Fundsmith hints at bumpy ride

Photo of Laith Khalaf, head of investment analysis at AJ Bell.
  • Terry Smith’s annual letter to shareholders reports a slight underperformance of the MSCI World Index over one year
  • Despite the value rally, quality stocks outperformed in 2021
  • Smith says unexpectedly high inflation could mean ‘an uncomfortably bumpy ride in terms of valuations’


Laith Khalaf, head of investment analysis at AJ Bell, comments:

“As usual in his annual letter to shareholders, Terry Smith pulls no punches, taking aim at Unilever and value stocks. The Fundsmith Equity fund returned 22.1% last year, very slightly behind the MSCI World Index, which returned 22.9%. 2021 was characterised by a rally in value stocks, which Smith doesn’t invest in, preferring instead to fill his portfolio with quality companies. The simplest conclusion to draw is that Smith didn’t beat the index in 2021 because his style was out of favour, but that’s not the whole story.

“The MSCI Quality Index, which Smith himself uses as a surrogate for his strategy in his letter, actually beat the MSCI Value index over the course of the year. The former returned 26.8%, the latter 23.1%, with the broad MSCI World Index returning 22.9% for sterling investors. So the quality style was actually once again a tailwind, despite value stocks having a much improved year, thanks to renewed economic optimism after the arrival of coronavirus vaccines. One might therefore have expected the Fundsmith Equity fund to perform better, were it not for some stocks let the side down, which Smith details in his letter.

“This shows investors shouldn’t necessarily expect outperformance over a one year period, even from a fund manager as good as Smith, and even if their style is in favour. That’s particularly the case for a concentrated portfolio, where individual stock performance can sometimes outweigh investment style. The proof of the Fundsmith pudding is of course in the long term performance figures, which remain exceptional. The fund has turned £1,000 invested ten years ago into £5,832 today, compared with £3,792 from the MSCI World Index. Fundsmith Equity has also outperformed the MSCI World Quality Index, which would have turned £1,000 into £4,821, demonstrating Smith has added value over and above a simple quality approach over a lengthy period.

“Looking forward, Smith highlights the risk inflation poses to valuations, but suggests the high margins enjoyed by the companies in his portfolio will offer protection. He’s right, but in an inflationary environment, it’s difficult to predict how the battle between these opposing forces might play out in share price performance. So while Fundsmith Equity is undoubtedly an excellent fund, investors should seek to have a range of management styles within their portfolio, in case the tide turns against one particular approach to investing.”

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