Patersons Model Portfolio Update - July 2018
Patersons Model Portfolio Update - July 2018


QVR Portfolio up 15.4% and Income Portfolio up 13.3% for the 2017/18 Financial Year, compared with the benchmark at 13.0%.


  • We sold out of our holdings in SVW and HVN, using the funds to top up our position in TAH, while adding new positions in MFG and AST.
  • The following stocks went ex-dividend during the month: QVR Portfolio -  CHC and SYD.  Income Portfolio – ARF and CHC.
  • Our cash position in the QVR and Income Portfolio is 17.9% and 19.2% respectively.  

Equity Market Performance         

Global equities were down 0.2% for the month of June, while US equities outperformed global equities with the S&P500 returning 0.5% for the month, although the Dow was down 0.6%.  For the rolling quarter, the MSCI All-Country Total Return Index (incl. dividends) was up 1.7% while the S&P500 was up 2.9%. European stocks were down 1.4% for the month of June and up 4.3% for the quarter, primarily as a result of a strong performance from the FTSE100. European bourses were weaker, reflecting comments by Jean-Claude Juncker, the EU President, that “the fragility of the EU is increasing” as ongoing geopolitical issues threatened to impact the stability of the Eurozone.
The past month saw geopolitical concerns around trade, and particularly the US-China relationship, continue to dominate investment markets. The US looks set to implement a 25% tariff on US$34 billion of Chinese imports on 6 July and while it is likely that some form of negotiated solution will ultimately be reached, things are likely to get worse before they get better.  While there is still plenty of optimism around the global economy, there are signs that growth in several economies has already peaked, putting a brake on stock markets and sending rising bond yields back in the other direction.
Some economic commentators are now suggesting the high of over just over 3% in 10 year bond yields seen in May, may be the peak yield for this cycle as geopolitical uncertainty and news flow on trade wars and emerging markets has since driven the yield back under 3%.  This decline in the long end, when coupled with rising Fed rates is causing the spread between the 2 year and 10 bonds to come in, to just 32 basis points, the narrowest gap since 2007 at the start of the last recession.  An inversion in the yield curve, where 2 year yields are higher than 10 year yields, has historically been a solid and reliable predictor of past recessions, with an inversion now expected to occur sometime in the next 12 to 24 months.
US economic data was mostly stronger in June with ongoing labour market strength flowing into income growth and higher consumer confidence levels meanwhile, the core private consumption deflator inflation rose to 2% year-on-year on May, right on the Fed’s target and consistent with ongoing Fed rate hikes every three months after the Fed delivered a hawkish tone at its June meeting. 
Meanwhile, the European leaders summit appear to have made progress towards greater Eurozone economic integration and a solution to its migration problem, which may be enough to keep Italy onside and to see Merkel’s coalition government in Germany retain power. All of which is a slight positive for Eurozone assets, albeit the Italian budget issues remain for the months ahead.
The Chinese share market has fallen around 22% From its high in January while the Renminbi has fallen around 6% from its April high, with the weakness triggered by signs of slowing growth in China, worries that this will be made worse by a trade war with the US and with the shift to Chinese monetary easing weighing on the Renminbi.  However, at this stage we don’t believe there are significant negative implications for the International or Australian markets as the Chinese share market is now trading on a PE of around 10.5 times, there has been no panic unwinding of margin positions, economic data is relatively stable, and there is confidence in how the currency is managed.        


ASX200 Performance  

Australia’s ASX 200 Accumulation Index was up 3.3 for the month of June hitting a 10-year high, while rising above the psychological 6,200 level, to outperform global markets. Growth orientated currencies, such as the commodity-linked Australian dollar, performed poorly as forex markets reacted to ongoing trade war concerns.  The Australian dollar continued to weaken against the US dollar, closing the month at 0.741, down 2.1%.  However, the decline in the Australia dollar makes the Australian equity market more attractive for overseas investors, likely driving a turnaround in bank stocks towards the end of the month. Expectations for a Reserve Bank rate hike remain firmly on hold, with expectations of a hike now pushed into 2020, following the RBA’s Tuesday meeting.  Continuing weak wages growth subdued inflation and the threat to global growth from a trade war combined with the negative wealth effect on a heavily indebted consumer given falling house prices and tightening bank lending standards all argue against a hike.
Of the 12 sectors in the Australian market, 10 sectors were higher in June with the Energy, Technology and Consumer Staples sectors the biggest contributors, while the Telecoms and Financials ex. Property sectors were the only detractors.  For the June quarter, the Energy, Healthcare and Mining Sectors were the biggest contributors, while the Telecoms and Financials ex. Property sectors were the key detractors in the quarter.


The Energy, Info Tech and Health Care sectors have had the best capital gains in the 12 months to 30 June 2018, while the Telecommunications, Utilities and Financials sectors have experienced capital losses over the period.


For the 12 months to June 2018, small cap stocks (exASX100) have outperformed large cap stocks (ASX100), although they have come back slightly in the past few weeks.  Very large cap stocks (ASX20) have underperformed since the middle of March, due to the poor performance of key investor portfolio stocks the banks, AMP (since removed from the ASX20) and Telstra, although the bank stocks had a period of outperformance late in the month which saw this underperformance narrow slightly. 


ASX100 Best and Worst

APA Group (APA) received a non-binding indicative offer for all shares in APA via a scheme of arrangement from a consortium led by CK Infrastructure Holdings Limited for $11.00 cash per stapled security. The offer is subject to ACCC and FIRB regulatory approvals. APA has granted CKI access to due diligence while the APA board has made no recommendation in response to the proposal.
Caltex (CTX) updated its 1H 2018 profit forecast, expecting a strong jump in first-half profit, bolstered by swing to a gain on its crude and product inventory from a year-earlier loss.  Caltex said it expected to record a profit of between $385 and $405m for the six months to June, compared with $265m in the same period last year. 
Ramsay healthcare (RHC) was the worst performer of the ASX100 in June after providing updated FY18 guidance, with core EPS growth expected to be approximately 7% compared to the previous guidance of 8-10% growth. RHC will also recognise a charge of £70 million (A$125m) net of tax at its full year result in August, consisting of an onerous lease provision and asset write-downs related to certain UK sites. The company noted that in addition to the significant downturn in NHS volumes in its UK business, it had also experienced weaker growth rates in procedural work and inpatient admission in its Australian operations in recent months, which was expected to continue into FY19. 
AMP Limited (AMP) announced that new chairman, David Murray, will commence the role effective immediately.  Mr Murray’s immediate focus will be on renewing the Board and strengthening the governance framework while remediation of customers and rebuilding relationships with regulators will also be priorities. Later in the month, the corporate regulator announced had launched action against AMP for alleged failure by AMP financial planners in relation to “Rewriting Conduct”.  The regulator also announced it is investigating AMP for ‘Fees-For-No-Service’, as well as making misleading statements.


Portfolio Performance

The QVR portfolio underperformed the benchmark in the past quarter, as a result of a significant underperformance in June, while the income portfolio has also underperformed in the quarter, although performance has improved in the past month. Both portfolios continue to be above the benchmark ASX200 Accumulation Index for the 12 months to 30 June 2018.  Since inception, both portfolios have significantly outperformed the benchmark on both absolute and risk adjusted measures.


NB: Prior to March 2013, the performance of the portfolios was calculated assuming an equal weighting to each stock.
Note that it is not unusual for the Income portfolio, which is defensive in nature, to outperform the market during bear markets and underperform during bull markets. On the other hand, the Model portfolio is expected to outperform its benchmark in all market conditions over the long term.


QVR Portfolio

The QVR Portfolio significantly underperformed the benchmark ASX200 Accumulation Index for the month of June with the portfolio impacted by our exposure to the worst performing stock on the ASX100 for the month, Ramsay Healthcare (RHC), which provided an updated profit guidance FY18, resulting in downgrades to consensus estimates.  Our exposure to Challenger (CGF) also was the other key detractor to performance for the June, after that stock gave up some its recent outperformance after being the strongest performer in the ASX100 in the previous month. 
Positive contributors included our exposures to Woodside Petroleum (WPL), given the continued increase in the oil price, with the stock, as well as the sector, experiencing further profit upgrades; Commonwealth Bank (CBA) was higher after a settlement was reached in the AUSTRAC case, plus the announcement CBA will spin off its wealth management arm, as well as a general re-rating of the bank sector from oversold levels, and Charter Hall Group (CHC) which continued to be re-rated by the market after its upbeat investor presentation the previous month, as well as recovering most of its dividend after going ex at the end of the month.


Income Portfolio

While the Income Portfolio underperformed the benchmark this month, it did close the close the gap to the benchmark over the quarter, primarily as a result of our exposures to Woodside Petroleum (WPL) and Wesfarmers (WES), as well as our exposures to the banks, specifically Westpac Bank (WBC), Commonwealth Bank (CBA) and ANZ Banking Group (ANZ). 
Our exposures to Harvey Norman (HVN) and Telstra Corporation (TLS) were the biggest detractors for the month, prompting us to re-asses our exposures there.  As a result of the expected continued weakness in consumer spending, we have cut our exposure to HVN. 
We continue to hold our position in TLS, despite the further downside risk to TLS’s dividend in the medium term with the company expected to maintain its 22 cents per share dividend for FY18, but with a likely cut in FY19.  While TLS management at its investor briefing day early in the month have put in a strategy to fix the long term returns on TLS, we believe they may need to rebase dividend expectations for FY19 and FY20.  While we continue to see some short term pressure on the TLS share price, we believe a rebasing of dividends to a lower level will allow more profit to be reinvested in the business to generate greater returns for shareholders over the longer term.  We are continuing to review the situation, potentially looking for an opportunity to average down in the stock at the appropriate risk/return level.


Sector Breakdown

In the charts below, we have distinguished the Miners separately from the Materials GICs sector and the Banks from the Financials GICs sector. We remain underweight Banks in both portfolios.