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Disclosure – Independent Investment Research

This is independent research issued by Kepler Partners LLP. The analyst who has prepared this research is not aware of Kepler Partners LLP having a relationship with the company covered in this research report and/or a conflict of interest which is likely to impair the objectivity of the research and this report should accordingly be viewed as independent.

Overview
Overview

Fundsmith Emerging Equities Trust (FEET) invests in the emerging and frontier markets with an investment strategy successfully employed by its former manager Terry Smith on the open-ended Fundsmith Equity Fund. Terry stood back from day-to-day management of the trust in May 2019. While the basic strategy has remained the same, there have been some subtle tweaks under the new manager Michael O’Brien, which we discuss in Portfolio.

These modifications and a more conducive macroeconomic backdrop have helped FEET post decent relative returns in the past two years. As we discuss under Performance, this followed a rough run of results in which the persistent underweights to technology and to China held the trust back relative to the MSCI Emerging Markets Index and its peers.

FEET remains a highly active and differentiated proposition, with strong sector and country biases. One of the changes under Michael’s management has been to reduce the number of positions, which could have the effect of increasing the divergence in performance between the trust and the index in future. The investment objective has also been changed this year in order to give the manager more freedom to invest in various sectors.

FEET trades on a discount of 7.8% compared to an AIC Global Emerging Markets sector average of 8.4%. The board pays the minimal dividend necessary to maintain investment trust status, and so has a historic yield of just 0.14%.

Analyst's View

FEET is an interesting proposition at this point in time. The poor early results from the strategy were clearly partly due to unfortunate timing. The investment process led the trust to have little exposure to China which has significantly outperformed since 2016. Similarly, the trust had a light exposure to technology and ecommerce which went through a period of very high outperformance. Leaving aside the question of the long-term appropriateness of the portfolio’s shape, in the short to medium term the outlook seems much better for a trust with these biases. China is facing a number of political and economic problems, and its tech giants are feeling the weight of renewed regulatory pressure. This makes it seem likely it will not see the same amount of outperformance and may even be vulnerable to a period of underperformance. India on the other hand seems to be in a better place, stealing business from China while enjoying the benefits of a wide-ranging reform programme under the current PM. On the other hand, FEET’s discount is not particularly attractive relative to the peer group, with the relatively good recent results perhaps attracting investors back in.

Over the long run, FEET’s success will still likely be determined by whether the consumer sectors outperform, such is the extent of the overweight even after the reforms to the process. There is also an implicit bet that company fundamentals will be more important than geographical listing over the long run, which justifies undertaking such a large overweight in India. We think the level of political and economic volatility in emerging markets makes this second contention questionable, and we note the trust has been consciously positioned away from countries with higher political volatility as a part of the reform programme.

bull bear
Disciplined and consistently applied investment process Highly active positioning can lead to underperformance if the positions don't pay off
Concentrated and active portfolio increases chance of outperformance
The discount has been persistent under the new manager
Focus on strong balance sheets and free cash flow could build a portfolio resilient in down markets
OCF is high relative to peers
Continue to Portfolio

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