A smoother ride in emerging markets

Terry Smith’s trust should come into its own during bear markets, says Max King.


FEET: a less volatile ride for investors
(Image credit: © 2014 Bloomberg Finance LP)

Terry Smith's trust should come into its own during bear markets.

Terry Smith's investment strategy is simple: "only invest in good companies, don't overpay, then do nothing". By investing for the long term in high-quality and durable, though superficially expensive, companies protected from competition by intangible assets such as brands, the Fundsmith equity fund, now £14bn, has delivered an annualised return of nearly 20% for seven years.

When the Fundsmith Emerging Equities Trust (LSE: FEET) was launched in 2014, raising £200m, there was every reason to expect its performance to be as impressive. However, it took two years for the net asset value to get firmly above the starting point. With emerging markets (EMs) weakening, Smith was reluctant to rush in only to find that many of the companies he wanted to buy bucked the market trend, while some businesses invested in proved less durable than hoped for.

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FEET steers clear of China

2017 showed a marked improvement with performance of 21% from a fully invested portfolio. The MSCI Emerging Markets index returned 25%, but around half of that came from the Chinese internet stocks that do not fit into the FEET thesis. These are "pretty unattractive as they are acquisitive, have modest returns on equity, and the legal ownership of media and internet assets in China is a grey area", says Michael O'Brien, an analyst at the fund.

In fact, FEET has only one investment listed in China, as "we worry about the corporate governance, accounting standards and strategy of Chinese companies. Forty years of communism killed domestic brands, so the Chinese prefer to buy from overseas". Exposure is mostly gained through Hong Kong, but still totals only 11% of the fund, against 39% in India, while the weightings in the MSCI index are 29% and 9% respectively.

Made for bear markets

FEET's "investable universe" is just 2% of the MSCI index, and is based on "companies with strong market positions that can compound returns through reinvestment". It includes locally listed subsidiaries of Unilever and British American Tobacco, as well as family controlled local companies. Portfolio holdings are about 50% more highly rated than the index, but have a return on capital twice that of the index, as well as higher operating margins and long-term revenue growth.

Two-thirds of the portfolio is invested in consumer staples, and half of the rest in healthcare. Consumer discretionary stocks, such as retailers, account for 6%, leaving little in technology, industrials or resources and nothing in financials or utilities. The portfolio "is probably not riskier than the developed markets equity fund as growth is higher, the companies are ungeared [have no debt] and barriers to competition are higher".

Fundsmith prides itself on visiting all its companies personally, but is a frugal firm, so O'Brien flies economy class on his meetings-packed trips. He is the proud holder of a Jakarta bus pass, as "it is the only way to beat the traffic, costs 16p a ride and there is Wi-Fi and air-conditioning on all the buses".

Unlike the Fundsmith equity fund, FEET has not outperformed the broader index since launch. It expects to lag in bull markets, which are "driven by passive investing and frothier, more speculative elements", but to be less vulnerable in bear markets. However, performance has improved, and FEET ought to give investors a less volatile ride than the EM indices or competitor funds.

Activist watch

Rolls-Royce has let activist investor fund ValueAct "off the leash", agreeing to let it speak freely about the aircraft-engine giant's strategy, which increases the likelihood of a break up, says John Collingridge in The Sunday Times. The US fund was given a seat on Rolls-Royce's board two years ago, on the condition that it would not lobby for a break up or publicly criticise the firm.

Having long resisted calls to split up, Rolls-Royce admitted in January that it would consider selling its loss-making commercial marine business. ValueAct, whose 10.9% stake makes it the biggest shareholder, will also no longer be banned from going below a 7.5% or above a 12.5% holding in the company (although, as a foreign investor, it is limited to a 15% stake).

Short positions error costs BlackRock $8m

In an attempt to overtake arch-rivals at Baillie Gifford, the £193m Fidelity Japanese Values (FJV) fund wants to overhaul its investment policy, says Citywire. Having failed to dislodge Baillie Gifford Shin Nippon at the top of the Japanese Smaller Companies sector since appointing manager Nicholas Price three years ago, the board of JFV now wants to switch to the mainstream Japanese sector and go up against top-performer Baillie Gifford Japan instead.

Subject to shareholder approval, a more flexible mandate would allow the manager, who had shifted the fund towards mid-cap stocks, to invest in micro stocks as well as the largest firms in Japan. The trust also wants to double the limit on investment in unlisted companies to 10%, and will adopt a performance-linked fee structure.

Index provider FTSE Russell's decision to include trade finance company LongFin in its Russell 2000 and 3000 indices has "left investors nursing losses of more than $10m", says Peter Smith in the FT. The provider decided on 14 February that it would include LongFin in its groupings of small and medium-sized firms used as benchmarks for passive investment products, with the company officially added on 22 March. This compelled index-tracker funds to buy up all available LongFin stock, pushing the shares up from their February low of $32 to above $71.

However, the provider had failed to note that LongFin did not meet a requirement that firms in those indices make a minimum of 5% of their shares available to trade. FTSE Russell subsequently removed the firm from both indices on 28 March. BlackRock funds alone suffered losses of about $8m, having bought and sold half of LongFin's available shares, which traded at $10 at lunchtime on Wednesday.

Max King
Investment Writer

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.