Long-standing domestic equity manager Australian Foundation Investment Company (AFIC) has made significant changes to its $7.3 billion portfolio in a bid to find the right balance between dividend and capital growth.
AFIC’s 2017-18 financial report shows that it had to wrestle with a problem that has troubled many investors in the local market: several reliable, high-dividend paying companies are having trouble finding growth opportunities and their share prices are falling.
“A key restraint on the current Australian market is the prolonged, subdued growth outlook facing many large companies. This arises from their market positions with no further consolidation possible, increased competition and disruption, and greater regulatory intervention,” AFIC says.
Notable examples are the big banks, big wealth management companies such as AMP, and Telstra. Such blue chips have been the mainstay of AFIC’s portfolio for years.
The fund’s long-term returns are solid, with an average return of 6.5 per cent a year over the 10 years to 30 June 2018, compared with a return of 6.4 per cent a year for the S&P/ASX 200 Accumulation Index over the same period.
However, the portfolio’s return over the 12 months to 30 June was 10.8 per cent (net of fees), compared with a 13 per cent return for the index.
In an environment where many large companies are facing subdued growth, there has been an increasing flow of funds into the small and mid-cap section of the market.
“This has seen a very strong price performance in those companies with the strongest growth expectations, primarily through a re-rating of valuations,” says AFIC managing director Mark Freeman.
AFIC has adjusted its portfolio in response to this situation. While larger companies continue to make up a significant proportion of the portfolio, AFIC has been increasing its holdings in a number of mid-sized and small companies with good growth prospects.
“This has been done with regard to balancing the need to grow dividends as well as provide meaningful capital growth within the portfolio over the long term,” Freeman says.
Major purchases during the financial year included adding to holdings in Macquarie Group, CSL, Sonic Healthcare, James Hardie Industries and Alumina, all of which AFIC likes because they have unique industry exposures in global markets. Holdings in Sydney Airport and Boral were also increased.
AFIC also increased its holdings in several of its smaller company exposures, including the buildings supplies companies Reliance Worldwide and Reece, and Carsales.com.
New additions to the portfolio included Qantas, data centre operator NEXTDC, Goodman Group, Cleanaway Waste Management, insurance broker AUB Group and Adelaide Brighton.
Sales included the complete disposal of shares in industrial chemicals and fertiliser company Incitec Pivot, Coca-Cola Amatil and Japara Healthcare.
AFIC reduced its holdings in QBE Insurance, AMP, Telstra, Treasury Wine Estates and Vicinity Centres.
Freeman says the coming financial year will be difficult for equity investors: “The drive by investors towards companies displaying good growth prospects is pushing share prices for these businesses very high. For AFIC it is a matter of being patient.”