Terry Smith, the founder of Fundsmith, has warned investors away from financials and leverage and defended his fund’s massive 62% weighting in consumer goods.
Smith says his other financials business, Tullett Prebon, of which he is chief executive, would not be a suitable investment for the Fundsmith Equity fund, the global stocks portfolio and sole product in his Fundsmith range.
The manager has warned investors away from high levels of leverage and says while Tullett Prebon itself is unleveraged, many of its customers have high levels of debt.
In his fund, Smith focuses on producers of inexpensive consumer goods with strong brands. These brands make them more likely to be able to pass on inflation in their costs to their customers and deliver high returns on their equity over an economic cycle.
Smith also concentrates on consumer goods companies which are not dependent on retailers with tough purchasing power and buys firms where a third of sales are made direct to the consumer—to an extent, like Fundsmith itself. (article continues below)
In terms of regions, Smith warns of getting caught up in a bubble in emerging market consumer plays and prefers globally diversified brands.
He says consumer goods firms listed in the developed world look expensive when they list in emerging markets, often with inferior liquidity and corporate governance.
In particular, he warns investors off the widely held notion there is a correlation between growth and investment returns, particularly in China, where many funds are sold on the basis of such a correlation.
Fund Strategy research has in fact proven there is no link between discrete annual returns from Chinese stocks and its annualised growth rate.
However, Smith also shies away from the notion that Japan, the world’s slowest growing region, represents good value for investors and could represent a risk for his fund if it surges off its relatively low multiples.
He says Japanese capitalism still runs on a different model to its Anglo-Saxon equivalent, citing companies who own shares in their competitors and issue new stock to dilute the holdings of activist investors.
He prefers the valuations he can get in the consumer goods sector as a whole to Japan, where he has no investments.