Terry Smith questions AI boom in annual shareholder letter

Smith ‘suspending judgement’ on who eventual winners of the trend might be

Terry Smith Fundsmith
Terry Smith

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Fundsmith Equity manager Terry Smith (pictured) has questioned investors’ conviction on Nvidia, Microsoft and the AI boom in his annual letter to shareholders, published today (9 January).

Smith said he was “suspending judgement” on who the eventual winners of the megatrend might be, if indeed there will be any at all. The ‘Magnificent Seven’ drove the S&P 500 last year on the back of increased interest in the technology, with Nvidia in particular enjoying bumper returns.

He wrote: “The stockmarket… has decided at the outset that it can identify winners in AI in the form of Nvidia designing the chips on which the generative AI models will run and Microsoft as a provider of an AI model.

“If it can do so at this stage it would seem to me to be a break with tradition. Think back to some of the major technology developments of the past half century or so and the early leaders.”

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He highlighted AOL, Myspace, Nokia and Yahoo as examples of companies that did not follow through on their status as early market leaders in periods of major tech breakthroughs.

“Does this experience suggest that we can predict a winner in the area of AI at the outset? Moreover, maybe there won’t be a winner, either in the provision of large language models or their use,” he continued.

“There are numerous large language models in development and deployment by the major tech companies: such as Alphabet’s Gemini, Meta’s Llama 2 and Microsoft’s ChatGPT, as well as stockmarket excitement about the deployment of such models by Adobe, Intuit and Fortinet among just the companies that we follow. There is no shortage of contenders.

“The adoption of AI may lead to a situation where everyone has it, so no one has any advantage. The analogy I would offer – with acknowledgement to Warren Buffett – is a football stadium.

“As the game becomes exciting and the striker runs into the penalty area with the ball, the second row of spectators stands up to get a better view. This blocks the view of those in the third row who follow suit. Pretty soon all the spectators are standing but no one has a better view than before, but they are all less comfortable.

“So, I think we will suspend judgement of who, if anyone, will emerge as a winner in AI.”

Underperformance

The £24bn flagship fund suffered its third straight year of underperformance in 2023, though it has returned 549.7% compared to the MSCI World Index’s 316.7% since inception in 2010.

Estée Lauder was the largest detractor to the fund’s performance during the year, with a negative impact to returns of 1.8%.

McCormick, Diageo, and Mettler-Toledo were also drags on performance in 2023.

On these holdings, Smith added: “We sold our stake in Estée Lauder whose mishandling of the demand/supply situation in China following reopening post Covid and in the travel retail market revealed serious inadequacies in its supply chain.

“McCormick has yet to return the profit margins in its food service business to the level they were before the pandemic. Mettler-Toledo suffered from a downturn in demand for laboratory equipment post the pandemic, demand falling in China and a tighter funding market for biotech companies.

“However, we have no concerns about their longer-term prospects and our holding in Mettler-Toledo, in particular, is small and we may be able to use share price weakness to acquire more.”

Fundsmith Equity’s largest contributors to performance in 2023

StockAttribution
Meta Platforms4.5%
Microsoft3.9%
Novo Nordisk3.6%
L’Oreal2.1%
Idexx Laboratories1.4%
Source: State Street

In terms of contributors, Magnificent Seven stocks Meta and Microsoft both led the way in terms of positive performance.

Pharmaceutical firm Novo Nordisk also aided Fundsmith returns, with the stock driven higher on the back of the release of weight loss drug Wegovy.

The fund has proven ever popular among retail investors and often places highly on platforms’ most-bought lists.

Taking a look at Fundsmith’s recent performance, AJ Bell head of investment analysis Laith Khalaf said: ““Fundsmith didn’t have a great year in 2023 relative to the global stockmarket, and this was the third calendar year of underperformance witnessed by investors. While returns were behind the global stockmarket last year, in absolute terms they were still strong, so existing investors won’t be too miffed about the fund’s 2023 performance.

“Terry Smith has a loyal following and a great deal of credit in the bank due to his long-term track record. The problem is Fundsmith Equity is now underperforming on both a three and five-year view, which are key periods fund buyers look at, so it might be harder for the fund to find new converts.”

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