On the back of its excellent performance, the Fundsmith Equity Fund has been a very popular investment in recent years. I’m a fan myself and have a decent-sized position in the fund within my ISA. Here, I’ll explain why I think it’s a better investment than a FTSE 100 tracker fund.
One of the main benefits Fundsmith offers over a FTSE 100 tracker, in my view, is that it’s a global equity product. This means fund manager Terry Smith has the freedom to invest in companies all over the world. By contrast, the FTSE 100 is a UK-based index that consists of the largest 100 companies listed on the London Stock Exchange.
The reason I see this as an advantage is that many world-class businesses are listed internationally. For example, companies such as Microsoft and PayPal, which both appear to have considerable growth potential, are listed in the US. If you only have exposure to the UK stock market through a FTSE 100 tracker, you could miss out on some compelling investment opportunities.
I also like the fact Fundsmith has more of a growth focus than the FTSE 100. As I’ve often said before, I see the FTSE 100 as a low-growth index. Given its substantial exposure to oil companies, banks, and tobacco businesses, and its low exposure to technology, I’m not convinced the index will be able to generate high returns in the future as the world becomes increasingly digital, with more of a focus on sustainability. Some 6-7% per year, over the long run, may be as good as it gets for the Footsie.
Fundsmith, with its substantial exposure to the tech sector, has the potential to generate much higher annual returns than this, in my opinion. Just look at its performance over the last five years – returning around 166% versus around 34% for a FTSE 100 tracker fund. Past performance is no guarantee of future performance, of course, yet I think there’s a good chance Fundsmith could continue to outperform the Footsie in the years ahead.
Another reason I like Fundsmith is the focus on ‘quality’ stocks – an investment strategy quite similar to Warren Buffett’s. Given Buffett’s long-term stock market success, I think investing in a fund that has a quality focus makes more sense than buying a whole index, which is likely to contain both high- and low-quality stocks.
Risks and fees
Of course, there are risks to consider with Fundsmith. Firstly, it’s a concentrated fund that holds less than 30 stocks. This means it has a more stock-specific risk than a FTSE 100 tracker, which holds 100 stocks. If one or two holdings were to underperform (which is certainly possible given that some of Fundsmith’s holdings trade at high valuations) the performance of the fund could be impacted. Additionally, with its high exposure to the US and the technology sector, there’s also geographic and sector risk.
It’s also important to consider fees. Through Hargreaves Lansdown, the annual fee on Fundsmith is 0.95%. By contrast, Vanguard’s FTSE 100 tracker has an annual fee of just 0.06%.
Overall, however, I think the risk/reward proposition the global equity fund offers is attractive. Given the choice between Fundsmith and a FTSE 100 tracker, I’d go with Fundsmith.
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Edward Sheldon has a position in the Fundsmith Equity fund. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Microsoft and PayPal Holdings. The Motley Fool UK has the following options: short October 2019 $97 calls on PayPal Holdings and long January 2021 $85 calls on Microsoft. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.