As seen in the Australian Financial Review, 21 October 2015

Home bias is common enough at Saturday morning kids’ football games but the players’ grandparents really excel at it when they get back home to their share portfolios.

Australian investors have a good reason to back locally-listed companies – the company tax paid inside franked dividends counts towards the owner’s personal tax liability. If the owner is retired, then the tax paid by the company will be refunded to the shareholder by the ATO.

Nothing’s sweeter than that.

Clients of privately owned Australian investment manager Elston are probably happy then with its Balanced portfolio, which is more than three-quarters invested in Australia. For a balanced portfolio, it is also heavy on equities.

“Absolute valuations on Australian equities might be fair, and after the recent correction there’s a bit more value there, but for us it is a relative world in the context of cash rates and bond yields,” says Elston chief executive Andrew McKie. “That’s why we have that overweight position to equities – international or Australian – versus underweights to fixed income or cash.”

Elston invests in the local market directly for two reasons, Elston says. “We can control cost and after-tax outcomes for investors, and secondly; we see a lot of concentration risk in the Australian index [which is dominated by banks and resources companies].”

The investment strategy for Australian shares allows 25 companies: 20 from the top 50 and five from the next 50.

It screens stocks in four stages. Stage one: take the top 50 and rank them on six value and six growth criteria. Stage two: compare independent valuations with market prices to deliver expected returns. Stage three: make qualitative assessments on management, operating margins, simplicity of operation and market share. If a stock passes all three stages and is on the shopping list to buy, momentum factors such as moving averages and short interest are considered before any transactions are conducted.

Fair Team

It all sounds like a lot of effort, especially when you consider they do it every week. “We’ve been managing portfolios since 2005 and have close to $1 billion in managed accounts,” McKie says. “There’s a fair team here.”

In the international allocation, Elston started to reverse an overweight position to unhedged US equities about 18 months ago and increase exposure to Europe and Asia. “It’s not as easy for US companies; interest rates will probably rise, the currency is starting to appreciate. We saw it as a tougher environment for earnings growth [in the US].”

The US equities allocation, held inside the iShares’ Global 100 ETF, is now half-hedged, half-unhedged. Macquarie’s Asia All Stars managed fund is used alongside the iShares MSCI EAFE exchange-traded fund for the rest of the global allocation.

Listed property is low at 6 per cent but that’s on the back of recent selling after a good run. McKie says the sector has performed well on the back of lower bond yields, but most investments were performing at a premium to net tangible assets and it was time for a trim. “If you’re overweight somewhere you’ve got to be underweight somewhere else.”

In fixed income the manager has steered towards managed funds with shorter duration, being the average maturity of securities in a fund’s portfolio. When rates are rising, capital prices of shorter-dated bonds will not suffer losses to the same extent as longer-dated bonds. For fixed income the portfolio is currently invested in the Macquarie Income Opportunities Fund and the BetaShares cash ETF. The allocation to the cash ETF is simply funds which were parked there having recently come out of corporate bonds. “That’s a tactical decision. We’re waiting to see what happens with the US rate rise.”

Natural Bias

The manager allows itself to go a maximum 10 per cent above strategic allocation to growth assets (international equities, Australian equities and property). “But we do have a natural bias towards defensives,” McKie says. “We can be up to 20 per cent tactically overweight defensives (bonds and cash). There’s a natural bias to be more conservative than aggressive.”

Asset allocation decisions are revised every three months. Strategic asset allocation for Australian equities is 47 per cent; tactically, the portfolio is 54 per cent.

McKie says the portfolio has returned 9.75 per cent since inception in November 2008, including franking credits and before fees of roughly 50 basis points. He reckons a non-retiree would lose about 40 basis points in tax.

If you would like more information please call 1300 ELSTON or email info@elston.com.au and an adviser will be in touch.