Based on his track record, Terry Smith is a man worth paying attention to. As of 31 December 2019, Smith’s Fundmsith Equity Fund had achieved an annualised rate of return of 18.2%, compared to the 11.9% achieved by its benchmark.
This translates to a cumulative return of a little over 364% for investors since its inception in November 2010. No wonder he’s often to referred to at the ‘UK’s Warren Buffett’.
Like those of the Sage of Omaha, I think Smith’s annual letters to shareholders contain lots of great advice for all long term investors. Here are some of the key takeaways from this year’s reflections.
Ignore the unpredictable
Despite achieving a total return of 25.6%, Smith said the performance in 2019 had been impacted by the rally in sterling following renewed hope of a breakthrough on Brexit. Considering the majority of Fundsmith’s holding are US-based, this clearly had implications for how the portfolio behaved overall.
Smith doesn’t think investors should lose sleep over such things. Instead, he recommended they imagine asking the management teams of those companies the fund owned to identify the top three factors responsible for their success. Things like “strong brands”, “market share” and “product innovation” would likely be mentioned. One thing they probably won’t talk about is currency movements.
This way of thinking neatly sits well with the Foolish philosophy that part of being a good investor is learning what you can control and what you can’t. Since no one has any idea where anything related to the economy is going for certain, it’s far better to concentrate on finding great businesses that are worthy of your capital.
Value isn’t everything
Fundsmith’s investing strategy is simple. Buy great companies, don’t overpay, and then do nothing. Notice, however, there’s no reference to focusing on what’s cheap.
Using an example from 2012, Smith suggested we should be wary of listening to anyone who believes that the strong run in stocks, such as those held by Fundsmith, was about to end and a rotation into value was just around the corner. Those taking this advice to heart, he said, would have lost out on all the gains achieved by so-called ‘expensive’ stocks in the years since.
Cheap stocks are rarely good businesses, Smith added, because most won’t make good returns on the capital they invest. Moreover, anyone profiting from one would then need to find another. This incurs transaction costs that ultimately impact on performance.
Whether you share his aversion to value for its own sake or not, it’s hard to argue against this last point.
Keep an eye on liquidity
While previously reluctant to do so, Smith also gave his thoughts on fellow fund manager Neil Woodford’s fall from grace.
Like many others, he identified that Woodford’s woes (and, consequently, those of his investors) were caused by the “lethal combination” of operating an open-ended fund that had a lot of cash invested in unquoted, highly illiquid companies. This is problematic when everyone wants to get their money out at once.
Given Smith’s assertion that 57% of his fund could be liquidated in seven days, it seems unlikely his shareholders will ever encounter this scenario.
Nevertheless, his decision to mention this within his letter is a good reminder of the need to monitor the actions of those working on your behalf.
