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Fundsmith Review

Topic: Fundsmith 24 September 2021

The past 18 months has been a volatile time for investors with sharp and unpredictable market swings making for an uncomfortable landscape with almost all major regions, markets and industries experiencing significant challenges. 

The period has seen a number of trends that has prompted some investors to shift strategies and change the funds in which they invest.  

With fluxing markets and general uncertainty, there was an increase in the number of assets held in funds with a Global strategy as investors sought comfort in Globally diverse funds, entrusting their managers to navigate the challenging market conditions. 

The most popular Global equity fund and indeed the largest equity fund in general is, and has been for some time, the Fundsmith Equity fund with current assets under management at £27.5 billion. The fund has been a favourite of investors for some time but over the past 18 months it has experienced periods of underperformance and there have been signs that confidence in the fund is not as it once was. 

In this report, we analyse the performance and sector ranking of the Fundsmith Equity fund as well as the performance of Fundsmiths 3 other funds, the Smithson Investment Trust, Fundsmith Sustainable Equity fund and the Fundsmith Emerging Markets Equities fund.

Our analysis identified that despite periods of underperformance over the past 18 months, the Fundsmith Equity fund has performed comparatively well in the longer term. In contrast, the popular Smithson investment trust and Fundsmith Emerging Equities trust have both consistently underperformed.

 

Key Findings

  • Since inception up until 1st September 2021 the Fundsmith Equity fund has returned cumulative growth of 561.75%, which is second only to the Baillie Gifford Global Discovery fund which returned growth of 605.85%, but considerably greater than the 206.49% sector average.
  • The Fundsmith Emerging Equities Trust and Smithson Investment Trusts have both failed to deliver competitive returns
  • Why Terry Smith believes the trend towards value investing in 2021 will prove to be the wrong way to go for investors.
  • Launched in 2014, the Fundsmith Emerging Equities Trust has consistently underperformed the sector average.
  • Over the past 2 years the Smithson Investment Trust has delivered returns that were well below its peers.
  • Despite a period of underperformance at the start of the year,  the Fundsmith Equity fund has comfortably outperformed the sector for the year to date.

Terry Smiths Investment Strategy 

Fundsmith’s success is built on a simple investment strategy, which involves taking bold bets on a small number of companies and holding them for the long term, without paying attention to the quirks of a macroeconomy. This is rooted in Mr Smith’s belief that “nobody is capable of consistently predicting macro events” and that it is more worthwhile to identify good companies, a skill he honed over decades working as an analyst. “You might think every fund manager tries to invest in good companies, but I can assure you they don’t,” he says. “At Fundsmith we have spent a lot of time coming up with a definition of what is a good company.” 

Fundsmith invests in mature companies with strong balance sheets and established brands, which are capable of reinvesting their profits and compounding value for investors over time, while excluding cyclical sectors, such as mining and financials. 

He avoids companies that require leverage to generate profits, which is why he won’t invest in companies that require borrowed money to function or survive – such as banks. 

Terry Smith says that his philosophy of investing in good companies is easier said than done, but he believes most other fund managers don’t do this. “Very few investment managers boast about the fact that they invest in low-quality businesses, but most of them do, often because they consider such businesses as ‘cheap’. They buy these companies because they believe the price to be too low relative to their assets or earnings and then wait for the market to revalue them upwards. This is logical; however, the revaluation will depend on the whim of the market or events which are difficult to predict, such as the business cycle, takeovers, restructuring or management change. So the revaluation might happen quickly, it might take a long time, or it may never happen at all. None of these are particularly good for an investor.”

 

Focus on Quality Not Value Stocks

Terry Smith has dismissed the rally in value stocks, insisting his focus on quality growth companies will win out in the long term and that ‘no amount of recovery or low valuation will turn a poor business into a good one’.

The veteran stock picker was irritated by commentary around the stock market shift last November on vaccine news, which caused companies that would benefit from lockdown ending to surge, while growth stocks fell out of favour.

The Fundsmith Equity fund went on to lag the MSCI World index in five of the seven months from November through to May.

But the value trade has petered out over the last couple of months as concerns about the strength of the economic recovery have mounted, leading investors to switch back into quality growth stocks.

In his half-year letter to investors, Smith said the fund has now powered back ahead of its benchmark. Despite this, it recorded a rare net outflow of £130m over the six months, although this was dwarfed by the more than £3bn increase in assets generated by its investment performance.

‘Since markets started to sense an end to the economic disruption caused by the lockdowns in the final quarter of 2020, there has been a so-called “rotation” from quality stocks, of the sort we own, into so-called value stocks and those expected to recover as the lockdowns end,’ Smith said.

‘In such a situation, our fund is always likely to underperform for a period, after all the companies we invest in mostly have little or nothing to recover from.’

Smith said this ‘inevitable blip’ in performance masks the fund’s strong performance through the combined period of the post-March recovery phase last year and the later November value rally.

He had pointed out that while value names such as American Airlines, Carnival Cruises and oil giant Exxon had all rebounded more than 100% from their post-Covid lows, they each remained well below their pre-pandemic levels. The fund, in contrast, was 25% above its pre-Covid high at the end of June.

‘You could have made some good gains by buying the value or recovery stocks at or close to the bottom, although, of course, this depends on getting your timing right, but if you ran the value/recovery stocks across the period of the downturn and recovery, they would still have significantly underperformed our portfolio,’ Smith said.

‘There are several lessons to be learnt from this, not the least of which is that no amount of recovery or low valuation will turn a poor business into a good one and quality is the main determinant of long-term performance.’

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Fundsmith Equity Fund

Fundsmith Performance Jan 2021

 

The table above shows that for the first half of 2021 the Fundsmith Equity fund underperformed comparative to the sector, which prompted investors to withdraw from the fund earlier in the year in favour of value funds which saw huge inflows during the same period. 

However, with the performance of value funds stalling and the return to rising performance for growth focused equity funds, the Fundsmith Equity fund has seen its assets under management rise primarily due to performance gains. As the above chart shows, it was during this period (May 2021 - September 2021) that the Fundsmith Equity fund recovered from the woes of the first half of the year with its net performance for the year to date now comfortably above the sector average.

 

Fundsmith Performance Since Inception

 

Since inception up until 1st September 2021 the Fundsmith Equity fund has returned cumulative growth of 561.75%, which is second only to the Baillie Gifford Global Discovery fund which returned growth of 605.85%, but considerably greater than the 206.49% sector average.

 

Fundsmith Performance Feb 2020

 

Since the pandemic induced market crash in February 2020 up until 1st September 2021, the Fundsmith Equity fund has returned growth 31.48% compared to the sector average of 25.96%. The period was one of the most challenging in recent history due to high volatility and Global market uncertainty and despite a period of underperformance from December to April, the fund has recovered well in recent months. 

Top performing Global funds

 

The table above features 15 top performing funds that compete alongside the Fundsmith Equity fund in the Global sector. Each of the funds has outperformed at least 75% of the sector over 2 of the 3 periods analysed. Both the Guinness Sustainable Energy and Baillie Gifford Positive Change fund have less than 5 years of history, but since their inception, they have been 2 of the best funds in the entire sector.

Download the best funds report to access all top performing funds

 

Fundsmith Sustainable Equity Fund

Despite previously saying that ethical funds perform poorly, Terry Smith entered the sustainable investment market in November 2017, by launching his Fundsmith Sustainable Equity fund.

The Fundsmith Sustainable Equity Fund follows the same Global strategy as the highly successful Fundsmith Equity Fund but as an ethical themed fund it has a number of key differences. The fund excludes sectors that do not fit sustainability categories of environmental, social, governance and innovation.

Sectors excluded from the Fundsmith Sustainable Equity fund

  • No Aerospace and Defence 
  • No Brewers, Distillers and Vintners 
  • No Casinos and Gaming 
  • No Gas and Electric Utilities 
  • No Metals and Mining 
  • No Oil, Gas and Consumable Fuels 
  • No Pornography 
  • No Tobacco

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The sustainable investment industry is of growing importance to investors and Fundsmith aims to capitalise on this interest with their Sustainable Equity fund. The fund currently manages £613 million of client assets, which although small in comparison to their flagship equity fund it is still a sizable share of the ethical investment market. This fund has closely mirrored the performance of the Fundsmith Equity fund and since its launch in November 2017 it has returned growth of 77.47% up to 1st September 2021. 

 

Fundsmith Sustainable Equity

 

However, over the last 12 months, the fund performed worse than 70% of competing funds within the IA Global sector with returns of just 21.29%.

 

Fundsmith Emerging Equities Trust (FEET)

Fundsmith launched FEET as a variation on their existing investment strategy with the Fundsmith Equity fund but with one added dimension: the companies invested in by FEET will have the majority of their operations in, or revenue derived from, Developing Economies and will provide direct exposure to the rise of the consumer classes in those countries.

Since its launch in June 2014, the performance of the Fundsmith Emerging Equities Trust has yet to come close to that returned by the Fundsmith Equity fund. For the 5 year period up to 1st September 2021, the trust has only managed to return growth of 27.83%, which is well below the 56.70% sector average for the period.  

In 2019, disappointed by the trust's performance, Terry Smith apologised to his investors and announced that he was handing over the day to day control of the trust. At the time Smith said, ‘Every human being, including me, has a limit to the amount of things they can focus on,’ he said. ‘Having people who are actually full time working on the trust as portfolio managers is more of a necessity than I thought it was.’ Indeed, since the handing over of the trust its performance has been more in line with the sector average, which is still some way short of expectations. 

The below chart shows the performance of the Fundsmith Emerging Equities Trust since launch on 24th June 2014 up to 1st September 2021. As the chart identifies, since launch the trust has underperformance and delivered returns that were below the sector average. 

 

FEET since launch

 

Smithson Investment Trust

When Smithson launched in October 2018, it received unprecedented demand that saw it break the record for raising the greatest amount ever by a UK domiciled trust in its initial public offering (IPO). 

Terry Smith launched Smithson as he believes small and medium sized companies have been shown to outperform large companies. Smith points out that small and mid cap companies have fewer research analysts studying them than larger ones and as such, it stands to reason that there may be less known about the mid cap stocks and consequently more discrepancies between price and value that Smithson can take advantage of.

Fundsmiths philosophy for Smithson is to look at companies within industries which have a history of delivering long-term value and avoid the temptation of looking at companies in industries that do not. One of the reasons for this is because Fundsmith believe there are many fads in investing which come and go: “the Dotcom boom; the mining “supercycle” (which turned out to be just a plain old cycle); the credit bubble; and most recently the cryptocurrency craze, one more example in a continuous stream of ‘new’ ways to make money. There are no new ways to make money. It is now a subject over which people have obsessed for centuries and so radical discoveries are unlikely.”

 

Smithson 2 year

 

The Smithson has experienced a difficult few years. As identified in the table above, it has performed below the sector average over the past 2 years with returns of 53.08% comfortably below the 63.10% sector average.

 

Smithson since launch

 

Despite underperforming over the past 2 years, the Smithson Investment Trust has managed to outperform its sector since it launched in October 2018. Since launch, the trust has achieved 93.80% compared to the sector average of 78.58%.

 

Summary

Fundsmith Performance Table

It is undeniable that the Fundsmith Emerging Equities Trust and Smithson Investment Trusts have both failed to deliver competitive returns, with consistently better performing alternatives available. Despite a period of underperformance over the past year the Fundsmith Equity fund has a history of outperforming its peers. Through this fund Fundsmith have proven their ability to develop and deliver superior risk adjusted return to investors through a Global investment strategy. Despite poor 1 year performance, the Fundsmith Sustainable Equity fund over the past 2 years has also delivered net returns that were above average. 

Terry Smith is often outspoken and not afraid to ruffle industry feathers but as a fund manager his results are somewhat of a mixed bag. Despite the underperformance of his investment trusts and the difficulties experienced by his equity and sustainable equity funds Smith remains as confident as ever that his strategies will deliver in the medium to long term.

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