As quoted from Fundsmith website, Fundsmith was established to be different from its peers so as to achieve a different result in line with Sir John Templeton’s axiom that “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
So, what does Fundsmith Equity Fund do differently to continue beating the index year after year? Let's delve into the key factors that contribute to his remarkable success:
Buying great businesses
Rather than seeking low price-to-earnings (PE) bargains, Fundsmith Equity Fund focuses on identifying and investing in exceptional businesses. Some notable holdings that have a higher PE ratio include Microsoft, LVMH, L’Oreal, and Novo Nordisk.
In the wise words of Terry Smith, ‘’you can’t compare Fords to Ferraris, the fact that the one is priced lower than the other doesn’t tell you anything about the bargain you’re getting’’. In other words, Terry smith believes PE ratio tells you nothing about the value of the business.
It is worth noting that despite owning the higher PE stocks in their portfolio, Fundsmith's risk measure remains lower than the category average, as evidenced by their Sharpe Ratio1 (Fundsmith’s 1.09 compared to the FTSE World Equity of 0.53 – Stat taken from April 2023).
1A higher Sharpe Ratio means the investment has given us better returns compared to the risk we took. It suggests that the investment has performed well and rewarded us for the amount of risk we assumed. On the other hand, a lower Sharpe Ratio means the investment has not provided sufficient returns considering the level of risk. It indicates that we might be taking too much risk for the returns we are getting.
Identifying the quality of business using 5 variables
Return on Capital Employed (ROCE)
Legendary investor Warren Buffett, in his 1979 annual letter as Chairman of Berkshire Hathaway, described ROCE as ‘The primary test of managerial economic performance’
Terry Smith considers ROCE the most crucial variable. As shown in their annual shareholder letter, Fundsmith Equity Fund boasts a ROCE of 32%, significantly surpassing the FTSE index's 18%.
So why is ROCE important to Terry smith?
ROCE is a measure that shows how well a company uses its invested money to generate profits. A higher ROCE indicates that a company is generating more profit for each dollar of invested capital, and suggest that the company is deploys their capital efficiently to generate returns.
Fundsmith Equity fund high gross margin of 64% compared to the FTSE index of 42%. Gross margin can be derived by subtracting the cost of goods from the sales.
In other words, Fundsmith Equity Fund holds companies that tend to be capital-light businesses to run their operations.
Fundsmith's Equity Fund operating margin of 28% outperforms the index's 18%.
In a period of high inflationary environment, it is import to own shares in companies with higher operation margins as it shows that the businesses have an advantage in pricing power
While there is a drop to 88% for Fundsmith Equity Fund in 2022, it is still above the FTSE index of 66%.
Cash conversion evaluates how effectively companies convert profit into cash. Businesses that require more capital expenditure and working capital to operate have a lower cash conversion %.
Fundsmith Equity Fund interest coverage ratio of 20x surpasses the FTSE index's 11x.
In laymen terms, Fundsmith Equity Fund profits are 20x of its debt interest charge, which means there is little doubt that the companies can service its debt payments even in a recessionary economy.
By following these strategies, Terry Smith has consistently outperformed the market, establishing his reputation as the Warren Buffett of Britain.
How has Fundsmith Equity Fund performed since launch in Nov 2010?
Disclaimer: It's important to note that past performance is not indicative of future results, and that investing always carries risks. It is essential for investors to thoroughly research and understand the risks associated with investing in any particular fund before making an investment decision.
With annualized rate returns of 15.6%p.a (accurate as of 30th June 2023) since its launch of fund in Nov 2010, Fundsmith Equity Fund constantly outperforms the MSCI World Index.
Investing into Fundsmith Equity Fund in Singapore?
If you are a retail investors looking to invest into Fundsmith Equity Fund, you can gain exposure via ILPs – Investment-Linked Plans.
Currently, there are insurers from Tokio Marine, Singlife, HSBC Life, FWD and Etiqa that carries Fundsmith Equity Fund in their 101-ILP platform. While fees and charges associated with ILP are typically categorized to be higher, there are usually start up bonuses and loyalty bonuses to off-set them.
It is also important to note that the ILP from Tokio Marine, Singlife, HSBC Life, FWD and Etiqa have varying policy charges, premium flexibility, premium holiday and additional bonuses.
Looking to invest into Fundsmith Equity Fund?
It is always recommended to consult with a qualified financial advisor before making any investment decisions. When considering any investment, it is important to evaluate several factors, including your investment goals, risk tolerance, and investment time horizon.
Chat with us to find out which insurer Investment linked plan is for you!
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