We come to the close of an interesting year for investors in Australia and for AFIC, with market reach close to record highs and as interest rates fall. This has seen high share prices for many companies despite some challenging economic and geopolitical issues such as trade tariffs. In this context we would expect volatility will likely persist in the new year, as investors grapple with these complexities.
When it comes to reflecting on the past year, it makes sense to look at it from two perspectives; AFIC’s investments and its business.
From an investment perspective, the Australian market has had a strong year despite some global macroeconomic challenges. Notably, gold and iron ore prices boosted the performance of the resources sector and this resulted in the distribution of special dividends to investors.
We’ve also seen investors rewarded for sticking with high-value blue chip stocks, many of which have performed well this year. However, with many companies reaching full valuations, the market is likely to be increasingly subject to greater levels of volatility if company results do not support such strong valuations.
A careful repositioning of the portfolio
To effectively navigate this market landscape, AFIC has repositioned the portfolio over the past 6 to 12 months, reducing the number of companies in the portfolio to focus on quality franchises with a strong competitive advantage and good financial characteristics. This has helped improve recent performance despite not being in some of the more speculative sectors of the market.
An example of this approach has been to increase holdings in CSL Limited and Macquarie Group whilst reducing the relative weighting in the major banks given the competitive and regulatory issues they are facing.
Franking credits and dividends a focus
From a business perspective, the threat of regulatory changes in refundable franking credits earlier this year was a concern for the majority of our shareholders. We had strong shareholder response to our survey gauging their position on the issue. Despite the ultimate election outcome which removed these concerns, the issue provided an opportunity for us to explore new ways to support and act on behalf of our shareholders.
In February, for example, we were able to pay shareholders a special dividend in anticipation of potential change in the franking credit regime. This was to ensure shareholders would receive value from AFIC’s participation in the BHP and Rio Tinto buy backs even in the face of the potential changes. Our continued alignment with the interests of our shareholders and the low-cost option we provide for investors has seen our shareholder numbers continue to grow very strongly through the year.
The market appears to continue to move through a period of volatility produced by several external influences. As Global trade conflicts continue to play out, and with the US presential election coming up, investors may drive more short-term volatility.
In terms of interest rates, they’re clearly going to stay low for an extended period, particularly in Australia where economic growth still seems to be subdued despite some sectors starting to show improvement.
For AFIC, we see these as short-term issues. As a long-term investor we have positioned the portfolio to satisfy our investment objectives in these market conditions. We may also look to this volatility for further buying opportunities in our key investments.
A close look out on banking stocks
We will continue to keep an eye on our position in banking stocks as a primary focus. Currently we have an underweight market position representing about 19 per cent of the portfolio. In particular, we are watching the competitive environment alongside the ongoing reputational and regulatory issues the sector is facing.
The key issue here is that banks supply a significant level of income for Australian investors, and although three banks have already cut dividends, it may be that we have seen the worst of such dividend changes. We aim to strike a balance between generating income from the banks while looking for other companies which can provide enough sustainable business growth, including dividend growth, to offset the fall in bank dividends.
Fundamentally, AFIC is a long-term investor focused on buying quality companies with a sustainable advantage that will allow them to perform well in various economic and equity market conditions. Rather than trying to second guess the market or economy, we will move into the new year sticking to the fundamental investment process that has successfully seen us through some of Australia’s more difficult financial conditions.