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Terry Smith takes fight to rivals over charges and defends Facebook buy

Terry Smith outlines all-in cost of investing in Fundsmith Equity versus that of rivals, tackling claims his fund is expensive.

Terry Smith takes fight to rivals over charges and defends Facebook buy

Star fund manager Terry Smith has taken the fight to rival fund managers over costs, lining up his £15.8 billion Fundsmith Equity's low transaction costs against the higher charges incurred by other big funds.

Citywire AAA-rated Terry Smith has a long term buy-and-hold strategy, characterised as 'buy good companies, don't overpay, do nothing' that he has long argued saves his investors money by limiting transaction costs.

In his annual letter to investors, he has persistently highlighted the fund's low turnover of holdings and resulting low transaction costs, and produced his own 'total cost of investment' figure, including both the headline ongoing charges figure and the impact of transaction costs.

Fundsmith has attracted criticism from some over its charges, including online stockbroker Hargreaves Lansdown, which continues to exclude the fund from its buy list.

Fundsmith's ongoing charge of 1.05%, and 0.95% when accessed through a platform, is higher than most rival funds'. But Smith has argued the total cost of investment is the more important figure, and now, with fund groups required to disclose transaction costs under new EU rules, he has detailed how his fund stacks up against others.

In this year's letter to investors he compared Fundsmith Equity to the next biggest equity and total return funds available to UK investors.

  Ongoing charges figure Transaction costs Total cost of investment Additional costs (%)
Fundsmith Equity Fund 1.05 0.04 1.09 4
Standard Life Investments GARS 0.89 0.25 1.14 28
Invesco Global Total Return 0.87 0.4 1.27 46
Invesco High Income 0.92 0.1 1.02 11
Stewart Investors Asia Pacific Leaders 0.89 0.13 1.02 15
Newton Real Return 0.8 0.15 0.95 19
Baillie Gifford Diversified Growth 0.82 0.63 1.45 77
M&G Global Dividend 0.91 0.09 1 10
Lindsell Train UK Equity 0.7 0.13 0.83 19
Artemis Income 0.79 0.13 0.92 16
Jupiter European 1.03 0.09 1.12 9
Newton Global Income 0.79 0.1 0.89 13
Ruffer Absolute Return 1.15 0.2 1.35 17
Woodford Equity Income 0.75 0.27 1.02 36
Aviva Multi Strategy Target Return 0.85 0.23 1.08 27
Average 0.88 0.2 1.08 23

Source: Financial Analytics, Fundsmith

'We have long said that we look forward to the day when we can compare our total cost of investment with other funds and that day has arrived,' said Smith.

'We are pleased that our total cost of investment is not only just 4% above our ongoing charges figure (OCF) when transaction costs are taken into account, but that this is the lowest increase in the group,' he said.

While Fundsmith's overall charges are not the cheapest in the table, the low transaction costs do mean five funds that appear cheaper than it according to their OCFs turn out more expensive.

And while Fundsmith appears an outlier on this OCF measure, as one of only two funds in the table charging more than 1%, the lower transaction cost brings its total charges broadly in line with the average.

What also stands out is the low transaction costs of the two big global income funds, M&G Global Dividend and Newton Global Income.

Fundsmith versus Lindsell Train

Lindsell Train UK Equity's transaction costs, while low at 0.13%, are surprisingly three times higher than Fundsmith's in percentage terms.

Citywire AA-rated manager Nick Train (pictured) adopts a similarly long-term buy and hold strategy as Smith, and last year didn't buy a single new stock for his fund. Smith bought two, Facebook (FB.O) and a further company he has not yet disclosed, and sold two, Dr Pepper Snapple and Nestle (NESN.S).

But Smith cautioned investors not to become 'obsessed with charges to such an extent that you lose focus on the performance of the funds'.

He then presented the three- and five-year performance for the same 15 funds, showing Fundsmith comfortably ahead over both periods, with an annualised performance of 16.9% and 17.9% respectively. 

The fund's closest rival over three, M&G Global Dividend, delivered 14%, while the nearest over five, Stewart Investors Asia Pacific Leaders and Jupiter European, returned an annualised 11.8%.

But it's worth pointing out that Fundsmith's list excludes its clearest rival, the Lindsell Train Global Equity fund, managed by Train alongside Citywire AAA-rated Michael Lindsell and James Bullock.

Its £5.3 billion of assets means it would qualify for the list, but Fundsmith examined just UK domiciled funds, and Lindsell Train Global Equity, despite its predominantly UK investor base, is domiciled in Dublin.

Over three years Lindsell Train Global Equity has returned 85.6% versus Fundsmith's 69%, while over five years there is little to separate them, with respective returns of 133.2% and 133.7%.

Fundsmith endured its worst calender year for performance since the fund's launch in 2010 last year, rising just 2.2%.

But relative to other funds, it did well: Smith pointed to figures showing just 202 of 2,592 funds in the various Investment Association sectors delivered a positive return last year.

'Ironically, 2018 was not a great year for our absolute returns but it was actually our second best year relative to all Investment Association mutual funds,' he said. '2011 when the market also fell was our best, probably not coincidentally.'

Facebook 'glitch'

Smith also used the letter to offer the first detailed reasoning behind his decision to buy Facebook for the fund last year.

Smith bought the stock in February, just a month before the social media giant became embroiled in the Cambridge Analytica data scandal, sending its shares falling.

Facebook was the third biggest weight on the fund's performance during 2018, behind tobacco company Philip Morris International (PM.N) and accounting software provider Sage (SGE).

'Our purchase of a holding in Facebook is certainly one of our more controversial decisions in the light of the furore over its use of personal data and what role some Facebook users may have made of this in elections,' Smith said.

'No doubt it will continue to be a difficult stock to hold in terms of media attention, but we have often found that the only time you can hope to buy stock in great businesses at a cheap valuation is when they have a glitch.'

Smith pointed to Facebook's historic price-earnings ratio of 19.7 times, roughly in line with that across the US S&P 500 index. 

That's despite the social media giant's return on capital employed and gross margin in 2017 being double that of the index, with operating margins of 50%, versus the broader US market's 13%.

'Unless there is going to be a much more severe deterioration in Facebook's operational performance than we have seen to date or reasonably expect, this looks cheap to us,' he said.

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