Morningstar

Fundsmith Equity T EUR Acc

Analyst Report
Morningstar's Take
|22/03/2024
by Daniel Haydon
A sound investment philosophy employed by a long-standing manager are key strengths for Fundsmith Equity. This remains a strong option for those seeking exposure to quality-growth investing in global equities. However, execution has disappointed slightly, particularly sell discipline. As a result, the Process Pillar is downgraded to Above Average from High, while the People Pillar retains a High rating.

Terry Smith co-founded Fundsmith LLP and this strategy in 2010 on the back of the success he achieved as investment advisor to the Tullett Prebon pension fund. His experience dates back to 1974 and spans equity research and senior management positions at FTSE companies. Smith is supported by head of research Julian Robins, a co-founder of the firm who has worked with Smith for more than two decades. This duo is supported by three analysts, the most recent being hired in 2020. Succession plans are well-formed, with Robins taking over if Smith steps back.

We like the investment philosophy, which is to buy and hold high-quality businesses that will continually compound in value. The approach is bottom-up, combining prescriptive screens with deep fundamental analysis undertaken by the team. The compact analytical resources are appropriate thanks to the clearly defined approach, which leads to a narrow investment universe of high-quality companies that sees little change.

While Smith’s careful sell discipline has long been an edge, some questions have become apparent more recently. Smith has admitted to the wrong timing of all four recent exits. In some cases (Adobe and Amazon.com), having seen their share prices rise significantly after selling, he now thinks he acted too soon despite feeling his fundamental analysis stacked up at the time. In retrospect, he wished he had better incorporated thematic tailwinds relating to artificial intelligence. Elsewhere, he waited too long to make full sales of Estee Lauder and Paypal, and this hurt performance. For a high-conviction fund of 20-30 stocks that trades infrequently, this is a number of missteps.

Elsewhere, the portfolio’s shape has changed marginally. In particular, the two top positions are now at the maximum 10% permitted under UCITS rules. This is at odds with the fund’s earlier years, with a maximum of around 6%, and 8% more recently. Smith says this increased weighting is the result of "running his winners." However, we note an inconsistency in that these same companies are held in the 6%-7% range for the related and much smaller Fundsmith Sustainable Equity fund, which he also manages.

Regardless of all this, the portfolio remains very high quality and different from the benchmark, even if there has been a slight reduction in active share in recent years. The enduring sector concentration remains, and many holdings have featured in the portfolio for 10-plus years. It continues to offer high and more durable returns on capital.

Over the past three years (through Feb. 29, 2024), the fund has lagged its MSCI All Country World Index but has outperformed its global large-cap growth Morningstar Category. Some of the underperformance against the index has been style-related, but there have also been some stock-specific upsets. Looking at 2023, the fund suffered from its large overweightings in consumer defensives and healthcare. Nevertheless, the strategy’s long-term performance remains stellar.
 
Morningstar Medalist Rating™Strong quality-growth offering, but with emerging questions on sell discipline.
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Morningstar Pillars
PeopleHigh
ParentAbove Average
ProcessAbove Average
 
Morningstar Medalist RatingMorningstar assigns the Medalist Rating to funds that are qualitatively and quantitatively assessed through manager research and algorithmic processes. The assessment turns on three key “pillars” – People, Process, and Parent – that yield an estimate of how well a fund will perform before fees but after adjusting for risk.
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