Daily Telegraph - Star fund manager Terry Smith: ‘Most investors today are too short-term’

Each spring, with the start of the new tax year and refreshed Isa allowances, the floodgates open for investment ideas of the ­season.

While investors would ideally check the fundamentals of each company they invest in, the truth is almost no-one has the time.

Outsourcing this work to a fund manager is the easiest and most effective way to introduce some active management into your portfolio.

While it is impossible to guarantee good investment performance, some fund managers have racked up such high returns that they have earned a huge following among DIY investors. Chief among them is Terry Smith.

He is one of the City’s closely-followed fund managers, with a return of more than 336pc in the past decade for investors in his £25bn Fundsmith Equity fund.

Yet in recent months the fund has underperformed global stock markets. Here, Mr Smith gives his side of the story to Telegraph Money.

What do you think the best company in the world is, and why?

L’Oréal. It is the world’s leading cosmetics company with great returns on capital, profit margins, cash flow and revenue growth.

It also has a founding family with a significant shareholding, which helps to ensure truly beneficial long-term decisions can be made.

The family has been smart enough to have three generations of non-family chief executives, all of whom have been outstanding.

It has mastered digital marketing, distribution and China better than any other major cosmetics company. It is also a leader in sustainability/ESG without virtue signalling and people are always interested in making themselves look good.

How did L’Oréal go right in China where Estée Lauder went wrong?

It has local manufacturing and so is much closer to the end market and can react more quickly with seemingly better intel.

Estée Lauder does not have any manufacturing east of Europe.

Which investment have you made at Fundsmith Equity that has most proved critics wrong?

Meta (formerly Facebook) is the most recent.

We faced a barrage of criticism when we bought the shares. They are up over 400pc in the past 15 months.

Why do you think passive investing is becoming increasingly popular?

Because investors find it difficult to find good active managers.

After all, it is axiomatic that more than half of active managers will underperform the index at any time since even the averagely performing manager incurs costs and the index has no costs, and passive funds have very low fees.

Fundsmith Equity has underperformed its preferred benchmark in one, three and five years. Why?

First, it actually outperformed in the first two years of that five-year period.

Second, from the period when interest rates began to rise in late 2021 it faced a strong headwind from the devaluation of high quality companies of the sort we own, as they are more highly valued.

Just like long bonds perform worse than short bonds in such conditions. This is simply a fact of life: no strategy outperforms in all market conditions.

Finally, in 2023 the problem was that performance was concentrated in very few companies. The Nasdaq delivered a return of more than 43pc, and more than two thirds of that return was delivered by just seven stocks – the so-called Magnificent Seven.

Unless you owned most of them with at least an index weighting, it was ­difficult to outperform and we didn’t.

We are unlikely ever to own Tesla, which is one of the Seven, and if ­anyone did own all of them you should perhaps question their risk appetite as six of the Seven underperformed in 2022 and Nvidia, the ­darling of the Seven, has had share price falls of more than 80pc twice in its life.

Are there any investment decisions you have made at Fundsmith Equity that you regret?

Not owning Apple earlier.

What do you think is the most common mistake that investors make today?

They are too short-term.

Do you personally invest your money in other investment styles/strategies that are distinct from the Fundsmith philosophy for some diversification? 

No.

The average fee in the “global” fund sector is around 0.9pc. Big funds can afford to charge lower, such as Scottish Mortgage at 0.34pc. Fundsmith Equity charges 1.04pc. Why?

Scottish Mortgage is a closed-end fund, which is not comparable with an open-ended fund where the ­manager has to deal with flows and requires a lot more client liaison, which has a cost.

The fees are simply not validly comparable and neither is the liquidity – you can have your money back any day from Fundsmith which you can’t at Scottish Mortgage, but maintaining that liquidity has a price.

Investors should not obsess about fees but rather about performance net of fees. The charges you cite are not the complete picture.

What about the cost of dealing incurred by the fund – isn’t this a drag on performance?

Our total cost of investment at 1.05pc, including dealing costs, adds just 0.01pc to our costs which is a very small fraction of the dealing costs incurred by most managers because our portfolio turnover is so low.

Most of Fundsmith’s investors use a platform or wealth manager and pay 0.9pc. Direct investors pay only another 10 basis points to get direct access to us.

Which companies are on your ‘watch list’ for investments? What is stopping you from buying them?

Why would I tell you that?

Which investors have been the biggest influence on the Fundsmith strategy?

Charlie Munger, Warren Buffett, Don Yackhtman, Tom Russo, Andy Brown.

Which themes do you think are going to drive the market narrative over the next decade?

It is not something I think about.