Why is Fundsmith the most popular fund?

06 November 2019

3 minute read

Michael Haslam, Head of Funds Distribution at Barclays Investment Solutions, explains the popularity of the Fundsmith Equity Fund.

Who's this for? All investors

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek professional independent advice.

What you’ll learn:

  • Why the Fundsmith Equity Fund is a popular choice among investors.
  • How manager Terry Smith approaches investing.
  • How investors can use these principles in their own portfolios.

Every month we publish a list of most popular funds that are bought by investors on the Barclays Smart Investor site, and every month the Fundsmith Equity Fund appears as one of the most popular choices. But why?

Firstly, it’s important to stress that just because something is popular, it does not make it ‘the best’. A popular fund is not a recommendation to buy it. It is crucial that investors do their homework and look for the most suitable fund for their long term financial objectives.

So what is the Fundsmith Equity Fund? Put simply, it is a portfolio of shares from around the world, including many well-known names such as Microsoft, Colgate-Palmolive and Nestlé.

The manager, Terry Smith, believes these types of companies provide goods and services that are difficult for other companies to replicate. The end result being they have potential to do well over a long period of time.

But what Smith does better than most fund managers is explain how he runs the fund in ‘plain English’. Too many fund managers blind investors with technical jargon such as ‘discounted cashflows’ and ‘structural growth opportunities’ to explain how they look for companies to invest in.

Smith however keeps it simple. So simple, in fact, he published a free guide called the ‘Owner’s Manual’, which explains his investment approach. Whilst this admirable characteristic won’t improve the performance of the fund, it does go some way to explaining its popularity.

Essentially, Fundsmith Equity has three key principles, and these are principles that can also be employed by individual investors managing their own portfolio of funds.

Buy good companies

I guess this is relevant to everything we buy in life, from clothes and cars to food and investments. Fundsmith looks for what it calls ‘high quality’ business. In effect, those companies that it believes can continue to sell their products or services for a very long period of time. Microsoft is a good example, where businesses and individuals may be expected to continue to use their Windows and Office products for many years to come, mainly because we tend now to communicate with each other in Microsoft Word, Microsoft Excel or via Microsoft Outlook emails. Adding in the fact the company has very little debt, makes it a good candidate for the fund, and a stock that can potentially do relatively well during both boom and bust periods.

Don’t overpay

It was Warren Buffett who once said: “Price is what you pay, value is what you get”. Sometimes you have to pay a little bit more for buying shares in high quality companies, so what Smith and his team focus on is not paying too much for them. It’s all about ‘value for money’.

Do nothing

Fundsmith’s aim is to keep trading at a minimum. This is because every time you buy and sell shares it bears a cost. This means the shares are held in the fund for a very long time. In fact, many of the names have been in the fund since it was launched back in 2010. Such is the rarity of when Smith buys a new company in the fund, it often makes the news!

The result is a portfolio of about 25 to 30 companies of well-known names. And even the most novice of investors can understand why each of the companies are in the fund, by simply following the principles set out in the Owner’s Manual

The risks

Despite its simplicity and compelling approach to investing, the fund is not without risks. Having just 25 to 30 holdings could mean that if one of those companies runs into trouble, the impact of its falling share price would be felt much harder than if the fund was invested in 100 companies.

In addition, looking for ‘high quality’ companies to invest in could lead the fund towards just those countries where such companies are based. As at the end of September, for example, two thirds of the fund is invested in companies in the United States. This could prove detrimental if the US stock market underperforms. Because the fund’s portfolio is a global share portfolio, many of the investments are not denominated in Sterling. There is no currency “hedging” (that is, steps sometimes taken to counter the effects of changes in currency values) in place, and the price of the shares in the fund may therefore rise or fall purely on account of exchange rate movements.

In the complex world of investments, simplicity is certainly a welcome retreat. Maybe this is why Fundsmith is so popular, and why it is today the largest fund in the UK but remember the popularity of an investment is not of itself a good reason to buy it. You need to do your own research and if you’re in doubt, seek independent personal investment advice. We don’t offer personal investment advice.

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