Fundsmith Emerging Equities 24 July 2019
Disclosure – Non-substantive Research
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour.
Fundsmith Emerging Equities Trust (FEET) employs the same strategy as the highly successful Fundsmith Equity open-ended fund, but applies it within the emerging and frontier markets regions. The three core rules as described by Fundsmith founding partner Terry Smith are to buy good companies, avoid overpaying, and “do nothing”.
This has led to a concentrated portfolio of 39 holdings with a strong bias to the ‘quality’ style: companies with high levels of cash generation, high and sustainable (in the manager’s view) return on capital employed, and management that acts in shareholders’ interests.
The fund is also concentrated in terms of geographical and sector exposures. The portfolio has 43% in Indian stocks, which is a passive breach of its 40% maximum in one country, and 66% in consumer staples companies. This latter bias has been unhelpful since late 2016, as staples have underperformed since then and more cyclical areas of the market have done best (technology, consumer discretionary and financial services).
The trust has underperformed its sector and index since launch, returning 29.3% in NAV total return terms, compared with gains of 54% for the MSCI Emerging Markets index and 55.4% for the average AIC Global Emerging Markets trust. The defensive positioning hasn’t helped in a bull market, while the trust has also not employed any gearing.
Terry has taken a step back from day-to-day management of the trust, handing over the reins to Michael O’Brien and his deputy, Sandip Patodia, in May of this year, but he remains CIO and controlling partner of Fundsmith. Since this decision, the shares have slipped onto an 8.8% discount, having traded on a premium for most of the trust’s life.
The company’s objectives are to maximise capital growth, so dividends are paid only to retain investment trust status. Last year the first dividend was paid of 2p, so the historical yield is just 0.2% and there is no guarantee dividends will be paid in future.
Given its concentration, and the strong conviction of the manager in the current strategy, the portfolio is likely to retain its positioning in India and consumer staples. This is in the hope they will win out over the long run against technology and financial companies, as well as China, which have all led the market in recent years and to which the trust is little exposed. This implies a bet on demographic forces (a growing population in India buying more consumer goods) being more important in determining the stock market winners of the coming cycle rather than technological developments and more sophisticated sectors. This narrow focus, which includes not investing in South Korea and Taiwan, makes us wary of viewing the trust as a core emerging market holding.
The trust’s defensive qualities are, in our view, balanced by the higher valuations of the stocks in the portfolio, which could cause it problems should interest rates and therefore discount rates rise. However, the portfolio has performed well in falling markets in this low interest rate environment, and central bank policy seems to be becoming more accommodative, which would imply a good environment for this style of investing.
|A clear and defensible strategy, consistently employed
|The major bets against technology companies and China could lead to relative losses
|A portfolio with strong cash-generation and defensive characteristics
|The willingness to issue shares at a discount is unwelcome in our view
|A wide discount relative to history that could swiftly close with a recovery in performance
|High concentration increases risk (as well as outperformance potential)