by Mark Freeman – Managing Director
AFIC’s primary goal is to deliver attractive capital and dividend growth over the long term, and when we say we invest in companies for the long term, we mean it.
AFIC has held investments in blue-chip stocks such as miner BHP Billiton, the major banks and retailers Coles and Woolworths ‒ throughout their evolution as companies – since AFIC was established in 1928. That’s over 90 years.
We’ve also held investments in a host of other companies for 20 years or more, including Transurban, Wesfarmers, Rio Tinto, Computershare, and Telstra. We’ve held many of these stocks because we assess a company’s growth potential over at least a 10-year period, not six months, and this approach has delivered long-term value.
Identifying quality businesses with opportunity for growth over the long term is at the heart of what we do.
A lot of businesses can grow quickly but will reach a point of inflection where growth rates become more challenging, or they are even more cyclical in nature where large fluctuations in earnings is very common. We look for companies that are going to produce growing earnings over a number of years, which is often a reflection of having a good market position in a good industry. That’s the starting point of selecting companies we want to have in the AFIC portfolio.
Ultimately, we want our dividends to grow faster than inflation. Dividends are linked to earnings growth, so if a company’s earnings are growing faster than inflation, so too can our dividends.
Identifying long-term growth potential
AFIC’s driving guide is to invest in quality companies, and we consider several factors in assessing quality.
The three fundamental factors are:
1. Sustainability of a company’s business model
We want to invest in companies that can sustain or improve their competitive advantage over long periods of time. We need to consider the ability of a company to avoid disruption (or to effectively embrace it), the impact of new entrants with new products/technologies and any other factors that could weaken the business over the long term. We’re attracted to companies that have a good chance of staying around for the next 10 years because people need and will continue to need them.
2. Uniqueness of assets and market position
When a company has or is developing a leadership position in its market segment, they will tend to generate better return on capital.
3. Independence from outside influences
We’re wary of companies that can be influenced by factors such as government regulation that can change the rules, companies that are too reliant upon a commodity price (AFIC does invest in miners BHP Billiton and Rio Tinto, but they have very strong market positions), or companies which operate in an environment where there are a lot of elements outside of their control.
Additionally, we avoid companies that have too much debt, and we always consider the quality of the executive team and the board. We prefer companies that have a consistent earnings stream, that is companies where revenue streams are more ‘annuity’ in nature ‒ more regular and more reliable.
Strong governance and risk management processes that include environmental and social risks are also part of our assessment.
Balancing the art & science of investing
Investing is all about finding the right mix of art and science.
AFIC uses an assessment system that ranks the quality of companies we may invest in – based on the considerations outlined above. We group companies according to quality and then overlay their growth prospects, which are just as important as quality. A company could be of high quality, but if it’s very mature and has limited growth prospects, it may not be considered as a worthwhile investment as an alternative.
In this context, it is then a matter of judgment, the art, what weightings a company has in the portfolio and when to make additions to these holdings over time. Conversely, as assessments of quality change then so can a company’s position in the portfolio change.
Navigating economic cycles, when to hold, when to sell
AFIC’s investment style is to hold stocks through economic cycles because we’re confident quality businesses have the ability to ride the inevitable ups and downs of economic conditions. This also means a low turnover in the portfolio which is ultimately more tax effective for shareholders.
The more portfolio turnover you have, the more tax you are going to have to pay, which can be a large drain on net returns. AFIC averages a turnover of six to seven per cent per annum, which is extremely low for a fund manager.
Interestingly, we’ve observed themes in many companies we’ve held over the last 20 years that validate our decision to hold onto them. Across sectors as diverse as mining to banking, we’ve seen companies build and achieve strong growth based on a good core business. We’ve then witnessed them expand and diversify, and in some circumstances made some errors along the way. However, the trend in many businesses, particularly over the last few years has been to return their core and run it well.
AFIC understands that there will be economic cycles and ups and downs. Sometimes a downturn in stocks presents an opportunity to add to a holding in a particular company. Nonetheless, AFIC is not against sometimes trimming or selling some positions.
We are prepared to exit a stock when we believe the time is right, even after holding it for 80 to 90 years. For example, over the last 18 months, AFIC sold its holding in energy provider AGL when the AGL share price was a lot higher than it is now. Using our long-term framework, we observed the industry structure was changing and likely to continue to change which would negatively impact AGL’s earnings potential.
Even though AGL is looking to adapt to changing market conditions, we need to consider influences that have real impacts on long term business models.
Conclusion
AFIC has a long history of building an investment portfolio with low risk and sound reward.
AFIC’s low costs, low volatility and tax-effective nature continue to stand out compared to other funds. A recent survey by Mercer ranking the volatility of returns from a universe of funds for the year to March 2021 placed AFIC at the top of the top quartile, which means we were just about the lowest volatility return fund relative to the return that was produced. We have also sustained our fully franked dividend throughout this most recent COVID period and the cost to investors of our product is extremely low at about 0.13 per cent, with no performance fees.
After more than 90 years, we are happy to observe that AFIC has continued to deliver on its objectives.
AFI invests in a diversified portfolio primarily of ASX-listed Australian equities and aims to provide shareholders with attractive investment returns through access to a growing stream of fully franked dividends and enhancement of capital invested over the medium to long term.
