I am a fan of Terry Smith, but I wonder how many others in the fund management business are, given his knack of puncturing some of the carefully-developed myths that help to keep the rest of the industry going. His latest offering, a “sustainable” global equity fund, is a clever and well-judged attempt to highlight the flaws in the way that many other funds in this fashionable sector are in practice put together.
It poses, quite deliberately, the question whether those who want to avoid investing in companies that operate in the most socially or environmentally unacceptable industries (alcohol, tobacco, pornography, gambling, fossil fuels and so on) are actually more interested in virtue signalling than they are in being successful investors. You can have the best of both worlds, he argues – good returns and a clear conscience – but not if you invest the way that most such funds go about it, which owes more to faddism than sound investment principles.
What his research shows is that – whether you call it socially responsible, environmentally-friendly or sustainable investment – many funds still end up owning shares in companies that are in the sectors their investors don’t wish to be in and, in any event, pay a high price for appearing to be more virtuous than they really are. The returns are lower than they could or should be because – to give the essence of his argument – they fail to take in to account the factors that make a fund economically as well as environmentally sustainable. Those factors include such mundane but essential things as return on capital, capital expenditure and rate of R & D spending.
Needless to say Terry thinks that he can do better and is using the results of a segregated portfolio that for the last few years he has been running for the charity Comic Relief to demonstrate as much. Its results have trumped those of the 17 funds with an ethical and sustainable mandate (according to the Investment Association), some by a large margin. This is despite excluding any company that invests in one of eight industries: oil and gas, defence, pornography, alcohol, tobacco, casinos and gaming, mining and gas or electricity utilities.
The portfolio has generated a total annualised return of around 24% since it was initiated in 2014, which is much the same as the Fundsmith Equity Fund, Terry’s unrestricted global equity fund, and 10% per annum better than the FTSE World index over the same period. Whether the new sustainable fund can continue to do as well in the future is of course unknowable at this stage: read the small print and its portfolio of 20-30 companies will be somewhat larger than the Comic Relief portfolio, so the results won’t be exactly comparable.
It has also been a very good period for the style of investing that Fundsmith adopts, and that may not persist. In practice the new fund will be investing almost exclusively in companies that are already in the larger global equity fund, but avoiding others in the portfolio which fail the sustainability test. These include some of its better recent performers. A number of drinks companies and tobacco stocks feature prominently in the Fundsmith Equity Fund, for example. Time will tell. Given that institutional investors have been generally underwhelmed by the performance of existing sustainable funds, while recognising that more clients want to invest that way, I dare say that the new fund will find a fair deal of support.
However the most interesting thing about the new fund is really the challenge that it poses to other competitors in this space. It highlights the fact that there is a world of difference between those who want to invest in things that will make the world a better place and those who simply want to avoid investing in sectors they believe are damaging the planet or society. The former may justifiably not be interested in maximising their returns, but the latter presumably are – and they are the ones who might profitably look into the reasons why many existing funds are not doing as well or even as much good as they claim to be.
Jonathan Davis 