Photo: Anthea Davison
Photo: Anthea Davison

Raging Bull Awards: Fundsmith Equity Fund

By Mark Bechard Time of article published Feb 3, 2020

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Raging Bull Award for the Best (FSCA-approved) Offshore Global Equity Fund on straight performance over three years to December 31, 2019

The Fundsmith Equity Fund achieved an average annual return of 16.6% (in pounds) over the past three years to the end of last year, according to its January 2020 factsheet.

Terry Smith, the chief executive and chief investment officer of London-headquartered Fundsmith, has managed the fund since it was launched in 2010.

Personal Finance asked Smith about the fund’s investment strategy and performance.

What is your investment philosophy when it comes to managing this fund? 

First, we seek to buy good companies. This may sound blindingly obvious, but you might be surprised how many investors either don’t do this or do not have a good definition of a high-quality business. In our view, a high-quality business can sustain a high return on operating capital employed. We invest in companies whose assets are intangible and difficult to replicate. We want companies that are resilient to change, particularly technological innovation, and with growth potential. We avoid anything that needs leverage or debt in order to generate returns. The companies in our portfolio are superior to those in the main indices on any of the financial measures of returns, profitability, cash flow, or balance sheet strength.

Second, we try not to overpay. Our portfolio consists of companies that are fundamentally a lot better than the average of those in the S&P 500 or FTSE 100 and are valued more highly than the average FTSE 100 company and a bit higher than the average S&P 500 company but with significantly higher quality. It is wise to bear in mind that “highly rated” does not equate to “expensive” any more than “lowly rated” equates to “cheap”.

And last, we try to do nothing – ideally, holding on to our portfolio companies forever so we can benefit from the compounding in value of our investments over time as the companies continue to reinvest their cash flows. Our aim to minimise portfolio turnover remains one of our objectives and in 2019 this was again achieved with a negative portfolio turnover during the period. Why is this important? It helps to minimise costs, and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor.

Which shares contributed significantly to the fund’s performance over the above-mentioned period? 

The five top-performing shares over the past three years in terms of their contribution to the fund have been:

  • PayPal, the leader in online payments outside China. We have owned it since it was spun out of eBay. It has been our top-performing share for three years running, which dispels the myth that you can prosper by taking profits.

  • Microsoft has been in our top five performing shares five times over the years since we bought it. Its successful transition to a cloud-based business under Satya Nadella has delivered extraordinary value creation.

  • Estée Lauder, the leading US cosmetics company.  

  • IDEXX Labs, the world’s leading supplier of veterinary diagnostics equipment. Pets are on a journey in terms of increasing spend on healthcare just like their human owners. Pets are treated like full family members, and the need for diagnostics is greater than in humans for a simple reason: they can’t speak.

  • Visa, another payment processor. They all have the ability to grow by replacing the use of cash.

What opportunities and challenges will the fund face over the coming year, and, following from this, how will the fund be positioned? 

We are focused on investing in quality companies, and we are convinced that our strategy can deliver superior returns over the long term. We do not waste time worrying about factors that we cannot control. We won’t change our strategy.

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