Terry Smith to launch emerging markets trust

Fundsmith, the investment boutique headed by Terry Smith, is seeking to raise between £100 million and £250 million for a new investment trust focusing on global emerging market (GEM) equities.

Speaking to Money Observer ahead of the announcement, Smith said he sees a "looming opportunity" in global emerging markets, with the chance to "deliver very good returns" in specific sectors. "Things are cheaper now due to a combination of factors", he says on the specific timing of the launch.

Reasons include the slowdown in China and last May's "taper tantrum", when plans to scale back quantitative easing (QE) in the US were announced. Nevertheless, Smith reckons weakness in GEM equities could continue for a while longer, given that QE tapering still has some way to go.

Consumer-oriented stocks

Smith says the new trust, Fundsmith Emerging Equities Trust (Feet), will be exclusively invested in consumer-oriented stocks, including retailing and brewing. Currently, Smith's existing developed markets fund, Fundsmith Equity, has no exposure to these sectors due to the fund's strict valuation criteria. Smith says Feet will follow the same "unique investment process" that has been successfully employed by Fundsmith Equity since its launch in November 2010.

Smith says there are currently "139 companies in Feet's investable universe", most of them in the consumer staples sector, which accounts for just 8.5% of the benchmark MSCI Emerging Markets index. Smith says he expects Feet to invest in between 35 and 50 of them.

Key facts about Feet

Name: Fundsmith Emerging Equities Trust plcLead manager: Terry SmithStructure: Authorised investment trust to be listed on the Official List of the London Stock ExchangeLaunch date: 20 June 2014Charges: annual management charge of 1.25%, no performance feeNo. of holdings: 35-55Info and prospectus:feetplc.co.uk

Backtesting performance of those 139 companies shows a market capitalisation-weighted return of 299% over the five years to 31 March 2014, compared with a 69% return from the benchmark MSCI Emerging Markets index (see table). Over 10 years outperformance is even more marked.

Smith says there are strong reasons to believe this is not a flash in the pan: he reveals that "more than four fifths of that performance was attributable to growth in free cash flow", which is one of the key measures Smith assesses before investing in a stock.

Smith adds: "The companies in which we seek to invest provide direct exposure to the rise of the consumer classes in the developing world. This rise is a well established trend with a predictable pattern of development and has a long way to run."

Closed-end structure

Explaining Fundsmith's choice of a closed-end investment trust structure, Smith says he would never run a GEM open-ended fund, due to his concerns about liquidity in the underlying holdings. The reasons most open-ended GEM funds underperform, he says, is that managers gravitate towards big stocks that make up the benchmark index, some of which are "poor-quality companies".

He also believes that when managers do choose illiquid investments in an open-ended structure, "this can have disastrous consequences if faced with high levels of redemptions; and fund performance can only suffer from punitive dealing costs of the inevitable cycle of inflows and outflows".

The trust will have an annual management charge of 1.25%, which is below average for the sector (all bar one of the existing closed-end vehicles also charge a performance fee). Should the trust only raise £100 million at launch Smith reveals that the 1.25% AMC represents a "break-even" fee for the management group, which has hired another five experts to analyse stocks.

Ungeared

The trust will be ungeared, and there will be a policy to control the share price discount or premium to underlying net asset value (NAV), at the discretion of the trust's board. In the event of a persistent premium extra stock would only be issued should the manager and board feel there are untapped investment opportunities. Smith admits these could be limited given the trust's current narrow investment remit.

But in the event of shares falling to a persistently wide discount, the trust has a substantial overdraft facility to buy in shares when necessary, rather than having to sell holdings to pay for share buybacks.

Smith appears to have stuck a good bargain with the issuing broker, Investec, as he expects the opening share price to be just 0.1-0.6% lower than the opening NAV. That compares to an average dilution for subscribers to a new trust launch of around 3%. Smith has pledged that Fundsmith will cover any unexpected further dilution at launch.

Smith will not sit on the trust's three-strong board of directors, which is chaired by Martin Bralsford, who's CV is littered with senior management roles in consumer-oriented industries.

Smith says he will subscribe £5 million himself to the trust. Applications must be received by 20 June.

For more information and a prospectus, visit feetplc.co.uk.