Terry Smith is not giving in to panic. As investment managers are convulsed by the coronavirus market sell-off, Britain’s most popular stockpicker is remarkably sanguine — and even bullish.
The veteran investor, known for his love of boxing and combative style, professes to be “not worried one iota” about a sustained recession caused by the pandemic lockdown.
“It takes a lot to impress me,” says Mr Smith, who manages the UK’s largest investment fund from his bolt-hole in Mauritius. The former stockbroker, who worked in the City of London for four decades before relocating to the Indian Ocean idyll, says that precipitous drops in markets needed to be viewed relative to previous crises, such as Black Monday, the 1990 oil shock, the dotcom crash and the 2008 credit crisis.
He is confident that his £17.8bn Fundsmith Equity fund will weather the storm. The fund is down 5 per cent year-to-date, a less steep drop than the 5.9 per cent fall for the MSCI All Countries World Growth index, thanks to its defensive positioning. “The average company in my portfolio has survived two world wars and the Great Depression,” he says.
In a letter to shareholders last month, Mr Smith said if two of his holdings — airline booking technology provider Amadeus and hotel chain InterContinental Hotels — went bankrupt as a result of the lockdown, Fundsmith Equity would lose about 5 per cent of its portfolio. “Whilst I would not be pleased with that, if that’s the worst thing that happens, I would suggest we can live with it,” he wrote.
Mr Smith’s defiant words encapsulate the tenacious and conviction-led approach that has made him the UK’s most popular fund manager of the past decade.
Often referred to as Britain’s answer to Warren Buffett, Mr Smith has won over legions of private investors and wealth managers since setting up Fundsmith in late 2010 by generating stellar returns year after year. An initial £1,000 investment in Fundsmith Equity would now stand at £3,448 compared with £1,184 for an investment in the MSCI ACWI Growth index, according to Morningstar data as at April 13.
His breakneck success flies in the face of claims that active management is a bygone industry following the demise of former star manager Neil Woodford last year and the flight of investor money into passive funds that track indices such as the FTSE 100.
“Terry Smith’s performance is proof that there is life in active management,” says Andy Bell, chief executive of investment platform AJ Bell. “Active managers have to differentiate themselves from the benchmark, and his fund does this in spades.”
Yet a decade on from the launch of Fundsmith, Mr Smith is facing his first significant test as he navigates the end of the 11-year bull run that has served as a tailwind to his style of investing.
He will also have to pay close attention to his fund’s capacity and liquidity as it approaches £20bn against a backdrop of increased scrutiny of blockbuster funds following Mr Woodford’s downfall.
Fundsmith’s success is underpinned by a simple investment strategy, which involves taking bold bets on a small number of companies and holding them for the long term, without paying attention to the vagaries of the macro economy.
This is rooted in Mr Smith’s belief that “[nobody] is capable of consistently predicting macro events” and that it is more worthwhile to identify good companies, a skill he honed over decades working as an analyst.
“You might think every fund manager tries to invest in good companies, but I can assure you they don’t,” he says. “At Fundsmith we have spent a lot of time coming up with a definition of what is a good company.”
Fundsmith invests in mature companies with strong balance sheets and established brands, which are capable of reinvesting their profits and compounding value for investors over time, while excluding cyclical sectors, such as mining and financials.
This style of quality growth investing chimed with the massive rally in stock prices over the past decade, which was fuelled by low interest rates and mass government bond-buying. Ben Willis, head of portfolio management at UK financial adviser Chase de Vere, describes Fundsmith Equity as “the poster child for the quantitative easing world”.
But Mr Smith argues that his investment approach works regardless of market conditions, pointing to the fact he achieved similar results during the financial crisis when he managed the Tullett Prebon pension fund using the same approach.
Mr Smith’s willingness to sail against the wind is part of the reason investors flock to him. In his stockbroking days he turned heads by issuing a “sell” recommendation for Barclays while working for its in-house research arm. He later won notoriety when he published Accounting For Growth, a book critiquing accounting practices at companies that included direct clients of his then-employer, UBS (which subsequently fired him).
A keen boxer, who colleagues say used to train every lunchtime when he worked at stockbroker Collins Stewart, Mr Smith stands out from the crowd of staid City executives. “He doesn’t do things by halves,” says a former adviser, recalling how Mr Smith took time out of his busy schedule to learn to fly a helicopter.
“Investors find it refreshing that he doesn’t pull any punches and is clear in his opinions,” says Jason Hollands, managing director at online investment service Tilney. “It adds to the aura of his fund.”
Recent interest rate cuts and stimulus measures announced by central banks to combat the current crisis will buoy Mr Smith’s investment style for a while longer.
But advocates of value investing, which involves picking cheap, unloved companies and waiting for a recovery, believe the blue-chip companies Mr Smith favours are overvalued and due a correction.
Mr Smith acknowledges “there is bound to come a period of time when value investing will outperform what we do”.
However, he argues Fundsmith’s “all-weather” approach of investing in mature companies with established brands will win out over time. “Value investing will have its day in the sun,” he says. “But it will never compensate for all the years in between where our strategy has outperformed value.”
Fundsmith Equity’s outperformance relative to its benchmark year-to-date appears to vindicate Mr Smith’s belief that “people still feed their dog and brush their teeth during a downturn”. He predicts a third of his portfolio — made up of Microsoft, payment processing companies, bleach manufacturer Clorox and household goods producer Reckitt Benckiser — will increase their revenues this year as a result of the health crisis.
Analysts agree the end of the bull run will not necessarily be the undoing of Mr Smith’s success. Research by Morningstar shows the lion’s share of his fund’s excess returns are down to his stock selection, rather than the tailwind provided by the market environment.
“Even when considering that growth has outperformed value and companies with strong balance sheets have done better than those without, Terry Smith has still been able to pick better companies exposed to those factors,” says Peter Brunt, associate director of manager research at Morningstar.
An equally pressing concern for Mr Smith will be managing liquidity risk in light of his fund’s huge size, especially with heightened focus on this issue in the wake of the dramatic run on the Woodford Equity Income fund last spring.
Wealth manager Charles Stanley dropped Fundsmith Equity from its list of recommended funds in the aftermath of the Woodford crisis due to concerns over the size of Mr Smith’s strategy. Meanwhile, Morningstar recently downgraded Lindsell Train’s UK equity fund, which has a similarly concentrated portfolio to Fundsmith Equity, citing liquidity concerns.
Mr Smith argues his fund has room to grow given it invests in extremely liquid, large-cap companies. “We own companies [that are so big] that we could put the entire fund into shares of a company and not have to disclose it,” he says.
He may also increasingly struggle to justify the fund’s 1.05 per cent ongoing charge, which is higher than what many of its peers charge, especially if his performance suffers a blip.
While Mr Smith argues the fund is better value than products offered by competitors due to its low transaction costs, critics say Fundsmith Equity lags behind in a world where active managers are reducing their headline fees to compete with tracker funds. “If [Mr Smith] launched the fund today, he wouldn’t be able to charge as much as that given the rise of passive funds and focus on fees,” says Chase de Vere’s Mr Willis.
Mr Smith’s personal wealth is estimated at about £300m, according to the Sunday Times. He pocketed at least £16m last year. Company accounts show that a further £116m was paid from Fundsmith UK to a Mauritius-based sister company, although it is not possible to see how much profit this company generates or how the amount was distributed.
However, these factors do not appear to have dented investors’ enthusiasm for Fundsmith. Tilney’s Mr Hollands says: “Investors don’t care that he has made a fortune, after all he has made them a lot of money. And many of them will probably stick with him even if he underperforms, as even the best managers do at some point.”
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