Latest / On The Money / Terry Smith’s overhaul: what’s behind it and what’s changed?

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Terry Smith’s overhaul: what’s behind it and what’s changed? · On The Money

• 0:03
  Kyle Caldwell: Hello and welcome to On The Money, a weekly show that tackles investments and pension topics in a practical manner. Today we're gonna be talking about a notable change that arguably Britain's most famous investor that's running money today, Teddy Smith, has made to the way in which he invests. In short, he's moved away from his famous do nothing low turnover strategy, instead carrying out a major overhaul of the funds. Joining me to discuss this topic is Dave Baxter, who is senior fund content specialist at Interact Investor. So, Dave, you covered Teddy Smith's recent twice a year letter Yeah.
• 0:45
  In which he announced this notable change. So, firstly, could you run through the reasons why he has dropped his do nothing mantra?
• 0:55
  Dave Baxter: So it comes back to his old performance of recent years sorry. It comes back to his old problem of recent years, which is performance. So if we look at performance over the first half of this year, I think the fund lost something like almost 3% in a, you know, rising period for markets. Then if we look over five years, his returns are very anemic, whereas they're very strong for the global index. Even over ten years, he's lagging.
• 1:22
  And then even since the fund's inception back in 2010, so remembering that performance used to be very strong, he's not that far ahead of the market. So he is trying to address this. And, basically, when he's talking about his underperformance, he thinks the culprit is tracker funds, something he's spoken about before, and this idea that momentum is driving the market too much. So what he's trying to do is be a bit more active, lean into those kind of momentum effects to an extent, and, yeah, I guess, try and stop fighting the market so much.
• 2:01
  Kyle Caldwell: So turnover for the fund, it tends to be very low. But in the first half of this year, and turnover hit nearly 52%. So let's dig into the changes that were made. So overall, he has started to build stakes in 12 new companies, and he has exited or started to exit 13 positions. The fund now has 31 holdings, which is a bit higher than usual.
• 2:28
  I think, typically, he's had around 25 holdings. And for those watching on YouTube or on Spotify, we're gonna show two tables outlining the sells and the buys. Dave, let's start off with the sells. Could you pick out those that piqued your interest the most?
• 2:48
  Dave Baxter: So let's start off with Unilever. It's almost surprising in hindsight that he hadn't sold it before because he's he's been quite kind of spiky with management in recent years. He argues that he's been upset with the fact they've kind of made some disposals, like spinning off Magnum and then doing a kind of tie up with the food company McCormick. And generally, he's been quite dissatisfied with management's behavior and that kind of thing. So they've dropped that.
• 3:16
  They've also dropped Nike, which is an interesting one because that's been a bit of a a troubled turnaround story in recent years. And he thinks that turnaround story is gonna, you know, take much longer to work out, if it works out at all. Then just to highlight one other well known name, there's the luxury goods brand LVMH. He worries that issues like, for example, problems in China will mean that, again, that turnaround will take longer to kind of come through if it does.
• 3:45
  Kyle Caldwell: I'm moving on to the buys. The one that stands out for me is Taiwan semi Semiconductor Manufacturing, TSMC, as the fund has previously stuck to shares listed in developed markets, whereas this is listed in emerging markets. So, what did you make of that day, and which others caught your eye?
• 4:06
  Dave Baxter: Yeah. I think it's interesting because, as you say, Fundsmith Equity has been a developed markets fund, and famously, Fundsmith actually ran an emerging markets investment trust, and they shut it down a few years ago because their approach didn't really seem to be paying off that well in that region. So that, first of all, is a departure, but it's also a departure in terms of his approach. So you could argue that TSMC is one of those kind of momentum shares at the minute. At the time of recording, the shares have returned something like 110% over twelve months.
• 4:43
  So he is jumping onto one of those kind of rocketing shares. One other thing to note is that TSMC is very easy to argue that it's, you know, an AI play. And previously, Terry has made quite a big deal of this idea that you can't yet predict who's gonna be a winner from the kind of AI theme. And another new holding app, Levin, you could also argue, kind of an AI play. Then if we turn to just a couple of other interesting buys, what caught my eye was he's brought back into Sage, and he's also brought into a company called Viva Systems.
• 5:19
  These are both in the software space. So he is, I guess, buying some of those software sell off victims. But one thing we hadn't kind of pointed out yet is another change is he wants to try and avoid buying into glitches. So famously, he bought names like Microsoft and you could argue Meta when they were on a bit of a kind of down moment, and that paid off very handsomely. But now he's a bit scared of getting caught out by this kind of momentum driven market and avoiding that.
• 5:51
  But you could argue that these are cases of glitches, so maybe there's some kind of inconsistency going on there. And then finally, he's brought in some of those kind of very well followed big US names. So you've had Netflix, you've had Uber, and you've had Mastercard, which joins Visa in the portfolio.
• 6:08
  Kyle Caldwell: I think it's a way of noting that Teddy Smith does give very detailed rationales, in particular for the buys that he's made Yeah. In his semi annual letter to investors. I think he's very good at communicating, he's very transparent. We've both interviewed Teddy Smith over the years, and he doesn't shy away from answering the tough questions. I think I think he actually welcomes them as well.
• 6:32
  And also, he doesn't have to write these letters twice a year, and we don't see other full management groups adopt this widely. I think I think it's really important to communicate with retail investors effectively, and when you're making changes to a portfolio, to to get them across and to explain your reasons why. And I think, you know, for me, this is one of reasons why I like investment trusts, because they have to produce a half yearly and an annual report. And as a retail investor, get lots of detail in there, in terms of the full manager's recent thinking, and what they've been doing in terms of changes to the portfolio. In terms of performance, as you've mentioned, Dave, the sort of the outperformance gap since launch versus the MSCI World Index, it is it has narrowed.
• 7:24
  Mhmm. However, the fund has still outperformed since it launched in November 2010. So I think if you bought from launch, and you've held all the way through, you're still gonna be pleased because you've that the fund has outperformed a global tracker fund over that period. However, if you bought five years ago, that's a much different experience. You will have, you know, you will have underperformed pretty notably.
• 7:51
  And I think in an ideal scenario, you'd have took some profits around five or six years ago, and you'd have been very happy then because the outperformance gap would have been much bigger than it is today. In terms of the changes that have been made to the portfolio, I can see both sides of the argument. So on the one hand, some investors may have been hoping that the investments held in the fund prior to these changes may have been ripe for a recovery, as many of the shares held had underperformed over the past five years. But then again, on the other hand, if you're entrusting a full manager to invest on your behalf, then you want them to invest where they're seeing the best opportunities. So, you know, you're gonna want a full manager to refresh the portfolio if they think that's the best thing to do.
• 8:45
  I think one important thing to get across is that, yes, he may have dropped the do nothing mantra, but the style of the funds in seeking out high quality growth companies, that hasn't changed.
• 8:58
  Dave Baxter: I I think you could disagree with that, though, because he is trying to kind of shove more momentum into his funds. So perhaps there is some people have at least argued there is stardrift. And I guess to play devil's advocate, I mean, I think it's on the one hand, it's good someone's trying to kind of adapt and especially if they think markets have changed materially. But the key concern I would have if I held fundsmith or are considering buying would be, has he now strayed into things that are not his forte? He doesn't understand, for example, you know, can he call things like who the AI winner is?
• 9:36
  And also, in recent years, one of the big criticisms of Fundsmith, from parties like Morningstar has been that he has struggled with timing his buys and sells. So for example, he sold out of Amazon relatively quickly, maybe after eighteen months or so, and then it kind of did very well. And he had some timing issues with names like Adobe. If he's committed to being more active and he said that he's, you know, we're not necessarily gonna see that 52% turnover level again, but you're probably gonna see higher turnover than used to, are we gonna run into more of these timing issues, or would we actually expect the team to get better on that front now by doing it?
• 10:18
  Kyle Caldwell: It could well be that you just made one big set of changes in the first half of the year, and we're not gonna get, you know, portfolio turnover anywhere near that going forward in the years to come. In terms of the points I made earlier on style, for me, I'd be more concerned if the types of shares you were buying did not fit the quality growth description. That would that would bring the alarm bells with me. But, but I do, yeah, I do take your point as well, Dave, that, you know, for some investors, they the reason they may have bought the fund originally is because they liked the buy and hold approach, and he has now dropped that mantra.
• 10:57
  Dave Baxter: And I guess one other point in his defense is perhaps there is some consistency remaining in that he six of these metrics have guided the fund, so he's tended to look at things like return on capital employed, free cash flow yield, and so on. And he did try to argue that the new portfolio looks quite good for those measures. And I always thought that should give a level of kind of discipline and robustness to what they're doing.
• 11:26
  Kyle Caldwell: Another investor that seeks to buy and hold and has also had performance issues is Nick Train. Now, the past couple of years, Nick Train has been a little more active than usual. He has bought some companies, but those changes have been minimal. I mean, what are your thoughts, Dave, overall on, you know, whether or not to bring the changes to try and improve performance or to sort of stick to the holdings that you've had for years?
• 11:56
  Dave Baxter: I personally find it a bit alarming to see more the kind of Smith approach because I even, I don't know, say six months ago, I remember myself arguing with someone that perhaps these portfolios, the Fundsmith and the Lentil Trains and so on, looked appealing because they're so out of favor, and a lot of that's to do with style, that really it could be something useful to hold in your portfolio because hopefully at some point when the market turns, that should do well. So it is useful to have that consistency, but I guess it's just with Nick Train, it's such an extreme. You have very big position sizes and things like London Stock Exchange, Experian, and so on. They've really struggled, so it is quite a big bet, and it does become quite challenging. And I guess as we've kind of written before, it's been interesting to see the much more high turnover funds.
• 12:54
  So names like Randmore Global Equity, Blue Well Growth, that kind of thing. They've really kind of come through in terms of performance in recent years. So maybe it's just a different market that kind of rewards nimbleness more.
• 13:08
  Kyle Caldwell: But the other side of the argument, I suppose, is that if you've held a share for a long time and it's underperformed, you're being quite stubborn in keeping hold of it. I mean, obviously, you're holding it because you think, in time, the prospects will improve, and ultimately, as a for manager, you'll be proven correct. But it can take a very long time for narratives to change, and sometimes, can end off holding on for a company too long and waiting too long for a recovery to play out, you're missing out on all the potential opportunities in the meantime.
• 13:45
  Dave Baxter: Yeah. And maybe that makes the case for being more active and more incremental, so you kind of trim a bit, add a bit, as you see, for example, in funds like Scottish Mortgage. Because if you're simply doing buy and hold and with big position sizes, then you're kind of you're stuck to that position to an extent, and it becomes a much bigger issue, positive or negative, for performance.
• 14:08
  Kyle Caldwell: And in terms of staff or managers, so in The UK, Teddy Smith and Nick Train are two very well known names. There's also Bill Ackman as well, the famous US investor. However, overall, this star for manager culture, it's much less of a thing today than it was, say, fifteen years ago when I started out as a club reporter for an investment trade title. I do think it's fair to say that back then, you know, from a particularly from, like, a marketing perspective, fund firms, they they marketed who was the lead manager on the funds, and, you know, this is the stock picker that can potentially beat the market. What are your thoughts, Dave, on for managing companies' movements, this more team based approach?
• 14:55
  I mean, you see some funds these days that have, say, three, four, or five named managers on the fund?
• 15:02
  Dave Baxter: I think in a way it lowers the stakes for the fund and for the company because back in those days you spoke about you'd have kind of these really big names, and then if the big manager left and went to another company, you'd see loads and loads of money pile out of that fund, and if that's an open ended fund that causes problems because they're having to, you know, provide cash for investors. So it seems sensible, but I would just highlight the fact that the choice of lead manager and the choice of, I guess, deputy manager, if applicable, I think that can still be really important to how the portfolio is run. Because, yes, you can have a team approach, but I and I'm sure you've had the same. I've definitely encountered kind of funds where one lead manager has a very specific view on one thing or one kind of investment, and then when someone else succeeds them, they have a totally different view. So the portfolio can change quite radically.
• 15:56
  Kyle Caldwell: I agree. I mean, for me, I like the fact that there's a lead manager on funds or there's two lead managers, because I think it it gives retail investors accountability for performance. I do think there's a danger that if you have four or five named managers, it's like, who who is the person that is, you know, at top of the tree that can address why a funders underperformed. Let's go back to the reason why Teddy Smith decided to do this portfolio overhaul. So as you mentioned earlier, Dave, he's acted due to the dominance of passive funds, so either index funds or ETFs, which he says has made the stock market become more dominated by momentum rather than fundamentals, such as how profitable a company is.
• 16:45
  So in light of this, should we, as investors, take notes and look to make changes to our own portfolios?
• 16:51
  Dave Baxter: Yes and no. It's good to adapt. I think it's good to be wary of how capricious and volatile markets can be at the minute, but it's very dangerous to be kind of chasing performance. People, of course, could turn to me and say, well, TSMC is up 100 over a year, that kind of thing, but it can turn. I mean, my mantra would always be the quite boring one of, you know, do participate in these markets, but remember to diversify.
• 17:22
  So look at regions maybe like The UK alongside The US, and look at those more kind of boring sectors as we've discussed before as well.
• 17:31
  Kyle Caldwell: Totally agree, Zave. I mean, we regularly speak on this podcast about the importance of diversification. Terms of areas where investors might wanna consider whether they're potentially a bit overexposed at the moment, I'd say the standout one is technology, and by extension, the artificial intelligence theme. So for three years now, we've been publishing a report each quarter called the II top 50 fund index. And what we do is we rank the most more funds, investment trusts, and ETFs over a three month period.
• 18:04
  And we base it on the number of buys, and we strip out regular investing because we wanna give a sense of the active decisions that DIY investors are making. We've just published our latest report, which you can view at ii.co.uk. And one of the trends we've seen in the second quarter of this year is of those 50 funds in that index, the number of technology funds, it's has risen from five to 10, and of those ten, three are actively managed funds. So there's the Polar Capital Technology Investment Trust. There's also the Open Enses Polar Capital Global Technology, and also the Allianz Technology Investment Trust.
• 18:48
  And then the other seven, they're all index funds or ETFs that give dedicated exposure to technology, and they are VANEC semiconductor ETF. That one appears twice on our index for both its accumulation and income share class. And then there's also LNG global tech index trust, Invesco e q q q, Nasdaq one hundred ETF, iShares MSCI global semiconductors ETF, and iShares s and p five hundred information technology sector ETF, and there's also a technology leveraged ETF that's managed by WisdomTree. And I do think in the second quarter of the year, I think what helped fuel demands for specialist technology funds has been the initial public offering of SpaceX. And we also saw in our II top 50 fund index, sell it from space that rose eight places in the rankings, the fourteenth, and we also saw a new entrant in VanEck Space Innovators ETF.
• 19:52
  What are your thoughts, Dave? Do you think investors are becoming a bit too overexposed to technology?
• 19:59
  Dave Baxter: Yeah. I think it's a big risk. It's very easy to get excited. You're having these kind of thematic exposures which have a lot of overlap, at least in terms of investment style. And then, as we've discussed before, one part of the market in the ascendancy has been emerging markets.
• 20:17
  People might increasingly get drawn into that. But a lot of that is also kind of the AI play, things like SK Hynix and Samsung Electronics. So it's it's almost quite hard to avoid the kind of tech AI area at the minute, but it is worth kind of trying to dig around and find some proper diversification.
• 20:37
  Kyle Caldwell: I think if you bought a technology fund five years ago, now could be a good time to consider rebalancing and taking some of those paper pros profits and turning them into real profits.
• 20:50
  Dave Baxter: Mhmm.
• 20:51
  Kyle Caldwell: And I've had conversations with, you know, many private investors over the years, and I know some of them don't like the idea of rebalancing. You know, one investor said to me, isn't this just throwing good money after bars? And I think some people worry about taking profits in a star performer too soon, and then the investments they decide to redeploy into, that they may might take a while to recover. Well, I think the things to bear in mind with rebalancing is the it's what what it does is it restores the risk level of your portfolio back to what it was when you when it was first put back when it was first put together. So that's that's what it does.
• 21:35
  And I I do, you know, I do totally agree that you can potentially sell a winner too soon, and you could end up investing into sort of an underperforming area that mightn't actually recover. Mhmm. So care does need to be taken, but I think you just need to bear in mind what rebalancing is and what it's seeking to achieve.
• 21:55
  Dave Baxter: Yeah. I mean, rebalancing is fundamentally not very sexy, but if you wanna look at some extreme examples, say you were lucky enough to have held Scottish Mortgage in 2020, that roughly doubled your money in that single year, You might think the good times will continue. Performance has come back eventually but it had a really difficult kind of five years or so. I think in 2022 it roughly halved So although it's not exciting, rebalancing would protect you from summon up.
• 22:25
  Kyle Caldwell: So Dave, think it's time to wrap up the episode. Thanks for coming on today.
• 22:29
  Dave Baxter: Thanks for having me on.
• 22:30
  Kyle Caldwell: That's it for our latest episodes of On The Money. Hope you've enjoyed it. We love to hear from listeners, and the way to get in touch is by emailing us on otm@ii.co.uk. And, hopefully, I'll see it again next Thursday.