Star turn: Terry Smith has won fans among investors for his no-nonsense approach and bumper returns since launching Fundsmith ‘Contrary to the mantra that every fund has to recite, past returns of companies are a good guide to future returns.’
As well as taking a potshot at Unilever’s mayonnaise with purpose and ESG mania, Terry Smith fired a broadside at the watchdog’s required risk warning in the latest letter to his Fundsmith shareholders.
The Fundsmith manager has won legions of fans among investors, thanks to his no-nonsense approach and more importantly a 570 per cent return since his fund’s 2010 launch vs the global stock market’s 287 per cent.
Smith was writing specifically about the merits of backing quality companies over cheap low quality firms, as he outlined his investment strategy.
In a style akin to the shareholder letters of Warren Buffett – an investor he admires greatly – Smith’s annual missive is a mix of stock specifics, strategy and thoughts on the current financial world.
Regardless of whether they invest in his fund or not, the Fundsmith annual letter is worth a read for investors.
One of the main themes this year is the supposed rotation to value – the idea that expensive growth shares have had their day in the sun and it’s now time for cheap beaten down companies to shine.
In his letter, Smith talks of a rotation from quality to value, whereas in general the chatter is often of a switch from growth to value.
Quality and growth investing share attributes but are different: the former involves profit machine companies with a robust track record of earnings and growth, whereas the latter is more typically characterised as involving disruptive companies – often with a tech influence – seen to have explosive growth potential.
Both involve paying up for the highly prized attributes of those shares
Fundsmith is the poster child for quality investing among UK funds, while at the more considered end of moonshot growth strategies lies something like Scottish Mortgage investment trust .
There’s not a great deal of crossover between Scottish Mortgage and Fundsmith, nevertheless the same question has been asked about these two highly successful and popular funds that have richly rewarded their investors.
This is whether the sparkling returns over the past decade or so can continue?
Delving deeper, critics ask where the balance lies between stock-picking skill and the tailwind of investing heavily in the US stock market and its soaraway profit machine and growth shares.
The implication is that a reversal of fortune is coming and after more than a decade in the doldrums it is value investing’s time to shine.
This is a perfectly reasonable thing to ask. After all, the conditions that have seen certain parts of the market outperform in the past are not necessarily going to be the same in the future.
The pandemic has shaken up the pieces of the global economy and they won’t all land back in the same place.
Meanwhile, monetary policy has gone further through the looking glass and the results of that remain to be seen.
Yet, Smith puts together an argument against trying to play this trade, stating: ‘In our view it would be a mistake to sell some of these good businesses in order to invest temporarily in companies which are much worse but which have greater recovery potential.’After outlining his investment philosophy and strategy, he elaborates further on this.Smith writes: ‘In our view, the biggest problem with any investment in low quality businesses is that on the whole the return characteristics of businesses persist.‘Good sectors and businesses remain good and poor return businesses also have persistently poor returns.‘These return characteristics persist because good businesses find ways to fend off the competition – what Warren Buffett calls ‘The Moat’ – strong brands; control of distribution; high spend on product development, innovation, marketing and promotion; patents and installed bases of equipment and/or software which are troublesome to change for example.‘Poor returns also persist because companies which have many competitors, no control over pricing and/or input costs, and an ability for consumers to prolong the life of the product in a downturn (like cars) cannot suddenly throw off these poor characteristics just because they are lowly rated and/or benefit from an economic recovery.’ Smith adds this chart and states it shows: ‘The excess returns — the amount by which it beats the index — of the MSCI World Quality Index (which I am taking as a surrogate for our strategy’ Despite these assertions it is, of course, possible to make some big short term returns on […]
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