Terry Smith’s Fundsmith Equity Fund is one of the (if not the) most popular funds in the UK right now. And that’s no surprise, as over the last five years it has returned an incredible 140%, which is a fantastic figure.
So, what is Smith doing differently to other portfolio managers and investors? Let’s take a closer look at his approach to investing.
Global investing
For starters, Fundsmith invests in equities on a global basis and therefore, Smith has access to a vast universe of securities. This is clearly an advantage as it provides the portfolio manager with a broad range of exciting growth opportunities that are outside the UK.
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Analyse mainstream UK equity funds and all too often, you’ll find the same old FTSE 100 names in the top 10 holdings. Yet look at Smith’s fund and you’ll see names such as Microsoft, Facebook and medical technology company Stryker in the top 10 holdings, all of which are US-listed and have performed very well over the last few years. My takeaway for private investors? It can pay to diversify outside the UK.
Strict criteria
Turning to Smith’s investment process, it’s clear that he has very strict criteria when it comes to choosing stocks. Specifically, he looks for high-quality businesses which have the following attributes:
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Advantages that are difficult to replicate
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Resilience to change (particularly technological innovation)
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Low leverage (debt)
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A high return on operating capital employed that is sustainable
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A high degree of certainty of growth from reinvestment of cash flows
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An attractive valuation
Looking at this criteria, it’s very similar to Warren Buffett’s approach to investing. And there’s nothing overly complicated about it.
Sector bias
Yet it’s worth pointing out that Smith tends to avoid certain sectors such as financials, and heavily cyclical sectors such as construction, utilities, resources, and transport. Instead, he prefers to invest in sectors such as technology, consumer staples, and healthcare. At the end of October, Fundsmith had a 30.4% weighting to technology, a 28% weighting to consumer staples and a 25.5% weighting to healthcare.
Concentrated portfolio
Another feature of Smith’s investment strategy is that, unlike many other portfolio managers, he invests with a very concentrated approach, and his portfolio may only contain 20 to 30 stocks. This is a slightly more risky approach to investing, yet it clearly seems to work for the portfolio manager.
Long-term approach
Lastly, it’s worth noting that Smith is very much a long-term investor and he specifically states on the Fundsmith website that the fund “will not adopt short-term trading strategies.” Moreover, he also states that the fund will not use derivatives, shorting strategies or market timing tactics. In other words, he keeps things very simple, as investing should be.
So overall, there’s nothing too complicated about Terry Smith’s investment strategy. There’s nothing that private investors couldn’t do themselves. I feel the key is to keep things simple, invest in high-quality businesses, diversify and invest for the long term.
