Fundsmith Equity – fund update

Our latest view of this popular global equity fund.

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  1. Rob Morgan

Fundsmith Equity fund invests in a portfolio of high-quality companies listed globally in developed markets. Its investment approach is clear and disciplined, and performance since inception has been very strong. Manager, Terry Smith, has been assisted by favourable market conditions since its 2010 launch with good-quality growth stocks in favour with investors during an era of low interest rates. Yet the manager’s stock selection has also been highly impressive and he has added considerable value for investors.

Mr Smith and his team look for a number of criteria for selecting companies including high returns on operating capital and good conversion of profits into cash flow. They tend to be attracted to businesses that sell small ticket items at short, regular intervals; industrial companies which make most of their profits from service or sales of spares to a large installed base; and franchisors that have royalties on revenues without the need to supply capital. In addition, the managers favour businesses whose advantages are difficult to replicate through brand names, high market shares, patents, licenses, distribution networks and customer relationships. They believe that together these define a company’s ‘franchise’ and its ability to consistently outperform competitors.

The past year was another fine one for the fund. It returned 19.6% versus 11.7% for the MSCI World Index and ranked 8th out of nearly 200 funds in the Investment Association Global sector – figures from FE Analytics to the end of June 2019, total return, bid-to-bid price with net income reinvested. The largest contributors to returns were Microsoft, IDEXX, Intuit and Paypal, while among the few detractors was tobacco firm Philip Morris. The refreshingly simple and consistent philosophy of ’buy good companies, don’t overpay and do nothing’ has continued to work well.

Past performance table: Fundsmith Equity Fund

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics.

It is easy to fixate on past performance, but what about the future? All things considered, we have concluded our conviction in the fund, the most popular of the constituents of our Foundation Fundlist among our customers, has started to wane a little. This has caused us to question whether the fund is still one of our best ideas for new investment on a five year plus view.

To us, a developing issue is the size of the fund, which we believe may, at some point, become more of a challenge for the manager. At around £19bn it is the largest UK retail fund and it continues to attract substantial inflows from investors. As a fund grows in size it can sometimes mean the loss of flexibility in terms of the number of available investments.

The counter-argument to this is that Fundsmith’s strategy is focused entirely on large and mega-sized companies. This means it is far more scalable than most other funds. Holdings are generally exceptionally liquid, meaning they are easy to trade in large quantities. Unlike many active managers who have to contend with rapid asset growth Mr Smith isn’t constrained by an inability to invest in small and mid-cap firms – the fund hasn’t ever invested in these parts of the market. In addition, Mr Smith operates a ‘buy and hold’ philosophy, which means he only rarely trades in and out of holdings. Yet the fact remains that the fund continues to forge into unchartered territory in terms of its size, and this presents a small discomfort to us on a longer term view.

Mr Smith has barely put a foot wrong since launch and the fund has provided an excellent example of how investors can benefit from active fund management in good-quality stocks. The fund continues to exhibit many of the key characteristics we look for in a fund: differentiation from the index, a high conviction style, and a strong process and team. As long as the ‘quality growth’ investment style remains in vogue, or the manager’s stock picking continues to be strong, the fund is likely to continue to enjoy decent returns relative to its benchmark, as well as the considerable support of investors.

Nonetheless, we feel it is appropriate to remove the fund from the Foundation Fundlist of preferred funds for new investment in order to reflect the opinions held across the Charles Stanley Collectives Research Team. Our Fundlist is regularly monitored and re-appraised, and we tend to make at least several changes a year in response to our evolving investment views.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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