The lowdown on Fund­smith’s pop­u­lar emerg­ing mar­kets trust

Does the fund de­serve its pre­mium given it has con­sis­tently un­der­per­formed its bench­mark?

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Save for three con­stituents, the trusts pop­u­lat­ing the As­so­ci­a­tion of In­vest­ment Com­pa­nies’ (AIC) Global Emerg­ing Mar­kets sec­tor trade at dis­counts to net as­set value (NAV), while the sec­tor av­er­age dis­count stands at 11.2%. The most well-fol­lowed among re­tail in­vestors among this pre­mium-rated trio, which in­cludes Black­Rock Fron­tiers (BRFI) and Jupiter Emerg­ing & Fron­tier In­come (JEFI), is Fund­smith Emerg­ing Eq­ui­ties Trust (FEET), cur­rently trad­ing on a 1% pre­mium and a com­pany in­creas­ing in size as it is­sues new shares to sat­isfy in­vestor de­mand.

How­ever, per­for­mance since in­cep­tion in 2014 has been patchy with the trust strug­gling to match its bench­mark. Does a re­cent uptick in per­for­mance sug­gest a pa­tient ap­proach is start­ing to pay off?

FEET IN FO­CUS

Cap­i­tal growth fo­cused ‘FEET’ is man­aged by com­bat­ive City fig­ure Terry Smith, who has forged a strong track record with the open-ended, de­vel­oped mar­kets fo­cused Fund­smith Equity Fund (GB00B4M93C53).

Un­like Fund­smith Equity how­ever, FEET in­vests in com­pa­nies which have the ma­jor­ity of their oper­a­tions in, or rev­enues de­rived from, de­vel­op­ing economies and which pro­vide di­rect ex­po­sure to the rise of the con­sumer classes in those coun­tries.

No-non­sense East London native Smith scours emerg­ing mar­kets for firms which make their money by a large num­ber of ev­ery­day, repeat, rel­a­tively pre­dictable trans­ac­tions, a process that leads him towards con­sumer stocks.

Blue sky or fad­dish names aren’t for him; in­deed, the me­dian found­ing year of the 49 com­pa­nies in the port­fo­lio is 1966, so it is fair to say these are tried and tested busi­nesses that have come through a cy­cle or two.

Fur­ther­more, as the FEET lit­er­a­ture ex­plains, the trust puts share­hold­ers’ funds to work with com­pa­nies that have rel­a­tively pre­dictable rev­enues and low cap­i­tal in­ten­sity, and cor­re­spond­ingly high re­turns on cap­i­tal.

‘The tar­geted com­pa­nies will

“The pre­mium on FEET rel­a­tive to its peer group de­fies all lo gic ”

also 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, it says.

Sig­nif­i­cantly, about one third of the com­pa­nies in which FEET can in­vest are quoted sub­sidiaries or fran­chisees of the multi­na­tion­als in which Fund­smith Equity may in­vest; the ad­van­tage is that Smith is well placed to con­duct due dili­gence and as­sess the cor­po­rate gov­er­nance of these com­pa­nies. To il­lus­trate, hold­ings in­clude Hin­dus­tan Unilever (In­dia), Col­gate Pal­mo­live (In­dia), Nes­tle Nige­ria and Kim­berly Clark De Mex­ico SAB.

QUAL­ITY IN­GRE­DI­ENTS

Smith’s em­pha­sis on sus­tain­abil­ity of re­turns steers the sea­soned stock­picker away from the fi­nan­cial sec­tor and heav­ily cycli­cal in­dus­tries such as con­struc­tion, man­u­fac­tur­ing, util­i­ties, re­sources and trans­port.

And he un­wa­ver­ingly sticks to his stated strat­egy of not over­pay­ing for shares and then do­ing as lit­tle deal­ing as pos­si­ble in or­der to min­imise ex­penses, al­low­ing the in­vestee com­pa­nies’ re­turns to com­pound for share­hold­ers.

Crit­ics will point out that FEET ac­tu­ally un­der­per­formed dur­ing the fi­nan­cial year to 31 De­cem­ber, with NAV to­tal re­turns of 21.2% com­pared to 25.3% from the MSCI Emerg­ing and Fron­tier Mar­kets In­dex, al­beit the rel­a­tive un­der­per­for­mance against the bench­mark in­dex was lower than in pre­vi­ous years.

Pa­trick Thomas, in­vest­ment man­ager and fund ex­pert, Canac­cord Ge­nu­ity Wealth Man­age­ment, scathingly com­ments: ‘The pre­mium on FEET rel­a­tive to its peer group de­fies all logic. It’s man­aged to un­der­per­form dur­ing a mar­ket en­vi­ron­ment that has heav­ily favoured the kinds of com­pa­nies FEET buys with a higher OCF (on­go­ing charges fig­ure) than most peers.

‘It is man­aged by a team with no real track record in the EM space. Yet there has never been a mean­ing­ful dis­count on the trust.’

Smith ex­plains: ‘None of the top ten con­stituents of the MSCI Emerg­ing and Fron­tier Mar­kets In­dex, which col­lec­tively rep­re­sent 25% of

that in­dex, are, in our opin­ion, of suf­fi­cient qual­ity for in­clu­sion in our port­fo­lio, as they con­sist of Chi­nese banks, a Chi­nese in­surer, e-com­merce plat­forms, con­sumer elec­tron­ics and semi­con­duc­tor man­u­fac­tur­ers.

‘These com­pa­nies bring with them risks of cycli­cal­ity, lever­age, opaque ac­count­ing, lack of clear own­er­ship rights and in­ad­e­quate fi­nan­cial re­turns.’ Fur­ther­more, 70% of the in­dex re­turns last year were gen­er­ated in China (in­clud­ing Hong Kong), Korea and Tai­wan, where the port­fo­lio is un­der­weight.’

Smith adds: ‘It may be that most buy­ers of ETFs do not know or care what their con­stituents are, or they and other in­vestors who take a dif­fer­ent view from us may be play­ing “greater fool the­ory”, and as­sum­ing that they will be able to sell these lower qual­ity stocks at an appropriate time and re­alise a large gain.

‘We do not have that skill. I suspect that nei­ther do many other in­vestors but it won’t stop them try­ing, of­ten with other peo­ple’s money.’

CON­FI­DENCE IN THE LONGTERM PO­TEN­TIAL

Terry Smith re­mains con­fi­dent his strat­egy will de­liver at­trac­tive long-term re­turns and is up­beat about the qual­ity of FEET’s un­der­ly­ing in­vestee com­pa­nies, ar­gu­ing their re­turns on cap­i­tal, profit mar­gins and growth are su­pe­rior to the firms that pop­u­late the bench­mark.

Ex­po­sure to health­care in the trust dou­bled dur­ing the year and FEET also bought two In­dian con­sumer durables com­pa­nies – Eicher, the maker of Royal En­field mo­tor­cy­cles and Havells, which makes con­sumer elec­tri­cal ap­pli­ances.

Smith also ini­ti­ated stakes in Ar­gentina-based e-com­merce out­fit Mer­cadolibre and Chi­nese air­line reser­va­tion play Trav­elSky Tech­nol­ogy as op­por­tu­ni­ties to own emerg­ing mar­kets IT stocks fit the in­vest­ment cri­te­ria for the first time.

Scru­tiny of the lat­est fact­sheet also re­veals that dur­ing April, Smith took ad­van­tage of the weak­ness in the Turk­ish lira to start a new po­si­tion in dis­count re­tailer BIM.

Fund­smith Emerg­ing Eq­ui­ties Trust’s man­ager, Terry Smith (Left).

Source: Fund­smith

Source: AIC

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