Terry Smith blames these three factors for 2025’s underperformance

Terry Smith has identified index concentration, the bulk of money in passive funds and dollar weakness as the culprits behind a year of severe underperformance for Fundsmith Equity I Acc.

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The £16 billion fund made a return of just 0.8% in 2025, putting it well behind not only the MSCI World index (up 12.8%) but also the average global equity fund, government bonds and even cash.

This marks the fifth full calendar year in which the fund, once the largest in the UK, has underperformed the global equity market.

As the table below shows , in 2021 performance only slightly fell short, but investors would have fared a bit better that year just owning the index.

Source: Fundsmith. Past performance is not a guide to future performance.

Since launch in late 2010, Smith is still ahead of the benchmark, with annualised returns of 13.8% versus 12.1% for the MSCI World index.

Smith, who manages the fund, said in his annual letter to investors that while he was not seeking to cast blame for the poor returns, 2025’s experience was down to three factors.

Mag Seven issues

He first pointed to the domination of returns by the Magnificent Seven stocks, noting: “It was difficult to even perform in line with the index in recent years if you did not own most of these stocks in their market weightings, and we would not do so even if we became convinced that they were all good companies of the sort we seek to invest in, which we are not.

“It would, in our view, represent too much of a portfolio risk to own them all, just as we would not own all five of the drinks companies we have in our investible universe even if we thought that prospects for the sector were good.”

Fundsmith Equity owns just three of the Magnificent Seven, Alphabet Inc Class A (NASDAQ:GOOGL), Meta Platforms Inc Class A (NASDAQ:META) and Microsoft Corp (NASDAQ:MSFT), although the fund may be less exposed than it once was.

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Fundsmith Equity doesn’t break out its position sizes in monthly factsheets but Morningstar data shows that Meta was its top holding at the end of August, accounting for 7.7% of the portfolio.

Microsoft, which spent a long time as the top holding, sat on a 5% weighting at the time. But neither name sat in the fund’s top 10 holdings list at the end of December, suggesting Smith has at least allowed the position sizes to drift lower.

The top five holdings at the end of 2025 were Waters Corp (NYSE:WAT), Stryker Corp (NYSE:SYK), IDEXX Laboratories Inc (NASDAQ:IDXX), Visa Inc Class A (NYSE:V) and Marriott International Inc Class A (NASDAQ:MAR).

Less in Meta and Microsoft?

Smith did not talk specifically about the outlook for the Magnificent Seven members currently in the portfolio but did note that the fund’s cash conversion had fallen due to a “sharp rise in capital expenditure” at Alphabet, Microsoft and Meta.

“The tech companies are in a race to build capacity for AI in the form of GPU chips and data centres,” he said. “Whether this arms race produces adequate profits and returns for the amounts expended remains an open question.”

He added: “When commentators discuss the future of artificial intelligence and whether there is a bubble in AI investments ,they often seem to miss the point. AI may have a profound effect on our lives and employment but that does not guarantee that investment in it will attain an adequate return or that returns will gravitate to the present incumbents.”

Smith added that Apple Inc (NASDAQ:AAPL), a former holding in the fund, was one to watch in the context of the AI arms race.

“Depending upon your point of view, it has either been left behind in the scramble to build large language models and hyperscale to provide AI infrastructure or it has opted out of the race,” he said.

“As a result, its capital expenditure in 2025 was a mere $12 billion, which pales into insignificance in comparison with the companies in the table above [sic].

“It may be making a virtue of necessity but maybe Tim Cook, the CEO, is working on an old adage, ‘You don’t have to own a cow to sell milk’. Apple has its devices and about a billion mostly high-end consumers locked into them and increasingly into its services.”

Other reasons for underperformance

In seeking to explain the fund’s underperformance, Smith also turned to a common lament of the active manager, that the sheer volume of money in tracker funds was helping to push up valuations on the biggest market constituents such as NVIDIA Corp (NASDAQ:NVDA).

“If you redeem money from an active fund like Fundsmith Equity and invest it in an S&P 500 index tracker fund, your new fund will buy the index stocks in proportion to their market value,” he said.

“Currently about 7% of it will go into Nvidia, which we do not own. About 35% will go into the Magnificent Seven of which we own only three stocks — Alphabet, Meta and Microsoft. This gives added momentum to those stocks we do not own which are a major part of the index.”

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Smith also noted that the depreciation of the US dollar versus the pound had hurt the fund’s performance in 2025, given that most of the companies in the portfolio are listed in the US “and more importantly that is their biggest single source of revenue”.

Turnover in the fund came to 12.7% in 2025, up from 3.2% the year before.

The team sold out of Brown-Forman Corp Class A (NYSE:BF.A) and PepsiCo Inc (NASDAQ:PEP), whose snack businesses Smith views to be “directly in the crosshairs of the impact of reduced appetites from weight-loss drugs”, and initiated stakes in Zoetis Inc Class A (NYSE:ZTS), Essilorluxottica (EURONEXT:EL), Intuit Inc (NASDAQ:INTU) and Wolters Kluwer NV (EURONEXT:WKL). The team also received a holding in The Magnum Ice Cream Co NV (LSE:MICC), which was spun out of Unilever (LSE:ULVR).

Turning to a former top holding, Smith lamented the poor performance of Novo Nordisk AS Class B (XETRA:NOV), which has had a torrid run of performance in recent history, but suggested the shares now looked attractive.

“Novo Nordisk has appointed a new CEO and made wholesale board changes and the present rating (a price/earnings of 13) appears to us to be expecting very little,” he said.

“If we did not already own it, I suspect we would contemplate buying it as a good business which has been depressed by a ‘glitch’, albeit a rather large glitch.”