Consumer staples have made up a sizable portion of many funds in the past, but their role within portfolios may have become redundant, according to some managers.
The main appeal of the sector is its resilience; investors can often rely on consumer staples businesses to make positive gains in all economic conditions, even downturns, due to their ability to increase prices with ease. However, their growth – while consistent – is often minor, meaning they are rarely able to beat the wider market.
It is for this reason that Peter Bates, manager of the T. Rowe Price Global Select Equity fund, has no exposure to the sector whatsoever.
“They grow in line with the economy, so they’re generally pretty expensive because they don’t go backwards, even in a recession. But while they don’t go backwards, they don’t really grow that fast,” he said. “You’re paying a lot for a company that has top-line growth of about 3% – I think I can do better than that.
“You own consumer staples not because you think you’re going to make a tonne of money, but because you want the insurance in your portfolio in the event that you have a bad economy. In that scenario, those staples anchor your performance because they don’t go down.”
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An allocation to consumer staples companies helped keep portfolios afloat most notably in 2022, when soaring inflation and interest rates sent global markets into disarray. Despite these headwinds, the FTSE All World Consumer Staples was up 8.4% that year while the MSCI ACWI dropped 8.1%.
But Stephen Yiu, manager of the Blue Whale Growth fund, said this was an anomaly. Holding consumer staples may have acted as a safety net for investors to fall back on that year, but it was a hinderance for most others. Those times are few and far between, so holding them as insurance in case of a downturn is a short-term way of thinking that leads to lower returns over the long term.
“The only time consumer staples played a role in recent years was in 2022. They outperformed significantly because everything else was down, but that is it. The rest of the time they have not done anything for you – they actually underperformed,” he said.
“And I think consumer staples businesses are going to underperform the market again over the next five years just as they have over the past five. So then, what is the role of consumer staples? There is none, because why would you want a lower return than the market?”
However, it is for these reasons that Brian McCormick has made them a core holding within his Jupiter Global Value Equity fund, which has 18.7% invested in consumer staples. They may appear dull at surface level, but he said investors are better off holding companies that grow year-on-year without losing them money rather than allocating to volatile stocks with fluctuating returns.
“When you have periods of market euphoria, then people who are holding those slower and more conservative businesses which are generating acceptable long-term rates of return look very stupid. And that is the behavioural challenge to investing,” he explained.
“But to protect capital through a cycle, you need to just stick to the knitting and buy good businesses that can generate reasonable rates of return through time and not get drawn into this group of five-year-olds chasing the football around the pitch. That typically leads to a very material level of capital impairment when the bubble is starting to pop.”
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Consumer staples may appear to offer consistency, yet Yiu said this traditional perception of the sector is outdated. They no longer have that resilience that made them so attractive in the past. These businesses used to control the entire distribution chain – namely through supermarkets – but digitalisation has fragmented the sources through which consumers can buy products and made it much easier for startup brands to disrupt the market.
As such, the overall quality of consumer staples businesses has deteriorated over the past decade and no longer holds the same esteem it once did among investors. This is reflected in the diminishing allocation to the sector in the MSCI World index – it accounted for 10% of the index 10 years ago, but has lowered to 6.8% today.
The consumer staples of today are often late-stage businesses with nowhere else to develop – they cannot improve upon their existing products so “come up with something gimmicky,” according to Yiu. The only route for growth therefore is to acquire up-and-coming startup brands, which is a costly process.
Yiu added: “They’re buying at a premium which reduces their return on invested capital. All these factors have basically caused the sector as a whole to deliver much less value for the money and the overall quality of these business has come down profoundly. The Unilever today is not the same as the Unilever it was 10 years ago.”
Yet despite the changing nature of the sector over the past decade, many of the UK’s most popular funds still have a significant weighting to consumer staples. Two of the most renowned are Nick Train’s Lindsell Train Global Equity and Terry Smith’s Fundsmith Equity. The two funds – together worth £28.2bn – have considerable allocations of 32.4% and 25.5% respectively to the sector.
They made stellar returns over the past decade – with Fundsmith Equity up 304.4% and Lindsell Train Global Equity climbing 228.8% – but have fallen well behind the MSCI World index in the last three years. Performance has certainly staggered, but Darius McDermott, managing director of Chelsea Financial Services, said this is less to do with their overweight to consumer staples and more to with their underweight to tech, which has dominated global market returns.
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“They were the favoured global funds for that steady, quality style of growth, but it’s also not like tech, so there are often other parts of the market that look more exciting,” he said. “If you look at Fundsmith, its investment style was very much in favour for the first 11 years of its life, but for the last three it’s been far less favourable because things such as tech, oil, banking and mining have done well – not Terry Smith type of stuff.
“This isn’t a consumer staples type of market, but I know they’re going to be in most global funds, or certainly those that have those quality, low turnover types of growth managers.
“So I think consumer staples are going to be a part of most portfolios most of the time because of that staple nature of their products, and the returns of the likes of Fundsmith and particularly Lindsell Train are going to have much more challenging periods. But is that because they own a lot of consumer staples, or is it because they don’t own enough tech?”
This is something that Train may have realised himself. With just 9.8% invested in tech, he said he “cannot conceive how to generate the returns we aspire to over the next, say, five years without meaningful portfolio exposure to technology-advantaged companies”. Train recently said his lack of tech over the past decade was an “obvious failing” in his investment strategy that only came to light when his once-high returns dropped, and is an area he looks to allocate more to in future.
“The portfolio did not, with the benefit of hindsight, have enough exposure to companies with products and services likely to become more relevant and valuable to their customers as we proceed deeper in the 21st century,” he said. “To put no finer point on it, the portfolio in 2020 did not have enough exposure to technology or companies well-positioned to exploit technology. It had some, but evidently not enough.”
More tech exposure may be on the cards for Lindsell Train Global Equity and could rescue it from further underperformance, but consumer staples will still be top dog within Train’s funds, according to McDermott. He said: “Through gritted teeth, I think he admitted he was probably wrong, but do you want to go buying tech when it’s gone up so much over the past few years?
“This is a a fund manager’s job, not mine. It’s down to them to decide what they think is quality. You could say Microsoft is a consumer staple because most people couldn’t live without it in their life.
“That to me is a staple, but it’s classified as tech, so there are going to be overlapping characteristics. Microsoft is one of the most cash generative businesses on the planet with all of the beautiful recurring income that Nick Train likes, but maybe historically it just hasn’t been a sector where he’s done as well. Still, if I woke up and I found a 30% allocation to tech in his funds, I’d probably be more worried than less.”
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But because of how the nature of consumer staples has changed so drastically over the past decade, managers who maintain a high allocation are setting themselves out for failure, according to Yiu. “If you decide that instead of owning technology and you want to allocate even more to consumer stables, then that is suicide,” he said. “You are making your life very difficult to outperform the markets. That will be a massive headwind.”
“There is a cohort of people who have grown up under the impression that you need consumer staples to protect your portfolio and that is the way to do things. But what you need to understand is that the world we live in today – and the world we are going to live in – is different.
“The dynamics have totally changed, so why do you think those companies are going to give you the same level of return? It’s a totally different game. If you decide to stick to your prior understanding of consumer staples, do you really think the likes of Unilever, Diego and Heineken are going to outperform tech companies in the next five years?”
