Advisers rule? Not OK for Mr Smith

When Terry Smith launched his direct-to-retail, web-only fund a year ago, the industry scoffed. But Fundsmith Equity has outperformed - and showed that small investors will still buy direct.

Patrick Collinson
Patrick Collinson

It is more than a decade since anyone took serious money from the direct retail market. The days when the middle classes clipped coupons from broadsheet newspapers and attached £10,000 cheques are long gone. Conventional wisdom among fund managers today is that distribution is king and financial advisers have a vice-like grip on the market.

Is Terry Smith the mould-breaker? A year ago, when he launched Fundsmith Equity, his first direct-to-retail, low-cost, web-only fund, the industry scoffed. Yes, he had £25m of his own cash to put in, but financial advisers wouldn’t touch it. There was no trail commission, and it wasn’t even going to be available on the platforms that advisers have become so accustomed to (trapped into?) using.

One year on, Smith is proving them wrong. Funds under management in Fundsmith Equity have soared to £200m. Smith himself has contributed just a little extra (his daughters’ ISAs, that sort of thing). Smith, of course, has a lot of friends in the super-high net worth category, and no doubt much has come in from them. But he’s also proving that small investors will buy direct.

Smith didn’t only set out to prove a particular business model. He also challenged the steep and entrenched fees of the asset management industry – now under the spotlight once again. How much are fund managers wasting on churning of portfolios? An awful lot, we’re learning. FundSmith Equity over the past year had a total expense ratio of just 1.17%, compared with the 1.7-2% common elsewhere. (Collinson continues below)

But above all, Smith has got it right (so far, at least) on performance. The 2,300 funds available to UK investors (another bugbear of Smith’s – why so many?) have over the past year managed to lose, on average, 11% of investors’ money. But Fundsmith Equity is enjoying a year-on-year gain of 6.4% despite the worsening economic blizzard that has battered stockmarkets. In the Global sector, where FundSmith Equity sits, it is ranked a remarkable third out of 270 funds. It’s a stunning achievement for a new launch.

Behind the fund’s success is a simple formula: buy shares in companies that make basic necessities – from toilet paper to nappies, baby food to pet food, soap to shampoo. No matter how hard austerity bites, western consumers will keep buying basics, while newly affluent consumers in China and India are buying for the first time.

It’s why his portfolio of just 20 companies includes names such as Unilever (makers of PG Tips, Flora, Dove, Persil and Domestos), Procter & Gamble (P&G) (Ariel, Pampers, Olay, Duracell) and Imperial Tobacco (Lambert & Butler, Gauloises, John Player Special, Rizla). In most cases their share prices have defied the downturn – Unilever is trading at £21 a share compared with £18 a year ago, P&G has edged ahead from $62 to $64, while Imperial Tobacco is changing hands at £23 a share, compared with less than £19. Smoking is in decline in the west, but elsewhere across the world new addicts light up every day.

If the performance carries on in this vein, we’ll be hearing a lot more about Smith as Britain’s answer to Warren Buffet – with bucketloads of the same folksy wisdom.

“We do the things others no longer do,” he says. “Analysts no longer read the primary documents about a company. We do read the annual report, while other analysts use company presentations as the source of their data. They’re the sort of presentations where you never see a clean earnings number. They’re always ’adjusted’ figures.”

Smith berates other fund managers for trading in and out of shares too frequently. Over the past year he has sold out of only one stock, Kimberly-Clark, and bought one other, 3M, the maker of Scotch tape and Post-it products.

“It’s important to look at the return a company makes on its incremental capital,” says Smith. “You can be seduced into buying a company which has high returns but, in reality, is in decline, where its new projects are not making as much money as its old ones.

“That calculation started to flash red on Kimberly-Clark. It’s the number two to P&G on things such as nappies, and P&G is quite resurgent. In short, Kimberly-Clark is getting a good kicking from P&G.”

”Analysts use company presentations as the source of their data … the sort of presentations where you never see a clean earnings number”

Smith’s other mantra is that investors should read, read and read rather than trade, trade and trade. “Between the three of us who run Fundsmith Equity, we read around 1,000 publications regularly. I read PotatoPro magazine, Elevator World, even Tissue World. PotatoPro, for example, helps you keep on top of what’s happening in the snack food industry.”

Smith’s favourite stock over the past year has been Domino’s Pizza, which has doubled in value from $15 a share to nearly $33 in the past 12 months. “For a while, it was producing a dire product. It did market research, and, more remarkably, published it. It found that some people thought that the cardboard box tasted better than the pizza.”

Management took customers’ views on board, and turned the company round. Even today, he says, it allows unedited customer comments to flash up on its ticker in Times Square.

The drawback to Smith’s fund is that it is likely to underperform when stockmarkets take off and consumer staples are seen as worthy but dull. That’s when technology and commodity stocks tend to make the running. But Smith is unabashed he thinks there are only about 65 companies across the planet worth investing in, and they will prove their mettle as the developed world’s economy continues to stumble. Two-thirds of the world’s population still don’t brush their teeth every day.

One quarter of the world’s hair is in India, he says. Sales of toothpaste and shampoo are only going one way – and that’s up.

Closer to home, Smith is less optimistic. Neither Plan A by George Osborne nor Plan B from Ed Miliband is going to dig Britain out of the debt hole it’s in, he says. “It’s not going to work, George. Growth is not going to come to the rescue. There is a Plan B, but it’s not Miliband’s, which is risible. We will have to cut public spending by a lot, lot more than this.”

Patrick Collinson is the Guardian’s personal finance editor.