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The New Warren Buffet

The former chief executive of Tullett Prebon launched ‘Fundsmith Equity Fund’ in response to excessive fees and poor performance within the investment management industry.

In his own words, he wanted to give “fat and complacent” fund managers a bloody nose. Today the performance of Fundsmith has been exemplary; appreciating by more than 100% since inception (November 2010).

Below is a summary of Terry’s investment philosophy:

He’s a long-term, buy and hold investor. He laments fund managers for being too active, because unnecessary trading damages performance and raises management costs (difference between the bid-offer spread and commission). Renowned investor Warren Buffet eloquently said that “Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases”.

Avoids over diversification, they highlight research which shows that around 20 to 30 stocks are required for optimal diversification. The more stocks you own, the less you know about each one – its called ‘diworsification’. As Warren Buffett said: ‘Wide diversification is only required when investors do not understand what they are doing’. Terry Smith article on why ‘Too many stocks can spoil a portfolio’.

Invests in resilient businesses; they avoid industries that are subject to technological innovation. New technologies create value for some investors while destroying value for many others. Example: internet destroying the media industry. Moreover he will invest in good quality business only when the valuation is attractive.

Invests in businesses with a sustainable high return on capital employed (this measures the efficiency and profitability of a company’s invested capital). Companies that typically fit this bill are non-cyclical consumer businesses (food and toiletries) with repeat purchases.

Buys companies with ‘intangible assets’ that are difficult to replicate. By this he’s referring to brands, licenses, patents, dominant market shares etc.

Avoids market timing, studies show that the most successful fund managers avoid market timing. Stocks are a ‘giffen good’, this means that demand paradoxically rises as prices increase. Driven by greed and fear, most investors end up buying high and selling low.

Avoid companies that require leverage – They only invest in companies that generate high returns on invested capital on an unleveraged basis. This is why they won’t invest in companies which require borrowed money to function or survive –  such as banks.

Terry and his investment team are ‘global investors’. With a global perspective the fund is able to ‘contrast and compare growth rates and valuations across different geographies’. They also believe that the proliferation of ‘national’ and ‘regional’ funds are anachronisms, this approach leads investors to being overweight in a one market and underweight in another.

You’ll also notice that the name ‘Fundsmith Equity Fund’ doesn’t say whether its a Growth or Income Fund, he regard this distinction as artificial and a marketing ploy.

Interesting read: The Fundsmith Owners Manual.

Fundsmith Emerging Equities Trust (FEET)

On the back of a successful global equity fund, Terry launched an emerging market fund in June 2014 – raising £192.9 million at launch. The fund was set up as an ‘investment trust’ to address the low liquidity of emerging market stocks.

Fund Characteristics

FEET will use the same strategy of its flagship global fund (Fundsmith equity fund), but have the majority of their operations in and revenue derived from the developing economies. They will invest almost exclusively in consumer stocks and provide direct exposures to the rise of the consumer classes in emerging economies.

More specifically he will identify companies which deliver most of their profits as cash, have predictable revenues, low capital intensity and high returns on capital. He believes this combination will bring compound growth in shareholder return over the long-term.

Investable Universe

Using the same successful investment process as Fundsmith global fund, Smith has identified 139 companies within the FEET’s investable universe. Once fully invested, he anticipates investing in between 35 – 55 of them.

Backtesting the performance of FEET’s investable universe shows a return of 298% over five years to 31 march 2014, compared with 69% for the benchmark MSCI Emerging Markets index. Performance over 10 years is more marked, increasing by 1187% against 188% for the MSCI EM index.

Update: Following the placing and offer, the trust raised £193 million, including £5 million from Terry Smith himself.

Fundsmith Emerging Equities Trust (‘FEET’) website –  http://www.feetplc.co.uk/

And the Fundsmith Emerging Market Equities Trust PLC – Owner’s Manual

All told – Terry Smith is an investment manager of exceptional calibre, a plain-speaking and outspoken maverick. Along with Nick Train and Neil Woodford, he’s one of the few fund managers I hold in high esteem.

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