Smith, who has invested his own money in both portfolios, says he doesn’t consider one to be better than the other, but he says emerging markets are likely to deliver greater outperformance over the long term. However, he warns investors need to be willing to sit through increased volatility.“I’ve got money in both. It depends on your appetite for price volatility. In emerging markets you need to be able to cope with more volatility. But [Fundsmith Emerging Equities] is likely to produce a higher return over time,” he said.
A number of industry experts have voiced concerns over emerging markets in recent months, with Rathbones FE Alpha Manager James Thomson saying that he expects them to underperform developed markets for at least the next decade.
Smith remains optimistic for the asset class over the long-term, however.
The manager says the his trust and fund, which focuses more on developed market equities, offer different risk/reward profiles and investors need to understand this properly, particularly when it comes to price volatility.
Emerging markets started the year on low valuations, having lost 4.41 per cent in 2013, while developed markets experienced their best year since the financial crisis.
Since the start of 2014 however, emerging markets have surged, picking up 9.53 per cent year-to-date.
Year-to-date performance of index
Source: FE Analytics
While Smith is taking the same long-term quality approach to managing his trust as he does to his open-ended fund, he has given himself an investable universe in the former of 139 companies - much wider than the 65 companies he will consider in the global fund.
“I’m willing to go lower in the emerging markets fund because it’s a closed-ended fund,” he explained.
Smith says liquidity can be a major issue for open-ended portfolios, which is why he doesn’t look further down the market cap spectrum in the Fundsmith Equity fund. He is more comfortable picking smaller companies in an investment trust structure.
However, he says he still looks at a small universe compared with most fund managers because of the stringent quality requirements he demand. Smith adds that holding a concentrated portfolio means that each company accounts for a far bigger portion of the return, so it is vital that each one can make decent returns throughout the market cycle.
To ensure his holdings can do this, he looks for companies with high margins and a high cash return on capital.
Smith says a classic example of the kind of stock he likes to buy is French cosmetics giant Loreal - a well-established company with a strong brand and ongoing revenue stream.
“It’s a great business,” he said. “There are few things that are better than cosmetics. No man in a relationship with a woman has any idea what a woman spends on cosmetics. And the more expensive it is, the better it’s supposed to be.”
In a previous FE Trustnet article, Smith said that rather than looking for tomorrow’s winners, it is better to invest in companies that “have already won”.
“We invest in large, well established businesses which make their money through a very high volume of relatively small, repeat predictable everyday events,” he said.
Valuation is also important when it comes to picking good stocks, Smith says, and one of his key measures for measuring valuation is dividend yields.
“Dividend yield is one of the valuation yardsticks we pay a lot of attention to,” he said.
Smith’s flagship Fundsmith Equity fund has been one of the best performers in the IMA Global sector over the last three years, picking up 53.57 per cent.
It is up 68.35 per cent since launch in November 2010, putting it more than 20 percentage points ahead of the MSCI World index. The average fund in the sector has made less than half this amount over the period.
Performance of fund vs sector and index since launch
Source: FE Analytics
The manager’s recently launched trust is barely off the ground, yet has attracted nearly £193m.
The trust is behind the MSCI Emerging Markets index and IT Global Emerging Markets Equities sector since launch, having lost 0.65 per cent. However, a month is obviously too short a length of time to make any sort of judgment on performance.
Numis’ Charles Cade recently tipped the trust because he likes the manager’s long-term buy-and-hold strategy and points out Smith has a solid track record on his global equity portfolio.
The trust, however, is trading on a wide premium of 7.1 per cent, though this has come in a bit from its average premium of 7.44 per cent. At its most expensive, the trust was trading on a premium of 8.61 per cent. The majority of trusts in IT Global Emerging Markets are currently on a discount of more than 6 per cent.
Smith is positive about the growth of the consuming middle class in emerging markets and says every stock in his trust is related to this theme.
“One of the most consistent trends since World War II has been the emergence of the consumer middle class. We’re not consuming as much in developed markets. But there is new consumption in emerging markets,” he said.
Fundsmith Equity has ongoing charges of 1.09 per cent.
