The 2020-21 financial year has been another extraordinary period. In March of last year, after the market had fallen over 30 per cent, the future and the course of the economy was hard to predict, but there’s been a significant turnaround since then.
The Australian share market has performed very strongly as the positive stimulus provided by Government and central banks, and better-than-expected company earnings, have helped counter some of the impact of COVID-19. The efficacy of vaccines has reinforced the positive investment mood.
AFIC has performed well in this environment to the benefit of our shareholders. In 2020-21, the portfolio returned 31.9 per cent, including franking credits, compared to 29.1 per cent for the S&P/ASX 200 Index. Over the last four six-monthly periods, our outperformance relative to the ASX 200 has ranged from 1.02 per cent to 1.87 per cent. These consistent outcomes reflect the underlying quality of our portfolio.
We have sustained our 24 cents annual dividend in a year when our earnings were under pressure from COVID-related dividend cuts among some of the companies we invest in. Our policy of utilising reserves and retaining a pool of franking credits for such an eventuality is an integral part of our historical dividend policy.
Furthermore, because there is no external fund manager deriving any income from the portfolio – unlike most of the fund-managed products in the market – our management expense ratio (the cost of running the company) is still extremely low at 0.14 per cent, with no performance fees. This means that more of our returns end up in the hands of shareholders.
Our focus is on high quality
Our investment process is based on finding quality companies and holding them for the long term. We seek companies that have a strong industry position, hold unique assets, have a definable competitive advantage, have strong boards and management, and which can be bought at a reasonable price. These companies provide superior returns over the long term.
The strong performance of our portfolio over 2020-21 reflects the benefit of holding a diversified portfolio of high quality companies, and a number of businesses benefiting from economies reopening after COVID-related lockdowns.
Some of the high quality stocks in our portfolio where we see huge opportunity for multiyear growth and an attractive return on capital are small business cloud accounting software company Xero, online car classifieds business Carsales, sleep apnoea treatment company ResMed, and fibre cement cladding manufacturer James Hardie.
In 2020-21, we made new investments in PEXA, Fineos, Domino’s Pizza, IDP Education, and Temple and Webster – all companies with strong industry positions in their core markets.
Short-term share price weakness provided the opportunity to strengthen our holdings in Transurban, CSL, ResMed, BHP, Carsales and Coles. All are high quality companies and are all core holdings within the portfolio.
We exited several companies over 2020-21 – Altium, Lifestyle Communities, Alumina and Origin –because we expect the competition to intensify, or there is a structural shift occurring in the industry which will leave the company at a competitive disadvantage.
ESG is embedded in our investment process
We appreciate that that companies are increasingly focused on environmental, social and governance (ESG) factors and that ESG is of increasing interest to our shareholders. Consideration of ESG has long been part of our investment process. Because we look to hold investments over the long term, the sustainability of any business model is critical to our definition of quality and the returns we can expect to receive as shareholders. Therefore, we consider how companies are aligned with our investment process and look to engage with their boards and management where we have concerns.
ESG matters are just one part of our investment considerations. For example, we recently exited our position in Origin Energy. The primary reason for this was that Australia's electricity generation is shifting from hydrocarbons to renewable energy, so we expect that the competitive position of Origin's asset base will diminish. Consequently, the long-term returns that Origin is likely to generate will be lower.
We used the proceeds from our divestment in Origin to invest in companies with better prospects and operating what we consider to be more sustainable business models over the long term.
Less than two per cent of AFIC’s portfolio is invested in the oil and gas sector, specifically in Woodside and Oil Search, where most production is in LNG as opposed to more heavy carbon-intensive liquids or oils. We see LNG as a transition fuel away from hydrocarbons to renewables. We also don’t hold any direct exposure to pure-play coal companies. That goes back to our investment process where we consider the sustainability of business model over the long term.
One of the biggest stocks in our portfolio is Macquarie Group, which is very involved in renewable energy, particularly with earlier-stage projects.
We are a long-term investor, and markets have historically gone up over the long term. We don’t expect that to change, but there can be lots of volatility in between.
The outlook for earnings growth remains solid, but we believe that companies with international earnings are relatively better positioned to deliver.
There are several factors of which we are mindful.
Economic conditions always present opportunities and challenges for companies and share markets and it’s hard to make predictions. But in setting our portfolio, we look to identify quality companies, hold them in a meaningful way, and look to own them over the long term to benefit from the power that compounding returns can deliver to shareholders. We feel comfortable that the portfolio is invested in high quality companies with attractive long-term growth prospects.