In typically pugnacious style, when launching Fundsmith (B41YBW7) ten years ago with a personal investment of £25 million of his own cash veteran City dealer Terry Smith called the UK fund management industry ‘broken’, accusing it of over-trading, fund proliferation, closet indexing and over-diversification.

He promised to ‘run the best fund ever’ and bring retail punters ‘a method of investment which they have not been able to access before’, all with no up-front or performance fees. He also promised to try to ensure that the amount of capital gains tax investors paid was ‘as large as possible’ thanks to his investment success.

A decade on, has Fundsmith measured up to these bold claims and, say it in hushed tones, could it have done better?

WHAT IT SAID ON THE TIN

Fundmsith promised to invest without reference to a benchmark and to only own a maximum of 30 stocks around the world, in businesses which didn’t face ‘obsolescence’ through technological change.

While not identifying which stocks his fund would pick, Smith was clear he wanted companies with direct to consumer business models and longevity, such as food, beverage and tobacco firms, and that he wouldn’t be tempted by ‘hot’ stocks: ‘We are conviction investors. It requires real emotional discipline not to chase the latest fad.’

He promised to be a long-term, buy and hold investor, only owning stocks which would compound in value over the years. When necessary, his firm would also challenge companies where it felt capital allocation decisions were being wrong made or executive pay was wrongly structured.

WHAT INVESTORS GOT

Fast-forward 10 years and Fundsmith has certainly given investors a capital gains tax headache. Anyone who put £10,000 into the retail accumulation shares at inception would be looking at a holding worth more than £50,000 today according to Bestinvest, while investing £100 every month over the same period would have built a nest egg worth £32,000.

In terms of average annual return, net of costs, few investors have been able to hold a candle to Fundsmith over the past decade. A total return of 445% since 1 November 2010 is more than double the 215% generated by the MSCI World Index and equates to a compound annual growth rate of 18.6% on average.

Growth hasn’t always been even though. The 2010 out-turn, published on the Fundsmith website, was a gain of just 6.1%, and 2018 saw a gain of just 2.2%. In contrast, last year’s gain of 25.6% was the highest since inception.

Nor has success happened by accident. The firm’s oft-repeated mantra of ‘buy good companies, don’t overpay, do nothing’ has worked extremely well over the past decade for a number of reasons.

FOLLOWING WINDS

Late 2010 may not have been the ideal time to launch a fund business, but even so it was fairly evident the clouds from the financial crisis had begun to clear and the global economy was getting back on its feet, so it certainly wasn’t a bad time to launch.

Moreover, managers who only buy good companies have been well rewarded this past decade as investors have put an ever-increasing premium on growth, while interest rates have remained abnormally low, reducing the discount rate and increasing the theoretical terminal value of ‘long-duration’ investments.

As Smith has observed in his annual shareholder letters, his stocks – like all ‘quality’ stocks – have tended to see their valuations rise more than their earnings over the years, a phenomenon crudely referred to as PE (price to earnings) expansion.

Arguably, the pandemic has only strengthened the outlook for growth companies which in turn has seen their valuations rise even further this year.

Absent the pandemic, and had the global economy rallied in a co-ordinated way causing inflation to rise, and with it interest rates, the performance of ‘quality growth’ companies might have been very different.

Also, Fundsmith has a huge competitive advantage thanks to its much longer investment horizon than most of its competitors and the fact it can run its winners, one of the secrets to amassing genuine wealth. For example, it isn’t unusual for the best-performing stocks in the fund, such as Microsoft or Paypal, to be the same from one year to another.

COULD IT HAVE DONE BETTER?

It may seem miserly to ask, but we have to wonder whether Fundsmith could have done better still. By deliberately eschewing certain sub-sets of the market, has it missed out on even higher growth?

For instance, while it favours growth companies with intangible assets like strong brands, dominant market shares, installed bases and so on, it tends not to buy into ‘innovation’ or invest in developing markets.

As a result, and also maybe as a result of the furore among shareholders over its purchase of Facebook shares, over the last five years the fund has missed out on the remarkable share-price performance of stocks like Alibaba and Tencent, unlike rivals such as Scottish Mortgage Investment Trust (SMT).

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