By most accounts, Terry Smith is something of a bruiser. He is "straight talking" or "outspoken". He is a "maverick trader" who "doesn't suffer fools gladly" and who "can be aggressive" and "intimidating to work with". He also clearly scared the wits out of an Independent journalist who interviewed him a few years back and concluded, "it's best not to get on the wrong side of Terry".
However, spend a few minutes with him and you will soon find that the only thing aggressive about Terry Smith is the fact that he has lots of opinions and wants you to know what they are. If you agree with him on most things and he has no reason to think you are a fool he is absolutely charming. Good news, then, that as luck would have it, I do agree with Terry on most things (so far at least) and our meeting is almost entirely sweetness and light.
When I arrive at his office in Cavendish Square, London, I am fresh from a debate about the future prospects for the economy with the ex-Northern Rock chairman and author of The Rational Optimist, Matt Ridley. We took opposing positions (guess which side I was on?) and I am full of thoughts on the subject. So Terry and I arrange our coffee and amuse ourselves by trading examples of irrational optimism. The Japanese market in 1989, he says. The way bond yields in Tsarist Russia fell to all-time lows in 1914 (just before the revolution), I say. US bond yields in 1981, he says. At the time everyone was positioning their portfolios for indefinite double-digit inflation. Enter Paul Volcker, Margaret Thatcher and a sharp tightening cycle. China today, he says.
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I agree. I'd talked that morning about the inflation engulfing much of China. I'd heard of factories putting up prices every 24 hours, of minimum wages going up 20% and of shops raising prices so fast they aren't printing new labels any more just crossing out the old and popping in the new. So what happens, I ask, if this keeps going? "China falls over," says Terry, who knows China better than most of us, having done business there for some time. The biggest thing about China, he says, is that it "isn't a democracy". Think about that and then "please name a country that has made a peaceful transition to democracy".
It's a good point. But can inflation really be the trigger for violent change? Terry reminds me that if we keep at it long enough, forecasting this kind of thing really is going to make astrology look respectable. But if you have to make a guess, he says, and you add up inflation alongside falling demand for Chinese products in the West, then "you do actually get a massive economic doubt over China". The regime will do what it can to distract the population from this "people don't very readily give up power". But add in the 45 million men in China who will never find a partner ("if I were looking for someone to start a punch up I'd go and talk to that lot") and, in the end, "there will be a democratic revolution in China", followed by "a chaotic period and possibly a very, very dangerous chaotic period".
I wonder who might pick up the manufacturing baton from China (even before the chaos). Might it be Africa where, depressingly, labour is even cheaper than it was in China. "Africa? No." That's me told. So where? Terry's answer chimes nicely with what I have already heard from manufacturers: somewhere in the West. Perhaps the area between Milan and Turin, which was once "one of the most productive areas in the world", plus a little Germany mixed in with "places like Brazil". It is a "combination of developing world, but not China, and old world that has survived in manufacturing, or which has real hard-core expertise in it". So there is hope for old Europe. Does he think the euro will survive? Yes. Does that mean we should be buying European stockmarkets? Maybe.
Terry thinks it foolish to talk about being bullish or bearish in general he is a stock-picker. But nonetheless, he "would be rather shocked if equities didn't go up quite a lot this year". Why? Quantitative easing (QE). QE1 kind of worked, but QE2, which was supposed to keep bond yields down, drive a wealth effect in the housing market and deal with unemployment, "has achieved none of these things". Instead, thanks to the fact that money has to "pop out somewhere", it has caused asset inflation: "it certainly popped out at the end of last year in equity markets". It is also worth noting that we are in the third year of the presidential cycle. And Barack Obama is "not going to be the first president in history to close the throttle at this point".
That doesn't mean that he rules out a reckoning at some point. It will just be a "worse reckoning". The corporate and private sectors have to cut their debt. That means that, however much stimulus the government chucks into the mix, they are going to find themselves fighting a losing battle for years to come. Add inflation and Terry looks to be firmly in the stagflation camp. At this point we drift into topics not strictly in the remit education, grammar schools, whether Alan Greenspan in is an arch-anarchist goldbug trying to destroy fiat money from within, and so on.
However, when Terry says enthusiastically, "I've finally found someone with more opinions than me this is great", I realise I'm in danger of getting another interview transcript that shows me talking rather more than my interviewee. I bet this doesn't happen to Terry often. So we move back to finance and to his new fund management company, Fundsmith.
The fund launched late last year, advertising itself as low cost and high value. The low cost bit means it charges 1% a year in management fees and aims to keep the other costs as low as possible. There are to be no performance fees, no initial fees, no redemption fees, no overtrading, no leverage, no shorting, no hedging and no derivatives. None of the things that drive up the costs of most funds will do so at Fundsmith.
The value bit comes from the investment approach. There is to be no over-diversification, no closet indexing and no lack of conviction. Instead, the fund will invest in around 20 to 30 businesses, all of which will be attractively valued, but also thought to be able to "sustain a high return on operating capital employed".
So how is it going so far? It is too early to tell on the performance, but the fund is certainly more popular than your average launch. Terry has got in £70m already. On day one someone invested £200,000 with a debit card via the website. "The next day someone did one for £250,000 and then we had one for £400,000."
I ask him if he thinks they are all happy with the 1% fee. "I know where you are going with the fee," he says. "I'm not going anywhere with it," I pretend. "Yes you are, stop pretending," he says. Hmmm. I think he might know I think the fund-management industry grotesquely overcharges retail investors. On the plus side, he turns out to agree. Over time he does expect the nature of charging to evolve: percentage charges will edge down and then somebody will go for a flat fee. It won't be soon, simply because all the big managers have let their costs expand to meet their 1.5% fees. Unlike Fundsmith, "they haven't got an infrastructure for 1%". However, at some point someone will do it. "And I would love to be the person"
So why isn't he, given that he has just launched a new business? Because you can't do it until you reach a certain size until you have a viable business. "Otherwise we would be sitting there on day one with a flat fee designed for having £500m with only £70m." It is a fair point. But I'm not going to let this one go. If anyone can shake up this industry, and if anyone can be the one who really does offer the retail investor value, it is Smith. I think he is off to an excellent start. But I'm going to be watching his assets under management. And when they hit £500m, I'm heading back to Cavendish Square for another chat.
Who is Terry Smith?
Terry Smith graduated in History from University College Cardiff in 1974. He obtained an MBA at The Management College, Henley, in 1979. He became a stockbroker with W Greenwell & Co in 1984 and was the top-rated bank analyst in London from 1984-1989. In 1990 he became head of UK company research at UBS Phillips & Drew, a position from which he was dismissed in 1992 following the publication of his best-selling book, Accounting for Growth. He joined Collins Stewart shortly after, and became a director in 1996. In 2000 he became chief executive and led the management buy-out of Collins Stewart, which was floated on the London Stock Exchange five months later. In 2003 Collins Stewart acquired Tullett Liberty and followed this in 2004 with the acquisition of Prebon Group, creating the world's second largest inter-dealer broker. Collins Stewart and Tullett Prebon were demerged in 2006. By the end of 2006, some £2bn of shareholder value had been created by these companies.
Terry Smith's top tips
Intercontinental Hotels (LSE: IHG): Intercontinental doesn't own many hotels or provide much capital to franchisees. Instead, it gets a royalty on the revenues. It has 10% of the hotel rooms in China, but doesn't actually own any hotels there.
Becton Dickinson (NYSE: BDX): BD is the largest medical supplies company in the world think small-ticket, non-technical items and 37 years of continuous dividend increases. "I really quite like that."
Microsoft (Nasdaq: MSFT): This has 10% free cash flow, but has been overlooked because it has missed the mobile-phone/tablet market. But, given how competitive this is becoming, it might be well out of it. And its PC/server business is still "powerful".
PepsiCo (NYSE: PEP): the second-largest food and drinks firm in the world. Over $1bn in sales and "massive reach into the developing world".
Proctor & Gamble (NYSE: PG): 40% return on operating capital employed. Largest consumer products company in the world. "Fantastic brands."
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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