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  • What Terry Smith is saying

    What Terry Smith is saying

A Fundamental Approach to Investing From Terry Smith

FUNDSMITH EQUITY FUND LAUNCHES TODAY
 
Concentrated global buy and hold portfolio, no initial fee and a flat 1% AMC to direct investors
 
Fundsmith is a new asset management company established by Terry Smith because he believes that most existing equity funds have not delivered what they promised.  Fundsmith will be the main vehicle for his own investments. Instead of the multitude of expensive poor performing funds which investors currently have to choose from, the Fundsmith Equity Fund will offer investors the opportunity to invest alongside him in a high quality, concentrated portfolio of 20-30 resilient global growth companies which are held for the long term.   The portfolio has no benchmark or sector constraints.  

Terry Smith, founder of Fundsmith, says:   
 
 “The fund management industry is broken.  The vast majority of fund investors suffer from punitive fee structures, overtrading, fund proliferation, closet indexing, and over-diversification.   The net result is poor performance.   The average IMA Global Growth fund delivered a total return of just 0.7% in the ten years to July 2010, underperforming the index by 5.3 percentage points.   By contrast, the Tullett Liberty Pension Fund, which was significantly underfunded in 2003 when I took over as investment advisor, was returned to surplus by 2010, despite the market turmoil that took place in 2008, having employed a discretionary manager whose strategy is very similar to the one Fundsmith employs.”


Key benefits of investing with Fundsmith include:
 •A chance to co-invest with Terry Smith who will initially be investing £25 million of his own money. He intends to use Fundsmith as his main investment vehicle.
 •A flat 1% AMC if bought direct and a similar TER, as costs will be kept to a minimum.  Trading costs will also be kept to a minimum, as portfolio turnover will be very low.
 •A concentrated portfolio of 20 to 30 superior global stocks which are held for the long term.


Terry Smith continued: 
 
“We are conviction investors.  It requires real emotional discipline not to chase after the latest fad.   I will manage the fund, and have worked with Julian Robins, our Head of Research, for the best part of twenty five years. Where investments are concerned we see eye to eye."
 
 “We will not market time, hedge, trade, short, invest in sectors we don’t understand or panic when markets fall. We will only invest in companies that have attractive valuations, high barriers to entry and are extremely resilient.  We like companies with a business advantage that is hard to replicate and which are resilient to change, particularly to technological change.  The kind of intangible assets we seek are brand names, high market shares, patents, licenses, distribution networks, installed bases and client relationships.  We especially like companies that produce goods which are consumed at short and regular intervals and which sell directly to consumers.  A company that sells many small items every day is better able to earn more consistent returns over time than a company whose business is cyclical, like a steel manufacturer, or “lumpy”, like a property developer or which is large and/or durable like a motor manufacturer."  

“Following our screening process, most of our investible companies have been around for more than a hundred years, surviving two world wars and the Great Depression as well as the more recent banking crisis and the ensuing credit crunch."
 
“Our strategy may be simple, but it involves rigorous analysis and iron discipline to deliver superior performance. I’ve written an Owner’s Manual, so that investors will understand exactly what we set out to achieve.   It’s all about getting back to fundamentals, which is what separates us from the competition."
 
“Fees create an enormous drag on performance.  The Fundsmith Equity Fund is ideal as a core holding in an institutional portfolio.  Until now, such a quality global equity fund has rarely been available to retail investors, and never at this price.   We have been rigorous in challenging every accepted wisdom in setting up Fundsmith.  Today our website goes live. It allows investors to engage directly with us and invest in three easy steps.”  

Fundsmith invests in companies with the following criteria:
 
High returns on operating capital employed. In cash.  This approach rules out most businesses that do not sell direct to consumers or which make goods which are not consumed at short and regular intervals.
 
Businesses whose advantages are difficult to replicate.  We seek companies with brand names, high market shares, patents, licences, distribution networks, installed bases and client relationships.  Together these define a company’s franchise and its ability to outperform competitors. 

No significant leverage required to generate returns.  We only invest in companies that earn a high return on their capital on an unleveraged basis in recognition that sometimes credit is withdrawn.  

Growth driven from reinvestment of their cash flows at high rates of return.  We like to find businesses with a high degree of certainty of growth from reinvestment of their cash flows at high rates of return.
 
Resilient to change, particularly to technological innovation.  We will not invest in industries which are exposed to rapid technological innovation and therefore obsolescence. This approach renders many sectors uninvestible.
 
Attractive valuations.  We estimate the free cash flow of every company after tax and interest, but before dividends and other distributions, and after adding back any discretionary capital expenditure which is not needed to maintain the business.  Otherwise we would penalise companies which invest in order to grow.  We only buy stocks when they are reasonably priced based upon this cash flow yield.
 
Fundsmith’s approach to investing includes:
 
Invest for the long term:  Our ideal holding period is indefinite.  FSA research shows that the average mutual fund manager turns over his portfolio 80% p.a., costing the fund 1.5% in dealing commissions and spreads,  a figure which is not included in the widely quoted TER.
 
No market timing:  If investors had missed the 20 best days between 1980 and 2009, an index fund would have risen by just 240% instead of 700%.  Therefore we won’t risk playing “hokey cokey” with your investment and will maintain a full exposure.
 
High conviction:  According to modern portfolio theory, close to optimal diversity can be achieved after adding the 20th stock.  Too many investment managers have abandoned focused stock picking and behave like lemmings and closet track the index. 

Emotional discipline:  Investors are their own worst enemy.  Research from Dalbar, Inc.  in the US shows that the average equity fund investor significantly underperforms the average equity fund due to their propensity to buy funds at the top and sell them at the bottom of market cycles.  This is a core reason for writing our Owner’s Manual, the aim of which is to help our investors understand the importance of rational and emotionally disciplined investing.  Often the best course of action is to do nothing.
 

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