Fundsmith are attempting to raise between £100m and £250m for the launch of the trust, slated for 25 June 2014.
There are few closed-ended options for investors in emerging markets and Charles Tan, investment companies analyst at Cantor Fitzgerald, says that Smith’s (pictured) offering will be a good addition.
“This kind of fund that aspires to be different from the pack is very much welcome,” he said. “The Terry Smith brand does have a strong track record in the open-ended space because he has done very well,” he added.
Smith’s approach is based on looking at free cash flow rather than earnings. The latter is easily manipulated by company accountants while cash is cash.
“You can’t hide with cash,” Tan said. “Terry Smith’s reasoning is where better to apply this free cash flow model than emerging markets equity where so often you do get dodgy dealing.”
The open-ended Fundsmith Equity fund targets a free cash flow yield of 7 per cent. On the trust the manager says only that the aim will be to pick companies with a free cash flow yield high relative to peers and rates.
Fundsmith also look for companies with strong brands and intangible assets, in contrast to many analysts who prefer physical assets.
The manager argues that these intangibles are harder for competitors to replicate and companies that possess them have a greater chance of returning more than the average stock over the long run.
This is a similar approach to that employed by the Liontrust FE Alpha Manager duo of Julian Fosh and Anthony Cross, who have had great success with a UK strategy along these lines.
Fundsmith’s focus is on return on capital, the rate of return generated on the investment by both equity and bondholders, which Smith says should be as intuitive as checking the rate of interest on your bank account but is often overlooked by active managers.
This means that the trust will be looking for companies which use relatively low amounts of capital to derive their returns and that most profits are in cash.
Many investors were sucked into emerging market funds after the financial crisis, seduced by the arguments that superior economic growth would lead to superior market performance.
However, performance in the developing world has been relatively poor, with the MSCI
Performance of indices over 5yrs
Source: FE Analytics
Smith explains that the focus on the trust will be on the emerging market consumer story, which means that the fund will be very different from the benchmark and has a much better chance of producing strong long term gains.
“FEET will be invested using the same strategy as the Fundsmith Equity Fund but with one added dimension: all of the companies in FEET will have the majority of their operations in, or revenue derived from, developing economies,” he said.
“It will avoid the same sectors which the Fundsmith Equity Fund avoids – financials; heavily cyclical sectors such as construction and manufacturing; utilities; resources and transport, and will instead invest exclusively in consumer stocks.”
“[These stocks] will also provide direct exposure to the rise of the consumer classes in the developing world. This rise is a well-established trend with a predictable pattern of development and has a long way to run.”
“Euromonitor forecasts that the consuming class (representing consumers with more than $5,000 in disposable income) in the developing world will grow by approximately one billion individuals between 2010 and 2020.”
“Further, a recent study by Groningen University, Brookings Institution and McKinsey forecasts consumption in the emerging markets to rise from $12tn in 2010 to $30tn in 2025, an increase of 150 per cent.”
“This compares to a rise, over the same period, from $26tn to $34tn for the developed markets, an increase of 30 per cent. Benefitting directly from this rapid growth is central to the investment strategy of FEET.”
Data from FE Analytics shows that the Fundmisth Equity fund has returned 66.84 per cent since launch as the MSCI World index has made just 45.47 per cent and the average IMA Global fund considerably less.
Performance of fund versus sector and index since launch
Source: FE Analytics
Our data shows that it has done so with a low correlation to its benchmark, reflective of a stock-picking approach.
The r-squared figure is just 64 per cent, which means that movements in the benchmark explain only 64 per cent of the movements in the fund. This is a bottom quartile figure for the sector.
Over the same time the fund has added alpha worth 7.79 per cent on an annualized basis, a top quartile figure of the sector, while it has been in the least volatile quartile of the sector.
The top holdings include Imperial Tobacco, Pepsico, Microsoft and Unilever, which are heavily exposed to emerging market consumers.
Gordon Smith, analyst at Killik, said: “We are holders of his broad global mandate which has a strong approach, looking at companies which has worked well.”
Smith says that this method seems likely to translate well to consumer-oriented emerging market stocks, and the Fundsmith fund will be the only emerging market trust with this focus.
He explains that the closed-ended structure is particularly appropriate because of liquidity issues: investment trusts don’t need to sell their stocks when unitholders redeem their holdings, which means they are not forced to sell stocks they like for bad prices.
Tan says that he does expect the trust to successfully raise the money it is aiming for, although he notes that this is an interesting time to be raising money for such a venture, with emerging markets having suffered a poor period.
The ongoing charges on the trust are expected to be between 1.6 per cent and 1.75 per cent in the first year.
