The Fundsmith Equity Fund has drastically outperformed major UK indices since it launched in 2010. Even so, critics of manager Terry Smith often pointed out that his portfolio hadn’t been tested in a major downturn. No longer.
From the beginning of 2020 to the end of March, Fundsmith’s shares fell 7.9% in value. Ordinarily, we’d regard such as result as very poor. Compared to the FTSE 100, however, it’s superb. The top tier of UK companies tanked 23.8% over the same period.
While no one knows what the future will bring, such a performance suggests Smith is worth listening to, now more than ever.
Three points jump out at me from his latest communication to investors.
Value (still) isn’t the solution
What’s perceived as ‘cheap’ will always attract investors. Terry Smith, however, remains against value investing. As he puts it, “Shares in companies that are lowly rated are so mostly for good reasons“.
These reasons – including high debt levels – also mean that inexpensive companies can still drop in price during a crisis. Since this has certainly been the case over the last month, the belief that they provide greater protection over more expensive stocks is flawed, thinks Smith.
Based on this, I think it’s fair to say that existing holders of Fundsmith need not worry about strategy drift for the foreseeable future.
It also suggests that the FTSE 100, which contains both great and not-so-great companies, will continue to underperform Fundsmith. The latter has always focused on finding quality stocks, even if it involves paying more for them.
Expect the worst
Fundsmith’s index-beating return during the coronavirus outbreak so far does not mean that Smith is sure every single company he owns will survive. Two holdings – Hilton-owner Intercontinental Hotels and airline reservation provider Amadeus – have already been hit hard by the pandemic.
Although both are sensibly cutting costs, the fund manager estimates that their failure would reduce the value of Fundsmith’s portfolio by 5%. His view on this, however, is striking. “Whilst I would not be pleased with that, if that’s the worst thing that happens I would suggest we can live with it.“
I think this sort of no-nonsense thinking is vital at the current time and highlights two things.
First, the fact that even Smith is contemplating the demise of stocks he owns is further evidence that no one is capable of picking just winners.
Second, a degree of diversification is still vital, even if your portfolio is more concentrated than most.
Control what you can
Anyone and their dog can and will speculate on whether the markets will rise or fall from here. They’ll also ponder whether the eventual recovery will be sharp or more gradual. On this, Smith’s attitude is one I believe all Fools should be adopting. “I try to spend very little time considering matters which I can neither predict nor control and focus instead on those which I can affect.”
I couldn’t agree more. This is why I am drawing up a shopping list of companies to buy if/when they become available at what I consider to be reasonable prices.
Tellingly, Smith has already added new stocks to Fundsmith’s portfolio (although he remains tight-lipped on their identity). I may begin doing the same soon.