Terry Smith’s Fundsmith Equity fund is one of the most popular active funds among investors, but is its underperformance a concern?
In MoneyWeek’s monthly round-up of the most popular funds, stocks and trusts to invest in, Fundsmith has often been the most popular and often one of the few active funds that appears on the list of top 10, but in the last three months to December 2024, it seems investors have fallen out of favour for the funds and actives as a whole, with passives now dominating DIY portfolios.
Fundsmith’s underperformance at 8.9%, compared to the 20.8% of the MSCI World Index and the 12.6% of the IA Global in 2024, may have rattled some nerves, but in his latest letter to investors, CEO Terry Smith said: “Outperforming the market or even making a positive return is not something you should expect from our fund in every year or reporting period, and outperforming the market was more than usually challenging once again in 2024.
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“Just five stocks (the ‘Fab Five’) Nvidia, Apple, Meta, Microsoft and Amazon provided 45% of the returns of the S&P 500 Index (S&P 500) in 2024. This is similar to the concentration of returns provided by the so-called Magnificent Seven in 2023. Moreover, a single stock - Nvidia - produced over 20% of the S&P 500 returns in 2024.”
The technology boom has certainly dented active fund performance. While Fundsmith owns some of these stocks, it does not hold them all, to which Terry said in his letter that it was difficult to perform even in line with the index unless you owned them at least in line with their index weighting.
Which stocks brought Fundsmith’s performance down?
L’Oreal, which features in the funds top 10 holding and was once described by Smith as ‘one of the best companies in the world’ was one of the detractors, having seen an adverse effect from China where its economy is still struggling. Though, Smith continues to hold his view that L’Oreal is still a good business.
Other detractors were IDEXX, Nike, Brown-Formann and Novo-Nordisk.
IDEXX, which makes veterinary diagnostic testing equipment and supplies, is suffering from fewer vet visits after the scramble to adopt pets during the pandemic.
“As the industry leader in an area with real long-term growth prospects and a stock where we would probably struggle to buy back our position if we sold it, we intend to continue holding,” Smith said in his letter.
On Nike, he said the retailer has made great strides in online marketing and fulfilment, but neglected the bricks and mortar retail channel following the pandemic recovery. The fund awaits developments from Nike’s new management.
Brown-Forman, one of the world’s top five drinks companies and the distiller of Jack Daniel’s Tennessee Whiskey, “has suffered from the fall in consumption from the pandemic highs and is probably seeing early signs of the adverse impact of weight-loss drugs.”
Novo Nordisk was the fund’s most surprising poor performer in 2024. ”It remains the market leader in weight loss drugs, which it pioneered, and the year was marked by a stream of news about other conditions which these drugs treat effectively and label expansion applications which drug regulators seem willing to approve. Yet not only did the share price fall 10% but it finished the year on a P/E ratio half that of its nearest competitor Eli Lilly,” Smith said.
But he added that the fund originally bought Novo because of its radical approach to drug discovery and it expects further developments.
Top performing Fundsmith Equity holdings
Meta Platforms, Microsoft, Philip Morris, Automatic Data Processing and Stryker were the top performers.
“Given the number of repeat appearances in our top five contributors I am tempted to repeat one of our mantras which is that ‘You make money with old friends’. However, three of those old friends which have been repeat contributors were detractors this year, namely L’Oréal, IDEXX and Novo Nordisk. However, if anything I would regard this as a blip in their long-term record and we intend to (mostly) patiently await a return to form. In our view they are simply too good to sell and risk being uninvested when the tide turns.”
Are active funds still worth it?
Fundsmith Equity managers seem to know what they are doing when it comes to buying good companies and it is one of the funds which has outperformed a comparable index tracker over 10 years fairly comfortably.
And AJ Bell’s report into manager versus machine found that only 18% of active managers in the global sector outperformed the average index tracker in 2024 to the end of November, only 17% achieved this feat over the longer period of 10 years.
The performance has been driven by a small number of big technology names, which hold such a high weighting in the index meaning active managers are unlikely to be anything other than underweight the grouping dubbed the Magnificent Seven.
Should you stick with Fundsmith Equity?
“Investors can draw some reassurance from Fundsmith Equity’s longer term performance numbers, and from a clearly framed and executed investment strategy. Those who are attracted to the mantra of ‘buy good companies, don’t overpay, do nothing’ are themselves likely to apply a similar philosophy to the active managers they invest in, so many will undoubtedly stick with Smith through the tougher times, especially when they have enjoyed such long-term success and when recent returns have still been so positive in absolute term,” Laith Khalaf, head of investment analysis at AJ Bell, said.
Speaking of active funds, Khalaf added: “All active managers will undergo periods of underperformance; it’s part of the beat. Investors need to be willing to accept sometimes these periods can be quite lengthy. It’s always difficult to tell without the benefit of perfect hindsight when an active manager is going through a temporary rough patch, or if there is something more permanently problematic going on. It can help in this situation to assess whether the leopard is panicking and changing its spots by investing in things which don’t match up with the stated fund strategy. There is no obvious sign of this at Fundsmith, which is continuing to run a concentrated portfolio of higher quality names with little turnover.”
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