Some might see Fundsmith’s founder Terry Smith netting a tidy £16m personal dividend from his firm’s £26.4m 2019 profits as a little ironic. This is a fund, after all, that famously encourages its investors to play the long game.
But few of its thousands of investors are likely to begrudge him that. Since its launch a decade ago, Fundsmith has delivered a mighty 364% return, and since March last year the Fundsmith Equity fund has become the largest of its kind in the UK, finishing 2019 valued at £18.8bn.
Success so far is based on Fundsmith’s committed strategy to follow safe, long-established companies over the long-term, rather than following fads. Many of the investors who have, according to CityWire, poured in over £9bn since 2015 are also attracted by its “Owner’s Manual” – a determinedly jargon-free handbook explaining investment to the layman.
Fundsmith's 2019 return
No-one should be surprised by Smith’s ability to connect with investors. This is after all a man whose 1990s book Accounting for Growth – a dissection of the failure of FTSE100 companies to turn a profit – proved such a must-read that for a heady few weeks it even outsold Stephen Hawking’s A Brief History of Time.
Even so, the year to the end of March 2019 was a particularly spectacular year for Fundsmith, which returned 25.6%, with the Fundsmith Equity Fund returning 23% after fees. The influx of investor fees shot turnover up 35% from £122m to £165m.
Playing the long game
Fundamentally, Smith has always adopted a Warren Buffett-style approach when it comes to investment. “The company’s approach is to be a long-term investor in its chosen stocks,” he says, emphatically adding: “It will not adopt short-term trading strategies.” Fundsmith’s well-publicised criteria for its stock choice includes high-quality businesses that can sustain a high return on operating capital employed, have advantages that are difficult to replicate, don’t need significant leverage to generate returns, can reinvest their cash flows at high return rates, and are resilient to change.
Its risk element lies in its apparently narrow interests – it only ever holds 20 to 30 stocks at a time. At present 65% of these are listed in the US, and nearly a third are tech companies. That said, its current top five holdings are all major long-term players: Microsoft [MSFT]
, PayPal [PYPL]
, Philip Morris [PM]
, Estée Lauder [EL]
and Facebook [FB]
, which Smith describes as “high quality, resilient, global growth companies that are good value and which we intend to hold for a long time”.
Fundsmith’s success last year – in the 12 months covered by the company’s most recent accounts, flocking investors saw the company’s assets grow from £13.4bn to £18.6bn – is unquestionably down to shrewd market sense. (Around £2.5bn of the fund’s assets were hived off into a Luxembourg version of the strategy in May as part of Brexit planning.)
But it was also inevitably boosted by the downfall of Neil Woodford. While the Fundsmith Equity Fund was turning a £1,000 investment into £1,226 in the 12 months to March 2019, Woodford Equity investors lost £57. Those who trusted Woodford with £1,000 when he launched in 2014 would now have just £857, while Smith’s investors are sitting on £2,236.
Smith’s stolid long-term investment plan contrasts starkly with Woodford’s alternative, ill-fated strategy of eschewing the large tobacco and pharma companies that had brought him so much return and reputation at Invesco, and instead backing tiny unsustainable start-ups and illiquid and unquoted businesses.
Return on a £1000 Fundsmith investment for the 12 months to March 2019
But the contrast between Fundsmith and Woodford is not just about those disastrous investments which plunged the latter’s Equity Fund from a £10bn peak in 2017 to just £3.7bn last summer. The blithe alacrity with which Neil Woodford accepted £9m in dividends before freezing the fund – locking 300,000 savers in – sent thousands of angry former investors to the reliable, approachable, safe haven of Fundsmith. This was even before Woodford was unceremoniously fired and the fund wound up at the end of last year; with those locked in savers still waiting to get their money back.
In contrast, a recent Fundsmith investors factsheet revealed nearly two thirds of its equity fund could be liquidated within seven days. “We’ve always regarded this as an important subject,” said Smith, adding for good measure that Fundsmith Equity “never invests, nor will it ever invest, in unquoted companies, nor does it own any small or mid-cap companies. The smallest companies from a market value perspective that Fundsmith Equity Fund invests in are all members of the FTSE 100 index.”
The interest rate impact
Of course, nothing lasts forever – especially in investment – and both Fundsmith and its nearest, most similar competitor Lindsell Train has stalled in the last three months with sentiment seemingly starting to shift investment away from growth to value. Lindsell Train, whose upward trajectory has almost matched Fundsmith over the past five years, recently found itself at the bottom of 330 funds in the sector, while Smith’s fund fared little better, losing its investors 5.7% in the three months to October 2019.
“It’s an important reminder to investors that these funds have done well for a long time, but no style persists forever,” warns AJ Bell’s head of active portfolios Ryan Hughes. “A lot of the companies that Fundsmith is buying are on pretty rich P/E ratios and it doesn’t take much of a change in sentiment in the market to see a performance differential like this in a very short period.”
Fundsmith’s performance over the next year could also be stymied by a rise in interest rates by central banks, which could make value stocks overperform. Smith’s quality growth style of investing performs best when interest rates and bond yields are low.
“It’s an important reminder to investors that these funds have done well for a long time, but no style persists forever” - AJ Bell’s head of active portfolios Ryan Hughes
330% and rising?
But this seems unlikely to deter Fundsmith investors, who appear to remain confident in its long-term approach; despite the losses, the fund still took in net inflows of £1.3bn in the year to October 2019. And that confidence is no surprise, according to Morningstar associate director Peter Brunt. “Whether investors stick by Smith depends on the nature of the underperformance,” he says. “Professional investors are more likely to stay with managers when poor performance is the result of natural causes like market rotations, provided those managers have a very clear, disciplined, well-articulated, long-term investment approach.”
Smith himself told FTAdviser last month he could trace back “some seven years” of people warning quality growth stocks would underperform. “During that time the Fundsmith Equity Fund has risen in value by more than 330% and outperformed every year,” he said.
"So-called 'value' stocks will eventually enjoy their day in the sun, but even successfully capturing that will never compensate for missing out on the compounding returns of quality company stocks over the past decade."