Fundsmith Launches Regular Withdrawal Facility and Questions Accepted Reasons for Buying Income Funds
Fundsmith today announces that it has launched a regular withdrawal facility enabling investors to elect to receive a set level of periodic cash from the redemption of units in their holding of the Fundsmith Equity Fund which will be automatically remitted to their bank account.
Fundsmith understands that many investors rely on their savings to produce a source of income but does not believe the best investment result can be achieved by investing solely for income. For instance, the average IMA Global Equity Income fund made a total return in 2012 including dividends of +9.7% whereas the Fundsmith Equity Fund delivered a total return of +12.5% over the same period.
• Investing in the highest dividend yielding companies in the market can deprive investors of the potential to compound the value of their capital. We know of virtually no business that can grow without reinvestment. It is important to us that the companies in our portfolio reinvest at least a portion of their cash flow back into the business to grow. The companies in the Fundsmith Equity Fund all generate a high return on reinvested cash. Over time, this should compound shareholders’ wealth by generating more than a pound of stock-market value for each pound invested. On the other hand, investing in high dividend yield companies risks the likelihood that the company is over-distributing (paying out most or all of their earnings as dividends) and cannot reinvest to compound value.
• Funds which promote a high level of income are often charging their management fees to capital and so the total return is obscured. In the Fundsmith Equity Fund dividends are received as income, from which the costs of running the fund are deducted and the residual figure is available as a dividend to shareholders. Our analysis of the IMA Equity Income Sectors shows that the vast majority of income funds charge their costs against capital. This “sleight of hand” allows them to boast about a high level of yield whilst at the same time depleting the value of your capital. Charging costs to capital is tax inefficient as income is currently taxed in the UK at a higher rate than capital gains and, unlike Income Tax, Capital Gains Tax can be deferred by not releasing gains thus allowing value to compound on, what is in effect, an interest free loan from the taxman.
Terry Smith, Chief Executive of Fundsmith, commented: “Divorcing income from growth in equity investing is an arbitrary and dangerous distinction. We invest for total return and actively seek out those companies that can achieve a high rate of return on reinvested cash flow. Companies that over distribute profits can jeopardise their future growth. Our Regular Withdrawal Facility will allow investors to elect to drawdown 'an income' from their capital. This leaves our investment philosophy intact and removes the risk of bias towards investing in over-distributing businesses. It also has a significant advantage over charging costs to capital, from a domestic tax perspective, as capital gains are typically charged at a lower rate than income and can be deferred.”