When it became clear in the early 1990s that I had to learn the basics of accounting for my job, I was given the usual “accounting for dummies” books and went to some worthy lectures at Wits Ubiversity. But I was lucky enough that it was just the time when the controversial bestseller Accounting for Growth came out. It was written by Terry Smith, an award-winning banking analyst in London.
Smith argued that most of the growth in British companies in the 1980s — the Thatcher years — was due to creative accounting, not the improved efficiency of British industry. You could be forgiven for thinking the manipulation identified by Smith closely mirrors Markus Jooste’s bag of tricks at Steinhoff. Techniques include acquisition accounting, deferred consideration, extraordinary and exceptional items, off balance sheet finance, contingent liabilities, brand accounting, changes in depreciation and currency mismatching.
Many of these techniques are explicitly forbidden in the US and UK, though much of it a good decade after Smith’s book was published. And not before creative accounting made a decisive contribution to the collapses of Enron and Lehman Brothers.
I had not made the connection initially when Robert Walton at unit trust management company BCI launched the BCI Fundsmith Feeder Fund in January 2019. But the manager of that fund is the same Terry Smith. Fundsmith Equity Fund is now by far the largest unit trust in the UK with £18.6bn or R430bn under management, about three times the size of Allan Gray Balanced, SA’s largest fund.
Fundsmith’s record is impressive. Since inception in 2010 the fund has returned 17.6% a year in sterling, seven percentage points ahead of the MSCI World index. In the first four months of 2020 it was flat while the index was down 8%.
Fundsmith would have had competition to be the largest fund until recently, from another star manager, Neil Woodford, previously at Invesco Perpetual. But his Woodford Equity Income Fund collapsed. Smith says Woodford’s fund was a lethal combination of a daily-dealing open-ended fund with significant holdings in unquoted companies, and small quoted companies with very limited liquidity. The fund was gated, making it hard for clients to take their money out for long periods. Property funds also came under pressure after the Brexit referendum; even the M&G Property Fund from the blue-chip M&G investment house was gated for a while.
This is unlikely ever to happen to Fundsmith. The average market capitalisation of the fund is £114bn. Its underlying companies are likely to survive the cornavirus crisis. It rarely invests in banks or industrial cyclicals. It looks for high-quality businesses that can retain a high return on capital — and Smith should know when to spot figures that don’t add up. It looks for advantages that are difficult to replicate and are resilient to change. Valuation is a key concern. Recently, after their prices fell 40%, Smith snapped up holdings in Nike and Starbucks, which up to that point were considered too expensive.
Fundsmith is known for its catchy list of values, with no shorting, no market timing, no fees for performance, no upfront fees and no nonsense. It is just a plain global equity fund. Its main interests in the financial sector are through capital lite service businesses, the Paypal payment platform and Intuit, best known for its QuickBooks accounting software.
There is a high weighting in the pharmaceutical sectors, with US based multinational Idexx; Stryker, best known for medical devices; and Novo Nordisk, which many of us thought was a mining company but is in fact a Danish manufacturer of drugs for diabetes and obesity. It has a few more fun holdings such as Estee Lauder and McCormick, the US spice company comparable to Robertson’s in SA. That controversial cash machine Philip Morris of Marlboro fame is also a top 10 holding. And the ballasts of the portfolio are tech giants Microsoft and Facebook.
Many of these shares appear in competing funds, yet Fundsmith has done substantially better. There is no doubt that the gap between quality and value fund performance is at extreme levels, but this could turn, and there could prove to be much more limited upside in Fundsmith than in, say, Schroders Global Recovery (available in SA as Absa Global Value Feeder).
Smith has shown he is also mortal in the rather pedestrian performance of his Emerging Equities Trust. Since launch in 2014 it has given a 2.3% annual return, less than half the 5.3% from the MSCI Emerging and Frontier Markets index. Surprisingly, as a quality manager Smith has shown little interest in the Chinese giants, such as Ping An insurance, Alibaba or Tencent, or even Samsung of Korea, preferring the more reliable flows from the leading soy sauce manufacturers.
The focus is on India, which accounts for 44% of the fund. The fund will benefit from the growth of the middle class, with big holdings in Nestle India and Hindustan Unilever. Smith expects the affluent time-poor to turn towards instant coffee, Milo and pot noodles.
• Cranston is a Financial Mail associate editor.
Correction: May 9 2020
An earlier version of this column incorrectly stated that Idexx is an “Indian veterinary drug firm”, when in fact it is a US based multinational
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