by Mark Freeman, Managing Director
The speed of change, not the recovery, in investment markets in 2020 was arguably both the biggest surprise and biggest opportunity for investors. At AFIC we successfully capitalised on several buying opportunities throughout the downturn, including participating in some key capital raisings to further solidify our position in what we consider as high-quality companies.
Interestingly, we entered calendar 2020 with the mindset that we may see a correction in the markets from the highs in January by the end of the year, but the sharp fall in March through April following the outbreak of COVID-19 and the pace at which the market has rallied has been staggering.
In a matter of only months, we witnessed the heavy impact of COVID-19 on markets while a vaccine was potentially still years away. Since then, multiple potential vaccines have been developed and markets generally have rallied as interest rates continued to fall to record-breaking lows, leaving yield-seeking investors with little choice but to put their money into equities.
These record low interest rates were a critical driver of the flow of funds into equities that has buoyed the market recovery due to the limited returns in other asset classes such as fixed interest.
We paid a stable dividend of 24 cents per share to shareholders for the financial year, despite the fall in company profits and dividends received because of the economic impact of COVID-19. Pleasingly, we enter the new calendar year with what we regard to be a strong portfolio position, with a good balance of quality companies that are expected to continue to grow despite any further market uncertainty and across a number of different industry sectors.
Long-term profit versus immediate value
We believe it is important to look at long term drivers of future profit growth when considering the valuation of the stock at any moment in time.
Throughout 2020, we originally saw higher quality companies with good long-term outlooks lead the market recovery, the implication being that investors were looking for lower risk investments while still hunting for yield.
More recently, we’ve seen value investments follow suit, companies that are perceived by the market to have been left behind in the rally and undervalued irrespective of some of the key attributes we consider as quality. With little option for attractive investment outside of equities, more recently there has been a rotation toward value from growth, which has delivered a rapid turnaround in some of these more cyclical stocks.
We are likely to see further rotation in the market towards value stocks in 2021. However, our focus will remain on high quality companies rather than looking at short term gains.
Australia’s banking sector has recently faced significant headwinds that have eroded some appeal for investors. In the past, the banks have maintained a reputation for paying consistent, strong dividends, which has attracted income focused investors, but with slowing economic growth and the threat of new entrants, some of this attraction has diminished.
A key challenge for banks going into 2021 will be the impact of bad debts. With the easing of stimulus, such as JobKeeper and JobSeeker, banks will no doubt keep an eye on the volume of defaults from borrowers that can no longer afford to service their debts. This is something we will also be focusing on as next year emerges.
However, as the sector emerges from a Royal Commission and multiple inquiries, with stronger capital positions, investors are anticipating more stable dividends albeit at more subdued levels as the economy moves to recovery. In a low interest rate environment, the banks will maintain some appeal but not with the expected growth of previous years.
At AFIC we have lowered the exposure to this sector over the past few years, however as we look toward long-term economic recovery, they may still provide a reasonable amount of income for the portfolio.
One sector that performed strongly toward the end of the year was energy. The oil price has been steadily climbing as the world has further opened up following COVID lockdowns and people have started travelling again.
Whilst there may be more room for growth in these investments as economies hopefully open further, we remain underweight the sector in general as we see further long-term change in the sector, with the world transitioning to alternative sources of energy. Our two major holdings are Woodside Petroleum and Oil Search which are significant providers of LNG, a fuel that may assist with this transition.
Interestingly, there may be both positive and some negative implications of a viable vaccine for COVID-19 on certain companies in the healthcare sector. A vaccine will, over time, reduce the demand for some other products and services, such as testing around the virus, that increased through the pandemic. Ironically, this may reduce the ability of some companies to replicate the very positive revenue streams that we have seen this year.
Regardless, AFIC is confident in the long-term profitability and quality of our holdings in the healthcare sector, such as CSL Limited and ResMed. These companies hold a sustainable competitive advantage in the products they produce. It is unlikely that the demand for these products will reduce irrespective of the outlook for the global pandemic and a vaccine.
Strong position moving into 2021
As it turned out, investors had to be quick to take advantage of opportunities in 2020, as the window to invest in quality companies that had taken a hit to the share price ended up being relatively small. We were pleased during this window to have increased our holdings in companies that we think can deliver earnings growth over the long term.
As 2020 ends, we believe the market is starting to look fully priced. Further growth in markets may be challenging depending on the earnings companies can deliver over the next twelve months.
We do not try and attempt to predict what markets will do in the future, but we believe our portfolio is in a strong position to face any volatility while having the ability to capitalise on opportunities that may emerge. With our long-term perspective, we will hopefully look back on this year as a trying year for our investors, but not for their portfolios.