Terry Smith is arguably the most successful British fund manager of the last ten years. Although the current bear market may well have more twists and turns to come, so far his straightforward philosophy (buy good companies, don’t overpay, do nothing) is proving that it works in tough times, as well as the good ones. This year his Fundsmith vehicle is down 7.9% (Q1), as against his benchmark’s fall of 15.7% (MSCI World Index).
Smith and his trusty sidekick (Julian Robins) seem to be adept at opportunistically pouncing on quality companies when they have an issue of some sort. Buying well-run, growing companies at reasonable prices is often enough by itself to generate healthy returns, but if you can manage to do this when the shares are temporarily lagging, then that is even better. IDEXX, Novo Nordisk and the Mystic Meg-like purchase of Clorox are all relatively recent examples.
That said, Smith’s sale of Domino’s Pizza during 2015 must rankle, with Domino’s being up more than 200% since then. I suppose this is the fund manger’s equivalent of a first world problem (the rest of us usually sell after a prolonged fall in price, timing our decisions perfectly so as to miss out on the turnaround and recovery). Nevertheless, it is somewhat reassuring to see that nobody is perfect.
Anyway, noticing Domino’s striking year-to-date progress (+25%) made me wonder how Smith’s other cast-offs have fared in this Age of Pestilence, and so I did a bit of digging.
2013
In 2013 Fundsmith sold McDonald’s, Schindler, Serco, Sigma-Aldrich and Waters. McDonald’s was sold due to concerns about sales growth (lack of) and Schindler due to its valuation (deemed excessive).
Serco was sold due to Fundsmith’s concerns about an acquisition it had made in India and the sale proved well timed, in light of subsequent problems that were to emerge regarding the company’s electronic tagging of offenders in one of its businesses.
Sigma-Aldrich is was a leading life science and high technology company. It is now owned by Merck. Fundsmith sold it due to concerns about an attempted takeover by S-A of a much bigger competitor.
Waters is one of those appallingly dull operations favoured by knowledgeable investors (as opposed to us amateurs). It is a measurement company, which produces analytical workflow solutions involving liquid chromatography, mass spectrometry and thermal analysis innovations Yes, anyway … Fundsmith repurchased this one subsequently.
So, how have these Fundsmith cast-offs fared so far in the turbulent markets of 2020?
McDonald’s: -6.24%
Schindler: -11.34%
Serco: -27.19%
2014
2014 saw the sales of Swedish Match, CDK and Indivior.
Swedish Match, which makes snuff, chewing tobacco, cigars, matches and lighters, was sold due to concerns about the development of e-cigarettes (potential competition) and fears about possible future competition to the cigar business from Cuba. Who would prefer Swedish cigars to Cuban?
CDK Global and Indivior were small holdings acquired following spin-offs from ADP and Reckitt Benckiser respectively. CDK supplies software to motor dealers and Indivior is a small pharmaceutical company that makes drugs to treat opioid dependence.
Swedish Match: 21.92%
CDK Global: -36.25%
Indivior: 26.92%
2015
It was 2015 that saw Fundsmith make possibly its biggest error in selling Domino’s Pizza, previously one of its star performers. Choice Hotels and eBay were also given the heave-ho.
Domino’s Pizza was sold on valuation grounds. I do think it is possible to query valuation as a rationale for sellings. So what if Mr. Market drives up a company’s price to indefensible highs–surely all you need to do is close your wallet while lowering your expectations for its future returns? In the meantime, just content yourself with calculating its contribution to your portfolio return. To me, selling a good business on valuation grounds is an affont to the ‘Do nothing’ philosophy.
Choice Hotels was discarded due to reservations Fundsmith had regarding its investment in the development of a third-party reservations system. It is striking how many of Fundsmith’s sales are due to capital allocation decisions.
eBay was sold following its split with PayPay. PayPal, the online payment processing company, has since been one of the market’s stellar performers outperforming eBay by more than 30% a year.
Domino’s Pizza: 25.29%
Choice Hotels: -31.23%
eBay: 9.42%
2016
Fundsmith was more forgiving in 2016, disposing only of Procter & Gamble. Companies don’t come with much more pedigree than P & G, so what was the rationale here? No reason was given in the annual report, besides a note that P & G had been an underperformer. It hasn’t since, however, out performing the US market comfortably over the 3-year timeframe.
Procter & Gamble: -3.67%
2017
In 2017 Fundsmith disposed of JM Smucker and Imperial Brands.
JM Smucker is a company I have nearly bought for my own portfolio several times. It makes awful coffee, boring jams and bland peanut butter, but is now equally invested in the terrific pet food sector. It is shocking and almost absurd (to me) to observe how pet owners seem to be increasingly projecting their own ridiculous food preferences onto their pets. Given that pet food manufacturers are of course happy to oblige by providing increasingly ludicrous and luxurious offerings, the margins available should have been obsene (literally dog food marketed as restaurant-quality fodder). Nevertheless, they weren’t and so Fundsmith sold. I wonder if this one might reappear in the Fundsmith stable at a future date when JMS gets its act together?
Imperial Brands was at one time the most successful British stock market investment (mirroring Philip Morris across the pond). In recent times, however, it seems to have been resting on its laurels while existing solely to sell to old Europe and pay a fat dividend.
JM Smucker: 13.97%
Imperial Brands: -18.94%
2018
Two other all-time great market performers were sold in 2018: Dr. Pepper Snapple and Nestle.
Dr. Pepper Snapple, which has quietly been one of the US market’s most consistently high return investments, was sold following the formation of the Keurig Dr. Pepper entity (an unusual coffee and soda pop combination). Certainly, this is an unusual combination, but is it any more unpalatable than chocolate and dog food (Mars or Nestle) or sugar and shirts (Associated British Foods)?
Nestle needs no introduction and I will not make the usual follow-on mistake by now giving it one. Fundsmith sold this due to its apparent receptiveness to the whispered entreaties of an activist investor (a short-term minded breed invariably treated with suspicion by Smith) and another case of suboptimal capital allocation (in Fundsmith’s opinion). His comment on that front in the annual report was cutting:
We rely on the management of our companies to allocate capital in ways which create value for us as investors, and this deal did not seem to meet those criteria, although it certainly seemed to fit the activist imperative to do something and looked like a good deal for Starbucks.
Keurig Dr Pepper: -8.15%
Nestle: 0.72%
2019
In the final full year reported on, Fundsmith cast aside the 3M Company and Colgate Palmolive.
The 3M Company, which is an old-fashioned conglomerate makes an extraordinary collection of things that range from heavy-duty healthcare machinery, to post-it notes and face masks (as you may have noticed recently). This was sold due to… guess what? Yes, questionable capital allocation.
Colgate Palmolive makes toothpaste, amongst other bathroom basics, and was disposed of due to its lack of a growth strategy (a parallel with Imperial Brands).
3M Company: -15.84
Colgate Palmolive 4.98
Conclusion
It is interesting to see that the average return of Terry’s cast-offs in 2020 year-to-date is a loss of only -3.48% (including dividends). The MSCI World Index for the same period is -9.51%. Fundsmith’s performance over the same period is -2.64% (as of Apr 24).
So although his cast-offs have very marginally underperformed his current crop, they have still comfortably outperformed the index and–as a standalone portfolio–would look very good to me. Poking around in the Fundsmith rubbish bin also made clear his relentless focus on his holdings’ capital allocation decisions. No mercy is shown to those who do not do a good job on that front. Warren Buffett, the master allocator, would no doubt approve. The consistent application of its philosophy, clarity of thought and attention to detail is striking in the on-going management of Fundsmith’s portfolio.