Star fund managers – an investing style that’s out of fashion

Two of Britain’s most acclaimed star fund managers – Terry Smith and Nick Train – are both struggling with a multi-year spell of disappointing returns. Yet they are reacting in very different ways. Smith seems inclined to blame passive investing, company management, the state of the economy, analysts, the state of the market in general and practically everybody else, as seen in his latest letter. Conversely, Train has castigated himself and apologised at length for letting investors down, as anybody who attended the Finsbury Growth and Income (LSE: FGT) meeting this month will know.

The truth surely lies between the extremes. Train has made mistakes in stock selection, but so has Smith (as we all do). At the same time, both have a particular style and are biased towards a type of company that is out of favour in today’s markets. Almost all managers will do better in certain market regimes than others. Recognising that is crucial to deciding where to invest and what expectations are reasonable.

Both star fund managers have had to change their approach to investing

Both Smith and Train have focused – in slightly different ways – on what they see as quality companies: businesses that can grow earnings steadily, earn strong returns on capital and compound over time. They were heavily invested in areas such as consumer staples and placed considerable value on dominant brands. These kinds of companies did very well for much of the 2010s, but many have struggled this decade – not just in relative terms (understandable in a tech bull market) but in absolute terms as well.

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There is a range of reasons for this. The era of ultra-low interest rates made the steady and rising income from these kinds of stocks very attractive, which pushed up valuations too high by the end of the decade. The post-pandemic inflation spike and cost-of-living pressures have hurt their ability to keep growing earnings either by selling more or by raising prices.

Emerging-market growth – a key part of the bull case for many – has been patchier than expected. More recently, GLP-1 weight loss drugs may be starting to weigh on demand not just for food but other products such as alcohol (it remains unclear how significant this is).

As these issues have become more obvious, both managers have adjusted their approach. Train is tilting towards data and digital businesses. Smith has shifted more into tech – moving in and out of some stocks with uncharacteristic speed – and has increased his exposure to healthcare. The thesis behind all these sectors is clear.

At the same time, we should note market conditions may not be as helpful to large incumbents as they were in the 2010s. There is far more uncertainty. Will data and software businesses capitalise on AI or be undermined by it? Will healthcare costs and margins come under attack in a much more populist political environment? We just can’t know at this point, and Smith is right to say that investors should be ever more alert for strategic missteps.

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