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Fundsmith Equity research 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.

The financial world can seem daunting from the outside and it can be difficult to understand exactly what a fund manager is trying to achieve or how they are different from the crowd. There are managers, however, who adopt a simple, tried and tested approach which can be easily understood. Terry Smith, manager of the Fundsmith Equity Fund, is one such manager.

He does not believe one can rely on ever-changing economic forecasts to provide the basis for investment decisions. Instead, he seeks good-quality businesses which he believes will deliver strong cash flows into the future, regardless of the economic background. His approach has tended to result in a bias towards companies with a strong brand or franchise, and those which own significant intellectual property, such as patents, trademarks and copyrights.

Businesses which are heavily reliant on strong economic growth for success, or those which have too much debt, are generally avoided. He is also wary of companies in areas of innovative change. For example, he recently sold a holding in Swedish Match, which produces smokeless chewing tobacco, as he felt the development of e-cigarettes could be damaging to the business.

His approach has so far proved successful and the fund has returned 106.3% since its launch in November 2010, compared with 42.5% for the sector and 56.2%* for the benchmark over the same period. However, this is still only a relatively short time frame and past performance is not a guide to future returns.

Annual percentage growth
Feb 10 -
Feb 11
Feb 11 -
Feb 12
Feb 12 -
Feb 13
Feb 13 -
Feb 14
Feb 14 -
Feb 15
Fundsmith Equity N/A 15.08% 20.63% 12.10% 29.91%
IA Global 17.76% -3.80% 13.27% 9.94% 12.23%
MSCI AC World 19.31% -1.45% 15.66% 6.66% 19.60%

Past performance is not a guide to future returns. Full year performance prior to the 01/02/2011 is unavailable. Source Lipper IM *to 02/02/2015.

Currently, almost 40% of the fund is invested in companies within the consumer goods sector, including stocks such as Imperial Tobacco and Dr Pepper Snapple. This area has performed strongly in recent years, however, our analysis suggests many of these companies look overvalued as their share prices are high in comparison to the amount of money they generate.

While Terry Smith accepts this, and is prepared for the performance of the fund to deviate significantly from the index and other funds in the sector at times, he is encouraged by the increased capital expenditure of the fund's holdings. This is a key requirement for most businesses to grow their earnings which, assuming the share price stays static, would result in these companies appearing more fairly valued.

Cyclically adjusted P/E of consumer goods businesses across the world

Read an explanation of P/E ratios

P/E ratios explained

A company's P/E ratio measures how much investors are willing to pay for its earnings. It is calculated by dividing the value of a company's shares by its earnings. A company with shares worth £100m, for example, and earnings of £10m is said to trade on a P/E of 10x. A company with a P/E of 20x is described as expensive relative to a company with a P/E of 10x because investors are paying twice as much for the same earnings.

The grey line in the chart shows the cyclically-adjusted price/earnings ratio of the UK stock market over the past 30 years (calculated by dividing share prices by a ten year average of corporate earnings). The blue and purple lines use 'standard deviation' - a statistical measure of how far away a variable is from its average value - to show whether this P/E is historically high or low. The black line represents the long-term average.

These ratios should not be looked at in isolation. Other factors and investment risks should be considered when choosing investments.

Source: HL correct as at 30 January 2015.

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Our view on this fund

We like the manager's long term, high conviction approach and our analysis suggests the majority of the fund's outperformance can be attributed to strong stock selection. The concentrated portfolio of between 25-30 holdings means each stock can contribute significantly to performance but is higher risk. We currently feel there are alternative funds available which offer superior performance potential. The fund is therefore not currently on our Wealth 150 list of our favourite funds across the major sectors.

Find out more about this fund including how to invest

Please read the key features/key investor information document in addition to the information above.

The value of investments can go down as well as up, this means you could get back less than you invested. Therefore all investments should be regarded with a long term view. No news or research item is a personal recommendation to deal. If you are unsure about the suitability of an investment please contact us for advice.
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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