Raising interest rates is now a necessity, but the severity and persistence of these rises in order to quell inflation is not something Terry Smith is optimistic about.
In a half year report for Fundsmith, released earlier this month, Smith called the use of interest rates to subjugate inflation a “blunt instrument” and said it will take a while for this to work as consumers had saved more cash than usual during the pandemic.
“Higher interest rates will do nothing to correct the continuing supply problems in commodities, semiconductors…it may take some time and high interest rates for demand to become depressed enough for the supply to exceed it and so start to moderate price inflation," he said.
Fundsmith lost 17.8 per cent in the first half of this year, and although it does not have an official benchmark, Smith compared that to the MSCI World Index which fell 11.3 per cent in the same period.
Portfolio turnover in the first half of the year was 32 per cent, ongoing charges figure for T class accumulation shares was 1.04 per cent, and with the cost of all dealing added, total cost of investment was 1.05 per cent.
Jan 1 - June 30 2022
Inception to June 30 (cumulative)
Fundsmith Equity Fund
Equities (MSCI World Index)
Smith warned that in a period of rising interest rates, long dated assets fare worse than short-dated, in both fixed income and equities.
“The share prices of more highly rated equities which are in effect discounting profits or cash flows further into the future by being rated on higher PEs tend to be more affected by rising interest rates than lowly rated so-called value stocks,” he said.
“Our portfolio is not exempt from this effect.”
Fundsmith 5-year performance
Source: FE Fundinfo
The top three biggest detractors in the funds were PayPal (-3 per cent), Meta Platforms and IDEXX (both -2.3 per cent).
However, Smith re-iterated his commitment to growth stocks, saying the fund did not miss out much by not owning more lowly-values value stocks during the period and called the rotation from growth to value “rather underwhelming”.
The S&P Value Index fell by 12 per cent in the period, compared to a 28 per cent decline for the S&P Growth Index and a 30 per cent decline in the NASDAQ, he highlighted.
“Falling less than others when times are tough has obvious merit but still isn’t a sufficient payback for the long preceding wait during which value stocks underperformed massively,” Smith said.
“The first half of 2022 marked the end, for the time being, of a long period during which the shares in our companies benefited not only from their underlying business performance but also from falling interest rates and thus rising valuations,” Smith said.
He added that not only did this tailwind disappear but a significant headwind materialised and although he claims no insight into how far this will go, he is “confident” that the companies in the portfolio will survive and prosper “relatively well”.