Global markets have been incredibly volatile in recent weeks as they adjust to the COVID-19 pandemic and what it means for businesses and economies around the world. The challenge of understanding the economic impact of COVID-19, subsequent low oil prices and the risk of deep unemployment rates, amongst other factors, is making it hard to predict how the market will behave in the short-term.
What we do know is that quality will survive and economic markets will eventually rise again. At this stage, earnings will continue to fall making it difficult to price markets, but quality companies will lead the upswing, when it eventuates.
“One thing we do know is that markets do eventually recover, I expect this one will be no different, although it will be very volatile along the way.” Mark Freeman, AFIC CEO
Downturn is only one phase in the market cycle, and although downturns can be challenging to ride through like all phases it will pass, and we can be confident that many businesses will see rejuvenated growth.
This is one of the potential benefits of taking a long-term perspective when buying companies; holding on through difficult markets means an investor may avoid selling at a loss and can still take advantage of distributions from their investments even while valuations are down. In fact, many long-term investors see market downturns as an opportunity to buy more shares in high quality companies at a lower price.
Long term investing can also reduce the number of trades that an investor will need to make, meaning the investor will pay less in brokerage over time and less tax in capital gains tax. Tax and fees can add up, so holding for a long time in a low-cost fund, such as AFIC, means an investor can reap more of the benefit of their investments.
Keep calm and compound
Dividends are a key consideration for long term investors. The accumulation impact of re-investing company dividends throughout your investment journey over a long time has been shown to be incredibly powerful as investors can use their share of company profits to purchase a greater stake in that company or grow their portfolio in a cost effective way over time.
In Australia, many investors also receive a tax rebate on dividends which have already incurred company tax, called imputation or 'franking' credits. Below is a chart that demonstrates how reinvesting dividends and the benefit of franking credits over the long term has added significantly to returns in the Australian Market.
Chart showing the impact of frankingQuality is king
Howard Marks, Co-founder of Oaktree Capital put it nicely when he said recently that the bottom of the bear market is reached only when optimism from market speculators is nowhere to be found, and only the day before the recovery begins, meaning it is impossible to know exactly when that is. Investors are likely better off buying when they have access to quality companies at great value, which is the environment AFIC has been trying to take advantage of.
The AFIC portfolio is a group of quality businesses with sustainable competitive advantages that will provide opportunities for growth over the long-term, even when considering the fallout from the COVID-19 outbreak. We are also confident that, when markets eventually recover, it will be high quality companies like those in our portfolio that will lead the recovery.
Quality businesses are also generally better resourced with strong cash flows and balance sheets, predictable, recurring earnings and strong management that can support them in continuing and even upscaling operations when the market does begin to improve.
These are the companies we look for and hold, and for that, we take great comfort in looking through our portfolio of stocks.