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Fundsmith Equity: July 2021 fund update

Investments can go down as well as up so there is always a danger that you could get back less than you invest. Nothing here is personalised advice, if unsure you should seek advice.
  • Terry Smith is a seasoned investor
  • He uses an established three rule process: Buy good companies, don't overpay and do nothing
  • Performance has been strong since launch in November 2010
  • The fund does not currently feature on the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

Fundsmith Equity aims to deliver long-term growth by investing in high-quality companies from around the world. Smith focuses on larger businesses from developed markets which means the fund could complement others investing in higher-risk emerging markets or smaller companies. A quality growth focus means it could also work well alongside those investing in unloved companies with recovery potential.

Manager

Terry Smith's had a long and esteemed financial services career, working his way from bank analyst to chief executive of broker Tullett Prebon. He was also previously adviser to the Tullett Prebon pension fund, and appointed Andy Brown of Cedar Rock Capital to manage the investments. Inspired by Brown's investment philosophy and process, Smith launched Fundsmith Equity in 2010. He initially ran it part-time as he was still chief executive of Tullett Prebon, before leaving the business in 2014 to focus full-time on the fund.

Smith's been the sole manager ever since but has the support of a small team who've worked closely with him for many years. He also manages a sustainable version of this fund and is the Fundsmith business' chief executive and chief investment officer. As both his funds are similar and the business is focused on a small number of portfolios, we think he's able to devote enough time to managing the fund.

Given how long Smith has been in the industry, questions around his retirement are natural. Over the years he has made hires and surrounded himself with a tight knit team. Plans for his succession are in place but for the moment he remains integral to Fundsmith. At their last annual general meeting (AGM) Head of Research Julian Robbins, a long-term colleague and friend was named ‘the first line of defence' as and when Smith does eventually decide to step back.

Smith has built an impressive long-term track record and we believe he uses a simple and straightforward investment approach. The fund doesn't currently feature on the Wealth Shortlist though. To conduct our analysis, we require regular access to the fund manager and up-to-date, monthly portfolio data, which some fund groups, including Fundsmith, choose not to disclose. We can't, however, make an exception to our process, so we won't be considering the fund for the list as things stand.

Process

Fundsmith Equity follows three simple rules.

Rule number one is to ‘buy good companies'. Smith hunts for high-quality businesses which can dominate within their market niche. Companies with intangible assets are favoured, such as brand power, intellectual property, or a product or service that customers can't do without and would struggle to replace, even when times are tough. His focus on sustainable growth means he avoids companies whose prospects are closely tied to the fate of the economy like airlines and property developers.

Smith looks closely at a company's profits and pricing power – the ability to mark-up prices even during tough times without impacting consumer demand. Companies must also be in a strong financial position, so companies that require lots of debt to function such as banks and real estate are avoided.

Smith mainly invests in companies from developed markets with nearly 70% of the fund invested in the US and the remainder in European countries like the UK, France and Denmark. Consumer focused companies make up the largest part of the portfolio, and Smith also invests a significant amount in technology and healthcare.

The second rule is ‘don't overpay'. Smith only invests in companies he believes he can buy at a fair share price. Whilst some of these companies may be considered ‘expensive' on today's metrics, Smith believes their ability to grow faster and stronger is worth the premium price.

Smith is a long-term investor and once he invests in a company, he uses rule number three – ‘do nothing'. He aims to hold onto companies for the long term, which help to benefit from compound growth. Trading less also helps keep dealing costs down and increases performance potential.

The process results in a portfolio of 20-30 companies, and currently there are 28. This means each holding can have a significant impact on performance, both positively and negatively, which can increase risk.

Over the past 12 months only a few changes have been made. At the end of 2020 Smith sold consumer goods company Reckitt Benckiser, a company that he first bought over a decade ago. The proceeds went towards purchasing French luxury goods company LVMH. In February he sold his stake in testing services company Intertek and purchased US consumer goods firm Church & Dwight. More recently, he sold UK software company Sage.

Culture

Fundsmith is a boutique fund group with offices in Mauritius, London and the US. It was founded by Terry Smith in 2010 with the launch of Fundsmith Equity and has expanded to include a small stable of funds and investment trusts, most of which are run along the same lines. This dedication to the founding investment philosophy is attractive.

The business is employee-owned, with Smith owning the largest stake, and managers all investing significantly in the funds. This means both the business and the funds are run with the long term in mind, and managers' interests are aligned with investors.

Managers at Fundsmith typically invest in companies with good ESG (Environmental, Social and Governance) credentials, though they do not follow a strict ESG approach. Corporate governance and engagement are a key part of the investment process, which includes analysing a company's ownership structure and the way management is compensated.

Cost

The fund is available for an annual ongoing charge of 0.96%. This is higher than many other funds in the Global sector, and means the manager has a higher hurdle to deliver a positive return. We recognise the long-term value that Smith has added over and above these charges, although there's no guarantee of that in the future. The HL platform fee of up to 0.45% per year also applies.

Performance

Since launch in November 2010, Smith has done an exceptional job in outperforming the global stock market. He has also outperformed peers, with the fund returning 527.8%* vs 202.2% for the IA Global sector average. Remember past performance isn't a guide to the future. Investments can fall as well as rise in value and you may not get back as much as you originally invest.

Whilst his quality growth style has helped, our analysis suggests that Smith's stock selection has been the primary driver of returns. His focus on quality has helped the fund hold up relatively well when markets are falling. The fund has also outperformed during rising markets. That said, over the past 12 months the fund has lagged the peer group returning 24.4% versus 26% for the IA Global sector.

Following the successful vaccine trial in November, investors turned to out-of-favour ‘value' companies. Smith has tended to avoid these companies so this hindered performance, though in more recent months the fund has outperformed again. We expect Smith to deliver good performance over the long run, particularly during market wobbles, although there are no guarantees.

Annual percentage growth
June 16 -
June 17
June 17 -
June 18
June 18 -
June 19
June 19 -
June 20
June 20 -
June 21
Fundsmith Equity 25.0% 15.2% 18.5% 9.2% 24.4%
IA Global 24.1% 9.4% 7.3% 5.6% 26.0%

Past performance is not a guide to the future. Source: *Lipper IM to 30/06/2021.

Find out more about Fundsmith Equity, including charges

Fundsmith Equity Key Investor Information

Important information - Please remember the value of investments, and any income from them, can fall as well as rise so you could get back less than you invest. This article is provided to help you make your own investment decisions, it is not advice. If you are unsure of the suitability of an investment for your circumstances please seek advice. No news or research item is a personal recommendation to deal.


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