Evidente launches its benchmark aware, long only model portfolio for Australia for the 2017 financial year. This post provides the executive summary of the full text report, which is available to clients of Evidente.
Evidente's long only, benchmark aware portfolio is designed to be a high conviction, concentrated portfolio with no more than 30 stocks, an active share of no less than 30%, tracking error of no more than 7%, maximum individual stock weight of 10% and no sector constraints. The stock selection process represents a mix of top down and industry thematics as well as bottom-up factors.
The key macro theme that guides portfolio construction is the prospect that interest rates will remain low in Australia and globally for an extended period, thanks to the substantial reduction in the value of human capital, reflecting lower expected growth in future incomes (see chart). Evidente estimates that lower growth projections alone have cut the present value of human capital by one-third which has underpinned the grindingly slow recoveries in Australia and globally.
The model portfolio therefore has a strong defensive bias despite stretched valuations, notably overweight positions in stocks that rank strongly on Evidente's proprietary model of earnings certainty. An overweight bet in discretionary retailers represents the key cyclical exposure, based on the prospect that consumer spending will remain the key driver of growth and help to ameliorate the effects of Australia's capex cliff.
The key bottom up criterion used in stock selection is a high internal rate of return (IRR), which is backed out using a dividend discount model. Some of the stocks that have the highest IRRs and make it into the model portfolio include Wesfarmers, Bluescope Steel and Caltex.