Terry Smith has recently issued his annual newsletter to investors in his Fundsmith Equity Fund. Those who invested primarily in UK focussed index trackers last year (FTSE-AllShare down 2.5%) will be possibly annoyed to discover that Mr Smith managed to achieve a total return of 23.3% last year. He had the advantage of being invested in global equities perhaps which generally did better than UK stocks, but he still managed to outperform his benchmark which is the MSCI World Index.
How did he achieve this performance, which repeats what he has done in previous years? Well there are a few hints in the newsletter.
He makes some negative comments about the world economy and the effects of Quantitative Easing (QE) but then says that his investment approach is “thankfully not based upon our view of the global economic outlook”. He simply concentrates on buying shares in good companies.
The tactic of many fund managers of buying dogs because they are cheap in the expectation or hope of a recovery gets some negative comment and he suggests that while they await “the kiss that will turn their corporate frogs into princes, they steadily erode value”.
He emphasises the importance of Return on Capital Employed and quotes Warren Buffett on the subject. The investments held by Fundsmith apparently returned 29% versus 18% for the market. He also notes their high gross margins, high profit margins, good cash conversion, low leverage and high interest cover.
Mr Smith mentions some of his winners and losers last year (a number of the winners repeated their performance in the previous year which reinforces the message to hold on to your winners and sell the losers). But overall he trades very little. His mantra is “Don’t just do something, sit there”. In other words, he minimises his investors’ costs by not overtrading.
Note that this writer has recently purchased a holding in the Fundsmith Equity Fund after commenting on it in previous years. I hope I have not joined the party too late. It will be interesting to see how long Terry Smith can keep up this level of performance. A meeting for shareholders in the fund is being held on the 3rd March which I plan to attend.
Roger Lawson
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