Smithson manager calls for patience as expensive stocks crash

Fundsmith’s smaller companies trust faces headwinds in 2022 after beating the market last year.

Pressure on the highly rated shares owned by the £2.6 billion Smithson Investment Trust (LSE:SSON) is not causing manager Simon Barnard to deviate from his strategy of paying a premium for “high-quality” companies.

Despite the small and mid-sized companies trust – from Terry Smith’s Fundsmith firm although not managed by Smith himself – dropping 25% already this year, Barnard is standing by its approach of buying companies that are expensive relative to profits.

Such shares are falling more than the market as investors weigh up the prospect of rising interest rates, which decrease the value of future profits and therefore harm stocks that trade at high multiples relative to their earnings.

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Writing in its 2021 annual report, released today, Barnard said: “When markets turn down, it will always be tempting to sell investments that are still in profit to ‘lock in the gains’, but it is not something we would advise, unless the investment in question is particularly overvalued. The reason is that long-term compounding investments, such as those we seek for the portfolio, are extremely hard to find.”

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He added: “Owning high-quality companies with sustainable growth is a winning strategy over the long term, has been shown to work through several economic cycles, and is one which we know we can execute successfully.”

Barnard also highlighted how the stocks he owns can maintain profits even as inflation is rising, saying: “The companies we own have high gross margins, and therefore low raw material costs. As inflation affects both the cost of raw materials and the cost of plant and equipment, those that spend less as a proportion of revenue on these items will be relatively less impacted by cost inflation.”

He added that patience is core to the trust’s proposition to investors, saying that once an investor has found the right companies, all they have to do is wait.

He said: “We think that patience is one of our competitive advantages, because with the strategy we employ, it tends to pay off. To sell a rare investment in which you still have confidence regarding the long-term outcome, to avoid a short-term decline which you cannot be confident in, makes no sense to us.”

Despite the start of a rotation in investor preferences for cheap shares over the expensive ones, Smithson had a successful 2021, beating its global stocks benchmark by one percentage point.

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The strategy made investors 18.8% last year compared with 17.8% for the MSCI World Small and Mid Cap index.

Barnard said that standout performance from some companies meant the investment trust beat the market even in a difficult environment for the highly rated stocks it owns.

The top stocks were cyber security company Fortinet, which rose 140% in 2021, and engineering software firm Nemetschek, up 86%.

The biggest detractor to performance was flight booking software group Sabre, which suffered as the Omicron variant impacted travel. It fell 28%.

Subject to a vote at the trust’s next Annual General Meeting, the Board will issue 20% more shares to allow it to manage share price premiums. The trust traded at a 3% premium last year, 3.7% premium in 2020 and 3.4% premium in 2019. It is currently trading on a small discount of 0.4%, according to investment trust analyst Winterflood.

Smithson applies the successful investment philosophy of Terry Smith’s open-ended Fundsmith Equity fund, but instead focuses on global smaller companies deemed too small for the original Fundsmith fund.