Fundsmith Equity Fund: update from Terry Smith

It has been a disappointing period for holders of the Fundsmith Equity Fund, as 2024 was the fourth consecutive calendar year that it had underperformed the benchmark and the third that it had lagged behind its global peers. The main reason was the underweight exposure to the large US tech companies that have driven the market higher, yet the longer term record is still excellent and it remains a popular option amongst retail investors.

Manager Terry Smith has recently published his annual letter to shareholders in which he explains his current views and positioning. The update is always insightful and worth paying attention to if you have money in the fund or are thinking of investing.

Objective and approach

Smith is a long-term investor and has stringent criteria that he uses when selecting which stocks to include in the portfolio. These are designed to ensure that the fund only holds good quality businesses that: can sustain a high return on operating capital employed; whose advantages are difficult to replicate; and that do not require significant leverage to generate returns.

The companies also need to enjoy a high degree of certainty of growth from the reinvestment of their cash flows at high rates of return; be resilient to change, particularly technological innovation; and be trading at an attractive valuation. This disciplined strategy has resulted in a concentrated global portfolio with very few additions and disposals.

The underlying holdings

At the end of January the £23.6bn fund had just 26 different holdings that had a median market cap of £95.2bn and on average were founded in 1922. Most are incorporated in the US, which accounts for 71.2% of the assets, with the remainder invested in Continental Europe and the UK¹.

Top-10 holdings

1. Microsoft
2. Meta Platforms
3. Novo Nordisk
4. L’Oreal
5. Stryker
6. Visa
7. Automatic Data Processing Inc
8. Philip Morris
9. IDEXX Laboratories
10. LVMH 

Source: Fidelity International, 31 December 2024

It’s an approach that Smith sums up as: ‘Just a small number of high quality, resilient, global growth companies that are good value and which we intend to hold for a long time, and in which we invest our own money².’

Performance

In 2024 the T Class Accumulation shares rose by 8.9%, which was well behind the increase of 20.8% in the MSCI World benchmark. One of the main reasons for this was that 45% of the returns of the US equity market – the biggest component of the global index – were due to 5 stocks (Nvidia, Apple, Meta, Microsoft and Amazon) where the fund had an aggregate underweight position³.

However, the longer-term record is still excellent. Since inception in November 2010 the fund has generated a cumulative return of 607.3% compared to the 403.4% produced by the benchmark and 254% from its global peers³. Past performance is not a reliable indicator of future returns.

What are the manager’s latest views?

Writing in his annual letter for 2024, Smith said that the fund consists of companies that are fundamentally a lot better than the average of those in the S&P 500. This is demonstrated by the fact that on a look-through basis, the portfolio has a Return on Capital Employed of 32%, a Gross Margin of 64%, an Operating Margin of 30% and Interest Cover of 27x, all of which are far superior to the S&P 500 and FTSE 100 indices⁴.

“What we are seeking to achieve with the Fundsmith Equity Fund…is to produce a high likelihood of a satisfactory return rather than the chance of a spectacular return which could be spectacularly good or spectacularly bad⁵.”

How do the costs stack up?

The ongoing charges figure for 2024 for the T Class Accumulation shares was 1.04%, which is fairly typical for an actively managed global fund. However, a key differentiator is the long-term approach that results in a much lower level of transaction costs than some of its peers, with Fundsmith calculating them to be just 0.01% last year⁶.

For more information see Fundsmith Equity Fund

Past performance is not a reliable indicator of future returns

^1,2 Fundsmith, Factsheet as at 31 January 2025
^3,4,5,6 Fundsmith, annual letter 2024

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.