Making returns while using the value style of investing is harder than winning the lottery, Terry Smith has said.
Since launch in 2010, Mr Smith's £16bn Fundsmith fund has returned 156 per cent over the past five years, becoming the top performer from more than 200 funds in the IA Global sector over the same time period.
The fund deploys the growth style of investing, where the companies bought tend to very established businesses that grow at a regular rate over the long-term, but because they are established the valuations at which they trade tend to be above the market average.
Investors who use the value style of investing tend to focus more on the valuation at which the company trades, and buy shares in companies that trade at below the long-term average.
Mr Smith said: "We are often asked why we invest in a company that grows in value steadily over several years, rather than in a company that will perform very well for a year then sell it to buy another the next year, and so on.
"The answer is, we would do this if it were possible. Think of our preference for buying a single stock as being akin to buying a lottery ticket when you only have to guess one number.
"In the UK lottery the numbers run from one to 59, so your probability of winning is one in 59. Now jump back to the reality where you have to pick six numbers correctly, suddenly your chance of success is one in 45 million.
"This is more like the scenario of having to constantly pick new investments, although we would argue that choosing winning stocks every year would require many more than six correct decisions."
Mr Smith’s Fundsmith company is about to launch a small and mid cap investment trust, Smithson, which he will advise in his role as chief investment officer but will not manage.
Richard Penny, who recently launched the Crux UK Special Situations fund and has used the value style of investing throughout his 20-year career, said: "Ultimately the price you pay is the biggest determinant of the returns."
Alistair Mundy, who runs the £1bn Temple Bar Investment Trust, which also uses the value style of investing, said the policy of low interest rates and quantitative easing deployed by global central banks since the financial crisis had contributed to the value style of investing underperforming relative to growth.
He said this was because the companies which grow at a slower pace look relatively more attractive when bond yields are lower, but as bond yields rise, which they should do as interest rates rise, then the companies owned by investors such as Mr Smith look relatively less attractive and value investments would perform better.
Nick Train, another investor who uses the growth style of investing and is a friend of Mr Smith, said value investing may not be an effective strategy in the future because many the companies trading on low valuations are doing so because they are being ravaged by the effects of technological change and won’t recover in share price terms, so the valuation is cheap for a reason rather than just being cheap.
david.thorpe@ft.com
