Cade, head of investment companies’ research at Numis, says he is encouraged by the trust's long-term buy-and-hold strategy and the track record of Smith's open-ended Fundsmith Equity fund. He adds that although emerging markets have struggled in recent years, there are signs that the worst may soon be over, making now the perfect time to buy into the sector. “Valuations now look attractive following a period of weak performance in emerging markets,” he said.
“Generally emerging markets are now looking more attractive. People have become a lot less pessimistic and valuations have come down significantly.”
Cade adds that although the trust’s strategy is unproven in emerging markets, its well-timed entry into a recovering sector gives it greater margin for error.
“It makes sense to invest in emerging markets from a long-term perspective through a closed-ended fund. The only question you really have at this stage is how their strategy in global equity markets will fit in with emerging markets. You could say it is a little untried.”
“However, it does come down to your view on the effects of QE tapering and a slowdown in Chinese economic growth. But certainly it is a better time to be setting up a closed-ended fund in any asset class when the markets are struggling a bit rather than at the end of a cycle.”
Terry Smith will manage the £193m trust alongside head of research Julian Robins and Tom Boles, Jonathan Imlah, Michael O’Brien and Sandip Patodia. Smith has invested £5m of his own money into the fund.
Fundsmith Emerging Equities will adopt the same investment approach as the five crown-rated Fundsmith Equity fund, but will invest in companies that either derive the majority of their revenue from or have the majority of their operations in developing economies.
It will have a concentrated portfolio of between 30 and 55 stocks that are selected from a list of 139 companies supplied by Fundsmith. This means the stocks will already be well known to the management team.
“Around a fifth of the stocks identified are quoted subsidiaries, associates or franchisees of multinational companies such as Nestle or Unilever,” said Cade.
Cade says this high-conviction approach focused on the consumer sector will set it apart from existing emerging market investment trusts.
“It is much more like a Nick Train-style approach where you ignore most of the market and just focus on areas that you like, in this case quality consumer names.”
“It is also very differentiated and with Smith’s high profile in the press, I would expect it to trade well initially. Ultimately, long-term it will depend on whether Smith will be able to find value in consumer-facing emerging markets stocks.”
Emerging markets have had a torrid time over the past few years, steadily underperforming developed market equities after a series of sell-offs caused by events such as the tapering of QE and a perceived slowdown in China’s rate of growth.
According to FE Analytics, the MSCI Emerging Markets index is up 54.64 per cent over five years compared with 126.43 per cent for the S&P 500 and 96.43 per cent for the FTSE All Share.
Performance of indices over 5yrs
Source: FE Analytics
The index is still down 8.85 per cent from May 2013 when the initial sell-off began.
The slowing growth of China is a much discussed and divisive issue among investors and economists. Some of them point to the dangers of a “hard landing” while others say the trend is healthy, as the country becomes more focused on “quality growth”, rather than large capital projects and exporting to developed nations.
Cade says that in a bid to avoid the Chinese slowdown, Fundsmith Emerging Equities will steer clear of financials, utilities, resources, transport and heavily cyclical sectors such as construction and manufacturing, and will instead invest exclusively in consumer stocks.
He added: “The managers state that they would not invest in banks in Europe or the US due to a lack of transparency, and find the idea of investing in banks in China 'simply staggering'.”
“However, they will consider investing in some industries that are seen as unattractive in developed markets, notably retailers and breweries.”
“The focus is on companies with relatively predictable revenues and low capital intensity that deliver most or all of their profits in cash. They will have defensible and strong market positions, typically derived from a combination of brands, trademarks and distribution systems or networks.”
“There is a strong valuation overlay, but the managers will not attempt to time markets, and aim to be long-term, buy-and-hold investors.”
Cade says his only misgiving is the fund’s cost.
“Terry Smith has highlighted that the launch costs of Fundsmith Emerging Equities are low relative to traditional investment trust issues, as the majority of the marketing was undertaken in-house, although the ongoing charges are relatively high, in our view.”
“However, Fundsmith has a good track record in its OEIC and we believe that the long-term buy-and-hold strategy in emerging markets is well suited to the investment trust structure.”
The base management fee is 1.25 per cent of net assets and the ongoing charge ratio is estimated to be 1.6 to 1.75 per cent in the first year. There is no performance-related fee.
