Nick Train and Terry Smith are two of the UK’s top fund managers. Train’s global fund, Lindsell Train Global Equity, is up around 133% over the last five years. Meanwhile, Smith’s fund, Fundsmith Equity, which is also a global fund, is up about 161%. To put those numbers in perspective, a FTSE 100 index tracker has returned a total of about 17% over that period.
What’s interesting about these two fund managers is that they’ve been able to generate these extraordinary returns with very straightforward approaches to investing. Both keep things very simple. They don’t do anything that you and I can’t do. With that in mind, here’s a look at five things we can all learn from Nick Train and Terry Smith.
Follow Warren Buffett
The first thing that stands out to me about these two portfolio managers is that both focus on businesses that are very profitable.
Fundsmith’s holdings, for example, had an average return on capital employed (ROCE) – a key measure of profitability – of 29% in 2019. By comparison, the average FTSE 100 company had a ROCE of 17%. So, Smith invests in companies that are far more profitable than the average company. It’s a similar story for Train.
It appears that they’ve followed Warren Buffett here. In his 1979 letter to investors, Buffett wrote: “The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed and not the achievement of consistent gains in earnings per share.”
Valuation is not the ultimate focus
The next thing to note is that neither go for really cheap ‘value’ stocks. Look at the holdings in Fundsmith and LT Global Equity and you’ll find many stocks that are relatively expensive. Unilever, for example, which can be found in both funds, currently trades on a forward-looking P/E ratio of about 21. PayPal, which is also in both, is on a P/E of about 50. Both fund managers are willing to overlook a higher valuation if the company has high-quality attributes.
“Concerns that any company’s shares are too expensive have not been particularly helpful over the last few years and into 2020. Instead, apparently ‘expensive’ companies with a strategic growth opportunity have often carried on doing well in share price terms,” Train commented in July.
Brands are powerful
Like Buffett, both also like companies that own powerful brands. A dominant brand can be a competitive advantage. I mentioned above that both fund managers hold Unilever. Its brands include Dove, Radox and PG tips. Both also hold Diageo. Its brands include Johnnie Walker, Tanqueray and Smirnoff. These are all dominant brands that generate consistent sales.
Consumer staples are reliable
This brings me to my next point – both fund managers like the consumer staples sector. At the end of August, Fundsmith had 29% of the fund allocated to this sector. At the end of July, LT Global Equity had 44% in this sector.
The reason they like this sector is that it contains reliable companies. Many sell products that we buy repeatedly, regardless of economic conditions, meaning they’re not as cyclical as other companies. This helps portfolio performance during downturns.
Best ideas focus
Finally, it’s worth noting that both run relatively concentrated portfolios. Both tend to hold less than 30 stocks. So, they diversify, but they don’t over-diversify. Instead of buying loads of stocks, they focus heavily on their best ideas.
