Fundsmith Equity has been one of the big beneficiaries of the post-financial crisis environment. Its quality-growth style has been in favour since the fund launched in 2010 and it has attracted considerable inflows during that time. 
Now stood at £18.3bn, the five FE fundinfo Crown-rated fund it is one of a handful of funds that is well-known outside the industry and is widely backed by a range of fund selectors.
Veteran fund manager Terry Smith’s (pictured) bottom-up, high conviction approach has seen it make a total return of 351.91 per cent since launch against a 124.76 per cent gain for the average IA Global peer.
Performance of fund since launch
Source: FE Analytics
Nevertheless, the fund has seen performance dip more recently falling into the peer group’s bottom quartile over three and six months, making losses during the respective periods of 6.01 per cent and 2.01 per cent.
Performance of fund vs sector over several time frames
Source: FE Analytics
This drop-off in performance has coincided with the recent rally in value stocks, an investment style which has been consistently out of vogue for much of the past decade as investors have piled into growth stocks in the low-rate environment.
As such, Trustnet asked several fund pickers whether they still thought that Fundsmith Equity had a place in investors’ portfolios.
Charles Stanley pensions and investments analyst Rob Morgan (pictured) said the size of the fund had soared during the past decade and has continued to attract inflows, although this may be cause for concern.
“As a fund grows in size it can sometimes mean the loss of flexibility in terms of the number of available investments,” he explained. 
However, in fairness, Morgan added, the fund does invest entirely in large and mega-cap companies, “meaning that it is far more scalable than most other funds” and holds high liquidity.
Yet, that didn’t stop Charles Stanley from dropping Fundsmith Equity fund from its ‘buy-and-hold’ list in July as its conviction in the fund had “started to wane”.
Five months on and Rob Morgan pensions and investments analyst at Charles Stanley said the firm currently rates the fund as a ‘hold’ due to ongoing concerns over the fund’s size.
“The fund continues to forge into unchartered territory in terms of its size, and this presents a discomfort on a longer-term view,” Morgan said.
And whilst Charles Stanley is generally positive on the fund, Morgan said the firm retain “a certain amount of doubt about the future”.
And Morgan is not alone in his concerns about the equity giant.
Alexander George, associate director at Dart Capital, said that the fund “faces a number of headwinds which will make it challenging for Smith, to repeat the exceptional outperformance which he has delivered over the last decade”.
As one of the few discretionary fund managers not to have held Fundsmith Equity, George explains, his opinion on Fundsmith has been formed by observing from afar.
While admitting that, along with his peers, he has been impressed by the decade of strong performance he is concerned about the “valuation headwind” that Smith may be running into with his stock choices.
According to George, Fundsmith’s high returns have been driven by stock selection process and the manager's buy and hold philosophy, which means that the portfolio rarely changes.
Although this has done well in an era that favours the growth style, George said stocks in industries that Smith favours – such as medical devices, software and consumer staples – are trading at extremely expensive valuations relative to their own history.
“Whilst this premium valuation is understandable given that these industries are seen as offering investors exposure to secular growth at a time when growth across the global economy is scarce,” said the Dart Capital director, “we believe it will likely serve as a headwind to performance over coming years unless global bond yields decline even further.”
George said this valuation problem has already been seen in two recent US additions to the Fundsmith Equity portfolio: whiskey producer Brown-Forman and food manufacturer McCormick.
Brown Forman, he said, trades at around 35x next year’s earnings despite only growing operating profit at around 5 per cent compound annual growth over the past decade.
Similarly, McCormick is trading at elevated valuations of 30x earnings despite having a highly leveraged balance sheet and delivering only modest organic growth.
“Whilst these companies operate in markets which are deemed to be non-cyclical and largely immune from disruption, investors are now paying roughly double for each dollar of profit these companies generate than they were when the bull run in quality-growth stocks kicked off at the end of 2010,” George said.
But one overarching concern that both Morgan and George agreed on was the value rally becoming a threat to the growth style that Smith specialises in.
Ryan Hughes, head of active portfolios at AJ Bell, also highlighted this as a potential risk to the future performance of Fundsmith Equity.
“With the gap between value and growth stretched the record levels and the potential for the yield curve to steepen next year should governments decide to go on a borrowing spree,” Hughes said, meaning that “the potential for market leadership to move away from the winners of the last decade is high”.
Performance of styles over 10yrs
Source: FE Analytics
As the chart above shows, the MSCI World Growth index has made a 249.38 per cent return over the past 10 years, while its value counterpart is up by just 157.98 per cent, in sterling terms.
But more recently the value style has performed better.
Any prolonged downturn in the growth style could have a significant impact for the fund, said the AJ Bell fund picker.
“With an enormous fund size and a concentrated portfolio, it is clear that the investable universe for the fund is somewhat limited and this does leave the strategy vulnerable to shifts in sentiment to the market as we have seen in recent months,” Hughes said.
Charles Stanley’s Morgan added that “the past six months have seen the ‘quality growth’ style fade in terms of market leadership, an environment that hasn’t played to the fund’s strengths”.
Despite wariness towards the quality-growth style, however, Morgan said the fund continues to exhibit “many admirable characteristics”, including: differentiation from the index, a high conviction style, and a strong process.
“Therefore, overall, I would rate it a ‘hold’ at the present time,” he said.
Hughes agreed that Fundsmith Equity was currently a ‘hold’ option for him too, while George labelled it a 'potential hold', meaning that investors could still keep it in their portfolios but would not recommended adding more to their allocations.