Active Golden Oldie

Active Vs Passive Redux (ASX:AFI)

Active Golden Oldie
Don’t Get WreckedWhen Getting Adventurous

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It’sbeen 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 agood time to see what the reliably boring folks at Australian FoundationInvestment Company (AFIC) have been up to.

What is AFIC and what in the hell is an LIC, a new brand ofice-cream?!

AFIC is an LIC that was started in 1928and from that point has been investing for their shareholders. It is a veryboring, largely unfancy fund that has, by virtue of its age, been run by manyfund managers over time. An LIC, or listed investment company, is a group thatlists on **promotion blocked** (the ASX in this case) with the sole intention ofinvesting in the shares of other companies. In this respect they function justlike other investment fund managers however they provide two key benefits thatmany fund managers can’t or won’t. The first is liquidity. By being a listedcompany, a shareholder is able to sell their parcel of shares at any timeduring ASX trading hours. This is a huge benefit to investors as the gapbetween wanting access to your capital and getting the deposit in your accountcan 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 foranother day. The second major benefit to a LIC in general and AFIC inparticular is their willingness and commitment to dividend smoothing.Basically, the business is trying to slowly increase the dividend paid toshareholders year on year. Some years this will be right at the limit of cashreceived from their underlying assets but others it will be far less. Overtime, they are setting themselves up as a steady income stream.

Ah, but what about the benchmark?!

That’s a great question and it shows howfar you’ve come as an investor to even ask about it. Here’s where things get alittle uncomfortable for me though when it comes to AFIC, but for the risktakers amongst us it probably offers an opportunity. Over the last 10 yearsAFIC has underperformed their benchmark, the S&P/ASX200 accumulation (meansdividends 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 differenceis even more stark when you look at the returns from the last 12 months. Theindex returned 26.4% while AFIC notched 19.2%. So, I’m left with my oldrefrain; Please invest in a passive, broad based index fund and live a happylife. In fact, for those interested in the power of compounding index returns Ican’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 pricehasn’t been moving up very much the NTA (net tangible assets) of AFIC has. NTAis reported daily and represents the cash value of all the shares the companyowns after paying taxes/capital gains if they were forced to sell. That NTAnumber has grown 28% in the last year and 9.2% over the last ten. What doesthat mean? It means that today, AFIC owns $8.45 of assets (after tax) and theshares are trading at $7.62. That’s an 11% discount. At this point, it would befair to say that you are buying $1 coins for 89 cents. The shares in AFIC havebeen 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 aninvestment portfolio isn’t the rate of return you get. Sounds odd, right? Thesingle biggest thing holding investors back is simply getting invested in thefirst place. There are a myriad of reasons why this happens, they don’t save inthe first place, they get paralysis of analysis having overthought everythingto the point of frustration, but for the love of God, just invest in something whichis something I’ll touch on later.

Why would I get a difference between the NTA and the shareprice?

The basics are this: if the market isjubilant about the prospects of AFIC and their managers to pick greatinvestments 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 couldjust buy myself. For what it’s worth, in late 2021 AFIC shares were in facttrading at a 20% premium to NTA. Right now the market thinks that AFIC has losttheir touch, that the shares will fall precipitously, or that the managementteam is about to set fire to a shit tonne of capital (see Deterra - ASXRR - 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.

TheEnvironment

Now is probably a goodtime to take a walk down the road of the last 31 years as they have compoundedreturns at 10.01% p.a. and see the sort of major events that occurred underAFICs watch:

The wake of therecession 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 hits0.1%

RBA begins bond buyingin a serious way

RBA Cash Rate hits3.1%

Everyone, everywherehas inflation (Australia hits 7% p.a.)

House prices begin tofall. No, really this time!

Just kidding -Australian median house price hits $960k

So, in a span of justover 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 todo incredibly well for themselves simply by staying put and not chasing thelatest fad. So after just getting into an investment the second greatest trickto compounding is getting out of the way and giving it time to grow. Theexamples to come will illustrate this point very clearly.

InvestingA Little

If you had invested $2k in April of 1993(1,136 shares) and ticked the DRP box, what sort of results would you belooking at now as 2024 comes to a close? Keep in mind that I have assumed thatthe tax rate of the investor is 30% and so all franking credits have been usedin a pass-through to the tax man.

For starters (as you likely know) theshare price is $7.63. Your current investment would be worth $38,493.35 andyou’d now have 5,410 shares. You could expect $1,406.60 in dividends in thecoming 12 months if dividends stayed flat. This is 70.33% of your initial $2kinvestment, every year. You would have grown your capital 19.24 times at anannual compound growth rate (CAGR) of 10.01% p.a. I know numbers on a page areonly really interesting for nerds so please feel free to gloss over them andjust take in the graph which paints the picture perfectly.

InvestingA 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 thefigures for AFIC since 1993. Let's assume you invested $5,000 upfront and thenyou invested $2.5k every half until today. This is not only fair but probablyacts as a surrogate estimate of actual investing behaviour. That is; buy in $5kbundles and then slowly but surely accumulate more via dollar cost averaging. Aside note here to spruik dollar cost averaging as an investing superpower. Weall do it via our superannuation accounts and the DRP acts the same way.

Assuming you checked the DRP box (availablethe entire time AFIC was in action over this 31 year period) and your tax rateaveraged 30% (same as the franking tax rate). You would have started with afund value of $4,998.40 (rounded down as you obviously can't buy more sharesthan you can pay for). You acquired 2,840 shares at $1.76 each.

Over the next 31 years you put in $157.5k inextra cash ($2.5k every 6 months plus the original $5k, with this Septembercompleting year 31). Including your reinvested dividends, you bought 107,145new shares along the way. You started, as you’ll remember, with 2,840. This hasturned your initial $5k investment and 6 monthly purchases (worth $157.5k allin) to a current value of $772,430.68 (see graphic for easier viewingpleasure). This is the stuff decent retirement plans are made of. Not bad forsomething so boring.

Final thoughts?

Well, I’m left lookingat this business and concluding a few different things. Firstly, it hasn’t beenable to beat its benchmark over a ten year period. This is a red flag for meand on the face of it I would invest in the S&P/ASX200 index (ASX:STW bythe way) on principle. But equally I’m left thinking that AFIC doesn't have atrack record of major cock ups. They haven’t lit hundreds of millions on firelike some letterbox royalty companies have. They have been investing solidly inthe background and growing their NTA at a reasonable clip. Let’s look at thefollowing quote: a cynic is someone who knows the price of everything and thevalue 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 potentialupside 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 beloath to put anyone off simply investing in the first place. If I had to defendit in the pub and I wanted to be pithy, I might say this: price is what youpay, 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.