Terry Smith’s Fundsmith Equity is the UK’s largest fund. It’s not hard to see why. Smith achieved an annualised return of 18.4% from launch (November 2010) to the end of April this year for investors.
Despite this stellar performance, there are signs that some want out. Almost £360m was taken out of the fund in the first three months of 2021. Let’s look at why this might be happening.
Why is Fundsmith out of favour?
The most obvious cause of Fundsmith’s outflows is down to the rotation into value stocks. Having made a lot of money from Covid-proof tech giants in 2020, investors now want to recycle profits into companies that could recover strongly as the coronavirus pandemic comes to an end.
Fundsmith is about as far as you can get from being a value-focused fund. Instead, Terry Smith only buys what he believes to be the best companies around. These are firms that generate high returns on the money they invest in themselves. They’re resistant to competition, resilient in the face of change and boast strong brands. They’re also not cheap. This helps to explain why Fundsmith hasn’t benefited from the rebound as much as other funds.
So, what are some of the arguments for me staying in or moving out of Fundsmith now?
Fundsmith: The bear case
Well, there’s a chance that the switch to value stocks could continue. As economies fully reopen, investors are still bargain-hunting. Airlines — which Terry Smith is particularly scornful of as investments — could register big gains.
There’s also something to be said for the fact that the average size of a company in Fundsmith’s portfolio is almost £165bn. It’s not easy for these to double revenue and profits (and share prices) overnight. Small-cap stocks, however, can provide outsized returns if picked well.
At the risk of sounding ageist, it’s also worth remembering that Smith, like most successful managers, is no spring chicken. While he’s not expected to retire soon, I doubt he’ll want to still be managing investments into his 90s like Warren Buffett. As football teams replace star players, so must investors.
Fundsmith: The bull case
On the flip side, Smith has always been very clear that there will come a time when Fundsmith will underperform the market. Using the Tour de France as an analogy, the UK fund manager has said that he’s looking to win the race for his investors, not every stage of the race. Smith is not a market-timer. Nor will he buy/sell on a whim. As a holder, that gives me confidence. I’m also comforted by the fact that Terry Smith has a large amount of his own money invested.
When it comes to addressing Smith’s inevitable retirement from Fundsmith, investors should know that there’s already a succession plan in place. While his eventual replacement is still to be confirmed, there’s a decent chance it will be his long-serving head of research, Julian Robins. Again, this consistency is reassuring.
Bottom line
Terry Smith won’t be concerned over recent outflows from Fundsmith. On reflection, I’m not concerned either. As a long-term investor, I believe that good businesses will always trump bad businesses eventually. Fundsmith’s investment strategy is to buy the former, not overpay, and then do nothing. For me, the third step is particularly relevant today. Growth will come again.
