Investec has initiated a buy recommendation for the Fundsmith Emerging Equities trust this week with director of investment company research Alan Brierley highlighting the trust as representing “significant contrarian value”.
It currently trades on a 12.7% discount, down from an all-time high of 20% on 18 March.
Brierley noted Terry Smith’s successors had made several changes to “reinvigorate performance” like ramping up exposure to healthcare and technology and decreasing weightings toward more economically challenged countries, as well as dialling up concentration to companies run or controlled by families or founders.
Managers Michael O’Brien and Sandip Patodia unveiled their change in strategy during the trust’s virtual AGM in May, after a year of running the trust in Smith’s stead.
“The focus on quality represents a solid bedrock, and we believe the portfolio is well placed,” Brierley said in a research note. “The shares offer significant contrarian value, with a strong fundamental investment case enhanced by the current discount.”
The £260m trust follows the same philosophy of Smith’s £20bn Fundsmith Equity fund and the Smithson Investment Trust of buy high quality businesses, don’t overpay and then do nothing.
While Brierley said Smith’s central approach has delivered “exceptional long-term returns in developed markets” Feet’s historical performance has been “dull”.
Since launching in June 2014 it has failed to beat the sector average, returning 9.5% against the IT Global Emerging Market’s 14.6%.
On a one and three-year view performance has improved landing Feet in the second quartile though it is still down –8.5% and –5.8% against the sector’s losses of –14.9% and –7.6% over the same time frame.
Investors have been shunning active EM for ETFs
Brierley notes in general emerging markets have severely lagged developed market counterparts, particularly the US, which has made the asset class highly unloved.
“In October, emerging markets will complete a lost decade; since the relative peak in October 2010, US$ total returns are just 29%, materially behind the MSCI World and S&P Composite total returns of 145% and 241% respectively.”
Feet has also suffered from a “marked polarisation in fund-flows” since its IPO with investors piling into ETFs which typically invest in the largest index constituents where Feet is significantly underweight and pulling money from active emerging market funds in droves.
But Brierley said the trust’s high active share of 95% means it can deliver performance that is “materially different” from its benchmark, the MSCI EM index.
Feet has “significant exposure” to the consumer, with consumer staples making up 57.7% versus the benchmark’s weighting of 6.5%. It is also more exposed to healthcare (14.6% versus 4.3%) and underweight cyclical areas like financials (2.5% versus 19.6%).
This divergence from the benchmark extends to geographic exposures with Brierley noting the trust’s “material overweight” to India, which represents 41.4% of the portfolio, and zero exposure to Taiwan and South Korea which are 12.1% and 11.4% of the benchmark.
China and Hong Kong exposure of 18.3% is also under half the benchmark weighting of 40.3%.
“This approach will result in a portfolio that bears little resemblance to the underlying benchmark, and accordingly performance is likely to be materially different.”
