Terry Smith, CEO and chief investment officer of Fundsmith, has issued his annual shareholder letter in which he offers his explanation for the Fundsmith Equity Fund underperforming for the fifth consecutive year.
The actively-managed fund returned just 0.8% in 2025, compared to 12.8% for the MSCI World Index, marking five years in a row that the fund has trailed global equities.
Laith Khalaf, head of investment analysis at AJ Bell, called it “a grisly year for Fundsmith Equity” which, despite avoiding a loss, was only able to eke out meagre returns in a year of strongly rising equity markets.
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“As the performance table in Terry Smith’s shareholder letter shows, even cash returned five times more than the fund last year,” said Khalaf.
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Smith attributed the underperformance to the overvaluation of artificial intelligence (AI) stocks, in particular the Magnificent Seven, increased investor purchasing of index funds, and a relatively weak US dollar.
“I am not seeking to ‘blame’ anyone or anything for our Fund’s relative performance,” said Smith. “What I am seeking to do is explain it so that our investors have a clear understanding of what has happened and why.”
In brief, Smith’s explanation rested on three factors:
1. Index concentration
Major global indices, in particular the S&P 500, are now heavily concentrated in big tech stocks.
By the end of 2025, the ten largest stocks accounted for 39% of the index, and had generated 50% of its total returns through the year.
Smith highlighted that this was the most concentrated the index had been since 1930 and that it had taken until 1954 for the S&P to regain its previous high before the subsequent crash.
“It was difficult to even perform in line with the index in recent years if you did not own most of these stocks in their market weightings,” said Smith, “and we would not do so even if we became convinced that they were all good companies of the sort we seek to invest in, which we are not.”
2. Rising index investing
Passive investing is on the rise: the proportion of US equities assets held in passive funds passed 50% in 2023. This compounds some of the challenges for active managers that are posed by over-concentration.
As capital flows into index funds, the constituents of those indices rise in value, and this effect can be multiplied because other index funds (as well as many ostensibly actively-managed funds that, in reality, tend to follow the index) follow suit.
In other words, the amount of money currently invested in index funds will naturally inflate the value of megacap stocks.
“Fund managers have long realised the career preserving nature of so-called closet indexation in which they do not stray far from the index weightings,” said Smith. “Given our experience in recent years, who can blame them?”
“Even if we are right in diagnosing this move to index funds as one of the causes of our recent underperformance and it is laying the foundations of a major investment disaster, I have no clue how or when it will end except to say badly.”
3, Dollar weakness
Donald Trump’s economic policies led to a weaker dollar compared to the pound in 2025, and this was another headwind for Fundsmith.
The fund is priced in sterling, but most of its holdings’ revenue is derived in dollars. A weaker dollar therefore reduces the (sterling-denominated) value of the fund.
“That goes some way to explaining lower absolute performance for sure, though the index and other global funds suffered the same currency headwind, so on a relative basis, it’s no excuse,” said Khalaf.
Challenging times for active managers
Smith vowed to stick to the fund’s strategy of long-term investing in what it views as quality businesses, and resist the temptation to attempt to become momentum investors or to pile into the large cap stocks that dominate indices.
But active management as an approach is enduring a challenging time. AJ Bell’s latest Manager versus Machine report found that less than a quarter (24%) of actively-managed funds beat a passive alternative over the last ten years. In the Global sector in which Fundsmith operates, that proportion falls to just 13%.
“Active managers simply can’t compete with the index or the funds that track them in an era when so much of the market return comes from the biggest stocks within it,” said Khalaf.
Khalaf warned that without some sort of market rotation, things could get worse before they get better for active funds.
“These longstanding market trends are being exacerbated by fund buying patterns which partly stem from the same root cause,” he said. “The dominance of megacap US stocks is driving better passive performance, leading to more flows into trackers and out of active funds.”
Since its inception in 2011, Fundsmith has outperformed MSCI World, and has delivered reasonable returns (despite trailing the index) over the last ten years.
“Investors should take encouragement from the fact Smith is sticking to his guns, and at some point, performance should turn a corner,” said Khalaf. “That’s not to say such a turnaround is imminent, or that an index fund might not perform better. But it you’re an active fund investor, you have to accept the fallow with the fertile, sometimes for much longer than you might like.”
