Every now and then a fund comes along that captures investors’ imaginations and Fundsmith’s flagship product is arguably one of the few funds to have sprung out of nowhere to become one of the most popular holdings among UK investors in a short period of time. 

Terry Smith launched his Fundsmith Equity (B41YBW7) fund eight years ago and today investors can’t get enough of it.

The veteran investor started his career in the City at Barclays Bank in 1974 where he spent a year before becoming a stockbroker, later moving on to UBS, where he was dismissed after two years following the publication of his book Accounting for Growth. 

He later gained notoriety for his role in the acquisition and later demerger of Prebon Group, latterly known as Tullett Prebon. And, finally, 36 years after starting his career, he launched his own fund.

SIMPLE PHILOSOPHY

Fundsmith seemed immediately determined to shake up the funds industry. It issued investors with an owner’s manual, promising to invest in a select number of high-quality businesses and then do nothing, for a simple 1% annual fee. 

It was not – and still isn’t – a particularly cheap fee, but it was a simple philosophy that quickly proved to work. Within a year, the fund had amassed £208m of assets and had returned 9.5%. 

After five years, assets had rocketed to £4.3bn and the fund had more than doubled investors’ money, with a return of 125.9%. Today, the fund stands at an incredible £16.2bn. It has returned 296.8% since inception, according to the latest factsheet.

STRONG PERFORMANCE

Fundsmith is a top performer within the global sector over all time periods and consistently tops most-bought and top buy lists. So, what is it about this fund that appeals so strongly to investors?

Brian Dennehy, director at independent financial adviser Dennehy, Weller & Co, says: ‘The key with Fundsmith Equity attracting money is easy enough: performance. Not only is it the second-best performer in a competitive and eclectic sector since launch, but it has been remarkably consistent.’

He points out that in each six months period since launch, the fund has been in the top quintile 73% of the time. Just one fund has delivered a higher return since its inception, and that is Baillie Gifford Global Discovery (0605933), which is up 318%. 

Patrick Thomas, investment manager at investment bank Canaccord Genuity, says: ‘Fundsmith remains one of the first additions to any new portfolio precisely because of the clear philosophy and behavioural discipline displayed over time. It is not easy to buy and hold good companies and most managers mess it up.’ 

CONCENTRATION RISK

Based on its track record, investing in the fund seems like a no-brainer. But it is not without risk. 

The portfolio is ultra-concentrated, with just 27 holdings, many of which have been there since launch. The top 10 investments account for more than 50% of its considerable assets. 

Almost two thirds of the portfolio is in US firms and 35% is in tech companies. The largest holdings include Paypal, Facebook and PepsiCo. These biases help to explain the strong performance – such growth stocks have led the way in global stock markets for a number of years. But there is no guarantee this trend will continue. If tech stocks fall out of favour, Fundsmith’s performance could take a turn for the worse. 

Dennehy adds: ‘The risks of the fund are obvious: the US exposure, technology exposure and concentration risk. Arguably, the US stock market has never been more expensive in its history and investors should be wary of picking up pennies in front of a steam roller from
this point.’

This isn’t just an issue for Fundsmith, though. A number of funds in the Global sector have a bias towards the US and technology including offerings from Baillie Gifford, Janus Henderson and Rathbones. 

Pre-emptively selling a fund because you fear its asset allocation may be wrong for the future is a tricky game – investors must reconcile with the risk of missing out on gains before the tide turns. 

DON’T MAKE IT YOUR ONLY INVESTMENT

For most investors, diversification is the key. Holding specialist funds, which have a particular style, or regional or sectoral bias, is perfectly fine as long as you have core holdings which are well spread to help balance that exposure. 

Alistair Cunningham, director at Wingate Financial Planning, says: ‘Some investors seem to be inured to the risk that sits behind this kind of highly focused funds. I met one investor who had his entire pension in Fundsmith. I’m aware the manager is well respected
but a 100% investment in such a concentrated fund is unlikely to be appropriate for most people.’

Terry Smith, founder of Fundsmith, says: ‘I would like to think it is our simple approach to communicating with investors allied with our simple investment approach [which has captured investors’ attention], but I am sure that delivering 300% growth since we launched the fund has also captured attention.’ (HB)

Disclaimer: Editor Daniel Coatsworth has a personal investment in Fundsmith Equity.

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