Terry Smith and research head Julian Robins took to the stage in London last month to respond to investor questions following their fund's worst ever year.
Following a disappointing year for Fundsmith Equity, investors were more eager than ever to quiz Terry Smith about his portfolio and views on global markets at this year’s annual general meeting (AGM).
The fund lost 13.8% in 2022 compared with a 7.8% drop for global shares, as investors flocked to cheaper “value” shares at the expense of the higher priced “quality growth” companies that Smith favours.
It was the worst ever year for the £23 billion interactive investor Super 60-rated strategy, both in absolute returns and relative to its benchmark.
Alongside head of research Julian Robins, Smith sat down with investors in London to respond to questions. Here are five takeaways from the AGM.
A stock they like but is too expensive
One of Fundsmith’s key tenets is to not overpay for good companies. This means they have a long list of companies that they like but are too expensive to include in the fund.
Robins said a company they like but are waiting for a market “glitch” to buy is Adyen, a Dutch online and offline payments processor. It has a market cap of €42 billion (£37 billion).
Robins said: “It did €2.7 billion of turnover before covid-19 and is now doing €8.9 billion. It delivers 30% return of capital operating in online payments, which is an industry that is likely to have a lot of natural growth. The only real barrier to investing is that it is trading on 60 times earnings.”
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Robins added that Fundsmith Equity had been good at being patient with expensive stocks and waiting for prices to fall.
“We waited five or six years to buy IDEXX Laboratories Inc (NASDAQ:IDXX) and that was a fantastic investment. You do get opportunities but have to be patient,” he said.
The potential of the ‘metaverse’
Facebook, now known as Meta Platforms Inc Class A (NASDAQ:META), announced in November 2021 it was going to divert more than $10 billion (£8.3 billion) a year of its profits to building a “metaverse”, referring to online worlds where people can interact, such as by shopping or hosting meetings.
Investors reacted by selling shares as they were sceptical about the protentional of the metaverse and for Facebook to be the firm to build it, and also because they thought there were better ways for Facebook to spend its cash.
Fundsmith Equity has owned Facebook since 2018. Smith admires its dominance alongside Google in online advertising and its more than two billion daily active users. At the AGM, he said it was the most undervalued share in the portfolio.
On the metaverse, Smith was opened minded. He said: “It is difficult to tell you exactly what it is. But by speaking with companies involved in it that we also invest in, such as Microsoft Corp (NASDAQ:MSFT), L'Oreal SA (EURONEXT:OR) and Apple Inc (NASDAQ:AAPL), we get a sense that there is a reality behind it that will emerge.
“It is not science fiction and a pipe dream. I think it is much more than that. Cosmetic companies are absolutely sure this will be part of the future for them. It is not a comfortable place to be. But let’s imagine that we just ran our portfolio with just consumer and medical stocks. Would you be happy if we had no exposure to tech? I don’t think you would.”
Why Smith finally bought Apple
Smith said in the 2014 AGM he would never own a fashion business, which he said at the time was “exactly what Apple has become.” However, he revealed he had begun buying Apple shares in November 2022.
At this year’s AGM, Smith said: “We go back over things that we reject regularly and see again if we are right or wrong.
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“We noticed that services revenue (such as music, TV and payments) from Apple had become 25% of revenues and was growing at twice the rate of the iPhone businesses and is an extremely profitable ecosystem with profits like a software business. It is a service business being served to a very good socio-economic group.”
He started buying shares at end of last year when his target price per share of $125 was hit following a sell-off, which Smith said gave the company a similar valuation to the average for the S&P 500 index. Shares now cost round $150.
Smith added: “We will be patient and there is a reasonable chance that the market will give us further opportunity to capitalise.”
The problem with investing in emerging markets
Smith and Robins were asked about why returns from Fundsmith Emerging Equity Trust (FEET), which was closed last year, were worse than the Fundsmith Equity and the S&P 500 despite having there being good companies in emerging markets.
The trust, which launched in June 2014, attempted to replicate Smith’s successful stock picking formula in developed markets to the emerging market region. However, performance did not live up to its billing, with returns around half what the index delivered over its eight-year life.
Smith said one of the main reasons for poor returns was the impact of currency exchange rates.
Shares listed in local markets are traded in local currencies and so have to be converted back to sterling to give the real return to UK-based investors. However, emerging market currencies are vulnerable to price swings linked to their politics and economies.
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As a result of this, Smith said you can find excellent companies but the problem is where they are listed.
He noted that investing in Indian equities was like “running up a down escalator” due to how weak the currency had been since FEET was running. He added that the costs of hedging currencies in emerging markets were too restrictive.
Nevertheless, Smith said Fundsmith Equity was still exposed to growth in emerging markets as 30% of the fund’s revenues came from the market sector.
“It is a very important part of the companies we own,” he said.
Why the favourable macro winds have “probably” gone for good
A common criticism of Smith’s investment approach is that a long period of falling interest rates, high growth and low inflation, known as the “Great Moderation”, has been a big tailwind for the fund manager.
Now, with interest rates approaching 5% in the US and at 4% in the UK to combat high inflation, there has been a rotation from growth to value shares performing best. One investor asked how Fundsmith Equity would perform in this new macroeconomic paradigm and whether the Great Moderation was over.
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Smith said the favourable economic environment that had been in place since the mid-1990s had “probably” gone for now, but his fund could still deliver for investors.
His team looked at the performance of companies in his investible universe of “quality growth” shares, his current portfolio and the S&P 500 between 1980 and 2001 and found that the types of stocks he liked outperformed cheaper shares in both falling and rising interest rate environments. In this period interest rates in the US averaged above 4.5%.
“The good news is that if we are living through a repeat of that then we should be alright,” he said
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