AFIC Portfolio Manager David Grace shares his thoughts on how AFIC has managed its portfolio during the volatile 2023 calendar year, and the outlook for 2024.
Trading throughout 2023 was volatile as the market fluctuated month-to-month, largely driven by macro-economic factors weighing on investor sentiment. This volatility however provided opportunities to further invest in companies when value was on offer. Despite these fluctuations the ASX 200 benchmark remained fairly flat throughout the year to November when it rose by 2.9% when franking is included. AFIC’s performance to the end of November has been ahead of the benchmark.
In line with our investment philosophy of investing for the long term portfolio turnover was low. Although we did use market volatility to take advantage of selected opportunities to buy more of the companies we like at attractive prices, such as in the healthcare sector.
Our patience is paying off
Prior to this year, the market had been driven by the strength of the resources sector as Russia’s invasion of Ukraine created supply chain challenges and China’s emergence from COVID lockdown lifted iron ore prices.
Although AFIC has meaningful holdings in large resources stocks such as BHP and Rio Tinto, we’re not overweight in the resources sector, particularly where smaller resources stocks are considered. Smaller resources stocks generally do not fit with our long-term investment philosophy and our aim to generate a growing dividend. This meant comparatively our portfolio underperformed the benchmark index in previous years.
AFIC’s portfolio is more biased towards industrials which have underperformed the market during that time, but in the 2023 calendar year to date the performance of resources and industrials have reversed. Although iron ore prices have held up, the resources sector has been marked by an aggressive sell-off of smaller resources stocks, especially lithium companies.
Stocks that we’ve been patient on while waiting for a recovery are now showing some improvement, for example CSL which had fallen quite significantly after concerns arising from the potential impact of weight loss drugs.
We also added to holdings in Transurban, Goodman Group, and IDP Education at what we consider to be attractive prices. These companies are high-quality industrials with strategic assets which are now starting to deliver earnings growth despite the more challenging macro-economic environment.
Healthcare heavyweights have more potential
Healthcare has been one of the poorest performing sectors throughout 2023. The sector has been impacted by inflated costs which hurt margins, but it’s now emerging from that. Revenue growth is improving, and cost inflation remains high but not increasing, which is delivering some margin expansion.
AFIC holds meaningful positions in healthcare heavyweights CSL and ResMed, both of which have been hit by the weight-loss drugs wave and concerns over what this means for their future earnings profiles.
For CSL, the exposure to weight-loss drugs is very small and will have an immaterial impact on the company. CSL is delivering meaningful earnings growth, with earnings up more than 20 per cent for the 2023 financial year and guidance for growth in the mid-teens in FY2024. We expect that growth to continue for a number of years, driven by various company initiatives, investment in R&D, new product releases, capital expenditure, and greater efficiency.
The threat from weight-loss drugs is potentially more substantial for ResMed, the thesis being that as you lose weight, the severity of your sleep apnea, which is what ResMed treats, reduces. In that case, you’re less reliant on having to use ResMed’s continuous positive airway pressure (CPAP) machines and masks to treat your sleep apnea.
We’ve elected to hold onto ResMed as we believe, despite the adoption of weight-loss drugs having the potential to reduce the total addressable market for ResMed (around one billion people globally who suffer from sleep apnea), the penetration of treatment globally is less than 10 per cent so there is still a significant population base that would benefit from the treatment that ResMed offers. ResMed is working on raising awareness to be able to capture more people into its pipeline and the company needs to capture only a very small percentage of the untreated population to deliver meaningful earnings growth.
ResMed is the market leader with 80 per cent market share, is very well managed, has a really strong balance sheet, and invests in R&D; key characteristics of the companies that AFIC looks to invest in.
Quality still matters in 2024
Overall, earnings growth for companies looks set for a period of stabilisation. Leading economic indicators suggest that the economy is slowing and that consumer and household savings rates are starting to decline amid the higher cost of living. As a result, it will be more challenging for companies to deliver earnings growth, particularly when costs and inflation are still elevated.
Therefore, it’s important to be invested in companies that are better placed to deliver earnings growth that is not totally reliant upon the macro-economic environment. CSL, ResMed, and Goodman Group are good examples of this.
AFIC remains invested in high-quality companies. We feel comfortable in the companies that we own and, as a long-term, low-turnover investor, we do not try and continually second guess the next market theme. We believe that capturing opportunities in good quality companies when great value is on offer is the best way to create value for AFIC shareholders over the long term.