- Fundsmith Equity has underperformed the MSCI World Index over a five year period
- But so have 80% of global equity funds
- Fundsmith Equity has still outperformed the average global fund
- The Magnificent Seven have pulled the plug on active fund performance
- The choice facing Fundsmith Equity investors: should I stay or should I go?
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Fundsmith Equity has been on a bad run if you compare its performance to the global developed stock market, but then so have most global equity funds. Four out of five funds in the global sector have underperformed the MSCI World Index on a five year view. Even over a longer time frame the sector has not been a sweet spot for active management. According to AJ Bell’s 2023 Manager versus Machine report, only 22% of active global equity funds beat the average index tracker over the last decade. Fundsmith Equity was one of them.
“The storming performance of the Magnificent Seven has not helped active managers. The sheer size of these companies has meant active managers would have had to allocate a significant chunk of their portfolio to these stocks simply to keep up with the market. Together these stocks now make up 20% of the MSCI World Index, and their exceptional performance is responsible for this benchmark being such a tough one to beat. Despite falling behind the index, Fundsmith Equity has still comfortably beaten the average global fund over five years. It is also one of the three best performing funds in the sector over 10 years.
Source: FE total return to 29 February 2024
“Fundsmith Equity investors might be chewing over that perennial question when fund performance starts to falter: should I stay or should I go? While underperformance is of course disappointing, it’s important to keep it in some context. Fundsmith Equity might have underperformed the MSCI World Index over five years, but it’s still comfortably beaten the average global fund. Its longer-term performance is also exceptional, which puts some considerable credit in the bank for the manager.
“Fund returns over the last five years have also been strongly positive. Underperformance is most painful when it’s accompanied by lacklustre or negative returns. Fundsmith Equity investors have received a 73% return over the last five years, equivalent to a compound annual return of 11.6%. That’s not a slap in the face. It’s not a like for like comparison, but consider the adjacent plight of investors in UK equity funds. The average fund in this sector would have generated a return of just 21.7%, and even the very best performing fund in the sector would have been significantly behind the returns provided by Fundsmith Equity over the last five years (see table above). Investors probably shouldn’t be too miffed about the absolute returns provided by Fundsmith Equity in the grand scheme of things.
“As well as placing historical returns in context, it’s important to consider the fund’s future prospects too. When a fund comes under performance pressure, investors should be on the look-out for managers diverging from their investment philosophy. Any such moves should serve as a red flag, as they suggest a fund manager is floundering, opening up the portfolio to the possibility of getting whipsawed, or undermining the reason investors bought into the fund begin with. There are no signs of Fundsmith deviating from its well-articulated investment philosophy. Anyone who has followed the fund for any length of time will not be surprised to find Terry Smith sticking to his guns. In their deliberations investors should revisit the reason why they bought the fund and whether the investment case still holds water. They should also consider whether there have been any changes in their personal circumstances or the rest of their portfolio which might affect the suitability of a global equity fund like Fundsmith Equity.
“Active fund investors should always expect periods of underperformance, and in today’s momentum driven markets, these spells can be lengthy. If you keep jumping ship when funds underperform, you might well miss out on a bounce back, or simply hop out of the frying pan and into the fire, as there is no guarantee any active fund you move into will outperform. You will also incur costs for switching funds each time you do so. On the flip side, sometimes by sticking with an underperforming fund manager you can end up experiencing further underperformance, and eventually pulling the plug. This more patient approach can however be mitigated by running a diversified portfolio, so if one active manager falls behind, the others can pick up the slack.”
