evolving & dynamic strategy. This White Paper is intended to provide an insight to how we make investment decisions; some are investigated & included, others are investigated & excluded.
As always, if you have any questions or would like clarification on the above, please contact us at firstname.lastname@example.org.
This White Paper is general in nature only & not intended as advice. All information & views expressed in this White Paper are correct at the time of publishing, 7th September 2016.