Terry Smith launched Fundsmith Equity promising easy investing for all. Three years on, we look at how he has performed
Three years ago maverick City multi-millionaire Terry Smith launched an investment fund promising easy, cheap and profitable investing for all. The boxing-mad son of a London bus driver said he would give the “fat and complacent” fund management industry a bloody nose. Three years on, he has amassed £1.5bn in the fund from more than 9,000 small (and some large) investors – and has managed to keep his promise.
An investor who put £1,000 into the fund, called Fundsmith Equity, when it opened in November 2010 will have seen it grow to £1,612 on its third birthday – a gain equal to 17.3% a year. That compares to the 7-8% a year earned by the average fund and puts Terry Smith in fourth place out of 244 in the “global” sector, where the underlying cash is invested in a range of shares from across the world.
His secret? Run a portfolio of just 20-25 stocks (the typical fund has 60 or more), invest for the long term (rival funds buy and sell their holdings on average every seven months, incurring high dealing costs) and focus on large, well-established companies which make their money through small, repeat, predicable everyday events.
“We do not seek to find tomorrow’s winners – rather, to invest in companies that have already won such as Colgate, Unilever and Domino’s Pizza which are already in dominant positions in their respective sectors. We are encouraged that the average company in our portfolio was established in 1901 and survived two world wars and the Great Depression,” says Smith.
Keeping fees down is crucial, he says. “I launched Fundsmith three years ago because I believed the fund management industry was broken. It is still broken. Investors continue to suffer from punitive fee structures, over-complexity, overtrading, fund proliferation, closet indexing and over-diversification.”
Too often, he says, investors believe that the standard 1.5% annual management charge is all they are paying but, in reality, they also have to pay for dealing and research costs, which, over time, can seriously eat into their returns. He says his fund pays commission to stock dealers of only 0.04% – and that, in any case, he doesn’t trade in and out of shares very often.
“We seek to minimise portfolio turnover costs by only ever investing in good companies that we would be happy to own indefinitely.”
His most profitable investment has been Domino’s Pizza, which in November 2010 was trading at $15.15 a share, but is now above $68 – and is still good value, reckons Smith. Yes, anyone can make a pizza, he says, but no one matches Domino’s for delivery. Indeed, in June the firm tested a drone, dubbed the “DomiCopter,” to deliver to a customer’s door by air.
Most of his major holdings are familiar household names, such as Microsoft, Reckitt Benckiser (makers of Harpic, Cillit Bang and Durex, among others) and Dr Pepper Snapple Group. But two of his other big holdings – Stryker and Becton Dickinson – will be more familiar to doctors and nurses. Stryker, based in Kalamazoo in Michigan, is the world’s biggest maker of replacement joints for hips and knees, while Becton Dickinson, based in New Jersey, makes more needles and syringes than anyone else.
Interestingly, two of the funds that have done better than Smith over the past three years have also been big investors in medical equipment, benefitting from an ageing population and new demand from emerging markets.
Was this a lucky call by Smith, which won’t be repeated? Smith points out that medical equipment makes up around 18% of the fund, while the “consumer staples” stocks, such as Reckitt Benckiser, make up 45%. As important has been his decision to shun large parts of the stock market, including banks, insurance, property, housebuilders, oil, mining and resources.
Mining and resources have been about the worst place for investors in the past three years, and Smith says that even after hefty falls, the stocks are too risky to buy. “We’re not into global resources. My car can’t tell one petrol from another. There’s no brand value. We also want to buy companies that can last for ever; every resource company has issues about depletion.”
The books of the banks are still difficult to read, he says, and that comes from someone whose ability to see through a set of accounts is legendary. The same goes for insurance companies “whose accounts are almost the definition of opaque”, he adds.
Will investors continue to reap returns of 17% a year? Smith says his portfolio of companies is in good shape, but he does not share the recent optimism about an economic turnaround in the UK or even the US, and reckons China is the biggest debt bubble in world economic history.
“I’m a pessimist on the economic outlook. I closely follow 75 worldwide companies, and another 175 in the next layer down. The vast majority of these are currently showing revenue growth that is significantly slower in the last six months than in the same period a year earlier. Things are getting worse more than they are getting better. I don’t think there’s actually a recovery. Statistics, such as purchasing managers indexes, have been somewhat bent out of shape, and are no longer particularly meaningful.”
He points to a statement last week by the boss of Kraft Foods (a stock he does not own), who warned that the only place where sales were rising was in America’s equivalent of Poundland (called Dollar stores); that people are falling out of the workforce; and that many US consumers have “minimal ability to buy more than what they need for a given week or sometimes a given day”. The economic and financial crisis remains far from over.
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