Morning Note: Market news and an update from Smithson IT

Market News

Asian stocks – Nikkei 225 (-2.1%); Hang Seng (-0.6%); Shanghai Composite (-0.3%) – followed US equities – S&P 500 (-1.8%); Nasdaq (-2.6%) – lower as continual shifts in US President Donald Trump’s approach to tariffs on trade partners whipped up market uncertainty and dented confidence in the economic outlook. Trump said he will delay Mexico tariffs on goods under USMCA. The exemption is expected to last until 2 April, when Trump plans to enact a fresh round of tariffs. About 62% of Canadian imports and half of Mexican products will still be subject to the measures.

An index of the dollar fell for a fifth session, its longest losing streak in almost a year. Gold held steady at around $2,910 an ounce as China added to its reserve for a fourth straight month. Bitcoin fell as details of a US strategic reserve underwhelmed. White House crypto czar David Sacks said the US’s reserve won’t use taxpayer money to buy cryptocurrencies. Donald Trump’s executive order called for a strategic Bitcoin stockpile that will be capitalised with tokens already owned by the government.

US non-farm payrolls are due out today, with 160k jobs expected to have been added following 143k in January. The unemployment rate is forecast at 4%. The data could guide the Federal Reserve’s policy direction. Patrick Harker said he’s increasingly concerned that the decline in price growth “is at risk” amid mounting pressures.

The FTSE 100 is currently 0.4% lower at 8,640. Rachel Reeves plans to reform the UK’s welfare system to find savings, she told a Sky News podcast. Initial forecasts show she may miss her target of ensuring day-to-day spending is covered by tax receipts. Sterling trades at $1.2910 and €1.1910.

EU leaders with the exception of Hungary’s Viktor Orban, pledged unwavering support for Kyiv and set out conditions for achieving a peace settlement. The EU is to explore long term reform of fiscal rules for defence. German factory orders slumped -7.0%m/m in January, well below the -2.5% forecast.

Source: Bloomberg

Fund Update - Smithson

Smithson is an externally managed investment trust, established by its Investment Manager, Fundsmith LLP with a net asset value of around £2.0bn. The policy is to invest globally in shares issued by small and mid-sized listed companies.

Earlier in the week, the company released its 2024 results. The NAV and the share price rose by 2.1% and 4.9% respectively. Performance was behind the benchmark, the MSCI World SMID Index, which returned 11.5%, and cash (+5.1%) but ahead of UK Bonds (-2.3%).

The longer-term performance since launch in October 2018, is 63.2% in line with the benchmark return of 64.2%, representing an annualised growth rate of 8.2%, compared with the benchmark increase of 8.3%. After a strong start, performance over the last three years has undermined the longer-term track record. One headwind to strategy performance has been the impact of increased bond yields on the valuation of the fund’s faster-growing and more highly-rated companies. In addition, in 2024 the fund suffered from a lack of outstanding winners.

In response, the manager has made some adjustments to the investment management team and the investment process. The primary change is to focus ever closer on the specific areas where the manager thinks the best long-term returns will reside. While the manager was concentrating on companies of £500m to £15bn in market capitalisation, he now believes his attention should be placed on businesses in the lower half of this range. That said, the Board is also proposing to amend the company's investment policy so that the portfolio manager may invest in any company that, at the time of initial investment, has a market capitalisation within the range of the constituents of the MSCI World SMID Cap Index, currently $64m to $67bn.

In common with all funds managed by Fundsmith, the company has a simple and focused strategy of investing in high-quality companies, seeking not to overpay for those shares, and then holding them as long-term investments. A high-quality business is viewed to be one which can sustain a high return on operating capital employed and which generates substantial cash flow. The average return of the companies in the portfolio is 26%, versus 8% for the benchmark index.

This rate of return should be sustainable – the focus is on companies that rely on intangible assets that are difficult to replicate such as: brand names; patents; customer relationships; distribution networks; installed bases of equipment or software which provide a captive market for services, spares and upgrades; or dominant market shares.

In addition to high returns, a company’s quality also manifests itself in several other metrics: high gross margin (62% vs. 30% for the benchmark); strong cash conversion (104% vs. 80% for the benchmark), and balance sheet strength (61x interest cover vs. 5x for the benchmark). The operating performance of the companies in the portfolio has been strong – over the last twelve months, the median average growth in free cash flow was 22% on a weighted average basis.

The company currently holds 32 investments, in the middle of the target of 25-40, with the top 10 holdings accounting for 42% of the fund. The five largest holdings are currently: Diploma (distributor), Verisign (domain name registration), Rational (commercial kitchen equipment), Verisk Analytics (data analytics), and Moncler (fashion brand).

By sector, the largest exposures are: Industrials (40%), Information Technology (21%), and Healthcare (15%). By geography, the breakdown is: the US (51%); Europe (29%); the UK (14%); and other (6%). Although there are no emerging market stocks, the fund has a sizeable weighting to EM economies through revenue generated by its companies.

During the year, several new investments were made including Monotaro, an online MRO (maintenance and repair organisation) based in Japan selling all the products that businesses need to run, except for raw materials, and Medpace, a US company that provides outsourced research and development and drug trial services to small pharmaceutical and biotechnology companies.

Although the manager’s ambition is to maintain a position for many years, divestments are made from the portfolio as a result of one of three issues that the manager highlights come with the territory of investing in small companies. Firstly, management teams, particularly those which are founder-led, are able to and sometimes prone to abruptly change the capital allocation strategy of the company (Tenemos was sold for this reason). Secondly, the niche markets in which small companies operate can quickly shift in terms of demand trends or competitive dynamics, exacerbated by some companies having exposure to just a single market (IPG Photonics was sold for this reason). Finally, the more volatile share prices of small capitalisation companies relative to large capitalisation ones can lead to more frequent valuation extremes in the former group (TechnologyOne and Fortinet were sold for this reason).

This trading activity, as well as new additions to the portfolio, meant that discretionary portfolio turnover was 36% compared to 27% in 2023.

Given the fund’s focus on capital growth, a dividend hasn’t previously been proposed. However, the company now has a positive accumulated balance on its revenue account for the first time. In order to retain its investment trust status, the company is therefore required to pay a dividend and has declared a payout of 0.58p per share.

The total cost of investment was 0.89%, made up of the Ongoing Charge Figure of 0.86% and dealing, voluntary trading costs, and taxes of 0.03%.

Although the shares, which are part of the FTSE 250 index, initially traded at a small premium to NAV, since the beginning of 2022 they have traded at a discount, which ended 2024 at 9.1%. In response, the company has been buying back its shares – more than 25% of the shares in issue since the programme commenced in 2022. Buying shares back at a discount is accretive to NAV per share and added 2.4% to the NAV per share during 2024. Since the shares traded at an average discount of more than 10% in 2024, there will be a continuation vote at the AGM in April.

So far in 2025, the NAV and the share price have risen by 5.9% and 4.2% respectively (as at end February), with the current discount to NAV at 9%.

Source: Bloomberg