The shocking events surrounding Neil Woodford’s Equity Income fund in recent months are a good reminder of how important it is to focus on risk, and not just return, when investing your money for the future. If you’re trusting someone else to invest your money, it’s essential to do your due diligence and understand the risks involved.
With that in mind, today I want to look at some of the main risks associated with another popular equity fund, Fundsmith.
Concentrated fund
Looking at the Fundsmith portfolio, the first risk that stands out to me is that the fund is highly concentrated. At 29 November, it only held 27 stocks. What this means is that, compared to your average equity fund (which probably holds 50 to 60 stocks), Fundsmith has a higher degree of stock-specific risk. If one or two holdings in the portfolio were to crash, the overall performance of the fund could be dragged down substantially.
High valuations
Next, it’s worth noting that, due to fund manager Terry Smith’s approach to stock picking, many of the stocks in the Fundsmith portfolio trade at relatively high valuations. For example, Microsoft, which is a top holding in the portfolio, currently trades on a forward-looking price-to-earnings ratio of around 28. Similarly, PayPal, another top holding, currently trades on a forward P/E of 34. In a bear market, these kinds of stocks could potentially fall further than stocks that are trading at lower valuations.
High exposure to the US
You should also be aware that geographically, Fundsmith has a strong bias towards the US. Indeed, at 29 November, nearly two-thirds of the portfolio was invested in US-listed stocks. This means that if the US stock market was to take a large hit, the performance of the fund could suffer.
Fundsmith geographic split at 29 November 2019
| US | 65.5% |
| UK | 17.4% |
| Denmark | 6.4% |
| Spain | 4.2% |
| France | 3.1% |
| Finland | 2.8% |
| Cash | 0.6% |
Source: Fundsmith Factsheet 29 Nov 2019
Sector bias
In addition, be aware that at present, the fund is heavily biased towards three main sectors: consumer staples, technology, and healthcare.
Fundsmith sector allocation at 29 November 2019
| Consumer Staples | 31.4% |
| Technology | 30.9% |
| Healthcare | 24.2% |
| Industrials | 5.4% |
| Communication Services | 4.5% |
| Consumer Discretionary | 3.0% |
| Cash | 0.6% |
Source: Fundsmith Factsheet 29 Nov 2019
If these sectors were to underperform, the fund’s performance could be negatively impacted.
Large fund size
Finally, investors should also be aware that Fundsmith’s assets under management are very high, at £18.8bn. This could potentially impact the fund’s investment choices going forward. It’s worth noting that wealth manager Charles Stanley recently dropped Fundsmith from its buy list amid “discomfort” over the size of the fund.
Of course, these risks are not necessarily a reason to avoid the Fundsmith Equity fund. The fund has a brilliant performance track record, having delivered a return of around 360% since its launch in November 2010, and in my view, it looks well-positioned to keep generating gains for investors.
I see it as an excellent option for those looking for global equity exposure. Just make sure that you’re aware of the risks and that the fund is suited to your risk tolerance before investing.
