저자: TerrySmith · 외국인
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좋은 기업(투하자본이익률 높고 성장 지속성이 있는 기업)만 사서 오래 보유하는 것이 핵심 전략이며, 과거 가격 흐름보다 ROCE(투하자본수익률)를 봐야 한다는 주장. 핵심 원칙: 투하자본수익률(ROCE)이 자본비용(약 8~10% 가정)보다 높으면 기업 가치가 꾸준히 증가하고, 낮으면 감소한다. EPS 성장보다 ROCE를 중시해야 하며, 워런 버핏 1979년 주주서한을 근거로 제시. 사례: 항공업은 1994~2014년 평균 ROCE가 자본비용보다 약 5%p 낮아 가치를 파괴하는 업종이며, 유니레버는 꾸준히 가치를 창출한 대표 사례. 테스코는 EPS는 늘었지만 ROCE가 약 18%에서 12.5%로 떨어져 가치 파괴가 발생함. 펀드 현황: 포트폴리오 기업 ROCE는 약 26~31%(전년 29%)로 지수 기업(16~17%)보다 높다고 설명. 배당보다 재투자 여력이 큰 기업을 선호하며 배당 투자는 실수라고 주장. 성장 원천: 개발도상국 소비화, 선진국 프리미엄화, 고령화(의료기기·의료서비스), 공간(white space) 성장(안경·결제의 현금 대체·치약 보급), 반려동물 등 장기 구조적 성장 분야 중시. 경기순환주는 제외. 운용 원칙: 시장 타이밍을 하지 않고 항상 완전 투자, 헤지 및 공매도 없음, 잦은 매매 없음, 은행·보험·부동산·자원·유틸리티·항공·화학 등 주요 업종은 투자하지 않음. 시장 급락 때 패닉하지 않으며, 강세장보다 약세장에서 상대 성과가 좋다고 설명. 성과: 설립 이후 연 18.2%(2월 말 기준), 같은 통화의 MSCI 세계지수 약 11%로 연 7%p 초과. 채권 3.7%, 현금 0.6%. 운용자산 약 175억 파운드. 성공적인 운용자는 모든 장세·기간에 이기는 사람이 아니라 팀 전략으로 장기 우승을 추구하는 것이라는 비유를 사용.
다듬은 글
I'm a big fan of trying to communicate to people what we do, why we do it, uh because I think then we have the best chance of both of us getting a good outcome from it. I think if you don't understand what you're invested in or why you're invested in it when things go wrong, and trust me, they will from time to time, it's then that we make bad decisions for ourselves.
So, I think it's very important for me to try and communicate to you what we do. And it's not frankly very complicated. So, if I don't manage to do communicate that to you, it's certainly not your fault. As uh Einstein said, if you have a theory and you can't explain it to a six-year-old, it means you don't truly understand it yourself.
Um, go on a bit. There we go. So, yes, the Fundsmith Equity Fund, that's a disclaimer. We're required by our regulator to show you a disclaimer. You should take note of the disclaimer. I'll paraphrase it for you. Uh there's a company that we follow called Church and Dwight, an American fastmoving consumer goods company.
Uh they make arm and hammer uh toothpaste, for example, Trojan condoms, uh first response pregnancy testing kits presumably in case one of the products doesn't work as well as it should. And um uh their chief executive was once doing a presentation and he put up his uh disclaimer and he said, let me paraphrase it.
He said, "If you trust what I say and buy my shares, it's your problem." We have a very simple investment strategy is what I want to focus on this evening. Um, and there it is. That's it described. We try to invest in good companies and only in good companies. I'm going to give you a long definition of what we regard as a good company and why.
It is the single most important thing that we do. We try not to overpay, not to pay too much for their shares when we when we do that. And then we do the really tricky part of the strategy. This is the difficult bit. Nothing. Because we all think that what we are actually paying for is activity. No, we're paying for a result.
That's what we want. And if inactivity gets that result, and it does, then that's a good thing. Only invest in good companies. As I said, this is going to be by far the bulk of the presentation. If you've managed to stay awake until the end of this, you you're pretty much there in terms of the investment strategy, but I will touch upon the other parts.
That's our definition briefly of a good company. Now, don't bother trying to read it because I'm going to go through each of the points in turn. Okay, this is the single most important definition from a financial standpoint of a good company. It makes a high return on operating capital employed in cash.
For those of you who are not financial analysts, first of all, congratulations because there are much more important things to do in life than be a financial analyst. Secondly, you might wonder what exactly that means. that the amount the company produces in each reporting period, its profit or even better its cash flow divided by the capital employed which is in its balance sheet is a high number.
Uh in our current portfolio it's about 27%. I think I'll show it to you later on. I can't remember the exact number myself. That's the most important thing to look at when you're looking at companies. Why companies are just like us. Um it's not that complicated. Um, as it says there, if a company makes a return on capital employed ROC above its cost of capital, then it grows in value steadily over time.
If it makes one below its cost of capital, it falls in value over time. Now, the problem with that statement is I've already got into a technical point there, a cost of capital, which may be completely meaningless to most people. Think of it this way. They are just like us. If you borrowed money uh from me bank at I don't know what very generous rate they're offering at the moment but let's call it 5%.
And you invested in our fund and we compounded in value for you at about 17 or 18% peranom you would become richer. I hope we can all agree on that. Yeah. If you borrow from them at 5% and we make you 2% peranom we're going to make you poorer. Yeah. That's the same with companies. Companies have a cost of capital.
People often get very worked up about the fact that it's a a guess. You have to guess what a company's cost of companies. You there are ways of trying to get to it, but it's it's not something you can prove uh because it involves a thing called the cost of equity, which don't worry about at all. Start with the assumption it's 10% because that's what I do because we're never going to buy a company because it makes 11%.
So, we don't need to know exactly. We want companies that are going to shoot the lights out and make much higher returns in their cost of capital if they do. So like you borrowing money at 5% and making a return of let's call it 27% in the company the company will steadily grow in value over time. Don't take my word for it.
This is Warren Buffett. I imagine most of you have heard of Warren Buffett. Probably the most successful investor uh since the Second World War. Um and this is what he said in his 1979 annual letter which he writes to shareholders. He said the primary test of managerial economic performance bit wordy not how I would have put it but these are his words is the achievement of a high earnings rate on equity capital employed no return on equity capital employed without the achieve undue leverage and not the achievement of consistent gains in earnings per share.
Now I always have a a bet which I'm prepared to take you all on on this. If any of you are the recipients of company research and what you do, go tomorrow or when you get home tonight and have a look at the last 10 that have come into your inbox, okay? And I will bet you uh I guess we're in Mort, so it better be 20 rather than 20.
Um that if any one of the 10 says that they're judging the company primarily on its return on capital employed, just one, I'll give you the 20, right? Uh if it if none of them in the 10, you can give me the €20, right? When you've lost the €20, which you will, I'll give you a double or quit spec just to see if you can make your money back.
All 10 of them will mention the thing that he says to ignore, gains in earnings per share. Now, this is the world's most successful investor uh saying this and he said he said this as as you can see 50 years ago and it's been ignored by the investment industry almost completely since. I mean, what does he know after all?
Why why would you take note of what this man says? This is an illustration of of what I mean by this. This is an industry sector, the airline industry. Um it's a truly awful sector from an investment standpoint. Um, this is 20 years. So, it's 1994 to 2014. I didn't choose them because they suit me. It's pretty typical of the airline industry.
I didn't come up with the numbers on this chart. They came from uh the airline industry trade association, IATA. And as you can see on this chart, there's their cost of capital. This thing that I mentioned earlier, you can see this red squiggly line. It's a guess. I think if you average that line, it comes out at about 8 12%.
Frankly, it doesn't matter in terms of judging whether these are good or bad businesses. So their cost of funds if you like is 8 1/2%. Bit like them borrowing from this bank at 8 1/2%. These are their actual returns on capital. These nice gray bars here and there's the scale over there. You can see it goes up and down a bit.
It never once gets to the cost of capital. This is a machine for losing money. Basically if you average those bars it comes to about 3 12%. This so it's 8 and a half% cost 3 and a half% return. So they make on average negative 5% returns peranom. Um and if you read the report this is based on you would see that the airline industry during this period had an average uh capital employed in the world of about 500 billion US dollars.
So they lost 5% of 500 billion for their investors collectively peranom. It's amazing. Um and it's a really bad industry. Now I know when I speak to any audience there'll be some of you in the audience who will think maybe even say in the question session um well you can't be right because if you were right airlines would cease to exist.
Not while you keep sending them money to recapitalize them. They won't. They go bust. They're still flying around. You can go down to the airport and you can go and fly on an American Airlines flight or a Canada Air flight or a Swiss flight. All of these airlines went bust and were immediately recapitalized sha of their liabilities.
They weren't out of the air for even a nancond. Basically, uh, I always say competing in the airline industry must be like the financial equivalent of of one of those horror movies like Night of the Killer Zombies because even if you run your airline pretty well, your competition keeps going bust and then reappearing again without any liabilities.
It must be terrifying. Um, you know, I think in the last month, eight airlines have gone bust in Europe. Last month, Mark knows more about airlines than I do. It's a really terrible industry. If you have fund managers who are investing in airlines on your behalf and trust me you will have a people who are investing in airlines and you say Mr.
Mr. Smith said, "Airlines are a really terrible sector. Why you invested in them?" There are a couple of things that are likely to be said. One will be they won't have a clue what we're talking about. They won't have read Warren Buffett's 1979 annual report. They don't know about return on capital employed.
It's never entered their head. But even if they have got some some grasp of this, they'll say, "Ah, you see, I'm pretty smart." They'll say, "I buy it when the returns are down there, and I sell it when they're up there, and then I buy it back down when they come down here, and then I sell it when it goes up there." And there's only one problem with that.
I've never Well, two problems with it. One is I've never actually met anyone who can do that because you know you don't know when the returns fall down there whether that's the bottom you know um you don't know whether they get up there whether that's the top there's no announcement so you know you invariably end up getting your timing a bit wrong the other thing is this think back to this return on capital employed versus cost of funds you buy your airline stock and you say well it's pretty depressed down here at the moment there's a recession going on and I think it's all going to bounce back and I think there'll be some airline consolidation I think some of them will be taken over and so on and oh, there'll be a change of management or the oil price is going to drop or all of the above will happen and aren't going to make money.
Right? Whilst you're sitting waiting for these events to occur, this thing is steadily eroding in value. It's the it's the investment equivalent of trying to carry around a melting ice cube in your hand in terms of trying to realize your gains. Right? This is what a good company looks like. Um, and you can see I mean I've I've been using these slides for many years.
That's why 2014 is the final year. I don't need to change my examples an awful lot in life. I find bad sectors and companies are bad, good ones are good. Doesn't change an awful lot, frankly. This is Unilver, uh, fastmoving consumer goods company, which I'm sure you've heard of. This is a decade. It's a very typical decade.
There's its cost of capital. You might wonder why the cost of capital is down here on this chart where it was up there on the other chart. The answer is you've got to have it down there in order to get these bars on the scale, right? This is a company that makes, as you can see, about a 20% return on capital basically.
And its cost of capital if you average that line is about the same as the airline industry allegedly about eight or nine%. Basically this makes money and grows in value steadily year by year by year. Now you can get unoliever wrong. We all get things wrong. I get things wrong. If you buy unilver when its returns are there in 2008 and it has a really bad 2009 because of the global economy.
You probably don't feel too clever about your your particular uh timing of your purchase. But how the company grows in value will dig you out. Whereas in the airline, the how the company shrinks in value will bury you. Um, this is an example of a company uh that I wrote about in one of my Financial Times articles.
For the first four or five years that we were open, Tesco was the most powerful retailer in the UK um and was growing overseas. And people kept saying to us, you should own Tesco. Why don't you own Tesco? Um, and we even had questions. If you go back to our annual meeting videos, you'll see people asking questions annual meetings.
So I wrote an article for Financial Times before Tesco blew up which it did and I illustrated something and what I illustrated was the Warren Buffett uh quote about return on capital employed and earnings per share. These are the years when Sir Terry Lee ran it and as you can see what people were telling us to buy it for was this these lovely red upward margin earnings per share bars.
You can see they're just going up beautifully. Equally at the same time this thing return on capital employed was coming down. It went from about 18% at the beginning of the period to about 12 and a half% at the end of the period. If you let people put more and more capital at work at lower and lower returns, they are bound to show some earnings growth, but it doesn't mean they're creating any value.
Again, coming back to the bank, think of it this way. You've got a hundred euros with the bank and they pay you five in interest. Presumably, you get five at the end of the year. If you double the amount of capital at the bank to 200 and they pay you seven and a half, would that be a great result? I don't think it would be because you'd only be getting two and a half percent on the extra 100.
In Tesco speak with earnings per share, they would say, "Ah, no, that's growth of 50%." It's great. You need to know what return on capital they're getting. Don't look at the growth in earnings per share. It's an illusion. It's not a creation of value. What we now know is that during this period, Tesco did its investments in California and China, which destroyed immense amounts of value.
And so, that's basically what happens. the people who lost lots of money in Tesco and lots of fund managers and investors lost lots of money in Tesco. If you focus on the thing Warren Buffett says to ignore, which most of the research you get looks at as well, growth in earnings per share, and you don't focus on the return on capital employed, that's the outcome.
Do we in our fund own good companies? Every year we publish this called a look through ratio table. There's our fund over the last seven years. And we compare six operating metrics for our companies there with the Footsie 100 index and the S&P 500 index. Um, and this is basically if you take the companies in our portfolio at the end of each year and we work out their return on capital employed and their operating margins and their interest cover and so on and we wait those calculations for their size in the portfolio.
We can tell you what our whole portfolio would look like if it was a company. It's like a almost like a consolidated set of accounts. Almost, not quite. Um, and you can see there's the return on capital employed. As I said, my memory is like a civ on these things. Last year, our return on capital employed was 29%.
Okay. In the companies in our portfolio, as you can see, it doesn't vary an awful lot. It's been as low as 26 and it's been as high as 31. It goes up and down a bit. This is the index. So, if you went out and bought yourself an index fund, the look through the companies in the in the index, they're making 16 to 17%.
uh for every pound or euro or dollar of capital that you own as a shareholder in the companies in our fund, they're producing 29 p or cents on that in terms of return. The ones over here in the index are producing 16 or 17. Our companies are better. Um that's only 0.1. I'm afraid there is a bit more to say.
It's no good having high returns if you don't have a source of growth. You can have 29% return on capital employed, but we're looking for a company that has a source of growth because if it starts the year with 100 in capital and it makes 29% return, presumably ends the year with 129. Uh, now what we want is a company that can retain part of those earnings, not pay them all out in dividend.
One of the one of the the things I say about investment that you didn't touch on which seems to affects people a lot is you should never ever invest for income. It's a mistake. You want companies that can reinvest as much as they possibly can because that is how actual compounding in value works. If you've got a company that starts with 100, makes a 29% return maybe retains typically about half of that.
So it starts the next year with 115 in capital pays out the rest in dividend and it makes 29% on 115 and it does that year in year out. That's what you're looking for. Now that can only occur if they have a source of growth. They need to sell more stuff frankly in order to invest. You can't do you can't do the investment unless there's a source of growth in your business.
So, we look for sources of growth, sources of secular growth. We're not interested in cyclical growth where the company sells more things during a boom and then it sells a lot less in a recession, then sells more in the next boom and less next recession. We want people there are ups and downs of course all companies have some cyclicality.
We're looking for people who have a long and continuous driver of growth and it typically falls into one of these five categories. Consumerization of the developing world. In the developing world, when people go past a certain threshold of of dis of of disposable income, they become consumers. At the moment, the guess is $35,000 US basically.
So, when they have $10 a day to spend, they become consumers. Why? Well, they're working in a country or living in a country where they've now got a normal job. They're involved in the country is industrializing typically. Uh they need to actually have the convenience of being a consumer like we do.
They can't spend their entire life sourcing and preparing food, working in the agricultural sector. They need to actually go to work and have the convenience we have. They're also aspirational. They want to become consumers. So that's one driver. Another one is premiumization of the developed world.
The developed world is not consumerizing in the same way that this one is. It's not got the population growth that much of the developing world has got, but we've got premiumization. You know, we may not drink as much as we used to, but we drink more expensive than we used to. If we drank Smyrnoff, maybe now we drink Grey Goose or we drink Syrok, you know.
Um, you know, we used to drink uh Tankery Dream, but maybe we now get a craft gin. Uh, you know, we used to put Schweps mixer in there, maybe we put Fever Tree in there. Now we're we're we're not consuming more, but we're paying more for it. It's a source of growth. Sometimes it's aging populations.
I mean, obviously, one of the drivers in the developing world is the youth of population. Young people spend more money than aging people, except in one area. There's one area where aging populations definitely take the lead and that's anything in the medical area. So medical medical devices and equipment in particular uh medical services uh and some pharmaceuticals.
Um other areas for growth, white space, if you're not familiar with that's a term that's used in the marketing sales world. If you've got a map of a country or the world or a region and you've got no sales in a particular country and so on, you color it white on the map. It's somewhere you can grow into over time.
There are certain industries that have got massive white space to grow into and we know that they'll grow over time. Eyes, the majority of people in the world who need vision correction don't get it at the moment. They will eventually it will arrive and when they can afford it and the services available they will get reading glasses and other forms of vision correction.
Ah that happy sound. Um payments uh payment companies are something we invest in. People like Mastercard, PayPal, Visa. Uh people say which one do you prefer? And we say, well, actually, we like Visa, but Mastercard's pretty good as well, right? Why do we say it like that? Because actually their big competitor is not each other.
Their big competitor is cash. 85% of the world's transactions are still done in cash. It's white space for them to grow into. And if we uh try to explain to our children maybe or our grandchildren that the main mechanism that the world had for settling uh transactions was that you printed something on paper or plastic.
uh that had to be designed to prevent it being easily fooled. You had to securely transport it to a bank. Then you went to the bank and took it out. Then you went to a shop and you paid it in and then the shop paid it into the bank again and it was circulated again. They're going to regard us as mad cuz they just think you walk into Starbucks and you finding you've got your phone on you, you've paid.
Yeah. And that's their growth area. Um toothpaste, very similar to um to the eyes thing. uh twothirds of the world doesn't yet brush their teeth with toothpaste and a toothbrush, but they will over time they will. I mean, if they want to have a relationship with other people who use toothbrushes, fairly certain they'll have to get used to the idea.
Um, and some things are just trends. Pets, my favorite subsector for investment in is anything to do with pets or companion animals to give them the technical term. Pets are a fabulous growth area uh in a in in the developed world and increasingly in the developing world, a pet is a full family member.
If any of you got pets, you'll know this. They are child substitutes. They're grandchild substitutes. Uh people are having children later. They substitute for this. Um we are prepared to spend seemingly endless amounts of money on pets. Uh in pet food, you can get specialist pet food for overweight pets, diabetic pets, aging pets to prevent Alzheimer's, uh aging pets to promote flexibility.
You can get performance dog food if you run with your dog like a run faster. You can get it for your cat's thyroid condition. you name it. Um, and we are mad when it comes to this stuff. You know, Americans, uh, last time I checked, it was about four years ago, spent $10 billion that year on diet pet food.
Now, I've never met a pet that can open the cupboard. You could just feed it less. No, the diet pet food costs more than the standard stuff, doesn't it? It's great. Um, and the area of pets that's the absolute pinnacle of it is uh is in veterinary care because, uh, again, pets are moving along continuum like we did.
um 25 years ago or something like that, the average pet went to the veterary surgeon if if at all in its life twice. Once when it was born, it's jabs maybe be neuted and once when it died. That was it. Now, now they go at least as many times if not more times than their human owners. And they've got a there's a great one of our companies we invest in is a is a veterinary diagnostics equipment company.
And the reason for that is simple. You need more diagnostic assistance with with animals because they can't tell you how they feel. and they can't the vet can't have a chat with them and say where's the pain I mean usually the vet only my oldest daughter is a vet by the way norm the vet only finds out when they find the right spot and get bitten uh testing any form of testing I touched upon veterinary testing is a growth area think of health and safety the nanny state you know uh when you find horse meeting burgers how do you know you need mass spectrometry you need people who makes mass spectrometry equipment to tell you anything like that is a growth area um we like companies that make their money from a large number of everyday day small ticket repeat predictable transactions.
We don't like people who make their money if at all from a big one-off. You know, it's a building contract uh or a property development or a infrastructure project or a movie or something like that. You've no idea whether it's going to work. I always cite the example of Mullm the construction company which uh celebrated uh the contract which it got to build the tunnel from Dublin airport to Dublin docks.
It was a bit premature to declare victory because it bust the company. [snorts] Yeah, they got the contract. Okay. But, you know, they're going underground in terms of work is notoriously difficult to predict. Uh, movies, uh, unless the movie that you're about to make is one of rare multiple franchises.
So, Harry Potter, Pirates of the Caribbean, James Bond, a few, there are a few multiple franchises out there. There have been others as well. Star Wars and so on, but once you get outside that movie studios have not got a clue whether they'll make any money. Disney a couple of years ago lost $200 million on a movie called John Car.
This is Disney. This is not amateurs lost the money. Uh they have no idea whether it's going to work. It's terrible industry. Very exciting to work in but you know terrible. We like people who uh make their money from things that are relatively predictable. So uh when we have drinks, when we give our feed our pets, when we brush our teeth, when we apply cosmetics, when we make payments, when we ride up and down on an elevator or an escalator, uh that's that makes money from the service spares and uh and so on.
uh when they make uh medical devices that we know are going to be required in human bodies. There's an artificial hip uh there. Uh when you stay at a hotel, we like hotel franchise businesses. So, everyday predictable events. I think we were trying to work out on our way here this morning how many points we touched in our portfolio on on our way to uh I can't remember what ones did we come up with.
Reservation system reservation system. So, Amodus we own airlines um PayPal. I paid for some I I ordered something online from PayPal and I ordered some Philip Morris Icos heat sticks uh for somebody I know who who can't get them where they live. So I'm going to take them some some Philip Morris heat sticks.
So we three things we did this morning which uh which are in our portfolio just on our way here. Basically we like companies that can protect. So we're looking at these companies with these wonderful returns on capital 29%. Good. Um the trouble is there's a law of economics called mean reversion and if you've got a 29% return on capital the competition should turn up and try and take that off you there you know people should see that analyze that within any industry sector and say I'm getting into that sector that's a great sector to be in and they do.
So what you're looking for is people who can protect those returns and beat off the competition. Um I don't particularly like this term but it's one that Mr. Buffett has popularized. They need a moat. He says it's like imagining that your wonderful business is your castle. You need a moat to be able to defend your car.
So, what's the thing that you've got that enables you to do decade after decade producing returns which should be taken away by competition. And it's usually one or more of the following. Oop, sorry, gone too far. Uh, press the wrong button. What? Brands. We will pay more for branded goods than non-branded goods.
We pay more for primary brands than we do for secondary brands than we do for tertiary brands. Brands are something unlike patents where if you spend money on on renewing and uh the brand and advertising and marketing the brand, they can last forever. Basically, uh control of distribution and supply chain.
It's not just brands. Sometimes it's these elements as well. Distribution. If we sat here and brainstormed uh a new vodka tonight, which brand, which might be more interesting than what you're actually doing, I suspect [snorts] um then that would be great, but I'm not quite sure how we get it distributed because we go to the number one distributor to get it into bars and uh and restaurants and uh and supermarkets and say, "Here's our new uh Multis vodka.
What do you think?" They go, "Wonderful, but we're not carrying it." Why? Well, we've got an exclusive agreement with Smirnoff, so we're not going to be putting your vodka on our trucks. I'm sorry. Or they're even owned by Dio in many cases. Ditto would go to the number two and say here's our new and they go ah sorry but we've got an exclusive agreement with pero Ricard who've got absolute which is number two vodka brand we've struggled to get it out there sometimes it's a supply chain as well the example I always site is the dairy companies like Nestle and Denown in the developing world where you know if you go to someone like Pakistan India there was no dairy industry as we understand it there before these people arrived they went to dairy farmers uh convinced the dairy farmers to become dairy farmers gave them help with veterinary care and feed to develop a dairy herd.
Set up the the refrigerated transport system to get the milk from the farms to the processing plants. Set up the processing plants to make UHT homogenized spray dried uh uh dairy products and put the fridges in the shops at the end. You if you turn up to compete with them, you can't use all that stuff.
You can't go and put your things in the fridge or use their supply chain. You have to build it all from scratch. Uh now, it's not impossible, but it's darn difficult. And if you combine that with their brand, which usually speaks safety, particularly to consumers in the developing world, they're putting their product quite often into the most precious thing in their life, their child, you know, that that safety in that Nestle brand combined with their strangle hold on supply chain and distribution is a killer moat.
Basically, um, sometimes it's an installed base of equipment or software. I touched upon elevators and escalators. It's a great business. The money isn't primarily made from selling elevators and escalators. It's made from the service spares and so on. It's a legal requirement to have them serviced.
You can't opt out from having them serviced. They break down. They have to be serviced. Um sometimes the installed bases software. We said we touched various things coming over here today. Uh the the airline use reservation software. Uh basically once that software is installed, you don't change very often because it's a low cost.
It's a very small ticket. €4 per passenger typical from Amodus charge for processing a passenger for doing the reservation the uh boarding pass and the weight and balance calculation for the aircraft is done by them for €4 a passenger. Basically once you've installed their system you're reluctant to change.
It's a barrier to new competition coming in. And with the installed base of equipment like elevators and escalators, if you buy a KA or an Otus or a Schindler elevator, there's a 75% chance you will sign a contract to maintain it with the original equipment manufacturer. They've got you as a tame client.
Uh and patents, patents obviously guard against competition. They're our least liked form of moat for a simple reason. They expire. They are limited life. We like things that can go on forever seemingly. Um we like companies that are resilient to change, particularly technological innovation. Um, you know, we all hear about technology and we're told we're living in the most disruptive technologically rapidly advancing period in history.
I'm not convinced that's true, by the way. Uh, I'm a historian by training and I think the industrial revolution was quite interesting in that regard. But we all think whatever age we're living in is the most important one, don't we? Um, but what I do know is as much as it may change our lives, sometimes for the better, sometimes for the worse, it's difficult to make money with things that are changing rapidly techn technologically.
This is the top 10 software companies in the world in 1984. Okay, they were taken from a business plan from a company called Intuit which was founded in 1984 which we own. It's an accounting and tax software company based in America. This was their analysis of the top 10 software companies in the world in 1984.
So there you are, you're in 1984, you you think I'm wrong. You're going to go and make a technology investment or three. So you get up this list of the top 10 software companies in the world and you pick a couple. Unless you picked that one, I'm afraid you're in a bit of trouble because the the other nine have ceased to exist.
They're just not there anymore. And these were real businesses. I used and probably some of you did if you're old enough, Lotus Notes before I used Word. Um I used Visical from Vicor as a forerunner of Excel. These were companies with real real products. They've been vaporized. Don't exist anymore. Another area that's highly regarded from a technological innovation standpoint attracts lots of investors is the drug industry.
The biotechnology industry investing in biotechnology is an interesting approach in terms of the odds of success. Most drugs in most regimes have to go through four stages of clinical testing. These are the four stages and these are the failure rates. Okay. Test number one is is it safe? 97% of of drug compounds fail that first test.
Only 3% make it through the is it safe. 97% of them have some side effects that are deemed to be dangerous. Of the 3% that survive that are put into stage two, does it work? Does it actually do anything? Once they get to the point where they give you the drug and the placebo, if you're the same, it doesn't do anything.
Of that 3%, 95% of them fail that one. Of the 3% that failed that that succeeded and got through the 5% there, test number three is Yeah. Okay. So, it does something. it doesn't kill you. Is it better than an existing compound out there that's already got a patent? Because if it isn't, you're not going to get a patent.
88% don't survive that test. And then finally, the final test is usually does it have any other benefits or uses? So, it may be a a um a diabetes drug, but can you label it for obesity, for example? That's us. That's the final test, which is the one that most survive. If you analyze that, the likelihood of getting a drug up here.
So your one company your one drug biotechnology company you're thinking of investing in getting through all that is the calculation 1 -.97 multiplied by 1 - 0.95 plus 1 -88 1 -46 or 01 or in plain English you have a 1 in 10,000 chance of being right. It's an amazing bet. Don't take my word for it. That's the Pharmaceutical Research Manufacturing Association of America.
That's the That's their chart. I haven't changed it at all. A long and risky road. They're saying out of five to 10,000 compounds out here, right, you get one FDA approved drug. It's a really bad industry from an investment standpoint. Yet, people keep investing in it. There we go. We like industries where we're not likely to be blindsided by new technological development, where we can uh go to bed and expect to wake up tomorrow with the same kind of thing going on.
So we uh we take photographs of things when we're turning around. We took this uh this is an elevator system in uh San Francisco was installed in 1910. It's an Otus elevator. It's still going, still working. Uh Mr. Otus is the man who actually invented the safety elevator. He patented it in about 1858, something like that.
And if he came back to Earth uh now uh and he saw that elevator, he would say, "Yeah, it's a safety elevator." If I took him out of the lobby here and showed him these, he'd go, "Yeah, it's a safety elevator." There has been no significant technological innovation in the intervening period and I'm reasonably confident that I won't wake up one morning and find my holding in elevator companies has been wiped out by a new way of going up and down in high buildings.
I don't think it's very likely until the Star Trek teleporting system becomes a reality. Think we're okay. Nearly there now. You've nearly survived good companies. We like companies that operate in particular sectors. So ones that have got intangible advantages like brands, control of distribution, they've got installed bases.
So we're looking for intangible advantages. We don't like companies that remain that rely on tangible advantages like buildings, things like that because you can always replicate buildings with money. Uh whereas and with debt at that whereas with brands it takes a very long time and it usually requires real equity to do so uh to to replicate them.
Franchise we like I didn't touch upon that earlier given that our number one requirement is a high return on capital nothing much beats companies that use other people's capital basically uh a franchiseor gets his franchises to put up the capital for the business so think fast food that's what the business is about um just some examples uh we don't own all of these mostly the companies that we invest in are companies that you've heard of maybe one or two you haven't but I'm sure you've heard of Proctor and Gamble uh the world's uh uh biggest fastmoving consumer goods company.
I'm sure you've heard of Nestle, biggest food and beverage company. You might not have heard of Beck and Dickerson. Next time you're at the the doctors and you're having an injection or you're having a blood sample taken, um have a look at the pack they tear open. It will probably have that logo on the end.
Um and uh their biggest selling product uh is a uh disposable syringe. They sell a packet of 100 for£10. So it's 10 p per syringe. Nobody thinks but remember large number of small ticket repeat transaction. Nobody no doctor thinks twice about 10 p when they give you an injection and it has a unique feature which is the plunger can't be pressed twice.
It locks once it's done. So it prevents needle sharing 10 p. That's where they make their biggest single gain. Ka in elevators. I obviously talked about elevators. Colgate palm olive you touched upon the fact that people often say to me and that's why I wrote the article. Oh you try to back you try to find winners or something like that.
I say, "No, no. I like to bet on people who've already won. I'm like the person who goes to the races and wants to know the result before I'll put a bet on. I know that Colgate has won. Colgate's got over 50% of the world toothpaste market, 35% of the toothbrush market. It's number one in liquid soap, and it's number three in pet food." It won.
You want to get into oral care? They've won basically. I said I like resilience. Um, our average company was founded in Mark, I can't remember, 1927. 27. Thank you. Um, so they've seen two world wars and the Great Depression. They'll probably be okay, whatever comes next, I would guess. Um, but my my poster child for resilience is this company here, Brown Foreman, which you may not be familiar with.
It's the distiller of Jack Daniels Tennessee whiskey. That's its number one product. And Brown Foreman survived not only two world wars in the Great Depression, they survived prohibition, which is kind of interesting. So their product was declared illegal in their home market. They survived. They got a license from the US government to dispense whiskey for medicinal purposes.
There you go. You've survived. Good companies. Well done. Right. The rest is shorter. It's very important. And I hope now to illustrate not only what it is we're saying about them, but why it's important because I reckon if you I wish I'd kept a diary from my first day in work in 1974 in the financial service industry with two columns each day in there.
And I put a tick in the column when somebody said to me on the one hand is that a cheap stock or or not a cheap stock. Is that a cheap fund or not a cheap fund? Is it a cheap market? Not a cheap market. Tick in that column. And on the other hand, when they put one in the other column, is it a good company?
And I know which column where the balance would be. Trouble is, I don't know exactly because I didn't keep the diary. But overwhelmingly over the years and still to this day, people ask us, "Yeah, but is it cheap?" It's not the most important question. it. Providing you get the first decision right, which is you've got good things, whether or not they're cheap is a secondary consideration.
It's why it's second on our list. Okay, don't take my word for it. This is Warren Buffett's sidekick, Charlie Manga. [snorts] I don't know why he picked these particular numbers, but this is what he said. Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns.
If the business earns 6% on capital, this is the return on capital again, over 40 years. have no idea why you chose 6% at 40 years, but it doesn't matter. You hold it for that 40 years, you're not going to make much different than a 6% return. Here's the punch line. Even if you originally buy it at a huge discount, right?
Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, there's the punch line the other way, you'll end up with one hell of a result. Right now, Mr. Munger is not speculating on this. He's not offering you his suggestion. It's mathematically a fact, right?
Here's two companies and your investing career. 40 years seems like a long time, but actually most of us given our lifespan now are going to be investors for much longer than 40 years. Actually, even if we start in our 30s, say we're going to be investors for much longer than that. Um, and these two companies are you've got a very simple choice.
You've just got to own company or company B for the 40 years. That's all it is. That's all you're required. Company A has a return on capital employed of 20% and B has one of 10%. To make this simple in terms of mental arithmetic, so you don't have to do complex mental arithmetic, neither company pays a dividend.
So 100% of their post tax returns are invested in their business and they both have the same tax rate. So I hope having uh board for Britain on return on capital employed for the last 20 minutes or so, I could convince you that a might be the better investment to select. However, if only life were that simple.
On the day when you go to buy them, they are differently rated. A is trading on four times book value on the stock market. B is only two times book value. For those of you who are not analyst, book value is the capital take it as the capital employed there. So for every pound of capital employed in this lovely 20% earning company, you've got to pay four in share price terms.
Whereas unsurprisingly with this one only makes 10%, you've only got to pay two. Bit trickier, isn't it? Which one do you want now? It gets worse. when you come to sell them 40 years later because you want to invest in bonds and lose money. Um, this one has harved in valuation. I have no idea why it's occurred.
Um, it's out of fashion. Uh, your timing is bad for whatever reason. It just take my word for it. It's happened. It's gone from £4 for every pound of book value to two pound. This one on conversely is in fashion at the moment. It's doubled its valuation. Now, which one do you want to own? It's still a now believe it or not and we can send you the spreadsheet for anybody who wants this if you ask afterwards.
You've actually got enough information not for the gobbledegook that I talk about return on capital employed price the book you you've got all the data there where if we tell you the share price at the outset we can tell you what you would have gained at the end of what the compound return but you've got everything you need there in those few numbers your terrible timing here but in this very good company would have cut your share price compound annual growth rate to 18%.
you'd have taken 2% off from what Charlie Manga tells you is the underlying return. With this one, your brilliance or luck, I don't know which it is, would have got the return up to a whole 12%. Over the long term, it's the return that the company makes on the capital it reinvests which will determine your outcome, not whether you buy it cheap and sell it expensive or the other way around.
Um, here's a real company to illustrate that. This is a company that you've heard of, I would imagine. I would be fairly confident you've used its products. Um, it's a consumer products company. These are three years actual numbers. Don't bother looking at them all. I'll just pick out a few. Here's three years.
You can see it sales went from 15 billion to 17 nearly 18 to 19 billion. And it's uh net profit which is somewhere net income uh where are we net income went from $900 million to $1.1 billion. It's growing at about 8% peranom. Uh these are not atypical years. I put 20 years up there only because it would be a crowded slide.
They're very typical of how this company performs to this day. It continues to perform a bit like this. Um, and it did before. Um, what would you be prepared to pay for this company? So, now we get back to the cheap or expensive. So, never mind per share. We'll just do it for the whole company. So, if it makes $1.1 billion in net income, would you pay a PE a price earnings ratio of 10?
So, you buy Could I get you all to bow together with me tonight and we'll go and buy this company for 11 billion? Now, I reckon you would I you might be able to get you in for that one. Yeah. How about getting you to pay 20 times earning? So, we pay $22 billion. I think now we just start here and people go, "Well, it's a bit expensive, isn't it?" Yeah.
How about 30 times, 32? Not one of you would come with me. Mark might because he knows the example. The rest of you, I've got no confidence at all that I can get you to come along. uh 40 times you would be trying to get find if you find a short seller uh for the company basically at that point of the proceedings right now this is a company called PepsiCo and I didn't actually lie to you on the previous slide because I'm not like that but I did do something slightly misleading you'll see the years that I put up I labeled 2014 15 and 16 and actually they're not they are actually 1989 1999 um so they're 25 years ago so I did it to you because we can now tell what happened with our decision ision that I was trying to get you to make with me.
So, let's look what happened fundamentally. Uh the $19 billion of sales became 62 billion in the intervening years because we've got the 2016 results here. We can tell you what happened. Yeah. Um the $1.1 billion of um of profits became 6.6 billion dollars of profit. So, it went up six times. The market value went from 27 billion to $146 billion.
You'll get told, by the way, in relation to our strategy that these companies are more expensive than they've ever been. I'll come back to that perhaps a bit later. No, they're not. Actually, this company is much more lowly rated now than it was back then. So, 22 times earnings versus 25. Okay. How did we get on?
Well, if we' bought the company for 10 times, we'd have made 14.3% peranom return because we can tell you what happened to share price now over the 25 years. If I got you to pay 20 times, we'd have made 11.1%. If I got you to pay 30 times, remember none of you I didn't hear any protest. Yeah, I'd be in Terry.
I didn't hear any of that. We'd be on 9.3%. Okay. 40 40 times 8.1%. The S&P 500 for the same period with dividends reinvested was 9.1% prime. This is the toughest index in the world for fund managers to even equal, let alone beat. We could have paid 32 times earnings with PepsiCo and equal an index that most fund managers find it possible to beat.
Human beings are really bad at working out the effect of differential compound growth rates over long periods of time. We don't realize quite what happens when companies compound their earnings in the way that these companies compound. We're very very bad at judging the outcome. We could have paid 32 times earnings for PepsiCo back there at 1991 and and equal the index.
We could have paid 30 times and beaten the index. Uh basically now I know a valid question is yeah, but is this the same as 1991? I haven't got a clue. Um but I do know this. Every time you make an investment decision now you're making a judgment and a bet about the future. And I think this is a lot more predictable than your airline stock or your oil and gas stock or your bank uh and so on.
That's a real life example. Here's another real life example. Uh this is the S&P 500 and this is about market timing and valuation. Yeah. Let's imagine you were very very clever, lived a very long time and started very early and what you did was you bought the S&P 500 at its low in the in the 20th century and sold it at its high in valuation terms.
You would have been buying it in 1917. The lowest valuation S&P was the day America entered World War I. Uh when the price earnings ratio was 5.3 and you'd have sold it just at the peak of the dotcom boom in 999 when it's 34 times. Ignore the charts. Just just look at the the numbers perhaps for a moment.
Um you would have made a compound annual return of 11.6% peranom by buying at its low in valuation, selling at its high in valuation. Well done. That's pretty good return. Not bad. But we can break down what comes from your cleverness with the timing and the valuation and what comes from the companies just reinvesting by the following method.
If you put into a calculator, if you've got a Hud Packard 12C like me, the old industry standard, you can work out what you made from this because you can put in minus 5.3 present value, 34 future value, uh the number of years in here, which is 82 years, I believe. 82. Yeah. Um and press the button, it will tell you that 2.3% of that 11.6 came from your cleverness.
80% of the return came from the companies just reinvesting and compounding in value. Yeah. And this is 500 average companies. This is not a particularly good company with a 29% return. 80% of the return. It's an example of Pareto's law. 80% of the result comes from 20% of of the actions. 80% of this came from the companies investing in and not you doing anything.
Um if you do it with a good company, this is our friend Unilver again for 20 years and you do the same calculation. If you bought it in 95 on 16.8 eight times, sold it in 2016 on 21 times. Well done. Obviously, you made a 10.9% return over that period. If you do the same calculation, you'd find 1.1% of this came from the uplift in value.
90% of it comes from the company. Over the long term, it's what the company does that makes money, not what you do. We still having said all that, so I've said Charlie Manga says it's what the company does, not not your your valuation that gets you there. I've given you the theoretical company AMB. I've given you the PepsiCo example and I've talked about comparing what happens with the index and unilver.
Having said all that, we do try not to overpay because I mean you would be mad to go out there and deliberately overpay. So we do every day in real time compare a thing called the free cash flow yield. So the free cash flows that our companies generate after paying for everything except the dividend.
So we divide that by their market value to get a yield number. That's our cash flow. It belongs to us the shareholders. And we compare that free cash flow now and in about four or five years time can we can see is it growing. Remember we like growth with each other our investable universe of stocks that we follow that we would be prepared to own with the market with bonds and with any other yard stick.
And we try every day to make sure that we're invested in the companies which are good companies that we would own which give the best combination of value. So having said that it's not that important we don't ignore it. Um I said earlier you'll be told that um uh this is this is strategy is all about consumer staples and that they're more expensive than they've ever been.
This is just a price earnings ratio chart for the uh the 20 years there uh for the consumer staple sector. It's not our biggest sector of investment. So strategy definitely isn't about consumer staples uh per se and you'll see in the PE terms they're there at the moment 22 I think they're actually a bit further down because it's not a recent chart.
I think they're around about here now. As you can see they were much more highly rated in the 1990s basically. No, they're not more expensive they've ever been. And bear in mind the Fed funds rate was about uh was about 6% there basically during that period. So the actual underlying valuation uh rate was much much higher when they were much more highly rated.
Um they haven't been a particular help actually. If you look at there's our fund over the uh over the last 5 years in terms of compound returns. And here's some sectors you will see if you get down here consumer staples have actually been a net detractor from our performance over time. They haven't performed as well as our fund has performed over time.
So it's not all about them. Then finally do nothing. Um this is a a complex table. I apologize for that. But um this is our portfolio turnover rate. You can see the highest is 13.4% peranom. That is strikingly low by industry standards. I'll come on to that in a moment. Here's what it's been over the last half dozen years.
You can see 2% 5% is negative in three years which is a piece of gobbledegook I'm afraid. Um when we're calculating this turnover we don't do it on a way that we would like. We're given a formula and what the formula does is it looks at our buying and selling. So obviously we've got that number and then it nets against that any net inflows into the fund.
So net cash inflows. So when we've had big cash inflows which have exceeded our dealing, we end up with a negative turnover rate which is absolute nonsense. I mean I you know none of us know what that really means. Here's a better help. Here's our dealing costs. Okay. And you can see our dealing costs.
There's the actual numbers but here's them as a percentage of the assets. So last year we spent 018 of a percent on dealing. So we spend less than 200ths of a percent on dealing. Okay, I'll show you some other people as an example in a moment. Um, you know, we're talking about a 17 billion pound fund here.
Uh, those numbers would be a black armband day for the broking industry basically. Uh, which is is not our problem, but it would be if everybody ran money like this, but of course they won't. Don't. This is the 15 largest funds in the UK. And what we've done is we've taken our ongoing charges figures and there's there there's our one.
So, if you're in the uh the same class that I am in, the uh uh the uh Tclass, you'd be paying 1.05%. Uh peranom. We've added on our transaction cost and told you how much that adds to the disclosed fees. The reason we've done that is that cost of dealing that I've been talking about is not shown in the fee numbers that you get.
You know, the what was once laughingly called the total expense ratio excluded it. So, it was the total expense ratio except for the cost of dealing. Now it's revealed and you can see our dealing costs add 4% of the cost of the fund. Here's the 15 largest active equity and total return funds in the UK.
So the Standard Life GAR fund uh in there uh Woodford in Equity Income down here uh Linsel Train one of our good competitors over here. As you can see we are the lowest uh addition in terms of cost from dealing. We don't deal very much. We don't deal very much. One, because it costs money, and secondly, because it invariably involves a mistake.
Almost every time I ever sell a good company, it's a mistake. Uh, it's rarely a good idea. There's a quote to illustrate it. It is because people think they're paying for activity. They're not. They're paying for a result. Um, nearly finished. A couple of other things to touch on. We're the Groucho Marks of investment in Fundsmith.
What do I mean by that? Groucho Marks once said he would never join a club that would have him as a member. Yeah, we would never invest in a company that needs our money. Now, all of the companies we invest in are quoted. We don't invest in any private companies. So, don't become confused, please. But the companies are not quoted on the stock market because they need to come out for the market for more money.
The companies that we invest in uh because call us old fashioned, but when we've bought shares in a company, we like them to send us money after that, not the other way around. We think that's how this relationship should work basically. Now then, why are they quoted? They're typically quoted because they were once familyowned.
And as you know, families when sharies become dispersed and people don't want to work or can't work in the business anymore, a realization event has to occur. Quite often in the history, that's been an IPO. The company's been floated. So that's how they come to the stock market, not because they need any more money.
So when we're looking at a sector and we're thinking of investing in it, we look for a big private company in that sector that's been around for many decades, if not longer, and has never had to float. Which means we know in that sector, companies can grow and prosper and create value without ever ringing up the shareholders and asking for more money.
We can't buy them, don't get me wrong, we can't buy those companies, but they give us comfort that we're fishing in the right area. So we said to you that we like um uh small ticket uh everyday items. We like confectionary. Confectionary is an everyday luxury that people will buy for themselves even in quite poor economic times.
It's a it's a small treat they can give themselves. We can't own Mars. It's one of the large largest confectionary manufacturing in the world. It's owned by the Mars family. They have no intention it seems of ever selling the business. I said we like pet food earlier and I didn't touch upon it but upon that page uh with the major companies I showed you earlier were two of the top three pet food companies in the world.
Uh the one that I showed you back here get back a long way back there. Um Nestle with Rston Purina and Colgate with Hills Scientific are two are number two and number three in pet food worldwide. Now, if you know that, you might query if that if the number two and number three are in our investable universe and we could own them, why don't we own the number one pet food company?
And the answer, of course, is because that's also called Mars. Mars is a bigger pet food manufacturer than it is a confectionary manufacturer. It's a brilliant business. Um, we like the drinks business. The combination of uh some alcohol, some marketing, and some packaging uh is something that produces 70% gross margins, 30% returns on capital in cash.
It's a great business. If you look at the top five spirits brands in the world, we can own four of them through quoted companies. We can own Johnny Walker and Smirnoff through Dagio. Uh we can own uh Absolute Vodka through Pero Ricard. Uh and we can own Jack Daniels through Brown Foreman. We can't own Bicardi.
It's private. Now, we know these companies don't need our money because not only are they private, but Mars bought Wrigley Gun for $27 billion without coming to the stock market to raise any money. They don't need our money. And that's one of the great positives about it. This company bought Grey Goose Vodka for $2 billion in cash.
Didn't have to float to do it. Didn't have to raise any money from any outside equity holders. Just wrote the check. Um, we like franchise businesses because they use other people's capital to grow. We can't own the largest franchise business in the world by a number of outlets. It's a company called Doctor's Associates, which was set up by two doctors in Connecticut.
Its trading name is Subway. Largest number of fast food outlets in the world. They don't need our money. Um SC Johnson, we like household cleaning products, things you use to clean your bathroom, your kitchen, uh and so on. Um we know that this is a good business because of this company here. This was set up by a Mr.
Johnson five generations ago in America. He was an installer of hardwood flooring and uh he developed a wax, Johnson's wax, and he was obviously quite smart because he quite quickly worked out that flooring you didn't get a repeat purchase because it doesn't really wear out very quickly. Whereas the wax when you've used it, you have to go get some more to seal the floor.
his party trip was he put on his white what he would call pants after he'd sealed the floor with wax and skated around on his backside and showed you how clean it was. It was a cleaning product. Um and five generations later we have a family company that's private that supplies um uh Glade um uh air fresheners uh raid insect repellants ziplockc bags toilet duct disinfectants.
I said to you when you go to the doctors have a look at the the thing they they tear open before they take a blood sample or give you an injection. If it doesn't have Beckon Dickson on the end, I bet it'll have B Brown. It's a German company founded in about 1837, which is their number one competitor in the world.
It's never gone public. We know we're in the right area. Um, Arthrex is a company that makes bits that go into the human body. I've got a shoulder repair that I had done uh some years ago and uh and the uh the supplier was Arthrex, which is the leader in in shoulder repairs, which is the most difficult uh joint to uh uh accomplish a successful repair on.
Uh we can't buy them. They're private. But we can buy Striker and we can can buy Smith and Nephew. We can buy Zimmer Biomet who all make artificial uh knees and hips and and other joints. Um what do we do? Uh we only own 20 to 30 stocks. Never own more than 30. Never less than 20. There's not a magic number, but uh and I haven't touched upon it tonight because obviously there'll be some limit to what we talk about, but you do not need dozens and hundreds of stocks to obtain diversification.
Um uh the the research on this is quite clear. Somewhere in the mid20s in in all major markets, you have attained all the diversification benefit in terms of risk reduction that you can ever attain. So we own that. We charge a 1% flat management fee. We don't charge any performance fees. Um alignment of interest is not through performance fees.
It's because we co-invest with you. I have a very large sum. My colleagues have very large sums of money invested in the fund in exactly the same terms as you. If you're invested in our T-class, the reason it's called the T-class is because it's named after me. That's where I invest. Uh, basically, um, we don't think performance fees do align interests.
It's an asymmetric bet. Um, I know you've got a casino here. If you think that performance fees align it, if you'd all like to have a whip round and give me a hundred euros each, I'll go and play blackjack after dinner tonight and I'll keep 20% of the of this as a performance fee. There's a problem though, isn't there?
when I lose it, I'll only which is what actually going to happen. I'll only be losing your money, not mine. It's an asymmetric bet. I think you need co-investment and we have very low turnover. Said to you, um I've spent a long time and you've been very patient describing what we do and why we do it.
Here's what we don't do because most people tell you what they do. Here's let's tell you what we don't do. We don't market time with the fund. The fund is always fully invested in companies of the sort that we describe to you. Um we don't market time with the fund because we can't do it. Market time means we go into cash when we think the market's a bit high or going to fall and then we buy a few when it gets low and repeat the pro.
The reason why we won't do it is we know we can't do it. We we're no good at it. Basically, you can do it if you want. Feel free. I would just say though, there's only two types of people I've ever met in investment. Those who can't do it and those who don't know they can't do it. But if you think you can do it, then it's entirely your privilege.
Let me know how you get on. We don't hedge anything. We don't hedge currencies or interest rates on market indices. Um I can go through the reasons, but we simply don't. We don't trade frequently. We don't short anything. It's a fine skill shorting. When we were brokers, we wor with some of the most prominent short sellers that have ever existed.
You know, literally George Soros. I don't mean the Soros. I mean George and Stanley Drock Miller and Scott Bezant were all clients of ours. Um, partly because of the stuff I did on accounting and things like that, but we don't do it. Uh, we try not to panic when markets fall. Um, we try not to get excited about fads.
It's no good bringing us up and asking where we are on blockchain, what we're doing about cryptocurrencies or anything like this. The answer is ignoring them completely. That's not what we do. Uh equally, when markets do what they did last I I wrote one of my um my annual letter this year, the uh the fall in the market, the FT columnist um uh what's her name, the blonde uh woman, can't remember her name, Jillian Ted, uh said that the um uh the fall in the market was quotes eye popping and it was like 6% fall.
Well, I was in work on Black Monday in 1987 when it went down 22.6%. 6% in a day. I'll tell her what's eye popping, right? And I mean, and if you look back on the chart, you know what? That didn't matter. Ignore all this stuff, you know. And there's lots of sectors we won't invest in at all. I can give you the reasons if you would like to hear them, but we will never own, and I'm careful before I say never, a bank, an insurance company, a real estate business.
Uh we will never own anything heavily cyclical. So no chemical industrial chemicals, engineering, construction uh and so on. Uh we won't own any resource companies. So no oil, gas, minerals or mining. Uh we won't own any utilities. Uh so no electricity utilities or telephone utilities and so on. And fairly obviously no airlines.
So actually the vast majority of the market is of no interest to us whatsoever. Um, that's the Cape Arcus, which is a cycle event, the biggest one in the world, which we've uh had entrance in uh every year. Basically, we like to to do that together when we can. Uh, that's Chapman's Peak, which is the penultimate climb of, you can see the road snaking up there.
There's me there. Um, that chap's having a bit of a rest, as you can see. Um, why do I put that up? I think there are lots of examples that you can take from sporting events and apply into investment that are quite ignored by people. uh the largest uh cycle tour in the world, most prestigious cycle is the tour to France.
It's been run for over a hundred years. Okay? It's never been won by somebody who won every stage and it's never going to be won by somebody who won every stage. In fact, on a number of occasions, you can see them listed there, it was won by riders who never won a single stage. The first time they ever stood on the podium was in the Shonles when they were getting the uh uh the the race prize.
There are three, this is, you've got to be cycling a bit for this. There are three different types of uh of of stage. There's the time trial, which is where people are set off individually wearing a skintight suit and a funny-shaped hat, and they can't get within 20 meters of each other to get any aerodynamic assistance.
So, they're they're disqualified. It's a pure test of the ability of the rider on their own to supply a very high wattage in terms of power output for an hour unassisted. In contrast, in the Pelaton stages where everybody rides along together, you can get about a 30% reduction third reduction in your effort by being in the middle of the pelaton and uh and uh and cutting the amount of work you have to do.
I mistakenly when I did the London Paris race for the first time, I've done it a couple of times, thought that meant it didn't hurt as much, but it does. They just go faster uh using that particular um uh feature. That stage is won because when you get within every team that's got one carries a sprinter um and within three or 500 meters of the finish line, they let their sprinters go.
It's going to be won by a sprinter. Um a sprinter cannot win a time trial. For a time trial, think someone like Sir Bradley Wiggy, 6'3, uh something like 68 kilos with 7% body fat. You know, it's got a shape like that. Basically, that's a time trial. uh whereas you know when you're looking at pelaton stages with sprinters you're talking about somebody who's probably about uh nearly a foot shorter with a thigh circumference bigger than their waist right a powerhouse basically and the mountain stages have combination for so the reason I'm telling you all this is this I think often people when they're looking at investment seek a fund manager who can outperform in all market conditions and all reporting periods there is no such human being good luck if you find one let me know because I'm going to put give him some as well.
Um, you know, you you we're trying to win the tour to France for you. We are not trying to win every stage. Any rider who tried to win every stage would fail and fail to win the tour as a result. You have to be good at something, you know, and get your colleagues in the team to carry through the bits that you're not to get the best long-term result.
That's what we're trying to do for you. Um, lastly, here's what we've achieved so far. The main fund's got about 17.5 billion pounds in assets in it. Uh these are our returns since inception we've compounded at 18.2% peranom to the end of February. Um the equities that's the Morgan Stanley Capital National World Index in the same currency is about 11%.
So we've outperformed it by 7% peranom. Bonds uh at 3.7 and cash at 0.6. The pattern of returns pretty typically. We do our best relative work when markets are bad. Basically markets go down what we own is defensive both economically and in market terms. That's when we open the relative gaps. It's more difficult for us to open relative gaps when markets are are extremely bullish.
Yeah. Because then garbage of assault that we will not own goes up too. So we do our we may equal the market or even better it's at slightly in in up markets but the real relative return and and actually the more difficult part of the job is the defensive position of not losing people money when things are
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