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I am a great fan of Terry Smith and his investment approach. As an investor in his Fundsmith Equity Fund, I have seen annual returns of 21.7% according to ShareScope since I first purchased it in 2014. That fund is a global large cap fund. Terry has now launched a small and mid-cap investment trust based on similar investment principles which is called the Smithson Investment Trust. Subscriptions are being invited here: https://www.smithson.co.uk/
The Fundsmith Equity Fund is an open-ended fund whereas Smithson is a closed-end investment trust so may trade at a premium or a discount to net asset value (NAV). Fundsmith already have another investment trust in their stable – the Fundsmith Emerging Equities Trust (FEET) which was launched in 2014 and had a disappointing initial performance, but it has done better of late. It has consistently traded at a premium to NAV and is now at 1.5%. That is not common for investment trusts and rather shows the confidence investors have in Terry Smith and his team.
Smithson will be following the same investment philosophy as the main Fundsmith fund – namely “Buy good companies, “Don’t overpay” and “Do nothing”, i.e. they will not be active traders and will have a low stock turnover.
The “Owner’s Manual” for Smithson is worth reading. The focus will be on companies with an average market cap of £7 billion, so these are not going to be really small companies. The document argues that small and medium size companies have outperformed larger companies which is probably true in recent times. Hence the investment saying “elephants don’t gallop” originally attributed to Jim Slater.
The Owner’s Manual makes some interesting comments about their preference for companies with intangible assets as opposed to physical ones. To quote: “Intangible assets, on the other hand, are much more difficult to replicate. They are typically not ‘bankable’ in the sense of being able to borrow debt against them and so require more equity and long- term illiquid investment to build them, for which rational investors will demand a high return, all of which is good if this is being attempted by your competitors. And the best thing about investing in listed companies with strong intangible assets is that from time to time the stock market values them as if their high returns will decline in the future, just as other companies’ returns are prone to do.”
They are going to be looking for growth companies, but not extremely fast-growing ones which are often over-priced. They will avoid highly leveraged companies but will look for companies that invest in R&D.
Management charges on Smithson will be 0.9% of the value of the funds managed per annum and there will be no performance fees. This is good news. But it’s somewhat unusual in that it will be based on the market cap of the company, not the normal net asset value. The investment trust form was chosen because it enables the manager to invest in smaller companies without being concerned about liquidity – they won’t need to bail out if investors wish to sell their holding in the trust unlike in open-ended funds which require constant buying and selling.
The portfolio managers will be Simon Barnard and Will Morgan under the supervision of Terry Smith as CIO.
As regards dividends, this is what the prospectus says about dividend policy: “The company’s intention is to look for overall return rather than seeking any particular level of dividend. The Company will comply with the investment trust rules regarding distributable income but does not expect significant income from the shares in which it invests. Any dividends and distributions will be at the discretion of the Board”. So clearly the focus is on capital growth rather than dividends which might be quite small.
One of the key questions is will the shares trade at a discount or not? Small cap investment trusts often do and as the prospectus warns: “A liquid market for the Ordinary Shares may fail to develop”. There is no specific discount control mechanism although the company can buy back shares in the market and there is a provision for a continuation vote if there is a persistently wide discount after 4 years. Smaller company investment trusts often trade at significant discounts but this is more a medium-cap than small-cap trust and Terry Smith’s reputation may result in a premium as with FEET.
If you apply for shares in the IPO you can receive either a paper share certificate, have the shares deposited in a nominee account with Link Market Services Trustees or, if you are already a personal crest member have the shares deposited in your account.
Clearly though there is uncertainty about the future likely performance of the company. I said in a recent blog post that you should never buy in an IPO. To repeat what I said in that “there can be some initial enthusiasm for companies after an IPO that can drive the price higher but the hoopla soon fades”. So personally I think I may wait and see. But I suspect there may be some enthusiasm among retail investors for this offer. Terry Smith now has a lot of fans.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
Post Date: September 18, 2018
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Thank you for this analysis – I’m applying.
With regards to the principle of ‘never buy in an IPO’, I don’t necessarily buy that argument for Investment Trusts.
At launch, there is no spread and there is no stamp duty to pay (right?)
Examples of ITs which have never (yet) sunk lower than their launch price are Syncona (SYNC) (launched as Battle Against Cancer Investment Trust) which is 6 years old and Baillie Gifford US Growth (USA) which is 6 months old.
(Disclosure – I own some of one (C share issue) and currently regret not buying the other.)
Conventional wisdom suggests that at launch ITs go to an immediate discount but other high profile launches have gone to an immediate premium so I believe that Smithson has that potential too (although I’m not banking on that, of course).