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Hello everyone and welcome back. Terry Smith is one of those great and famous investors that I have always followed closely. His investing style has been a great inspiration to me and has helped me build a solid foundation in picking individual stocks. Today, however, Terry Smith seems to have thrown in the towel after several years during which his fund has continuously performed worse than the market.
Even in these first 6 months of 2026, his fund generated a negative return of 2.9% while its benchmark, the MSCI World index, generated a positive return of 11.2%. How did Terry Smith react to this latest setback? And how would Warren Buffett have reacted? We find out in today's video, so let 's get started right away.
Terry Smith just released his mid-year letter to investors, and there's some very unexpected news. From the very first lines, Terry Smith makes it clear that in the following paragraphs he will explain some changes in the way his fund is managed. Let's remember that Terry Smith became famous, and I particularly appreciated him for his strategy, which can be simplified into three very specific points: buy quality stocks, don't pay too much for them, and finally do nothing, that is, hold them in your portfolio for many years, ideally forever.
This investment philosophy fits very well with the one always professed by Warren Buffett. However, this strategy no longer seems to be working for Terry Smith. In recent years it has always performed worse than the market. As we can see from this table, his fund has been beaten by the market every single year for 5 and a half years now .
An investor in Terry Smith's fund will rightly ask himself, "Why should I continue to invest with him, when I could do better by simply buying a simple ETF?" And in fact, it is no coincidence that in the last quarter Terry Smith reduced practically all the positions present in his fund. This happens when fund investors sell their shares and then Terry Smith is forced to sell the shares to repay the investors.
It therefore seems clear that investors are literally running away. And in fact, in the letter published a few days ago, Terry Smith speaks precisely about this openly. Here's what he said: "The current market is dominated by so-called passive funds and ETFs and the boom in artificial intelligence. These two factors combined have created a market dominated by momentum, rather than fundamental factors like profitability, return on capital, and growth, which are what we focus on." So, for the umpteenth time in recent years, Smith harshly criticizes ETFs, saying that rather than passive investments, they are momentum-based investments , meaning that the companies that grow the most are the ones that receive the most capital, fueling this vicious cycle.
Anyone who doesn't have these stocks in their portfolio is destined to be left behind, like their fund. And I also underlined this thing for 2026 . "This is the year of the semiconductor sector. Anyone who doesn't have any of these companies in their portfolio is unlikely to beat the market. That's a fact." This image shows the outperformance of the momentum strategy, and we see that it is setting new 30-year highs.
Terry Smith points out that this vicious cycle feeds itself. Investors see that momentum is working, so they abandon actively managed funds like his and move their own capital into momentum investments, driving prices even higher and further strengthening these returns. Terry Smith continued, "I want to emphasize that we remain firmly convinced that owning a group of stocks that have better fundamentals than the market and holding them while they are appropriately valued will produce superior returns over the long term." At this point he quotes a saying that was used for the Indianapolis 500.
To finish the race in first place you must first finish it. This is to emphasize the fact that to beat the market in the long term you have to get there in the long term. And here Terry Smith, in a certain sense, confesses the limits of his fund's management. Keep in mind that his is an open-ended fund, meaning investors can buy or sell shares in the fund at any time, increasing or decreasing the funds available to Terry Smith for investment.
We manage an open-ended fund, and you investors can withdraw money whenever you want, and I imagine you're doing this more and more, to join the migration from active to passive management. However, it would be pointless for us to prove ourselves right about the risks of this strategy if our fund were to close.
It is with these premises that we are implementing some in the way we manage the fund. In short, Terry Smith is clearly saying that investors are fleeing his fund and therefore, to avoid the risk of having to close, he finds himself forced to make some changes. From now on, you should expect us to be much more active in the future.
We will take momentum into greater consideration in our investment decisions, both in terms of fundamentals and stock prices. In the following paragraphs, Terry Smith explains that he obviously can't predict how this ETF-driven, momentum-driven bull market will end , but he repeatedly says it will end badly and there will be a major crisis sooner or later.
All these phrases, from my point of view, seem more like marketing ploys to intimidate investors and convince them to stick with his fund for safer investments when all this euphoria ends. In practice, Terry Smith is trying to keep his fund afloat by embracing what he has always harshly criticized: following market trends.
In a certain sense, it is an obligatory choice after 5 and a half years of underperformance compared to the market. However, what makes us think that Terry Smith could be good at evaluating momentum factors, factors that he himself has always said he has never used and indeed has always stayed away from?
Personally, it seems almost like a desperate move to avoid bankruptcy and, honestly, I'm very sorry. However, for those who manage open-ended funds, this is the number one risk. We need to satisfy our customers, even if we are convinced that our strategy is the right one for the long term. Warren Buffett found himself in a similar situation in 1999, when technology stocks were generating insane returns, while shares of his Berkshire Hathaway were plummeting.
Buffett, however, had one weapon in his favor. He didn't run an open-end fund, but a company with his own funds, so he didn't run the risk of bankruptcy that Terry Smith runs. Buffett, therefore, was able to continue with his historical approach and, in a sense, ignore the disappointing returns. In his 1999 letter to shareholders, Buffett wrote: "We have had the worst performance since I've run the company and also the worst performance relative to the S&P 500, and the responsibility for our investment portfolio is entirely mine.
Over time, our stock returns should roughly match the performance of the underlying business. Despite our poor performance last year, Charlie Munger and I expect that Berkshire Hathaway's intrinsic value growth over the next 10 years will exceed the returns of the S&P 500. We obviously can't guarantee this, but our words are backed by facts and our money.
In fact, over 99% of my assets are invested in Berkshire Hathaway stock. Neither my wife nor I have ever sold a single share, and we have no intention of doing so." Now, this approach seems to me totally different and definitely better than Terry Smith's. Buffett clearly states that the responsibility for the disappointing returns of recent years is entirely his own, but at the same time he says he is convinced that in the next 10 years the returns will be better than the market and his words are not idle talk, precisely because, as mentioned, his wealth was and still is entirely invested in Berkshire shares.
He never said that from that point on he would change strategy and start investing in technology companies. He always remained faithful to his strategy and to the belief that the companies owned by Berkshire Hathaway were capable of beating the market for the next 10 years. And how did it go ? Buffett was 100% right.
Over the next 10 years, despite the 2008 crash also impacting Berkshire Hathaway shares, the latter managed to generate a return of plus 79% versus minus 24% for the S&P 500 index. We small investors also have the same advantage as Buffett and can't care if we don't manage to beat the market for 1, 2, 3, or more consecutive years.
The important thing is to have faith and be convinced of the actions we are choosing for the long term. Now, I would have liked Terry Smith to have used an approach similar to Buffett's, but unfortunately the open-ended nature of his fund really threatened to cause him to close down if the current trend continued much longer.
On the last paragraph, however, I have to say that I completely agree with Terry Smith. The companies in his fund are estimated to grow their free cash flow at a rate of 14% per year for the next three to five years. And if these estimates are correct, either their valuation would drop significantly or the share price could grow very similarly in the coming years.
Take MasterCard, for example, which is growing its earnings per share at a crazy pace, between 15 and 20% per year. MasterCard currently trades at a PE ratio of 30. If earnings per share grew 15% annually for 5 years, they would double. And if the price remained stable for the same 5 years, MasterCard would end up with a PE of 15.
It has never had a value this low in the last 10 years or more. And a company with that kind of growth would hardly see its PE ratio halve. So, as I always say, over the next five years or so, if earnings per share or free cash flow per share grow, then the stock price must grow too . For this reason too, I am deeply convinced that so-called value investing is not dead at all.
Indeed, perhaps it is precisely in these market conditions, when the masses are distracted by the stellar returns of a few companies, that the best companies can be found at a discount compared to the past and golden deals can be made. What do you think? And above all, what do you think of Terry Smith's change of direction?
I will be very curious to follow the next updates from him. If you don't want to miss my updates, like the video and subscribe to the channel. You know that would mean a lot to me. That's all for today. I say goodbye and see you in the next episode. HI.
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