The collapse of Neil Woodford’s investment empire last year prompted increased scrutiny on issues such as illiquidity assets and style drift but Terry Smith has reassured investors that they do not need to worry about these with his own asset management house. 
One of the biggest events of 2019 was the closing of Woodford Investment Management, which came in the wake of the suspension of its flagship LF Woodford Equity Income fund. The fund ran into problems after months of poor performance and heavy outflows highlighted its high weightings to illiquid unquoted stocks.
In the 10th annual letter of the Fundsmith Equity fund, the FE fundinfo Alpha Manager noted the strong performance of his own fund last year. Fundsmith Equity made its top-quartile total return in a row during 2019, outperforming the the MSCI World index in the process.
Smith (pictured) conceded that the £19.7bn fund had “a couple of poor months” in September and October, when a combination of the rally in the sterling and a ‘rotation’ from the quality-growth style that it follows into value stocks cost it around 6 percentage points of performance.
Performance of Fundsmith Equity vs sector and index over 2019
Source: FE Analytics
Many commentators have argued that value stocks are due to outperform the quality approach, given that the style has lagged for much of the post-crisis bull run, but the Fundsmith Equity manager pointed out that this argument has been made for several years – without any meaningful rotation actually taking place.
“If you read the breathless commentary on this in much of the press without knowing the actual performance of our fund you might be surprised to find that, notwithstanding these events, it ended the year up by 25.6 per cent which was our second best year since inception and outperformed the MSCI World index by 2.9 per cent,” he added.
While the manager spent the bulk of the letter – which can be found in full here – examining his investment strategy of ‘buying good companies’, ‘not overpaying’ and ‘doing nothing’, he also said it “seems impossible” to talk about 2019 without mentioning the demise of Woodford Investment Management.
The most obvious problem with LF Woodford Equity Income, Smith said, was that it was a daily-dealing open-ended fund with had a weighty allocation to illiquid holdings such as unquoted companies.
He also noted that Woodford is not the only one to have recently run into this problem, pointing to the current suspension of M&G Property as well as those property funds that were gated in 2016 after the Brexit referendum.
Performance of LF Woodford Equity Income vs index since launch
Source: FE Analytics
“Where does the Fundsmith Equity fund stand on this? We have always regarded liquidity as an important issue. As evidence of this, we have published a liquidity measure on our fund factsheet since 2012,” he continued.
“Equally we only invest in large companies. At 31 December 2019 the average market capitalisation of the companies in our fund was £114bn and we estimate we could liquidate 57 per cent of the fund in seven days.
“The reality is that the only type of fund which can guarantee 100 per cent liquidity on demand is a cash fund, and I presume that is not what you wish us to invest in. But I suspect you will find it hard to find more liquid equity funds than ours. It tells you much about its liquidity that some of the least liquid stocks we hold are the FTSE 100 companies, InterContinental Hotels, Intertek and Sage.”
In addition, Smith highlighted how much of the discussion around the Woodford incident has centred on the ‘star manager’ culture that exists in the asset management industry. While Smith doesn’t like that particular phrase, he does not believe this was at the root of the problem.
“I think this concern is focused on the wrong issue. I think it makes no more sense to avoid funds run by ‘star’ fund managers any more than it does to avoid supporting sporting teams because they have star players,” he said.
“The trouble arises not because teams have star players but if the star tries to play a different game to the one which delivered their stellar performance. Would Juventus do as well if Cristiano Ronaldo played as goalkeeper? How is Usain Bolt’s second career as a soccer player going?”
Instead, Smith believes the real problem is that when Neil Woodford started his own fund house, he radically changed the investment style that had served him so well over his three decades at Invesco Perpetual. While Woodford had started owning unquoted stocks while at Invesco Perpetual, this accelerated once he left to set up on his own.
Could this happen with the Fundsmith Equity fund? Its manager “thinks not”.
Performance of Fundsmith Equity vs sector and index since launch
Source: FE Analytics
“We have no desire to change our strategy. We are convinced that it can deliver superior returns over the long term. I would pose a different question which links the discussion of the Woodford affair with the earlier discussion of the ‘rotation’ from quality stocks into value stocks,” he said.
“If you expect such a ‘rotation’ to occur at some point and for value stocks to enjoy a period in the sun would you rather we tried to anticipate that and switched into a value investment approach of buying stocks based mainly or solely on the basis of their valuation or would you rather we stuck to our existing approach of buying and holding high quality businesses? I would suggest the latter approach might be better, and it is what we are doing. There will be no style drift at Fundsmith.”