What does it tell you when one of the most conservative listed investment companies goes up the risk curve?
Last week the $6.5bn listed investment company Australian Foundation Investment Company, a haven for personal investors for decades, released its annual report. Among all the details was commentary from management regarding the current and future make-up of AFIC’s portfolio.
Over the past year it has increased the weighting of small and mid-cap stocks from 15% to 22%. Around 47% of the market value of the All Ordinaries Index is in stocks outside the top 20, so the move may not seem like much. But some of the holdings have been in the portfolio for decades and carry big capital gains. With the portfolio holding minimal cash, it must have made sales and presumably there will be tax to pay.
The reasons given are fair. The world is currently experiencing extremely low growth and this looks like continuing for some time. With low growth and high payout ratios, dividends are in the firing line and we’ve already seen some blue chips cut theirs (eg ANZ, BHP and Woolworths). In order to achieve reasonable yield and growth, AFIC feels it needs to venture from the comfort of the big names.
Combine this outlook with three years of slight underperformance (of 1.5% a year compared to the ASX 200 Accumulation Index) and management may be starting to get a little ruffled. Potentially shareholders too. And ruffled shareholders may lead to a share price at a discount to NTA.
Looking at the top holdings in the portfolio now compared to a year ago you can see that the banks have received a trim, with Westpac (ASX: WBC) and Commonwealth (ASX: CBA) receiving the largest reductions. You can see further evidence of the transformation with stocks like Qube Holdings (ASX: QUB), TPG Telecom (ASX: TPM) and Treasury Wine Estates (ASX: TWE) entering the top 25 shareholdings.
This is not new territory for AFIC’s team. They also run the small to mid-cap focused Mirrabooka Investments Limited (ASX: MIR) and AMCIL Limited (ASX: AMH) which combines the best large cap ideas of AFIC with the best small to mid-cap ideas from Mirrabooka. The two portfolios outperformed AFIC by some way over the past 12 months, producing returns of 12.0% and 7.6% respectively, while AFIC lost 1.6%.
The issue with the two other LICs is liquidity. AMH has an average daily volume of just 73,000 shares while AFIC’s average is over 320,000 per day. Is the more liquid AFIC turning into AMCIL? Maybe, although that probably overstates it. What it does say is that AFIC’s management feels it needs a broader approach in order to lift performance, and they’re backing themselves to deliver it – even if there’s a short-term cost in the form of tax.
Of course the elephant in the room is whether the move has come too late for the grandfather of LICs. Clearly the underperformance would suggest it has. Small and mid-cap stocks have been on a run lately, with the Small Ordinaries returning 13.8% last year compared to 0.6% for the ASX 200 Accumulation. Becoming more active will open AFIC up to potentially outperform but also to potentially underperform further. It is an unprecedented time for the largest LIC in Australia. It has held smaller stocks before but nowhere near this level.
Whether or not they’re getting it right, AFIC’s shift emphasises an important point, which is that even for long-term investors it’s always wise to keep an eye on valuation and be ready to shift your money to better opportunities.
There are a number of great small to mid-cap opportunities on our Buy list, as well as a few larger stocks that are currently unloved. We also have lots of small and mid-caps in our Growth and Equity Income portfolios – something that has helped them outperform the All Ords by 10% over the year to June. These portfolios are available to invest in directly through separately managed accounts.
Smaller investors have a couple of key advantages over the likes of AFIC: smaller companies can make a real difference to our performance and it doesn’t take years to shift our portfolios to areas where we see better value.