It’s been a few years since we last checked in on our favourite active fund manager. With so many hitting the wall (Perpetual, Magellan, Bronte…) it feels like a good time to see what the reliably boring folks at Australian Foundation Investment Company (AFIC) have been up to.
What is AFIC and what in the hell is an LIC, a new brand of ice-cream?!
AFIC is an LIC that was started in 1928 and from that point has been investing for their shareholders. It is a very boring, largely unfancy fund that has, by virtue of its age, been run by many fund managers over time. An LIC, or listed investment company, is a group that lists on the stock exchange (the ASX in this case) with the sole intention of investing in the shares of other companies. In this respect they function just like other investment fund managers however they provide two key benefits that many fund managers can’t or won’t. The first is liquidity. By being a listed company, a shareholder is able to sell their parcel of shares at any time during ASX trading hours. This is a huge benefit to investors as the gap between wanting access to your capital and getting the deposit in your account can be measured in days. Try that trick when selling a less liquid asset like, say, extremely overpriced residential property. But maybe that’s a rant for another day. The second major benefit to a LIC in general and AFIC in particular is their willingness and commitment to dividend smoothing. Basically, the business is trying to slowly increase the dividend paid to shareholders year on year. Some years this will be right at the limit of cash received from their underlying assets but others it will be far less. Over time, they are setting themselves up as a steady income stream.
Ah, but what about the benchmark?!
That’s a great question and it shows how far you’ve come as an investor to even ask about it. Here’s where things get a little uncomfortable for me though when it comes to AFIC, but for the risk takers amongst us it probably offers an opportunity. Over the last 10 years AFIC has underperformed their benchmark, the S&P/ASX200 accumulation (means dividends paid and reinvested) and it isn’t great. The index has returned 9.8% where AFIC has secured 7.9%. This is, frankly, a meaningful difference. That difference is even more stark when you look at the returns from the last 12 months. The index returned 26.4% while AFIC notched 19.2%. So, I’m left with my old refrain; Please invest in a passive, broad based index fund and live a happy life. In fact, for those interested in the power of compounding index returns I can’t recommend the Vanguard Chart more highly. But for those who want to read on, there are a few nuggets of information you might be interested in.
The first is that while the share price hasn’t been moving up very much the NTA (net tangible assets) of AFIC has. NTA is reported daily and represents the cash value of all the shares the company owns after paying taxes/capital gains if they were forced to sell. That NTA number has grown 28% in the last year and 9.2% over the last ten. What does that mean? It means that today, AFIC owns $8.45 of assets (after tax) and the shares are trading at $7.62. That’s an 11% discount. At this point, it would be fair to say that you are buying $1 coins for 89 cents. The shares in AFIC have been trading at a discount to NTA for almost 3 years now. This implies that the ‘market’ expects the value of the shareholdings AFIC holds to fall.
The second, and perhaps most important, piece of information to consider is this: the biggest roadblock to building an investment portfolio isn’t the rate of return you get. Sounds odd, right? The single biggest thing holding investors back is simply getting invested in the first place. There are a myriad of reasons why this happens, they don’t save in the first place, they get paralysis of analysis having overthought everything to the point of frustration, but for the love of God, just invest in something which is something I’ll touch on later.
Why would I get a difference between the NTA and the share price?
The basics are this: if the market is jubilant about the prospects of AFIC and their managers to pick great investments the shares will trade at or above the NTA. Trading above NTA is… heroic in my humble opinion. I wouldn’t like to be the Gary paying a 20% premium for a portfolio of shares (that AFIC lists by the way) that I could just buy myself. For what it’s worth, in late 2021 AFIC shares were in fact trading at a 20% premium to NTA. Right now the market thinks that AFIC has lost their touch, that the shares will fall precipitously, or that the management team is about to set fire to a shit tonne of capital (see Deterra – ASX:DRR – as a way to set fire to a few hundred million dollars). If you can take a breath for a moment, you might find in the papers in the next few months another series of articles along the lines of “hey, shit guys, there are these long term LICs that are trading below NTA, and the market is absolutely ripping”. Of course, almost by definition once the paper is written about it you’ve missed the boat, but the point remains, there is value available here if you have faith that the management team aren’t going to stuff it up.
The Environment
Now is probably a good time to take a walk down the road of the last 31 years as they have compounded returns at 10.01% p.a. and see the sort of major events that occurred under AFICs watch:
The wake of the recession we had to have:
Asian Financial Crisis
Tech Boom and Bust
9/11 Terror Attacks
Gulf & Iraq Wars
GST implementation
GFC
Greek Debt Default
Brexit
COVID-19
RBA Cash Rate hits 0.1%
RBA begins bond buying in a serious way
RBA Cash Rate hits 3.1%
Everyone, everywhere has inflation (Australia hits 7% p.a.)
House prices begin to fall. No, really this time!
Just kidding – Australian median house price hits $960k
So, in a span of just over three decades and seeing some huge shifts in the world and in the markets (easy to forget they aren’t the same thing) investors have actually managed to do incredibly well for themselves simply by staying put and not chasing the latest fad. So after just getting into an investment the second greatest trick to compounding is getting out of the way and giving it time to grow. The examples to come will illustrate this point very clearly.
Investing A Little
If you had invested $2k in April of 1993 (1,136 shares) and ticked the DRP box, what sort of results would you be looking at now as 2024 comes to a close? Keep in mind that I have assumed that the tax rate of the investor is 30% and so all franking credits have been used in a pass-through to the tax man.
For starters (as you likely know) the share price is $7.63. Your current investment would be worth $38,493.35 and you’d now have 5,410 shares. You could expect $1,406.60 in dividends in the coming 12 months if dividends stayed flat. This is 70.33% of your initial $2k investment, every year. You would have grown your capital 19.24 times at an annual compound growth rate (CAGR) of 10.01% p.a. I know numbers on a page are only really interesting for nerds so please feel free to gloss over them and just take in the graph which paints the picture perfectly.
Investing A Normal Amount
Now I hear what you are saying, nobody invests $2k initially and they certainly don’t stop investing throughout their lives. So, with that more than fair critique taken on board I present to you the figures for AFIC since 1993. Let’s assume you invested $5,000 upfront and then you invested $2.5k every half until today. This is not only fair but probably acts as a surrogate estimate of actual investing behaviour. That is; buy in $5k bundles and then slowly but surely accumulate more via dollar cost averaging. A side note here to spruik dollar cost averaging as an investing superpower. We all do it via our superannuation accounts and the DRP acts the same way.
Assuming you checked the DRP box (available the entire time AFIC was in action over this 31 year period) and your tax rate averaged 30% (same as the franking tax rate). You would have started with a fund value of $4,998.40 (rounded down as you obviously can’t buy more shares than you can pay for). You acquired 2,840 shares at $1.76 each.
Over the next 31 years you put in $157.5k in extra cash ($2.5k every 6 months plus the original $5k, with this September completing year 31). Including your reinvested dividends, you bought 107,145 new shares along the way. You started, as you’ll remember, with 2,840. This has turned your initial $5k investment and 6 monthly purchases (worth $157.5k all in) to a current value of $772,430.68 (see graphic for easier viewing pleasure). This is the stuff decent retirement plans are made of. Not bad for something so boring.
Final thoughts?
Well, I’m left looking at this business and concluding a few different things. Firstly, it hasn’t been able to beat its benchmark over a ten year period. This is a red flag for me and on the face of it I would invest in the S&P/ASX200 index (ASX:STW by the way) on principle. But equally I’m left thinking that AFIC doesn’t have a track record of major cock ups. They haven’t lit hundreds of millions on fire like some letterbox royalty companies have. They have been investing solidly in the background and growing their NTA at a reasonable clip. Let’s look at the following quote: a cynic is someone who knows the price of everything and the value of nothing. I’m left in a pickle because I’m probably the cynic here. Would I be better off in the index fund, yes. Would I miss out of the potential upside if/when the market wakes up to the value held inside AFIC? Also, yes. While I by and large don’t trust fund managers to beat their indexes I’d be loath to put anyone off simply investing in the first place. If I had to defend it in the pub and I wanted to be pithy, I might say this: price is what you pay, value is what you get.
If you’ve made it this far, I feel like I should apologise for all of the waffle. If you are keen to see the above product with all the graphs and pictures included head on over. Should you find yourself casting about for some more long form investing rants, you can find them all at our site. Happy investing.
