Fundsmith Equity has been a very popular fund among UK investors for years. As a holder, I’m always interested in what star money manager Terry Smith and his team have to say. Here are what I believe to be three of the most important messages from this week’s (virtual) annual shareholder meeting.
1. Great businesses rarely go bad overnight
Despite its popularity, Fundsmith Equity’s recent performance hasn’t been particularly great. Based on its most recent factsheet, Terry Smith’s flagship fund fell 13.2% in the first two months of the year. That’s a lot worse than its benchmark (the MSCI World Index) which fell ‘just’ 6.8%.
Does this concern me? Not really. As a committed Fool, I’m far more interested in returns over the long term. Here, Fundsmith has excelled. It’s returned 482% from inception (2010) to the end of February.
Smith continues to attribute these gains to owning the right companies. To drive the point home, he reflected this week that he and colleagues were ‘business-pickers’ rather than stockpickers.
The reason for this, Smith said, is that “returns are persistent“. Great companies — those that have barriers to entry — tend to stay great, even if they cost more to acquire. Therefore, he sees little point in getting involved in the rotation to lower-quality ‘value’ stocks we’ve seen in 2022 so far.
As a quality growth investor myself, I can’t help but agree.
2. Buy the dip
At a human level, the current situation in Ukraine is clearly appalling. Seen purely from an investment perspective, however, Terry Smith believes we should look at the situation “historically“. Smith used the annual meeting to point out that the past shows that buying shares during times of military conflict usually pays off.
As evidence, Smith picked out a number of examples, including the Gulf War. In August 1990, the S&P 500 hit a low not long afterward before recovering strongly. The same thing happened earlier in the century during the Six Day War in 1967 and also during the Korean War. In Smith’s words, “The sweep of history suggests to us that buying on the cannon is the right thing [to do]“.
There are exceptions, of course. Smith’s noted the similarities between the Ukraine/Russia conflict and the Yom Kippur war in the 1970s. The latter happened at a time of inflation and soaring oil prices. Stocks went down and continued falling. Clearly, no one knows if that may happen again. However, I’ll certainly bear it in mind.
Speaking of rising costs…
3. Own stocks that have pricing power
Inflation in the UK hit its highest level in 30 years back in February. That’s enough to rattle the most sanguine of investors. For Terry Smith, however, there’s a way of tackling rising prices. It involves owning businesses that have high gross margins.
Gross margin is simply the difference between how much it costs to make something compared to how much it gets sold for. So, if a product costs 50p to produce and it’s sold for £1, the gross margin is 50%.
As Smith succinctly puts it, gross margin is “the single biggest defence” against inflation. It won’t come as a surprise then that the Fundsmith portfolio owns companies with higher than average gross margins.
Knowing this, I’m satisfied that Terry Smith is probably doing a good job of protecting my capital. I have no issue remaining invested.