- Fund delivers 12.4% return versus benchmark 16.8%
- Fund remains the best performer since inception
- Stocks perform better than bonds in the long run
Fundsmith Equity Fund (B41YBW7) underperformed in 2023 after generating a total return of 12.4% compared with 16.8% for the MSCI World Index.
In typical combative fashion founder Terry Smith points to the 4% annualised outperformance of the fund since inception in November 2010 which means it remains the best performer out of 165 funds in the Investment Association Global sector.
Smith acknowledged 2023 was a difficult year with the so-called ‘Magnificent Seven’ dominating returns and helping the Nasdaq Composite Index gain 43%.
‘We do not own all the Magnificent Seven and would probably not be willing to take the risk of doing so, even if all of them fitted our investment criteria’, commented Smith.
WINNERS AND LOSERS
The biggest detractor from performance in 2023 was beauty products company Estee Lauder (EL:NYSE) which knocked 1.8% from the fund, although most of the damage was done in the first-half.
The position was sold due to the firm’s ‘serious’ inadequacies in its supply chain which were revealed during China’s reopening post Covid.
In contrast Smith’s long term favourite L’Oréal (OR:EPA) handled China reopening with aplomb with the position adding 2.1% to the fund’s performance.
Top contributors to performance include Facebook owner Meta Platforms (META:NASDAQ) and long term holding Microsoft (MSFT:NASDAQ) which added 4.5% and 3.9% respectively.
The huge success of weight loss drug maker Novo Nordisk (NVO:NYSE) was reflected in the stock contributing 3.6% to the fund’s performance.
INVESTING IN THE BEST
Smith highlighted the overall portfolio’s superior fundamental strength compared with the main indices as evidenced by higher returns on capital and margins although cash conversion at 91% remains below the long-term average of 100%.
The weighted average free cash flow yield (the free cash flow generated as a percentage of the market value) of the portfolio ended the year at 3% compared with a median 3.7% yield for the S&P 500.
Just because the portfolio is trading at a higher valuation than the average of the companies in the S&P 500 doesn’t mean they are expensive, argues Smith.
WHY STOCKS ARE BETTER THAN BONDS
With so much investor focus on surging bond yields in the last year Smith pushes back on the idea that bonds are a better investment than stocks in the long run.
Between 1928 and 2023 the annualised return on 10-year US Treasury Bonds was 4.6% whereas the S&P 500 compounded at 9.8% with dividends reinvested, says Smith.
In addition, stocks offer an underappreciated feature which no other asset class can match. Smith points out the reinvestment of retained profit is the source of compounding which underpins the returns of long-term investment.
On the topic of the rise of investor interest in artificial intelligence Smith proffers a wait and see approach. ‘I think we will suspend judgement of who, if anyone, will emerge as a winner in AI’ concludes Smith.
