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Acknowledging accountability

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24 May 2019

David Prosser discusses Terry Smith’s recent step down from Fundsmith Emerging Equities and the role of non-executive directors.

Accountability is a word that we don’t hear enough of in the investment industry. A sector that often makes bold promises to clients isn’t brilliant about conceding that it hasn’t delivered: sorry often seems to be the hardest word.

Full marks then to Terry Smith, the renowned investment manager who launched his Fundsmith Emerging Equities closed-ended fund five years ago. He has just announced he will step down from day-to-day management of the fund amid investor disappointment about its performance. And he’s apologised to investors who feel they have been let down.

Smith’s record as a fund manager is impressive and the Fundsmith Equity fund he continues to run has been a stellar performer. By contrast, Fundsmith Emerging Equities has struggled to keep pace with competitor funds, largely because Smith has often refused to invest in high-performing technology businesses he has regarded as over-valued or holding too much debt.

There are plenty of advisers and investors who will share Smith’s views about emerging markets – and believe that better-performing funds may be in for a shock if and when sentiment turns. Nevertheless, Smith accepts his investors have missed out on the returns earned by their peers in other funds – and that he must take responsibility.

This is accountability in practice. Acknowledging customer disappointment and then taking action is what all companies should do, in the financial sector or elsewhere. Investors who do not believe they are getting what they were offered deserve to be told what the company is going to do about it.

In this case, Fundsmith Emerging Equities is undergoing a management shake-up - Michael O’Brien and Sandip Patodia are taking over day-to-day responsibilities for the fund with Smith retaining an advisory role – and reducing its fees. The fund’s annual management charge will come down from 1.25 per cent to 1 per cent.

This price cut is to be applauded. Delivering an immediate uplift in performance is not within the new managers’ gift, much as they will hope to deliver it. Charges, on the other hand, can be reduced straight away, unlocking at least some value for investors.

One interesting question is whether Fundsmith Emerging Equities would have responded in this way if it were not structured as an investment company. Indeed, would an open-ended fund ever follow such a course?

The point here is that investment companies have greater accountability wired into their very existence. They’re set up like any other publicly-listed company, with an independent board that is responsible, by law, for safeguarding the interests of the company’s owners – its shareholders. Investors in other types of fund, by contrast, are putting money into a product marketed by a fund management company. They can take their money out of such funds, of course, but they don’t have means to hold them to account.

This distinction sounds hypothetical and abstract until such time as investors actually require that accountability. During the good times, no-one worries too much about ownership structures. When things go wrong, investors who have access to mechanisms through which they can make their case – via an independent board or at company meetings – are in a much stronger position than those who have simply bought an investment product.

None of which is to predict how the changes at Fundsmith Emerging Equities will affect performance in the future, or to answer the question of whether investors should stay loyal. It’s simply to point out that accountability is a rare commodity that investment companies are much better placed to give their investors.

One final point. Smith points out that his own interests are aligned with those of his investors because he has a substantial holding of his own money in the fund. In fact, research shows that investment company managers have a strong record of putting their own “skin in the game”. That should concentrate minds too.

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