During the recent Switzer Investor Strategy Day Marcus Bogdan, Portfolio Manager for the Switzer Dividend Growth Fund (the Fund or Portfolio) presented on the current top three concerns for Australian investors, stocks held in the Fund and where investors can find income when investing in Australian equities.
Transcript of the presentation
[Marcus] – Good morning, my name is Marcus Bogdan. I’m the Portfolio Manager for the Switzer Dividend Growth Fund. The investment objective of the fund is to deliver long-term growth, both in capital and income by investing in Australian-listed equity shares. The portfolio aims to do this with lower volatility and greater downside protection relative to the ASX 200 Accumulation index. Income is paid quarterly and will be franked to a material extent.
My background is for over 30 years, I’ve been an investor in the Australian equity market. I started my career as an Australian equity analyst in the early 1990s as we were coming out of Australia’s worse banking crisis in 100 years. And over the course of three decades, I’ve navigated through economic cycles and economic crises, through the banking crash of the early 1990s to 2000 tech crash, to the global financial crisis in the early part of this century, and more recently, through the pandemic, which we’re experiencing today.
Our investment methodology is based on a strict analytical framework. We’re invested in Australian companies and so the first point of discovery is through looking at the earnings quality of the companies that we’re investing in. We want to understand where each company is through their earnings cycle, the history of earnings and the returns generated over that period are of particular attention. Understanding the makeup of earnings. How much is organic, how much is through acquisition growth? The cashflow generation and the sustainability of returns. The second element is industry analysis. Understanding the size of the industries, the growth rates of the industries and also the returns generated over time. And importantly, understanding the regulatory overlay that sits across the industries that we’re invested in. Balance sheet strength and resilience is a particular component and a really important part of the way that we invest and a core consideration in the companies that we choose. Management and board execution are particularly important, the focus and the clarity of the strategy.
ESG has always been a pivotal, of importance around environmental and governance issues. And more recently, through the pandemic, ESG has started to really gain an incredible relevance in the way that we look at companies. And we look at that through the prism of materiality, of the most important factors affecting companies from an ESG perspective and we want to be invested in Australia’s highest-quality companies and the ESG lens is a particularly important part of that. Our valuation metrics are important in identifying companies of reasonable price and offering a core margin of safety and we want to look at valuation through the cycle, considering multiple valuation points. We also consider both domestic and international comparisons and we need to bring all of that together into a portfolio.
We want the portfolio to have the attributes of resilience, lower volatility, lower investment drawdown and faster recovery. We want to have multiple sources of different types of return and different types of risk. So we do pay attention to diversification in the portfolios that we have. Our strategies have delivered consistent growth for our investors and importantly, we’ve been able to do that with lower drawdown and faster recovery periods.
This graph illustrates the seven years that we’ve been running our capital and dividend strategies, that in each period where the market has fallen by 10% or more, the portfolio has delivered lower volatility, greater downside protection and most importantly, it’s been able to recover at a faster rate back to its previous peak and that was most recently illustrated through the pandemic where our portfolios had recovered back to the previous peak in January and February and the Australian broader equity market has still to recover to its previous peak. So today, the ASX 200 is around 1.5% below its February 2020 peak. The drawdown was dramatic but so was the destruction in earnings. In 2020, EPS declined by around 22% and dividends declined even by a greater rate of around 25%. But the recovery has been based on strong fundamentals. A stronger than expected economic recovery, and we’re seeing that in broad economic numbers but importantly, we’re seeing that at a company level and companies in Australia are well positioned to grow their earnings by at least 20% in calendar 2021 and we expect also to see dividend growth of at least 20% this year. So today, if we look at the dividend of the Australian equity market, the dividend yield is around 3.8%. Now, this is well below the median average of 4.3% over the last 30 years.
What we are confident about is that we’re on the foothills of a recovery in both earnings and dividends. We can see that those dividends will be built up into the next 12 to 18 months. And that has been primarily driven by a strong recovery in resource prices, a strong recovery in the banking sector and a very good recovery that we’re seeing in a group of Australian industrial companies. Indeed, the Australian market is a very attractive dividend market based on international comparisons. Australia has the second highest dividend yield of the jurisdictions that we look at and importantly, we are seeing the strongest DPS momentum in the Australian equity market and that is terrific for income-seeking investors.
– [Interviewer] Thank you, Marcus. And if I may ask, what is your biggest concern for Australian investors today?
[Marcus] – There are really three concerns that we are mindful of. The first one is around COVID. It is around the difficulty that we’re seeing in different variants of the disease and also, the efficacy of the vaccines and also the distribution. And the uneasiness that we’re seeing across different jurisdictions. We can take heart of what we’re seeing in Israel, in the United States and the United Kingdom where there has been a very significant rollout of the vaccine. Other jurisdictions have struggled, Europe, Latin America and even in Australia, we’re at the foothills of rolling out the vaccine. And so that is something that we are very mindful of and we’re keeping a close watch on because it will drive future economic returns.
The second element that we are looking at very carefully is the great experiment that we’re seeing in both monetary and fiscal policy. We’ve seen an unprecedented response at a monetary level. We’re seeing interest rates at record lows across the globe. But we’ve also seen an incredible fiscal response and in the first instance, we were concerned that that fiscal support may have been pulled too early but now we are dealing with excess liquidity and our concern is around how that capital will be allocated in the future. And will capital be allocated in a sensible way.
The third element that we are looking at is to make sure that the overall equity market is based on strong fundamentals. At this stage, we’ve seen where the market is today is based on that sharp recovery that we’re seeing both in earnings and in dividends. So I’d like to now turn to the companies that we are invested in. As I said at the outset, earnings resilience, industry leaders and strong balance sheets are particularly important.
Those companies that exhibit earnings resilience are companies like Amcor, BHP, Cleanaway, Wesfarmers and Woolworths. BHP, for example, has been a core beneficiary of the recovery that we’re seeing in the Chinese economy. China was the first economy that was affected by the pandemic but it’s certainly been the first economy that has really delivered very, very strong economic growth and BHP, through its iron ore and its copper commodities has been a core beneficiary of that. Wesfarmers and Woolworths have been clear examples of strong Australian companies. Wesfarmers, that we’re seeing through the housing recovery and the beneficiary of having such a strong business, such as Bunnings, and Woolworths that has been able to deliver and change its model to be able to increase its online sales by nearly 100% over this period of time have also benefited and delivered both earnings and dividend resilience.
We also want to be invested in companies that are recovering, that will be beneficiaries of the reopening of the Australian economy. And there are three examples that I’d like to draw your attention to. The first is Ampol, which is the service station and fuel business and the convenience offering. We are seeing a recovery in both in local vehicle strength. We’re seeing recovery in the industrial and commercial sense, particularly in diesel and ultimately, we will see a recovery in jet fuels. Ramsay Health Care was absolutely affected by the cessation of elective surgery, not only in Australia but in multiple jurisdictions. We’re seeing a very rapid uptick in elective surgery in Australia and those rates returning to more normal levels. We’re seeing also that there is a change in the relationship between the public and the private system and the private system has been a very important component in reducing overall waiting lists. Ramsay is very well positioned, both in the UK and Europe when ultimately, those economies will recover and those hospitals there will be beneficiaries of the contracting out that we’re seeing from the public sector into the private sector.
We have also increased our position in the Australian banking sector, notably through Commonwealth Bank and Westpac. And we want to be well positioned for that housing recovery that we’re starting to see true evidence of that coming through. And we want to be exposed to the mortgage banks, namely CBA and Westpac. We expect to see strong earnings and dividend recovery in both of those companies and importantly, the capital structure for Australian banks has never been stronger. Our attention is also turning to Australian quality companies that have lagged the recent companies. Companies such as Brambles, CSL, Coles, Medibank and Spark are all very strong industry leaders that we believe that their valuations now look attractive, given their relative performance to the Australian market. Brambles has delivered both earnings and dividend growth over the forecast period and is well positioned to recover, particularly in those northern hemisphere economies. CSL, we expect to recover its plasma values, particularly as the US economy recovers. We expect the underlying demand for plasma therapies remains robust. And CSL also provides us a strong position, particularly in flu and flu vaccines. Medibank will be a beneficiary of the restoration of elective surgery and Spark New Zealand, the leading telco of New Zealand will also see both recovery and earnings and very, very strong dividend growth.
– [Interviewer] Thank you, Marcus. And finally, are there any holdings or things that you are finding exciting over the next 6 to 12 months?
[Marcus] – We have increased our positions both in CSL recently on the weakness that we have seen in that share price and we’ve also increased our holdings in Medibank as well. We do hold some cash in the portfolio. So if markets do become choppy and difficult, we are well positioned also to be able to invest counter-cyclically. So if I could conclude, the attributes that we’re looking for in this portfolio is our investment in Australian-leading companies, companies that have demonstrated why they are industry leaders, that they’ve demonstrated good growth overall economic cycles and they’ve been able to do that by prudently paying dividends to investors and have strong and resilient balance sheets.
Thank you for your attention today and we look forward to welcoming you as investors in the Switzer Dividend Growth Fund.
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