Fundsmith Equity Fund these days is an exception in a sea of underperforming value investors. Terry Smith, CEO and CIO, had a very structured set of ideas and applied them flawlessly since its inception in November 2010.
To good to be true
Some might say that his criteria led him to invest in consumer staples, health care and technology companies at exactly the right time, when rates were extremely low and, against all odds, stayed low for a long time. That benefited stable, yielding businesses.
Others might point out that Smith invested mainly in U.S. or European companies and because of that benefited from the significant devaluation of the pound after Brexit (Fundsmith is quoted in pounds, and its managers do not try to predict foreign exchange variations, eliminating the need to edge currency exposure).
Or they say that he was just extremely lucky to have chosen the right set of companies that got almost perfect performance records and that it will be very difficult to accomplish the same in the future. (Other value investors also follow similar strategies and have not come anywhere close to Fundsmith’s track record over the last eight years.)
It could definitely be that in the next eight years, the more cyclical, more leverage companies will be favored against the stable consumer and tech businesses. Or that the pound will recover. Or that the set of companies chosen by Fundsmith will not be the best ones.
But an investor should not expect to get 19.5% a year for the rest of their life! What should be highlighted from the Fundsmith journey is the soundness of its strategy over the long term.
Charlie Munger (Trades, Portfolio)
We all know that it was Charlie Munger (Trades, Portfolio) who influenced Warren Buffett (Trades, Portfolio) to progressively change his investment strategy to select businesses with durable competitive advantages and competent managements, buy them at a reasonable price and hold them forever. But then the questions arises: Why should we pay a high price for a high-returning business when we can buy a reasonably returning business very cheap?
An example
Smith gave a terrific example in the Fundsmith 2016 Investors Conference about the importance return on capital employed (ROCE). Imagine that you can invest only in one of two companies for 40 years:
- Company A makes a 20% annual ROCE. You can buy it a four times book, and you can only sell it (40 years later) at twice book.
- Company B makes a 10% annual ROCE. You can buy it at twice book and get the opportunity of selling it at four times book.
Also, the companies do not pay any dividends and reinvest all their earnings back into the businesses at the same ROCE rates.
Which one would you choose?
Well, company A would give the investor a 18% CAGR, and company B would return 12% CAGR.
If you have a long-term time horizon, the return on reinvested capital is the single best determinant of performance.
Read more here:Â
Fundsmith: The Charlie Munger ApproachÂ
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