Fundsmith Equity has had a very strong run in what has been a broadly very weak 12 months for global equities, delivering the best return in its sector and taking in a more than £1bn of new cash from investors.
Thanks to a host of reasons centring on suggestions of slowing global growth, investors have gone very bearish compared with this time last year when the FTSE 100 started hitting a series of all time-highs as risk-on was the very much the prevailing mood.
According to FE Analytics, the fund is up 16.93 per cent while the average peer in the IA Global sector made a loss of 2.48 per cent and the MSCI World index fell 0.81 per cent.
Performance of fund, sector and index over 1yr
Source: FE Analytics
The performance of FE Alpha Manager Terry Smith’s £5.3bn fund is no doubt pleasing for its investors, especially given the rough period for stock markets over this period but also as it represents the continuation of more than five years of strong performance and the question of whether at least, in the short term, it will similarly perform.
While many managers have long term track records that prove they are clearly doing something right, funds that always go up without periods of underperformance don’t exist and in fact this fund is now bottom decile over the (admittedly very short term period) of one month.
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 means the fund has more than doubled the MSCI World’s gain and almost tripled the return of its IA Global sector peers, with the best performance of any fund in the sector over this 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.
The portfolio is also best in the whole sector for the measures of risk adjusted returns such as the Sharpe and Sortino ratios over this period. It’s annualised volatility is higher than the MSCI World, though by just 3 basis points.
Steve Lennon, investment manager at Parmenion, holds Fundsmith in his personal portfolio and says it makes a good core equity holding.
“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 which filters through to an attractive ongoing charges figure [OCF].”
“This philosophy does lead to some biases within the portfolio. For example, the fund will never own banks, because they must employ leverage in order to achieve a decent return, or oil & mining because of the high correlation to underlying commodities which makes earnings unpredictable.”
“On the other hand, the sectors which the fund does tend to invest in could be currently viewed as expensive relative to the wider market although it is important to note that they have historically traded at a slight premium.”
The manager’s holdings are dominated with the high quality companies that are lowly leveraged, generate reliable earnings and have strong franchises – with stocks such as Johnson & Johnson, Dr. Pepper Snapple, Pepsico, Imperial Tobacco and Microsoft all featuring. However, the group does not include portfolio weightings.
Source: FE Analytics
Lennon added: “For me personally, this fund forms the solid core of a global equity allocation. Like any fund, it can be expected to lag the market from time-to-time, particularly during cyclical bull markets or should a sector it will not hold rallies strongly.”
“However, the “Buffet-esque” philosophy is one that has proven the test of time in various guises and the small team at Fundsmith have a great track record.”
Smith has a focus on ‘high quality’ companies that he believes carry strong brands and market advantages over their peers that are hard to duplicate, do not need significant financial leverage to generate returns and have consistent earnings. He then buys and holds for the long term.
This ‘Warren Buffett-esque’ style has no doubt paid off since launch as is seen as being simple and consistent, according to most analysts, and ostensibly explains his many fans and ongoing high rate of inflows.
Adrian Lowcock (pictured), head of investing at AXA Wealth, says the strong performance arguably makes the portfolio look somewhat expensive and due a period of underperformance. 
“Given the strong performance of the Fundsmith Equity fund and indeed how much this came a little unexpected by the manager I think it is realistic to expect periods of consolidation. Given the manager is not prone to switching holdings, over-valuation in the short term is likely to be a primary reason for underperformance and would follow outperformance relative to the market.”
“However, these companies have strong brands and market positions and the manager expects them to do well over the next few decades and therefore arguably warrant a premium rating to the rest of the market.
“The best time to buy this fund is after a period of underperformance and when valuations look less expensive, then it would be a case of buy and hold following the managers philosophy.”
Tilney BestInvest’s Jason Hollands says the bias towards non-cycical names makes it ideal for testing times ahead and therefore a good time to ‘buy’.
“I would not suggest investors ditch the fund on the back of strong performance. Far from it, I would argue strongly that with global growth weakening, there’s a very compelling case for being invested in a fund focused on stocks with high brand loyalty as these types of businesses are typically very resilient through the ups and downs of the economic cycle and have high barriers to competition,” Hollands said.
Rob Morgan, analyst at Charles Stanley Direct, says he thinks it is clear hold as Smith has clearly demonstrated his ability to pick stocks.
“While Fundsmith Equity has been invested in the types of stocks that have become fashionable and therefore more highly rated - strong, resilient companies benefitting from long-term compounding of earnings - credit must also go to the manager for adding value above any beyond a typical basket of such stocks.”
“In short, Terry Smith (pictured) and team have demonstrated good stock selection, so I would view it as well worth hanging on to for the long term.”
However, he says the fund will go through periods where it underperforms the market and its peers.
Over the last 60 full calendar periods – which total five years back to January 2011 – the fund has beaten its benchmark in 42 months and its sector peers in 39 months.
“Certainly, there is likely to be periods where the fund lags behind, especially given its high-conviction, concentrated approach, and it is possibly due such a period given the extent of recent outperformance,” Morgan said.
“Indeed, should global growth surprise to the upside it is funds with more exposure to economically-sensitive areas that are likely to provide larger returns, at least in the short term. However, I would view this fund as a long term core holding, and if it is already a part of a portfolio then it would make sense to retain it.”
Square Mile Research rates Fundsmith Equity the fund’s, noting it can miss out on a bull run but this is made up for the ongoing strength in weaker markets.
“It benefits from a charismatic manager who together with Fundsmith's head of research Julian Robins, has developed a product that has a clearly defined philosophy and process, and in our opinion, seeks to deliver an achievable objective. Equally, the types of companies held are those that many investors can relate to, for most will be household brands providing every day goods and services,” they said.
“The philosophy is very straightforward, to invest in higher quality companies and hold them for the long term. Unitholders therefore should not consider this proposition for a short term foray into global equity markets. We would subscribe to the belief that over long term, the types of companies held would tend to outperform and whilst the fund has delivered a stellar set of returns since its launch, there may be periods in time when the fund will lag more cyclically sensitive peers and its benchmark.”
Fundsmith Equity has a clean ongoing charges figure [OCF] of 0.97 per cent.
