Fundsmitten

Terry Smith and I both like the same stock. But the 2020s could be more challenging for his fund.

I visited the Fundsmith Annual Shareholders Meeting for the first time. I am not sure why it’s called an ASM, as it’s a fund, not a company. But it was a great chance to hear from Terry Smith about the fund, its performance and strategy. He then answered questions.

These questions are submitted by fund holders in advance; they are then filtered and directed by a journalist to Terry and his head of research Julian Robins. The answers are pre-prepared complete with slides, but apparently all questions receive an answer from Fundsmith. (I asked about earnings management in their portfolio and will let you know their response.)

Performance

Smith has been criticised for recently underperforming the ACWI (All Country World Index) benchmark. The S&P 500, home of most of his portfolio (7 of the top 10 positions), has done considerably better, so the underperformance is more marked.

Fundsmith Total Return Performance

Source: BTBS from Fundsmith and SlickChart and MacroTrend Data

The AGM slide showed performance over the last 6 years as per the first two lines above, excluding the cumulative column on the right. It also showed bonds and cash. Instead, I have added the S&P500 which I think is more relevant. It also showed the total return since inception to January 2024 at +567.2% vs +322.2% for the ACWI. Fundsmith was up 2.7% in January and c.5% in February.

Note the cumulative performance in the last 6 years is similar to the ACWI. The degree to which the fund has lagged the S&P 500 rather surprised me when I calculated this.

In recent interviews, Smith has been slightly on the defensive about recent performance. He argues that a return of 22.1% in 2021 and a lag of 0.8% vs the ACWI’s 22.9% is neither here nor there – I agree. But the performance vs the S&P has been poorer, especially in sterling terms. Many investors here forget that the depreciation of sterling has been a massive tailwind for international investments.

Smith then argued that the performance in 2022 and 2023 was down to the composition of market (ACWI) performance. And this composition is interesting. Smith pointed out that the Magnificent 7 drove a large part of performance and illustrated this with a chart showing that the group comprised 68% of the Nasdaq’s total return last year of 43.4%.

History Rhymes

Source: Google Images

Smith suggested that we have seen this movie before. He showed the slide above and a poster from an even older movie (The Seven Samurai) and observed that if you owned the Mag 7 over two years, you would have underperformed. He is spot on, as the group is up 2.1% over 2022 and 2023 vs a total return for the S&P 500 of 3.4%.

He highlighted a previous “super seven”, so dubbed by Goldman Sachs on April 7, 2000. The stocks and their subsequent performance are shown in the table:

Goldman Sachs Super Seven Total Return from April 7 2000

Source: Fundsmith

Fundsmith owns Apple, Microsoft, Alphabet and Meta Platforms and has sold Amazon, but has not owned Nvidia or Tesla. I think Smith was making the point that he doesn’t like fads rather than he doesn’t like these companies and stocks, and I would love to dig into this. I wondered if there was an element of “you can have your cake and eat it”. I doubt Smith would be prepared to come on my podcast to discuss this, but I would love to have the opportunity.

Smith went on to say that over those two years, the top performers were in industries he prefers to avoid – energy, insurance, industrials, IT and banks were the top 5 sectors, with Nvidia the top performer in IT.

I think this is perfectly reasonable and Smith has been absolutely clear on what he does as an investor and this is laudable. With many funds, you don’t really know what you are going to get next year. That’s absolutely not true of Fundsmith. The issue is that the fund’s outstanding performance in its first few years – and to be clear, he has delivered an excellent performance since inception – may not be as repeatable in the 2020s.

I have posited in these pages in the past that the 2020s may turn out to look rather different from the 2010s or indeed the period 1982-2019, when interest rates were falling. I have asked if the next decade might look more like it did for most decades from 1860-. If so, then what has worked more recently may work less well.

It’s not impossible that banks and energy might be two of the best performing sectors in the next decade. If that were the case, it would be a more difficult backdrop for the Fundsmith portfolio.

Interestingly both Smith (who early in his career was the number 1 UK banks analyst) and Robins have significant experience of banks. Smith announced that he was looking at a bank now, and considering adding it to the fund – he clearly thinks it’s a no-brainer.

I imagine that this must be a conundrum for Smith – if he buys a bank, some investors will throw up their hands and complain of style drift. Most, I believe, would give him the benefit of the doubt. And if he buys a bank for the fund, I will look at it very closely. I suspect if Smith buys a bank, that alone would be enough to propel the stock up.

Fundsmith Activity 2023

Source: Fundsmith

In 2023, Smith sold Estee Lauder after a miss and an operational issue. It went on to underperform. He sold Amazon when the new CEO indicated a desire to “GO BIG” in online food retail, something he has yet to execute. The stock has done well since the sale but Smith correctly looks at the rationale for the decision rather than the outcome.

He sold Adobe on the back of their stupidly expensive deal to buy Figma. He said they refused to give any data on the acquisition so he sold. The deal was subsequently abandoned (with a $1bn break fee) and the stock went up. Smith questioned the robustness of the business when they felt the need to buy this competitor which is an interesting point.

He likes P&G’s strategy to get out of more difficult businesses (funnily enough,  this is part of a case study in my forensic accounting bootcamp which kicks off tomorrow – this is your last chance to join). He likes Marriott as the world’s biggest hotels group which doesn’t own any hotels and he likes Fortinet as one part of a duopoly in cyber security with Palo Alto Networks, He took a 1/3 position after its first profit warning, awaiting the next two.

On AI, he owns Microsoft and Alphabet, He pointed out that the early internet leaders were not the ultimate winners. It’s so easy to overlook this:

Early Tech Winners – Where are they Now?

Source: Fundsmith

Smith also gave a stock tip which I think is particularly interesting and which I explain below for premium subscribers.

This Substack

Last week I completed a piece of research for a multi-billion hedge fund and it was great fun. I would like to spend more time on this sort of work. It’s coming up to my two year anniversary on Substack and I am reviewing how to continue going forward.

I enjoy producing the content and think it makes me a better investor and an improved writer, but the economics are decidedly inferior to my main businesses. For this reason, the free version of this newsletter will be taking a break. If you enjoy the content and would like to keep receiving it, please consider taking a paid subscription. Thanks for your support.

(In the original email I sent out, I rather stupidly called this an AGM. Sorry.)