It’s been a bumpy ride for investors in a year dominated by unsettling global events. AFIC Portfolio manager David Grace reflects on the market and AFIC’s portfolio over 2022 and reminds investors that the best returns come over the long term.
It’s been a volatile year for the ASX200 index over the 2022 calendar year, with many macro events weighing upon investor sentiment, particularly the Russian invasion of Ukraine and the consequences for the supply and availability of commodities.
Ongoing concerns about the pandemic coupled with uncertainty about where inflation settles and where interest rates peak also resulted in investors generally adopting a very short-term focus on equities markets.
The uncertainty around macro events created a series of cycles through the year that were short-lived. Some sectors of the market were in favour for a short period and then out of favour, resulting in a wide dispersion in returns across the different sectors of the market.
There was a big divide between the winners and losers. The standout performers on the market were the energy sector, up 55 per cent in the calendar year to date, and the utilities sector, up 31 per cent. By comparison, the market has risen two per cent.
The worst performer was the information technology sector, but it must be noted that the IT sector had a couple of strong years prior to this year. The real estate and consumer discretionary sectors were also weak performers on the back of rising interest rates.
The AFIC portfolio
Market rotation from sector to sector proved challenging for our portfolio over 2022 which underperformed the ASX200 index. However, over three and five years, the AFIC portfolio has outperformed or matched that benchmark.
In both good and bad years, it’s important to not focus solely on the numbers but understand what’s driving them. We are comfortable with the factors that drove performance over 2022 and, to put this year’s performance in context, a number of the stocks we hold had performed strongly over the prior couple of years and were unable to sustain that level this year.
We believe the companies in our diversified portfolio are of high quality, can navigate difficult periods and grow their earnings, have strong balance sheets and good management. There have not been a series of earnings downgrades across the companies that we own, and we’re comfortable with holding them. Indeed, we have taken advantage of lower share prices to add to selected holdings and add others.
How our portfolio changed
We increased our holdings in BHP, Santos, Carsales.com, Goodman Group, Woolworths, and Domino’s Pizza over 2022. Miner BHP operates long-life, high-quality, low-cost assets and, even at a low point in the iron ore cycle, has been able to generate cash flow to furnish shareholders with a dividend and reinvest in its asset base.
Energy company Santos is an LNG producer, and we consider LNG to be a critical transition fuel as the world’s energy needs move towards renewable resources. It should be noted that the energy sector is mostly driven by coal and that in 2022 the shares of some coals companies rose by more than 200 per cent. However, it's not our expectation that they'll have the same jump in performance next year, and we don't own any pure-play coal companies within the portfolio.
New to the portfolio were Mirvac and Breville. Property group Mirvac owns a high-quality portfolio of diversified properties across different sectors. The company’s balance sheet is in strong shape, and we rate the management team highly. The retreat in the property sector over the year enabled us to buy into Mirvac at attractive prices, and the investment is expected to generate a good yield.
We exited Sydney Airport which was taken over. Additionally, we exited Orica, Reliance Worldwide, and Endeavour Group where we believe their operating environment is going to become increasingly competitive. The released capital enabled us to acquire stock in companies that operate high-quality businesses and which we believe are more suited to producing good returns over our preferred long-term investment horizon.
The AFIC portfolio is well placed to ride out more volatility
We can’t predict with certainty what the market will do over 2023. However, we expect it still to be volatile until it becomes clearer as to where interest rates settle and at what level inflation peaks. The market has picked up quite substantially towards the end of this calendar year, so we’ve become more cautious about valuations.
The stocks within our portfolio appear to be at fair value or inexpensive, and the portfolio is well positioned from a valuation perspective.
Furthermore, the companies in the portfolio are good quality businesses that we believe can still generate good earnings growth over the long term. It reflects our investment approach and is likely to produce the best returns for our shareholders.