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Terry Smith: My trust will beat Fundsmith Equity over the next 10 years

24 April 2016

The star manager believes his Fundsmith Emerging Market Equity Trust is likely to outperform his top-rated global equity fund over the next decade.

By Daniel Lanyon,

Senior Reporter, FE Trustnet

Investors have a strong chance of seeing the Fundsmith Emerging Market Equity Trust outperform the developed market-focused Fundsmith Equity fund on a ten-year view, according to FE Alpha Manager Terry Smith (pictured), who heads the two popular portfolios.

The manager is most well-known for running the open-ended Fundsmith Equity fund which, having taken in £1.3bn of new cash in the past year, is one of the most popular in the 3,500 strong Investment Association universe.

It is now £5.5bn in size thanks to investor demand for Smith’s ‘no nonsense’ approach which centres on buying and holding firms with strong brands, reliable earnings and no leverage.  

As Steve Lennon, investment manager at Parmenion, puts it: “The investment philosophy is to invest in very high quality companies, not to overpay and then do nothing. Whilst this sounds incredibly simple, it means that a large amount of fundamental balance sheet and industry analysis takes place before capital is committed. It also results in very low turnover.”

This approach has been enormously successful for Smith.

Since launch back in November 2010, the fund has returned 140.13 per cent while the average fund in the IA Global sector has made just 44.78 per cent and the MSCI World index gained 67.41 per cent.

Performance of fund, sector and index since launch
  

Source: FE Analytics

This is top of the sector for total and risk adjusted returns and more than doubles the MSCI World’s gain and almost triples the return of his IA Global sector peers over the same period. It is also top over one, three and five year periods and has outperformed in every full calendar since its launch as well as in 2016 so far.

Smith also believes, however, in the emerging markets story of ‘compelling demographics’ and economic trends that herald ‘an unprecedented move to consumerism’ over the next generation for the several billion inhabitants of the likes of China, India and Africa that make up about half the world.


In fact, he thinks the next 10 years could see his ‘other’ portfolio, the Fundsmith Emerging Market Equity Trust, beat Fundsmith Equity by a considerable margin.

“I think it will ultimately be somewhere between surprising and disappointing. Something would have to change fundamentally on a permanent basis about the respective markets for it not to be true,” he told FE Trustnet earlier in the week.

Emerging markets have been broadly out of favour for the past three years but longer term have still delivered high returns.

 

Source: FE Analytics

Last year the market began panicking that growth in China, and by extension many emerging market countries, was under threat. In 2016 sentiment has tentatively ticked up. Smith says over longer term emerging markets will gain be strongly performing.

“Is it sustainable? I don’t know. But I do know that that growth rate is significantly higher than most others. It is my expectation therefore that the sort of trends that have driven it over the long term will in time reassert themselves and the growth rates will be high,” he said.

Like his fund, the Fundsmith Emerging Market Equity Trust focuses on return on capital, the rate of return generated on the investment by both equity and bondholders, something he says is too often overlooked by active managers.

He looks for companies which use relatively low amounts of capital to derive their returns and then most profits in cash.


Since launch in 2014 the trust has lost 2.45 per cent versus its peer average loss of 6.01 per cent and a gain in the MSCI Emerging Markets index of 0.2 per cent.

Performance of trust, sector and index since launch

 

Source: FE Analytics

Charles Cade, head of investment company research at Numis Securities, says it is an interesting fund with a very different approach from other global emerging market portfolios.

“I like the focus on quality companies and return on capital employed [strategy], but I have been a little wary about the fund as Fundsmith has not previously invested in emerging market stocks, albeit that its track record in the main equity fund is very strong.

“In addition, the fund is currently trading at a premium to net asset value [NAV] of 4.6 per cent and we see far greater value in stocks such as Genesis Emerging market or JP Morgan Emerging Market on discounts of 12.4 per cent and 13.7 per cent, respectively.”

Smith says he opts for an investment trust structure over an open-ended structure as he believes it is more preferable in the emerging market universe of stocks.

“We invest in exactly the same sort of things as in our main fund but that which we cannot own because of it being a daily dealing open-ended fund. It is incompatible to put together something like this with the limited liquidity that you find in emerging markets,” he said.

This was borne out in a recent FE Trustnet study, which found that trusts in the emerging market equity space have considerably outperformed their open-ended rivals over the past market cycle.

The trust has an ongoing charges figure of 1.73 per cent and no gearing. 

Managers

Terry Smith

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.