I’m not the first writer to use this terrible headline to describe Fundsmith Emerging Equities (FEET). I suspect I won’t be the last either. Some four years after it launched, with its performance yet to truly impress, it seems a valid question.
I should start by saying that I’m a big fan of Terry Smith, who is Fundsmith’s CEO, and I am an investor in the main Fundsmith Equity Fund. I suspect I may well purchase Fundsmith Emerging Equities at some point, too, but I haven’t pulled the trigger yet.
Why is FEET an investment trust?
You might wonder, as I initially did, why Fundsmith Emerging Equities is an investment trust, while Fundsmith Equity is a mainstream open-ended fund.
According to Smith, the answer lies in the types of companies the former invests in. They are typically much smaller (the median size is £3bn compared to some £50bn for Fundsmith Equity Fund). They also tend to have quite a small free float, meaning a large proportion of their shares aren’t traded on the stock market, as they are owned by long-term holders.
Such companies are harder to buy and sell in significant volume, and this better suits the structural nature of investment trusts. With a mainstream fund, the manager has to buy or sell its underlying investments when people decide to invest more money or take some out. An investment trust, however, has a fixed pool of capital and therefore should avoid this problem.
What Fundsmith Emerging Equities invests in
Both Fundsmith funds tend to invest in very similar types of business. Smith wants companies that “make their money by a large number of everyday, repeat, relatively predictable transactions”. So consumer goods and healthcare are favourite hunting grounds.
Fundsmith Emerging Equities is invested in almost twice as many companies as Fundsmith Equity (47 vs. 27). Some are emerging market subsidiaries of common investor favourites (such as Hindustan Unilever), but many names will be unfamiliar to most UK investors.
The largest holdings are Eastern Tobacco (Egypt), Britannia Industries (India), Vitasoy (Hong Kong), and Foshan Haitian Flavouring (China). Most positions make up between 1% and 4% of the whole portfolio, and their median founding date is 1966. As Smith points out, this means they should have seen quite a few economic cycles.
One thing to be aware of with Fundsmith Emerging Equities is that it’s betting big on India. Indeed, 40% of its money invested there. Compared to the make-up of the standard emerging market indices, it also favours Egypt and Indonesia at the expense of China, South Korea and Taiwan.
That’s probably the main reason its performance hasn’t set the world alight these past few years. Indeed, Smith doesn’t see much to like in the more glamorous emerging market stocks such as Tencent, Baidu and Alibaba.
Charges, performance and dividends
The annual management charges for the two funds are a little different. It’s 1.25% for Fundsmith Emerging Equities and 1.0% for Fundsmith Equity. Neither fund is cheap then, but as their portfolios are relatively stable from year to year, trading costs incurred within them should be fairly low.
There’s a big difference in their respective performance figures, though. Fundsmith Equity has produced returns of 19.3% a year since its launch in November 2010, while Fundsmith Emerging Equities has only managed 5.6% a year since June 2014. In terms of size, the former is worth a mere £330m, the latter a whopping £13bn.
With no dividends paid to date, Fundsmith Emerging Equities won’t appeal to income seekers. Smith hasn’t ruled out paying dividends in future but says the emphasis will continue to be capital growth.
It currently trades on a small premium to net assets. Soon after launch, it enjoyed a premium of more than 10%, but that early enthusiasm seems to have worn off now. In fact, for most of the second half of 2017, Fundsmith Emerging Equities traded at a small discount.
The best investment speaker around
I think there’s a pretty strong case to say that Terry Smith is the best investment speaker in the UK. He presents clearly and simply and focuses on the key metrics behind the companies he invests in.
I’d highly recommend watching the AGM videos of both funds, even if you are not that interested in investing. The videos for Fundsmith Equity include useful Q&A sessions where Smith isn’t afraid to pass comment on others in the industry. You also get a better idea of the team behind him, who all seem pretty impressive.
The latest Fundsmith Emerging Equities AGM video was published earlier this month. It runs for an hour, but there’s little in the way of filler. Encouragingly, much of the analysis is consistent from year to year, and also between the two funds.
Always have a plan
I particularly like Fundsmith’s three-point investing strategy:
- buy good companies;
- try not to overpay; and
- do nothing.
A “good company” is one with a high return on capital, high profit margins, and a high growth rate. And the companies that Fundsmith Emerging Equities holds tend to score even more highly on these factors than those owned by Fundsmith Equity.
Smith is keen to emphasise that the first point is far more important than the second. If you’re a long-term holder (decades ideally) then the vast majority of your gains should come from earnings growth rather than from any change in the valuation multiple.
The third point is the hardest of all to do, Smith says. Amen to that.
Is the best yet to come?
Compared to other emerging market investment trusts, Fundsmith Emerging Equities is in the middle of the pack right now. Performance in this sector tends to be pretty lumpy, with a few spectacular years here and there, and long periods where little seems to happen.
I suspect Smith will have the last laugh, though. With the middle classes set to grow much more quickly in Asia, the Middle East and Africa, it wouldn’t surprise me if Fundsmith Emerging Equities ends up boasting a better long-term return than Fundsmith Equity Fund.
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