PER­SONAL AC­COUNT

The Daily Telegraph - Your Money - - MONEY - Marc Sid­well marc.sid­[email protected]­graph.co.uk

Com­pe­ti­tion is good but in­vest in firms with a mo­nop­oly for profit

Think of the stock mar­ket like a giant bot­tle of ketchup: it drips out its bounty in un­pre­dictable globs. That im­age – vivid, con­crete and blunt – comes from Terry Smith and the man­agers be­hind his new Smith­son in­vest­ment trust, which started trad­ing yes­ter­day.

With his hugely suc­cess­ful Global Eq­uity fund, Mr Smith’s straight­for­ward style has pro­duced a re­li­able stream of in­dex-beat­ing re­turns from the fickle ketchup bot­tle of the mar­ket. The fund is up 309pc since its launch in 2010. Now, to judge from the record-break­ing en­thu­si­asm at launch, in­vestors be­lieve Smith­son can fol­low suit.

The global mid-cap trust had a launch tar­get of £250m. In­vestors piled in, and the tar­get was soon raised to £600m. In the end, Smith­son raised a record £822.5m, beat­ing the £800m for Neil Wood­ford’s Pa­tient Cap­i­tal in 2015.

Dis­il­lu­sion soon fol­lowed for Mr Wood­ford’s in­vest­ment trust, which fo­cused on the high-risk, high-po­ten­tial world of dis­rup­tive tech­nol­ogy.

But Smith­son has a very dif­fer­ent, much less glam­orous tar­get: sim­ply a high prob­a­bil­ity of an ac­cept­able profit. Mr Smith’s in­vest­ing ap­proach can be counter-in­tu­itive (see page 5 for more) but it also has the ben­e­fit of sim­plic­ity: buy good com­pa­nies; don’t over­pay; then do noth­ing. In the case of Smith­son, Mr Smith will su­per­vise port­fo­lio man­agers Si­mon Barnard and Will Mor­gan, and their ap­proach hews close to the Global Eq­uity model.

The key dif­fer­ence is Smith­son’s fo­cus on medium-sized firms, with an av­er­age size of £7bn. Such tar­gets are too small to suit the be­he­moth of the Global Eq­uity fund. In­ter­est­ingly, they are, on the other hand, much larger than the firms cov­ered by some of Smith­son’s near­est com­peti­tors. The firms owned by Ed­in­burgh World­wide In­vest­ment Trust, for ex­am­ple, have an av­er­age mar­ket cap of just £2.5bn, less than half as much.

The larger size of the firms in Smith­son’s sights fits with the man­agers’ de­sire not to try to pre­dict the next big thing, but to se­lect “com­pa­nies that have al­ready won”. The com­pa­nies that Smith­son is seek­ing have not only a proven record of fi­nan­cial suc­cess, but have es­tab­lished dom­i­nance in their mar­ket thanks to a durable ad­van­tage, such as in­tel­lec­tual prop­erty. This ad­van­tage should give them the po­ten­tial of steady growth for years to come.

This ap­proach has sim­i­lar­i­ties to the cham­pi­oning of mo­nop­o­lies by Peter Thiel, a co-founder of Pay­Pal. Thiel pro­posed in his 2015 book Zero to One that com­pa­nies should strive to be­come ef­fec­tive mo­nop­o­lies in their sec­tor, as Google has in search. Com­pet­i­tive mar­kets are ef­fi­cient ways to im­prove prod­ucts for con­sumers, but they also push down prof­its for war­ring busi­nesses. By con­trast, an earned mo­nop­oly, such as one based on unique patents, can re­ward in­vestors long-term.

And Smith­son’s man­agers are happy to re­ject fast-grow­ing firms in sec­tors where a win­ner has yet to emerge, such as tech­nol­ogy. As they put it, “rapid change and fierce com­pe­ti­tion has meant that these in­no­va­tions have rarely cre­ated long-term prof­its for share­hold­ers”.

One prob­lem with the wild en­thu­si­asm for Smith­son at launch is that it cre­ates its own com­pet­i­tive pres­sures, and is likely to keep the trust’s price trad­ing at a pre­mium to the net value of its as­sets. A pre­mium can be worth pay­ing, but it in­creases the risk of over­pay­ing, es­pe­cially for a new and un­proven ven­ture.

One al­ter­na­tive would be to in­vest di­rectly in firms that match the Smith­son the­sis. Its man­agers have iden­ti­fied 83 po­ten­tial in­vest­ments, of which they will only hold 25-40. Po­ten­tial hold­ings in the trust’s brochure in­clude New Zealand ap­pli­ance man­u­fac­turer Fisher & Paykel; Dan­ish bio­science firm Chr Hansen; British en­gi­neers Spi­rax Sarco; and Texan travel tech­nol­ogy spe­cial­ist Sabre.

Own­ing such firms di­rectly risks not be­ing di­ver­si­fied enough to cope with any un­ex­pected flops. But the real chal­lenge might be the dis­ci­pline re­quired to buy the shares and then do noth­ing for years, as Fund­smith rec­om­mends. As with ketchup, it’s tempt­ing to shake the bot­tle as soon as you get frus­trated, but if the Smith­son team are right, the best things come to those who wait.

Chr Hansen’s dairy cul­ture busi­ness could be a good bet for long-term growth, but make sure to stay di­ver­si­fied

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