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Will Terry Smith’s fund be a knock-out?

It is no surprise that Terry Smith (pictured) describes himself as a ‘come-forward’ boxer.

Smith, one of the City’s more pugnacious characters, is a keen pugilist who takes no prisoners in or out of the ring and says the best way to protect yourself is by stepping into your opponent rather than keeping him at arm’s length.

A seriously wealthy man, Smith could have easily called time on his City career after stepping down as Collins Stewart’s chairman. Instead, he chose to pit himself in a relatively new arena and put his reputation on the line.    

The mere suggestion that Smith, a qualified helicopter pilot, could have called it a day makes his hair stand on end. ‘Why should I retire? I can do this job until I die. I like doing things and don’t ever want to retire.’

Smith certainly was not shy in coming forward last month when he launched a high-conviction fund at his new investment boutique, Fundsmith.

As far as investment strategies go, the Fundsmith Equity fund could not be simpler. It will invest in a portfolio of just 20 stocks held for the long term with low turnover, which will help keep its total expense ratio at about 1%, some 0.8% lower than the conventional equity fund. 

This has led to Smith being dubbed by rivals (somewhat disparagingly) as the ‘Michael O’Leary [Ryanair chief executive] of the funds industry’. Far from bothering him, Smith is happy with the comparison. ‘[O’Leary] substantially lowered the cost of air travel while still providing a good basic service.’

At the fund’s inception he claimed it was designed for a ‘broken industry’. While he chose to slate fund charges at launch, he thinks there has been too much focus on his fund’s fee structure and not enough on the simplicity of the investment process.

‘According to the FSA, the average mutual fund turns over 80% of its portfolio every year, the cost of which is not included in the total expense ratio. Does the average fund manager really have that many good ideas a year? If he does, he’s a better man than me. I don’t think any human being has that many good investment ideas,’ he says.

Discretion on disclosure

Smith has no intention of sharing his ideas with the public. In fact, there’s no guarantee investors in the fund will even be told what he is investing in. ‘If we reveal the portfolio, people will be preoccupied and will ask “do I really want that stock in my portfolio?” We have not yet decided what information we will disclose.’  

He is, however, prepared to reveal the type of company he will invest in. ‘There won’t be any obscure holdings in the fund, you will have heard of the vast majority of the companies.

They are the type of firms which provide a high return on cash and compound your wealth. They are firms that focus on “small ticket” non-durables, producing the kind of products consumers need. The average company in our portfolio has been around since 1883. They have endured two world wars and the Great Depression. They are survivors.’ 

One stock down

One thing he had not bargained for was a takeover over approach for one of his holdings just 18 days after he launched the portfolio. But this is exactly what happened when Kohlberg Kravis & Roberts said it was in talks to buy Del Monte.

It emerged that Del Monte was one of his stock when Smith found it impossible to contain himself and used his blog as an outlet for his frustration.

'On one level this is good news. The price of our Del Monte stock has risen and will rise further if or when the takeover is completed. This will boost short term performance of the fund. But on the other hand it will mean that Fundsmith will lose a stock which it wanted to own.

'I purchased Del Monte on a free cash flow yield of about 10%. This is an unusually high yield free cash flow yield for a good company. I think I was able to buy Del Monte at this attractive free cash flow yield because not many people understood what it does.'

Track record

Investing with Smith will be putting blind faith in someone who has proven himself on several counts but has no demonstrative track record in retail fund management. However, he uses his influence on the Tullett Prebon pension fund as evidence that he knows what he’s doing.

Since he was appointed investment adviser on the fund in 2003, it has doubled the return of the benchmark on an annualised basis. He attributes this success to his appointment of a discretionary manager, the name
of which he refuses to disclose, which managed the pension in a similar vein to Fundsmith Equity fund.

Whether the retail market takes to Smith remains to be seen but he is so confident  of success he does not feel he needs to hunt down prospective investors, whom he expects to make the right choice when armed with the 29-page manual he has penned on the fund. ‘Our ideal investor is not someone who simply gives us a lot of money but someone who completely understands what we’re doing and why we’re doing it.’ 

Smith has backed his talk by pouring £25 million of his wealth into the fund, which now has about £30 million in assets under management. There is no capacity constraint, so investors have time to consider whether he is worth backing and investment could not be more straightforward. ‘You can be invested in my fund within three clicks on our website. Tell me another fund management group out there that offers such an accessible service.’

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