One of Australia’s long-standing listed investment companies, Australian Foundation Investment Company, is concentrating its portfolio as its investment team looks for greater conviction in its holdings.
Over the past four years, the fund has been going through what is calls a “portfolio adjustment”, reducing the number of stocks in the portfolio from 95 to 70, focusing on “quality businesses with a competitive advantage, strong returns on invested capital and resilient balance sheets.”
AFIC managing director Mark Freeman says this change has been a result of the company revitalising its investment process, with a stronger focus on areas such as industry dynamics and sustainable competitive structure.
As a result, there were some stocks at the bottom of the list that did not make the grade.
Freeman says this is an ongoing evolution. “When I started here 25 years ago there were 110 stocks in the portfolio.”
However, he concedes that the success of index ETFs in taking over the passive space of the equity market is a factor in the company’s decision to adopt a higher conviction approach.
It sold out of Perpetual, Boral, Link Administration, Orora, AMP and Iluka Resources. As a result of the exercise of call options, it also sold out of NAB. It reduced its holding in Lifestyle Communities.
Exposure to major banks has fallen from 28 per cent to 19 per cent, “given the competitive and regulatory issues the sector is facing.’
AFIC has also reduced the relative exposure of the portfolio to resources companies, primarily from participating are share buybacks.
AFIC has added to its positions in Goodman Group, CSL, Macquarie Group and Cleanaway Waste Management.
Lendlease Group Ryman Healthcare were new holdings in the portfolio last year.
For the 12 months to the end of December the fund produced a return of 22.8 per cent (net of fees). With dividends grossed up to allow for franking credits, the fund’s 12-month return was 25.5 per cent. The S&P/ASX 200 Accumulation index was up 23.4 per cent over the same period.
Over the six months to December, the fund returned 5.4 per cent, compared with 3.8 per cent for the index.
Over the past 10 years, the fund has returned an average of 9.2 per cent a year (with franking included), compared with 9.5 per cent a year for the index.
AFIC’s profile has always been a fund that tracks the index fairly closely, aiming for a modest amount of outperformance, and relatively low risk.
Freeman says the more concentrated portfolio does not necessarily mean higher risk. “Seventy stocks is still a diversified portfolio. Warren Buffett says the more stocks you put in a portfolio the less you know about them.
“If you are getting rid of the stocks you don’t have conviction in, you are reducing risk.”
The dividend cuts from three of the four major banks, combined with a reduction in the proportion of our portfolio in financials, has put a short-term drag on our dividend income streams as many of our new investments have lower yields.
“We believe the move to stocks with a better growth profile should enhance the potential for dividend growth in the medium to long term, particularly as bank dividends are expected to remain stagnant,” Freeman says.
AFIC confirmed its dividend reinvestment plan and dividend substitution share plan, the price for which has been set at a 2.5 per cent discount to the volume weighted average price of the company’s shares over the five trading days from when the shares trade ex-dividend.