Fundsmith Equity Fund: an update from Terry Smith

For investors in Fundsmith Equity, manager Terry Smith’s annual letter is an eagerly awaited event that sheds light on what he has been doing during the year and his views on the market. It is often highly illuminating and sometimes controversial, which makes it essential reading for all existing holders and anyone thinking of buying.

What does the fund invest in?

Fundsmith Equity invests in a concentrated portfolio of global stocks and takes a long-term view. It uses strict criteria to select the holdings and summarises its strategy in three simple steps: buy good companies, don’t overpay, do nothing.

Smith targets: high quality businesses that can sustain a high return on operating capital, whose advantages are difficult to replicate, that do not require significant leverage, which have a high degree of certainty of growth from reinvestment of their cash flows, that are resilient to change and whose valuation is considered to be attractive.

At the end of December the £27.3bn fund held a portfolio of 27 stocks with a median market cap of £89.1bn and that on average had existed for more than a 100 hundred years. These included the likes of Microsoft, Novo Nordisk, L'Oréal and Meta Platforms.¹

What is the manager’s latest view?

In his letter Smith says that in 2023, the returns on capital and operating profit margins were higher in the portfolio companies than in the past, while the gross margins were steady.

“Importantly all of these metrics remain significantly better than the companies in the main indices. Moreover, if you own shares in companies during a period of inflation it is better to own those with high returns and gross margins.”

Perhaps his most interesting comments were reserved for the performance of the Magnificent Seven — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla — that were responsible for most of the gain in the US indices last year.  The fund does not own all of them, with the manager saying that they would probably not be willing to take the risk of doing so, even if every one of them fitted their investment criteria.

This is because Smith questions the Artificial Intelligence boom that has powered their share prices higher and is suspending judgement on who the winners will be, if indeed there are any winners at all.

How has the fund performed?

2023 was the third year in a row that the fund underperformed the MSCI World Index, although it still generated a healthy gain of 12.4%. Please remember past performance is not a reliable indicator of future returns. Despite this the longer-term record is exceptional. Since inception in November 2010, it is the best performer in the Global sector with a cumulative return of 549.7%, well ahead of the 316.7% increase in the benchmark².

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. The Fundsmith Equity Fund invests in a relatively small number of companies and so may carry more risk than funds that are more diversified. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.