Smithson (SSON ) fund manager Simon Barnard’s patience with Fevertree (FEVR) looks to be wearing thin after the tonic maker’s plunging share price contributed to a ‘painful’ 28.1% drop in the global investment trust’s assets last year.

Shares in Fevertree, a top 10 holding in the £2.4bn global mid-cap equities fund, have halved in the past 12 months, knocking 3.2% off the trust’s net asset value (NAV) in 2022.

This made the stock, which Barnard bought what he thought was a low in 2019, the trust’s worst detractor as Smithson posted its first negative calendar year of performance.

Smithson shares slumped 35% last year, also hurt by a zero allocation to the best-performing energy and utility sectors which the growth investor shuns on philosophical grounds.

In his annual letter to shareholders ahead of full-year results in March, Barnard said Fevertree, which issued a profits warning last week, had suffered from very strong cost inflation in both packaging and shipping its premium tonic to the US from bottling plants in the UK and Europe.

Fevertree held ‘for now’

Fevertree’s profit margins had tumbled from over 50% to under 40% over three years, he said, as the company refused to hike prices in the US as it focused on growing market share.

Barnard, who has run Smithson since its record £822m launch in October 2018 under the oversight of star Fundsmith fund manager Terry Smith, told Citywire in a podcast in September (below) that he backed the strategy. However, his latest comment indicates the position could be reviewed if a recession dents Fevertree’s core UK market share.

‘We remain holders for now as we believe that over time the company can improve the margin, with our confidence boosted by the likelihood that margins in more mature markets such as the UK, which are not disclosed separately, are still very favourable. If this is combined with continued growth in revenue, the potential for future cash generation is substantial,’ Barnard said.

Barnard, whose problem with Fevertree is shared by Lindsell Train’s Nick Train, said he was not ‘particularly concerned’ about the impact of inflation on Smithson’s overall portfolio. He explained the high gross margins and low capital requirements of its quality growth stocks meant they were less vulnerable to cost increases than other companies.

However, he admitted there was no denying the hit from central banks such as the US Federal Reserve hiked interest rates from near zero to 4.5% in a frantic effort to curb inflation. Referring to Warren Buffett’s quote that, ‘interest rates are to asset prices like gravity is to the apple’, Barnard said the downward pressure of rising finance costs hit Smithson hard because its stocks were growing faster than the market.

The higher share price ratings they had enjoyed anticipated superior future cash flows but suffered a savage de-rating when the value of the profits stream was slashed.

Slow on Domino

Smithson, a US and technology-weighted portfolio, shares the same ‘buy good companies, don’t overpay, do nothing’ motto as his boss’ Fundsmith Equity fund.

However, there are times when action is needed and Barnard confessed he made mistakes in not selling quickly over-valued stocks such as Domino’s Pizza Enterprises and Fortinet, the US cybersecurity provider. He had remained a holder of both as their valuations were now more reasonable after steep share price falls.

The manager was more decisive at Ansys, selling the US simulation software house in December unimpressed by its habit of buying companies producing little or no profits.

A recent change in chief executive at Temenos, the Swiss banking software provider, has convinced Barnard to hang on after its move from a licence to a subscription model had not been well managed and had also weighed on the portfolio.

Barnard retained faith in Rightmove (RMV), although the UK online property portal has fallen out of trust’s top 10 in the second half of last year as investors worries about how it would cope in a recession. He pointed out the company generated revenues from estate agent subscriptions, not house prices or sales volumes. While agent numbers could fall in a downturn, they would quickly recover from a correction, he said, as a new estate agent ‘only needs a laptop, phone and contact list’ to set up in business.

Despite the macro-economic forces against growth stocks, holdings in Rollins, the US pest control company; TechnologyOne, the Australian enterprise software provider; and Moncler, the Italian fashion group, generated a positive return for Smithson last.

No ‘style drift’

Nevertheless, the manager likened the trust’s performance and relationship to the market as ‘a car being towed by an erratic driver’.

‘The current period is clearly one of the car drifting backwards,’ he added, ‘but to end up at the final destination of superior long-term returns, it makes sense to still be in the car when the rope snaps back,’ he said, urging investors to hold on to a portfolio of stocks that benefited from superior returns on capital and profit margins, which he believed remained important in these challenging times.

Smithson’s once highly-rated shares have fallen to an 8% discount to NAV, prompting the board to actively buy back the stock and replace investors who have switched more to value-style funds broadly benefiting from rising interest rates.

While the non-dividend payer’s performance has suffered, with the shares now underperforming its MSCI World Smid index with a 30.8% total return since launch by the year-end against the benchmark’s 34.9%, the underlying returns remain just ahead with NAV growth of 41.1%.  

Barnard said he would not fall into the trap of ‘style drift’ or looking to change his approach, and was hopeful that market conditions would become more favourable. ‘We will continue to strive to allocate your capital as effectively as possible using the same long-term strategy, whatever the environment.’

The shares risen 11% in the past three months, so the turnaround may have begun.