The Fundsmith Equity (GB00B4Q5X527) team has little trouble drawing a crowd, and such was the case at the Future of Private Investing event we held in mid-June. A “meet the manager” session saw Fundsmith chief operating officer Mark Laurence field all manner of questions from the audience ranging from specific holdings to the portfolio’s key metrics. The answers offer some useful insights for investors, and as the summer lull kicks in for markets these are worth digesting.
Firstly let’s turn to some stock specifics. Laurence did address the team’s decision to sell out of Amazon (US:AMZN) after just a year and a half. In his words the team had hoped for an inflection point in which Amazon was able to develop a high-return advertising business, after years in which the Fundsmith team had felt cynical about “a business that didn’t make much profit, albeit top-line growth had been quite impressive”.
But having taken a leap of faith the team ultimately sold out on the back of two concerns: the fact that Amazon had “tipped back into loss-making” and worries about the management team’s planned foray into the grocery market. The latter had prompted worries both because the grocery sector has traditionally been a “graveyard of returns” with high fixed costs, and because this venture ran counter to a promise from the company to invest in high-return businesses where Amazon has a particular unique technological edge.
Fundsmith’s “do nothing” mantra might reflect a tendency to resist churning the portfolio but holdings certainly come under scrutiny. Amazon aside, it was interesting to hear the team answer an audience question about Estee Lauder (US:EL), the cosmetics giant whose shares have struggled since the start of 2022. Laurence for now seems to view the recent troubles as a “misstep”, given the company has a large Chinese business vulnerable to last year’s lockdown as well as a big duty free business that has slowed in recent times. Laurence stresses that cosmetics companies still come with juicy margins, though the team is now “redoubling efforts to understand what went wrong and whether they can recover” in the case of Estee Lauder.
Turning to the broader portfolio, the Fundsmith team answered one question by noting that its free cash flow yield (or free cash flow generated as a percentage of market value) had risen from around 2 per cent in the era of zero interest rates to 2.5 more recently. As one measure of valuation, it might look less attractive at a time when interest rates and bond yields have moved higher, though that is just one metric in isolation.
As Laurence puts it: “There is still a risk that if inflation remains persistently high that the free cash flow yields need to be higher, but I think the market at the moment is assuming that inflation is brought under control and we return to reasonably lower rates.”
The Fundsmith approach has tended to focus in large part on how well company management teams can put to work, and Laurence’s comments on the pros and cons of share buybacks seem to reflect that. While he acknowledges that buybacks occur (and can be attractive at the right price), the team would “much rather see companies invest internally” – giving that such investments can offer the potential for much higher returns. With market dynamics shifting markedly, investors will hope the Fundsmith process continues to carry them through thick and thin.
