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Dividends and tax breaks: the case for the Australian Foundation Investment Company

Emma Rapaport  |  24 Oct 2019Text size  Decrease  Increase  |  
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Low-cost, tax-effective and favouring companies with higher levels of franked dividends. There's a lot for Australia's retiree class to like about the Bronze-rated listed investment company Australian Foundation Investment Company, says Morningstar associate director for fund research Tim Wong.

In a new research note, Wong says the low price of AFI (ASX: AFI) is its main attraction, charging an expense ratio of 0.13 per cent in 2019. This is far cheaper than the active cohort, and like its closest listed investment company rival Argo Ord (ASX: ARG) and passively managed large-cap Aussie equity ETFs from Vanguard and iShares.

AFI is one of Australia's oldest are largest LICs, having commenced operations in the 1920s. Today, the strategy invests $7.6 billion in assets on behalf of investors.

A LIC is a structure that allows investors to buy shares in a listed company whose business it is to invest in a range of companies (and other assets).

AFI gives investors exposure to a diversified portfolio of actively managed stocks, favouring large Australian companies trading on the ASX.

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From a portfolio construction perspective, Wong says AFI has a conservative, value and quality leaning strategy that picks companies with superior value and long-term sustainable earnings growth.

"The bottom-up approach incorporates traditional valuation metrics such as price/earnings multiples and dividend yield, as well as a qualitative assessment of balance-sheet, management-strength, and business-strategy soundness," he says.

Related article: Beat the market: should you buy active ETFs, LICs or unlisted managed funds?

Wong says AFI is well-diversified, with the portfolio typically ranging from 70 to over 100 stocks.

When it comes to individual stock selection, Wong says AFI's buy-and-hold approach favours companies with higher levels of franked dividends, with taxes a major factor behind investment decisions.

AFI is typically more conservative, with over 70 per cent of the portfolio in large and giant Australian stocks. However, it can invest up to 10 per cent of the portfolio in shorter-term opportunities. Turnover of stocks is typically low at around 5 to 10 per cent per annum.

Forty-nine per cent of the LIC's assets are in the top 10 holdings, which include Commonwealth Bank, BHP Group, Westpac Banking Corp and biotech CSL.

AFI can also pass on LIC capital gains dividends arising from underlying asset sales, against which eligible investors may be able to claim the capital gains tax discount.

"These features make AFI a relatively tax-effective option," Wong says.

But it's not all good news. Wong says the substantial amount of unrealised capital gains held means the company is less agile than its more active unlisted peers. And while the LIC’s large size helps with secondary market liquidity, Wong says it has traded at substantial premiums or discounts "from time to time".

AFIC chief executive Mark Freeman leads the investment team, following the retirement of former chief executive Ross Barker. Wong says the board of directors is "highly experienced" and "well resourced" but warns that there has been some turnover among the team in 2018/19, both planned and unexpected.

"Notably, Roger Walling left in May 2019, a little more than a year after joining, while other additions have bolstered the group," he says.

Australian Foundation Investment Company at a glance:

Bulls case

  • Offers a well-diversified, professionally managed portfolio that generates reliable and growing dividends at a low cost
  • Among the most-liquid listed investment companies

Bears case

  • Potential to trade at a premium or discount to net tangible assets
  • A conservative and less-nimble approach is likely to lag strong markets



is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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