Investing for Growth, is a collection of Terry Smith’s press articles from the last 10 years. Smith founded and manages the £24.4bn Fundsmith Equity Fund which since launch in 2011 has increased the value of investors’ cash by 489%. Here we look at five takeaways on how he goes about investing for growth.
It can’t be denied that Terry Smith’s Fundsmith Equity Fund has been incredibly successful over the last 10 years. There’s also no doubting Smith has some very forthright opinions and a very likeable writing style. Since 2011 he’s written for the Financial Times, Telegraph, Guardian, and Independent amongst others. He also writes to his shareholders annually to let them know what’s on his mind and, often, what’s wrong with the investment management industry. Here’s the 5 top things I learned from Investing for Growth: How to make money by only buying the best companies in the world.
1. Have an investment process and stick to it.
Terry Smith’s process is a simple one: invest in good companies, don’t overpay, do nothing. And it’s the process he set out on day 1 and still uses.
Good companies create value for shareholders by making a high return on capital (high above the cost of that capital) across the business and economic cycle. In layman’s terms, Smith says to think of it this way:
“Companies are just like us in some respects. If you borrowed money at [an interest rate of] 10% per annum and invested it at a 20% per annum return, you would become richer. But if you invested it at 5% per annum, you would become poorer. Similarly, a company which makes a return above the cost of its capital becomes valuable – it creates value for shareholders.”
Not overpaying just means buying the shares at the right price – again based on some financial metrics. If you buy right, Smith says, you don’t have to worry about the price you are going to sell at as you intend to hold on to them and watch the returns compound upwards. All of which leads to step 3: do nothing.
Buying and selling shares regularly leads to costs, which act to wipe out gains. Doing nothing reduces dealing costs, taxes and the payment of third parties like brokers.
2. Exchange traded funds are not all good
Exchange Traded Funds (ETFs) come in for quite a bashing in Investing for Growth. In fact quite a few of Smith’s articles take a pop at this seemingly ever growing industry. And there’s quite a few reasons he doesn’t like them:
- Not all ETFs buy the actual investments they are tracking. Some are synthetic meaning that rather than holding actual investments they are just based on contracts with third parties. That’s all good and well, he says, but if the financial crisis of 2008 taught us one thing, its is that third parties can and do default on their contracts. Contagion was the result.
- Second, Smith says, is the worry that some ETFs track investments that are themselves hard to buy and sell – known as illiquid assets. Some ETFs track investments that ordinary investors cannot access, like Chinese shares. The ETF itself is very easy to buy and sell, which could easily led to a mismatch between the price of the ETF and the prices of the things it is supposed to be tracking.
- Complexity is the third beef. Some ETFs use borrowed money to invest. Others are inverse ETFs – which allow you to bet against prices going down. And others still do both. Do you really know what you have bought and how it will behave when markets move up and down quickly?
Therefore, Smith concludes ETFs should only be used for day trading (where you buy and sell on the same day). If you want to hold an investment like this for longer you should use an index fund.
3. The golden rules of investing for growth
Most of these don’t need any explanation, but I’ve added some in where they do:
- If you don’t fully understand it, don’t invest
- Don’t try and time the market – guessing when’s it’s priced the best value to get in
- Minimise fees
- Deal as infrequently as possible
- Don’t over diversify
- Never invest just to avoid tax
- Never invest in poor quality companies – good companies are those which make high returns on cash (outweighing the cost of that cash) and which use some of that money to grow their businesses.
- Buy shares in companies which can be run by an idiot
- Don’t engage in “greater fool” theory – only buy shares in companies you want to keep and at a price you want to pay. Buying shares in the hope they will go up just so you can sell them on to a greater fool means you are reliant on finding that fool.
- If you don’t like what’s happening to you shares, switch off your screen – once you have bought good companies don’t worry about short term share price movements. If it bothers you, don’t look!
4. Watch the words
The name of an investment helps us understand what it does, says Smith. And often at times the names of investment funds lead to a lot of head scratching. In the UK, the regulator, the Financial Conduct Authority, has had a crack at solving this by asking fund managers to make names more reflective of what investors are likely to get, and indeed what they might understand. Smith says the problem still abounds – and found 24 US hedge funds (funds that can profit from rising and falling prices) with the word ‘Eureka’ in their title…
He also says you should stick to what you know as an investor – history is littered with examples of investors who have exceeded their remit and failed. Think Anthony Bolton or Neil Woodford recently. So if you need to know what you’re investing in, what do you suppose the ‘Soc Gen UK Step Down Defensive Kick-out Plan’ actually does?!? Or what about the ‘Best Ideas’ funds? Lots of fund managers use these phrases to describe their products. Smith bets that not many of them have ‘Worst’ or even ‘Average’ ideas funds.
5. Why quality matters when investing for growth
Smith repeats his mantra about good quality companies throughout the book. In one article from 2015 he says that quality is the most important thing when it comes good returns. Quality to him is high profitability from companies providing good products and services and strong market positions. He gives a great example: in part, the financial crisis was caused by the dressing up of poor quality investments (sub-prime mortgages) as investable AAA rated assets. Smith also makes the point that many investors seem to prefer being diversified across a range of poor quality investments rather than having a highly concentrated list of high quality ones.
Should I buy this book?
In all honesty, yes! And I’m not just saying that. The articles are readable in a matter of a few minutes. If I had one criticism it would be that there’s a fair amount of repetition as this is a collection of articles over a long time frame and from different publications. So they were never meant to be read like a book. But putting that to one side, it’s pretty easy to read because even though there’s lots of financial terms Smith explains them all so well. And I love the fact he’s not afraid to speak his mind and back it up with the numbers. Perhaps most importantly he puts his money where his mouth is and invests in his own fund.