Charles Stanley Direct has dropped Terry Smith's Fundsmith Equity fund from its buy-list, prompting the question – should investors sell out too?
The fund has been one of the most consistently brilliant performers in its sector since launch in November 2010 – it has made 377.92 per cent over this time compared with 178.37 per cent from its MSCI World index benchmark and 127.44 per cent from its IA Global sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
This performance is not the result of a sudden surge: it has beaten its sector in all eight calendar years since launch and its benchmark in seven of these – the only year it fell short, in 2016, the difference was 8 basis points and the fund still made 28.16 per cent.
Calendar-year performance of fund since launch
Source: FE Analytics
Rob Morgan, pensions & investments analyst at Charles Stanley Direct, has long been a fan of the fund, saying: “Fundsmith Equity’s 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.”
“The past year was another fine one for the fund. It returned 19.6 per cent versus 11.7 per cent for the MSCI World index [to the end of June] and ranked 8th out of nearly 200 funds in the Investment Association.
Performance of fund vs sector and index over 1yr
Source: FE Analytics
“The refreshingly simple and consistent philosophy of ’buy good companies, don’t overpay and do nothing’ has continued to work well.”
However, Morgan said that while it is easy to fixate on past performance, it is far more important to look to the future, and his conviction in the fund’s prospects over the next five years has begun to wane.
The problem, according to the analyst, is that Fundsmith Equity has become a victim of its own success.
“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,” he explained.
“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, which means it is far more scalable than most other funds.
Morgan accepts that the fund’s holdings are generally exceptionally liquid, meaning they are easy to trade in large quantities.
He also noted Smith’s ‘buy and hold’ philosophy, which means he 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,” Morgan added.
“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.”
He added: “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.”
However, other fund pickers continue to back Fundsmith Equity. Jason Hollands, managing director, business development & communications at Tilney, said that while it is undoubtedly large, because it doesn’t invest in small or mid caps, it is a different set of circumstances to other funds that have seen performance suffer as a result of inflows.
“Whenever we meet managers on our buy-list, we talk about capacity and our sense is this isn’t an issue at this time,” he added.
FE Invest also continues to hold the fund on its Approved Funds List. Fund analyst Sophie Meatyard said that while Fundsmith Equity’s growth in assets represents her biggest concern, and is something she continues to monitor, its size does not yet pose a threat to performance.
“The companies it invests in are large and mega cap stocks and it is not even confined to one region.”
Market cap of top-10 holdings
Source: FE Analytics
“We look at the liquidity profile and it has quite a high participation rate so we are not currently concerned with the level it is at.
“There is not a specific figure in terms of size that will make us drop it, it is more about whether the liquidity profile changes or if we see a huge spike in correlation. But we are not seeing that at the moment.”
For investors who are concerned about the size, Meatyard and Hollands both recommend Lindsell Train Global Equity, which takes a similar buy-and-hold approach to quality stocks, but is less than half the size of Fundsmith Equity and has lower charges.
Dzmitry Lipski, investment analyst at Interactive Investor, added that even if you are not concerned by the size of Fundsmith Equity, because it is a high conviction portfolio unconstrained by benchmark, geography or sector, the manager’s style won’t always be in favour.
“The quality growth strategy employed by the Fundsmith Equity Fund can be diversified by blending it with other funds that carry different characteristics, styles or market cap such as Artemis Global Income – a value-focused fund – or Standard Life Global Smaller Companies – a global small-cap fund,” he finished.