Fund manager Terry Smith has hit out at financial advisers who continue to promote value style equity funds in the media despite the stark underperformance of those funds over the past decade.
Mr Smith has a vested interest in talking down the performance of value funds, as the £19bn Fundsmith Equity fund which he runs and both of the other funds managed by his company deploy the growth style of investing.
Mr Smith’s fund has returned 137 per cent over the past five years, compared with 71 per cent for the average fund in the IA Global sector in the same time period.
A number of other funds that deploy the growth style of investing, including those run by fund house Lindsell Train and Baillie Gifford, have topped the performance charts in their respective sectors in recent years, while funds deploying the value style, which include those formerly run by Neil Woodford, performed less well.
However, it has not always been like that. Value funds and shares performed better than many growth stocks in the years immediately prior to the financial crisis.
The conditions in which value funds and shares typically perform better are those in which inflation and interest rates are rising, and economic growth is strong. Mr Smith has not ever run a fund during a period where those were the prevailing market conditions.
Value investors focus primarily on the share price and valuation of a company. This means they typically buy companies that are trading at below their long-term average valuation and below the valuation of the market as a whole.
In contrast growth investors tend to focus more on the long-term returns that a company can be expected to achieve, and less on the current share price or valuation.
Mr Smith said investors had been “waiting” for a decade for the value style of investing to work, and had sacrificed returns in that time period.
In his annual letter to investors in the Fundsmith Equity fund he then criticised advisers who advocate a strategy which contains both growth and value style funds as a way of diversification.
He warned this strategy had already been "disproved".
Mr Smith said: “There are some commentators who say that one way to address this is to have a portion of your portfolio invested in both strategies — some in quality growth and some in value.
"I think the assertion that there is no harm in this diversification approach has been disproved rather comprehensively by Warren Buffett, but what does he know?
"Perhaps we should look at the value investment versus quality and growth strategy debate this way: would you rather side with a) a large section of the UK financial press and rent-a-quote investment advisers; or b) Warren Buffett."
Mr Smith also made his case for growth investing.
He wrote: “Value investing has its flaws as a strategy.
"The intrinsic value of the company does not grow (except for any new capital that its hapless investors allow it to retain or subscribe for in some form of share issue), or even erodes over time, whilst the value investor is waiting for the lowly valuation to be recognised and the share price to rise to reflect this.
"Moreover, even when the value investor gets it right and this happens, they then need to sell the stock which has achieved this and find another undervalued stock and start again. This activity obviously incurs dealing costs but value investing is not something which can be pursued with a ‘buy and hold’ strategy."
He added: "In investment you ‘become what you eat’ insofar as over the long term the returns on any portfolio which has such an approach will tend to gravitate to the returns generated by the companies themselves, which are low for most value stocks.
"The longer the strategy underperforms the market and the more money it costs investors the louder the siren song becomes. And sooner or later they will be right.
"But a) they have no idea when that will be; b) if you had followed their advice to date it would require a gargantuan reversal of performance to make up the gains forgone; and c) that may continue to be the case for some time to come.”
Darius McDermott, managing director at Chelsea Financial Services, said: “Terry Smith is a fund manager we rate, and who we own in our multi-manager funds.
"He is an out and out growth manager and he has been very good at that. But I think he likes to make mischief at times, especially at this time of year.”
david.thorpe@ft.com
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