Fundsmith Equity, the largest fund in the UK with £23.27 billion in assets, has seen its fourth calendar year of underperformance. In 2024, the Fundsmith Equity T Class Accumulation grew 8.9%, while the MSCI World Index (net) grew 20.8%.
In a letter to investors, Terry Smith said outperforming the market or even making a positive return is “not something you should expect from our fund in every year or reporting period, and outperforming the market was more than usually challenging once again in 2024.”
He highlighted how only five stocks (Nvidia NVDA, Apple AAPL, Meta META, Microsoft MSFT and Amazon AMZN) provided 45% of the returns of the S&P 500 index, while SAP SAP alone accounted for 41% of Germany’s DAX Index. Meta and Microsoft were the two biggest Fundsmith contributors.
“Our fund is the second-best performer since its inception in November 2010 in the Investment Association Global sector of 162 funds, with a return 353 percentage points above the sector average which has delivered just 254% over the same timeframe.”
According to Morningstar data, the fund has returned 3.43% over an annualized three-year period, 8.85% over five years, and 13.35% over 10 years.
Fundsmith Makes Portfolio Changes
Smith runs Fundsmith with a simple three-step investment strategy: buy good companies, don’t overpay, and do nothing. Yet, over the past year, the fund sold out of three companies, Diageo DGE, McCormick MKC and Apple AAPL. The team also started purchasing stakes in Atlas Copco ATCO A and Texas Instruments TXN.
Morningstar Metrics for Fundsmith Equity T Acc
• Morningstar Medalist Rating: Silver
• Morningstar Category: Global Large-Cap Growth Equity
• Ongoing Charge: 1.04%
Morningstar’s manager research analyst Daniel Haydon, who covers Fundsmith Equity, says:
“Terry Smith underperformed again in 2024. This phenomenon is not exclusive to Smith. Many other buy and hold quality-growth fund managers we like have suffered too. Market concentration has been extreme. It was perhaps no surprise then that in his 2024 annual letter—which is always worth a read—he again pointed a finger to the index as a key driver for underperformance last year.
“One would be forgiven for thinking of Ground Hog’s Day when reading the letter: there were many similarities to last year’s missive. Two points stand out to me as interesting. Firstly, cash conversion has fallen, driven by large increases in capital expenditure at some key holdings —is Smith now more comfortable with large capex? The other is that portfolio activity increased, albeit very modestly. Smith has shown willing to take action. While not huge last year, outflows permit buy-and-hold managers to make sales without portfolio turnover increasing too much. The uptick in ‘name turnover’ is not out of lines with expectations.
“The most notable exit is the sale of long-standing holding in Diageo. After 14 years, he said goodbye to the stock in August 2024. Here, Smith pointed to the potential impact on demand for alcohol from weight loss drugs such as Ozempic, in addition to considerations about management quality. We have heard from other managers about the potential for GLP-1 drugs to affect demand for alcohol from other managers in the last 12-18 months but note that fellow purveyor of alcoholic drinks Brown Forman has been maintained in Smith’s portfolio. In any case, we will look forward to our annual review meeting with Smith in the coming weeks, where we will be focusing mostly on what is in the portfolio and his key decisions through the year, and not on what is going on in the index.”
Are Markets Beating Active Managers?
Commenting, Laith Khalaf, head of investment analysis at AJ Bell, says: “The question at present isn’t so much whether Terry Smith is underperforming the MSCI World Index, but whether the index is outperforming Smith and his fellow active managers.”
“Investors can draw some reassurance from Fundsmith Equity’s longer term performance numbers, and from a clearly framed and executed investment strategy. Those who are attracted to the mantra of ‘buy good companies, don’t overpay, do nothing’ are themselves likely to apply a similar philosophy to the active managers they invest in, so many will undoubtedly stick with Smith through the tougher times, especially when they have enjoyed such long-term success and when recent returns have still been so positive in absolute terms.
Khalaf adds: “Conversely, patience is not a creed Smith advocates for management of publicly listed companies, saying the speed of firing executives in the US is part of the reason for its economic success.”
Do Passive Funds Drive AI Growth?
In his letter, Terry Smith also took aim at passive tracker funds’ contribution to the AI growth. These vehicles, he says, inevitably end up with high exposure to the concentrated top of indexes like the S&P 500. With assets continuing to flow into passives, the largest portion of inflows into index funds are going to the largest companies which are already doing well—including those that are exposed to AI.
“In late 2023 passive investment via index funds exceeded the amount of assets held in active funds for the first time. They are now more than half of Assets Under Management (‘AUM’). However, during the Dotcom boom only about 10% of AUM was in passive funds,” Smith said.
He also highlighted the possibility of tech selloff, although he isn’t sure what the catalyst would be for this.
“This is a self-reinforcing feedback loop which will operate until it doesn’t. For example, were there to be an economic downturn which led to a reduction in tech spending, which is now so large a proportion of overall spending that it cannot be non-cyclical, one area of vulnerability might be spending on AI as it is not currently generating much revenue.
“Were the largest companies then to produce disappointing results, their share prices are likely to react badly which will drag down the index performance more than that of those active managers who are underweight in these stocks. But even if some scenario like this awaits us in the future, what exactly will cause this and when it may occur is difficult or impossible to predict.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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