Terry Smith: three shares I bought and why

The star fund manager explains the thinking behind a trio of big share purchases. 

Lee Wild, head of equity strategy at interactive investor:Hello, today I have with me my colleague Kyle Caldwell, collectives editor at interactive investor, and someone who needs no introduction, Terry Smith, founder, chief executive and chief investment officer at Fundsmith, which includes the UK's largest investment fund, Fundsmith Equity.

Hello Terry, delighted that you could join us today.

Terry Smith: Morning.

Kyle Caldwell: How much attention do you pay to the macro backdrop, especially given your ownership of consumer goods and consumer services companies, does it influence your decision making in any way at all, or is it completely irrelevant?

• This interview is part of a longer conversation with the UK’s most popular fund manager. To watch the other interviews, visit our YouTube channel.

Terry Smith:  It’s completely irrelevant in my view. I mean, I’ll say a couple of things about it. One is, when people talk about consumer goods, and they often take it a bit further than you did in your framing of your question, I would say, what the problem is, if there’s a macro downturn, it’s very dangerous to be that close to the consumer.

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To which my answer is, that’s right. The only thing more dangerous than being close to the consumer is not being dangerous to the consumer. Because in a consumer downturn, clearly consumers change their habits a bit, they spend a bit less, they trade down in brands, they go to another label, etc., etc.

So, it’s not like they’re non-cyclical, there’s no such thing as a non-cyclical, right. So, they’re affected. But if you think they’re cyclical, you should see what happens to the suppliers, right. And when these guys, you know, see what happens when these guys find that the consumer trades down a bit, so you know, a very small change in consumer consumption with affects our companies a bit, has a massive impact on the providers of services, ingredients, components, into those companies.

So, we are more immune, not immune, but more immune to the macro cycle than most of the rest of the market with those companies. The other thing to say about it is, I don’t see much point in trying to take notice of it because it’s impossible to predict, and when I say impossible to predict, I don’t just mean the events are impossible to predict, although I would maintain they probably are.

But I think the impact on the market is impossible to predict, markets are a two-order system. In order to get what your prediction is about the future right; you need to not only predict the events but how the market will react. I wrote this in our annual letter, so imagine that we were doing this call one year ago, and you knew I was the type of guy who could foretell the future.

And I said, there’s going to be a pandemic and the reaction to it will close down the global economy to such a degree there’ll be a 10% fall in GDP in one quarter in the largest economies in the world, like America.

Right, and you knew that was true, what would you have done with your equities is quite interesting. A) maintained it, b) bought a bit more, you know, c) run for the door. I’ve got you in c) mostly, I’ve got most people in c). You’d have missed out on an above average return last year in the MSCI in equities, right.

How does this, like there’s an old joke about the man who wanted to make a fortune and having prayed that what he would find one day would be down the street by some miracle of time travel, was next year’s newspaper, and he did. But the trouble is he got the news page, and what he really needed was the stock page, right.

To get these things right you’ve got to predict the events, the timing of the events, and the way the market will react, good luck. I’m not going to even try.

Kyle Caldwell: A couple of changes were made to the fund last year, LVMH (EURONEXT:MC), Nike (NYSE:NKE) and Starbucks (NASDAQ:SBUX) were all added, were those additions made to take advantage of the share price weakness at the height of the Covid-19 market panic, and why out of all the companies that fell sharply in the first quarter of last year, did you invest in those three?

Terry Smith: Yeah, I’m sure the answer is yes. They were companies in our investible universe, we coveted them, they gave us exposure of a sort we didn’t have before, we’ll touch upon that in a moment. And in the case of Nike and Starbucks they had 40% share price falls, at the same time as other things in our portfolio were riding high on the panic buying of things like disinfectants and home cleaning products, and over the counter medicines.

And we thought, the latter effect, the panic buying of disinfectants basically, was likely to be a temporary phenomenon, and whereas we had these very good companies, we thought, which were temporarily disadvantaged in share price terms. So, we took advantage, always something happening versus something else that we have to think about.

So yeah, look, why those, I mean an awful lot of people, stocks had very sharp falls, but we are not likely to be buying too many airline stocks are we, it’s not likely to be on our list of things to buy. So, it’s got to be a fall in something that we want to own, that we know we want to own.

Briefly, running through them, Nike, world’s leading sports apparel retailer and maker of trainers, a company with about a 30 percent return on capital, been growing about 10 percent per annum, and probably, if you look at the market research, the consumer brand that’s most adapted to online sales.

And so, obviously, equipped to prosper notwithstanding the events of the last year, or even because of them. Starbucks, we didn’t have anything in the QSR area in the portfolio anymore, clearly, very big hit by the closure of their city centre sit down facilities. And again, a company with high 20s return on capital, probably something like 7% per annum growth, pretty good stuff.

And of course, whilst all this was going on, it had something very positive that happened to it, which was completely ignored, which is it’s second largest market is China, and its biggest competitor in China, Luckin Coffee (NASDAQ:LK), was exposed as a fraud by these market events.

So, it’s basically got a pretty clear pathway to faster growth in China as a result of that, so that one. LVMH didn’t have such a big fall, but nonetheless, we thought we were never going to get a better opportunity than last year’s events, with the closure of travel retail events in China.

We like the luxury goods area, we think we know a bit about it because of our exposure to its cosmetics businesses and drinks businesses, but we had nothing that was exposed directly in the apparel, accessories, jewellery and watches area. And so, we thought, the best portfolio of those brands out there is the LVMH portfolio, so that’s why we bought that one.

• This interview is part of a longer conversation with the UK’s most popular fund manager. To watch the other interviews, visit our YouTube channel.