Business Insider - Investing legend Terry Smith's $30 billion equity fund returned 440% to investors over a decade
Here's his 4-part strategy for success and 10 pieces of investing wisdom to take into 2021
- A decade since launching a new equity fund, investing legend Terry Smith has amassed £23 billion assets under management and returned 440% to investors over that timeframe.
- Smith provides Insider with exclusive insight into his 4-step strategy for success.
- "Study the subject before you invest," said Smith in an email interview. "You probably need to study for several years and see at least one full business and market cycle before you can be competent to invest."
- Insider also breaks down the top pieces of investing wisdom from Smith's book, Investing for Growth, which collates his essays and letters to investors over the 10 year period.
In 2010, Terry Smith launched a new equity fund with only £39 million ($52 million) assets under management, £25 million ($33 million) of which was from his own personal account, as he started a new investment firm, Fundsmith.
By the end of the decade, the Fundsmith Equity fund had amassed £23 billion ($30 billion) assets under management and returned 440% to investors over that timeframe.
To put that into perspective, if an investor placed £10,000 into the Fundsmith Equity fund at launch, they would have just short of £54,000 this year.
The fund's performance over the last decade means Smith is viewed as an investing legend. He is often compared to legendary US investor Warren Buffett, and sometimes even referred to as Britain's answer to the Berkshire Hathaway boss himself.
"How does it feel to be a legend? Pleasing, obviously, but I never take anything for granted," said Smith in an email interview with Insider.
But Smith's trajectory to investment legend started long before the launch of Fundsmith. He started his career at Barclays in 1974 then became a top-rated banking analyst in London at UBS Phillips & Drew before releasing his best-selling book, Accounting for Growth, which covered the accounting techniques firms use to hide, or enhance, their performance.
The book was informed by Smith's time as analyst, but resulted in his dismissal from UBS for refusing to withdraw it. The dismissal didn't impact Smith's career too much, he later became chief executive of Tullet Prebon, one of the world's biggest money brokers.
But it has been Fundsmith that has really catapulted Smith into the limelight. The combination of the fund's impressive performance with Smith's blatant transparency on his investing strategy and his honesty on the markets garnered a huge following.
Smith collated those thoughts from his essays, articles and shareholder letters into a book called Investing for Growth to celebrate Fundsmith's 10-year anniversary.
The book provides investors with deeper insights into Smith's investing strategy, successes, failures over the 10-year period.
In fact, it was reading investors' insights, similar to the book he released in October, is what has shaped and informed Smith's investing strategy and philosophy over the years.
"I have been inspired by many investment practitioners and authors," said Smith, in an interview over email. "I started reading the now legendary Berkshire Hathaway annual chairman's letter in the 1980s. I have read literally hundreds of books and studied the investment process of many investors, ranging across almost every style of investment when I was an analyst and head of research. I knew many of the most famous investors, because I provided research to them. To be a success, I think you need to synthesize a lot of sources."
Throughout the book, Smith reiterates his 3-step core investment strategy that Fundsmith leverages, which is to invest in good companies, don't overpay and do nothing.
But in an email interview with Insider, Smith gives more some insight into the four factors he believes has driven his and the firm's success:
- "We developed and refined our investment strategy over decades before we started Fundsmith," Smith said. "We didn't start the business, raise a fund and then think 'how shall we run the fund, and what shall we invest in?' We already knew."
- "We launched a strategy which we knew worked in the sense of delivering superior risk adjusted returns, and we knew we could deliver it," Smith said. "We didn't think 'Ah, there's a lot of demand for BRIC, FAANG, ESG (insert current fad) funds, so let's launch one'."
- "We work hard," Smith said. "I think success is less about having great ideas and far more about good execution, and we work very hard every day at unglamorous tasks like analysing results, attending conferences, reading trade publications, and updating models."
- "And last but by no means least, I have help from some fine colleagues without whom this would not be possible. It's invidious to single out one, but I am going to. Julian Robins, our head of research and I, first worked together 34 years ago and he's the greatest combination of integrity and ability that I have ever encountered."
For young investors looking to get ahead in the world of investing, Smith re-emphasizes working hard.
"Study the subject before you invest," Smith said. "You probably need to study for several years and see at least one full business and market cycle before you can be competent to invest."
Insider breaks down the top 10 pieces of wisdom from Smith's new book to take into 2021 and outlines Smith's book recommendations for Insider readers.
10 pieces of investing wisdom
All the following quotes are from Investing for Growth.
1. If you don't understand a company, don't invest
One of the key components of Smith's investing mantra is to invest in good companies. How can an investor invest in good companies, if they don't understand them? Smith continually emphasizes throughout the book how crucial it is to understand the companies being considered for investment.
"I'm often asked why I won't invest in bank shares given that I was once a top-rated banking analyst in the City. The answer is that having an understanding of banks would make anyone more wary of investing in them. One of my basic tenets is never to invest in a business which requires leverage of borrowing to make adequate returns on investing."
In the book, Smith lays out the 13 ways he thinks about company valuations.
Source: Investing for Growth, Terry Smith
2. Be cautious of jargon
From IBM in a presentation using the word "roadmap" instead of "plan", to someone "reaching out to you" in an email, Smith is cautious and wary about any unnecessary jargon that could conceal an accurate picture of a firm's operational or managerial decisions.
"At Fundsmith, we keep a banned word count for the companies we analyze, because we think they provide an insight into their management … but when we do listen to management, the straight talkers get our vote and our money."
This counts also when selecting mutual funds.
"How about Pimco's Fundamental Advantage Fund? Would the fees perhaps be lower and attract investors into a 'Fundamental Disadvantage' fund?"
Source: Investing for Growth, Terry Smith
3. Have a watch list
Investors should have an idea of the companies they want to invest in and look for opportunities to buy into those great companies at good prices, Smith said.
One example in the book was when Bloomberg published a story about a strike at Fresh Del Monte Produce Inc, which is an entirely different company from Del Monte Foods. However, the news story caused the share price to drop, creating an opportunity for Smith to buy into the company more cheaply.
A similar opportunity could arise when companies have problems. It's up to the investors to understand whether the problems are temporary and create opportunities, or are an existential threat, Smith said.
"You might only get to invest in really good businesses at a cheap rating when they have a problem."
Source: Investing for Growth, Terry Smith
4. Get comfortable with selling a company
Smith recommends investors understand what a company is worth and that they should always be ready to sell when the valuation gets too high, no matter how much they like the firm.
"Domino's shares rose in price by 113% during the year and had reached a point at which they no longer represent good value. Domino's also has refinancing of debt due by 2014. There is nothing in the performance of Domino's which causes us the slightest concern about this, but there is plenty wrong with a banking system, which will be required to provide the refinancing. As a result we hope to have the opportunity to become investors in Domino's again."
Source: Investing for Growth, Terry Smith
5. Question share buybacks
Investors and commentators should analyze share buybacks the same way they would if they were to buy shares in another company, Smith said. He also highlights multiple times in the book how share buybacks can be used to inflate a company's earnings-per-share.
"Share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash which would generate a higher return."
"We regard the greatest risk to our investors — after the obvious potential for us to buy the wrong shares, or to pay too much for shares in the right companies — as being reinvestment risk: we seek to buy companies which deliver high returns on capital in cash. What the management then does with these cash returns is one of the major factors affecting futures returns on the portfolio."
Source: Investing for Growth, Terry Smith
6. Don't overpay
Smith, from the outset of Fundsmith, wanted to have a fund that would be a reasonable cost. Throughout the book he reminds investors not to overpay for companies or funds.
"If you are going to own a portfolio of good companies with high returns, which compound in value over time, you can't play 'greater fool theory', in which you knowingly overpay for the shares, hoping that a greater fool will buy them off you at an even egregious valuation, as you intend to hold on to them."
"Fees paid to fund managers and advisers are a drag on investment performance. The average UK investor who invests via an adviser, uses a platform and then invests via an adviser, uses a platform and then invests in mutual funds incur total charges of about 3% each year. This is higher than the yield on equities and most government bonds. So all and more of income from his or her investments is being consumed by fees."
Source: Investing for Growth, Terry Smith
7. Stop trying to predict the economy and market
Stop trying to time the market and macroeconomic events. Instead focus on high quality companies that can be resilient over many decades, Smith said.
"When it comes to so-called market timing there are only two sorts of people: those who can't do it and those who know they can't do it. It's safer and more profitable to be in the later camp."
"I am amazed by how much time and effort people waste trying to guess what will happen to known unknowns . Brexit, China, commodities, interest rates, oil price, quantitative easing, and the US presidential election are all known unknowns."
Source: Investing for growth, Terry Smith
8. Wait it out
At the start of the majority of Smith's annual shareholder letters, he reminds investors to think long-term about the returns of his funds.
"We never tire of reminding people that we remain critical of attempts to measure performance over short periods of time, such as a year."
"Rather than seeking superior portfolio performance by chasing high-risk stocks ("return-free risk"), investors should seek out "boring" quality companies, which have predictable returns and superior financial performance and that advantage of their persistent undervaluation relative to those returns to buy and hold them."
The same mantra of "wait it out" holds true for finding fund managers.
"Too often, investors seek to find fund managers who can outperform all the time and in all market conditions. The trouble is that no such person exists. But the attempt to find this mythical creature leads to some investors moving their assets between managers, incurring costs and most frequently ditching a manager whose investment style is out of step with the current market in favour one with recent good performance just as they are about to switch positions."
Source: Investing for growth, Terry Smith
9. Be cautious of shareholder activism
As with jargon, investors should be cautious of shareholder activism and activist motives, Smith said. On the whole, the firm is not a fan of activism. Often activist shareholders tend to follow a 5-step playbook laid out in the book that tend to disadvantage the long-term investor.
"All very exciting, but not much use to long-term shareholders like us, who are left with holdings in fragmented businesses, often with new management teams and strained management teams. Then, their accountants and others, followed by financial statements that contain so many adjustments that they border incomprehensible."
"In our experience, a dialogue which you seek to change behaviour is best at least started in private. Seeking a public spat at the outset, seems to us to be more closely aligned with a desire to seek a certain public profile, rather than to effect corporate change."
"However, whilst we question the motivation and methods of activists, and how companies respond to them, we do not always disagree with them."
Source: Investing for growth, Terry Smith
10. Admit when you are wrong
Finally, be able to admit when you're wrong and adjust your investment strategy accordingly, Smith said.
"Domino's proved us comprehensively wrong. Not only did it manage to refinance, but it did so on terms which enabled it to pay a $3 per share special dividend. So, I did what you should always do when you get it wrong (but which all of us rarely manage to):
- Admit this (most importantly to yourself)
- Reverse the decision
So Dominos was repurchased"
Source: Investing for growth, Terry Smith
Bonus: Book recommendations
In addition to being able to gain insights from Smith's new book, he also provided Insider with a small selection of books he would recommend to our readers:
Berkshire Hathaway's annual chairman's letter
The Warren Buffett Way by Robert Hagstrom
Liar's Poker, The Big Short, Flash Boys and Moneyball - All by Michael Lewis
The Predators Ball by Connie Brook
Hawkwood: Diabolical Englishman by Frances Stonor Saunders
The Most Dangerous Enemy by Stephen Bungay
Business Adventures by John Brooks
Merckx by William Fotheringham