Fundsmith股票基金——致股东年度信2015

January 2016

Dear Fellow Investor,

This is the sixth annual letter to owners of the Fundsmith Equity Fund (‘Fund’).

The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 compared with various benchmarks.

% Total Return 1st Jan to Inception to 31st Dec 2015 31st Dec 2015 Cumulative Annualised

Fundsmith Equity Fund1 +15.7 +131.4 +17.6 Equities2 +4.9 +64.3 +10.1 UK Bonds3 +1.0 +24.3 +4.3 Cash4 +0.0 +3.5 +0.7 1 2 T Class Acc shares, net of fees, priced at noon UK time. MSCI World Index, £ net, priced at close of business US time. 3 4 Bloomberg/EFFAS Bond Indices UK Govt 5-10 yr. 3 Month £ LIBOR Interest Rate. 1,3,4 2 Source: Bloomberg Source: www.msci.com

The table shows the performance of the T Class Accumulation shares which rose by 15.7% in 2015 and compares that with 4.9% for the MSCI World Index in Sterling with dividends reinvested. The Fund therefore outperformed the market in 2015 by 10.8%, its fifth consecutive year of outperformance, which is ironic given that outperforming the market in any given reporting period is not what we are seeking to achieve.

However, we realise that many or indeed most of our investors do not use the MSCI World Index as the natural benchmark for their investments.

Those of you who are based in the UK and look to the FTSE 100 Index as the natural yardstick for measuring your investments and/or who hold funds which are benchmarked to the FTSE 100 Index and often hug it will have had a much worse experience than the performance of the MSCI World Index. The FTSE 100 Index was down -4.9% in 2015 and the total return including dividends reinvested was still negative at -1.0%.

Similarly, for US dollar investors, the S&P 500 finished the year down -0.7% and only delivered a return of +1.4% with dividends reinvested. 2015 was also the fifth anniversary for our Fund and so maybe a good moment to pause and reflect on the longer term performance. As well as outperforming the market with a compound return of +17.6% against +10.1% for the MSCI World Index, our Fund was the third best performing fund out of 203 in the Investment Association’s Global Sector. Why only third, you might ask? The two funds which performed better than ours are specialist healthcare funds which have benefited from the extraordinary boom in takeovers within the biotech sector in recent years. That won’t last indefinitely, at which point anyone who has benefited from investment in those companies and funds needs to find the next hot sector if that is their investment strategy. This is a game we profess no skill at and therefore will not be playing. This skill also seems to elude most other investors but that does not seem to stop them trying.

2015 was not a particularly bullish year for equity markets which were held back by the slowdown in China, setbacks in other Emerging Markets and the move on from the end of quantitative easing in America to the first rise in interest rates by the Federal Reserve (‘the Fed’) in nearly ten years. After all that the S&P 500 Index was down by -0.7% for the year.

Trillions of pixels have been expended on the likely impact of this increase in interest rates and I do not intend to add much, if anything, to the debate. However, one aspect may be worth commenting upon. For at least the past three years we have been reading comments which suggested that investors in our Fund faced at least one problem: the shares we own are highly rated and have become more highly rated in recent years. This has often been linked with the observation that these stocks are ‘bond proxies’ - that the relative certainty of their returns and dividends compared with most equities makes them a substitute for bonds, which many investors now seek to avoid, and so they may fare badly along with bonds as and when interest rates rise.

There are several points to consider in response to this.

One is that during the period that these commentators have been sounding this warning, these stocks and our Fund have continued to outperform the market significantly. So if, like the proverbial stopped clock which is right twice a day, the scenario which they paint eventually comes to pass, it will be worth remembering what you would have missed out on if you had followed their advice when they gave it. They will certainly forget to mention it when they proclaim the brilliance of their foresight and the accuracy of their predictions.

There are also reasons to doubt both their predictions and the efficacy of their proposed solutions.

Firstly, the assumption that all US interest rates are set by the Federal Reserve (‘Fed’) is too simplistic. The target federal funds rate is a short term rate and was increased from 0- 0.25% to 0.25-0.50% on 17th December 2015. Longer term rates are set by the US Treasury bond market and the swap market in which banks, companies, people with mortgages and investors can switch between fixed and floating interest rates. The current 30 year US Treasury bond has a yield just under 3% which does not look quite so low.

It is possible that the main surprise with the Fed’s rate rise (I refuse to use the popular term ‘hike’ as ‘to hike an object’ is described in the dictionary as a sharp or unexpected increase - a description which clearly does not apply to the Fed’s decision) is the limited

2 scope for subsequent increases and the lack of effect on long term rates. In which case worries about the effect on so-called bond proxies may prove to be overdone.

Secondly, what would these commentators have you do about this possible adverse impact on so-called ‘bond proxies’? Presumably they recommend selling them in view of this predicted disaster and investing your money elsewhere. Leaving aside the commentator who suggested that the answer was to invest in a fund which is ‘more immune to future market performance’ (seems like an overly modest target - why not just find one that only ever goes up?), the most common suggestion, it seems, is that you should consider switching into more cyclical stocks because they are more lowly rated and their returns are too volatile to be considered as bond proxies. Switching into cyclical stocks in anticipation of a rise in interest rates, what could possibly go wrong?

As ever, spotting potential problems with our or any other investment strategy is not that difficult. In all my years in business I have never found that identifying a problem is quite as difficult as solving it. Likewise, suggesting what it is you should switch into that is immune from problems which may result from an interest rate rise is a bit more difficult.

However, it seems likely that sooner or later the ‘stopped clock’ commentators will prove to be right and our Fund will experience a period of underperformance. What to do about that? You could try some so-called market timing and redeem your shares in the Fund in advance of this event and maybe re-invest later when you think the time is right for it to begin outperforming again. If you do so I hope you have better luck and/or skill than I have because I know that I can’t accomplish that successfully.

If you intend to remain invested in the Fund, as I do, including through any periods of underperformance, you might also, like me, take comfort in the fact that our investment strategy is based first and foremost on buying shares in good companies. We cannot promise you much about our Fund. But one thing we are clear about is that we seek to own shares in good companies and at least most of the time we succeed in that objective.

Repeating an approach we took last year to demonstrate this, the table below shows what Fundsmith would be like if instead of being a mutual fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis and compares this with the market (in this case the FTSE 100 Index and the S&P 500 Index).

Fundsmith FTSE 100 S&P 500 Equity Fund* Index+ Index+ ROCE 26.0% 14.8% 17.5% Gross Margin 61.1% 40.2% 43.7% Operating Profit Margin 25.0% 14.3% 15.3% Cash Conversion 98.4% 69.8% 70.9% Leverage 29.3% 38.5% 52.5% Interest Cover 16.1x 8.2x 8.7x Note: ROCE, Gross Margin, Operating Margin and Cash Conversion are the weighted average for the Fundsmith Equity Fund and averages for the FTSE 100 Index and S&P 500 Index. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are medians.

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Source: Fundsmith LLP Source: Bloomberg

What does this table demonstrate? In short, that our companies have much better financial performance than the market as a whole and are more conservatively funded. 3 The companies in our portfolio are certainly not immune to periodic downturns in business and/or management errors, and their share prices are subject to the usual factors which affect the stock market, but we can at least be reasonably sure that they are adding to their intrinsic value over time by continuing to invest at wonderful rates of return.

If I gave you an exhaustive list of all the subjects in investment and the ways in which investors and commentators behave that perplex me then this annual letter would be considerably longer. However, one of these subjects is the obsession with share prices. Ultimately, of course, a focus on share price movements must be correct. It is no use owning shares in good companies if the strength of their business is never reflected in the share price, but a continuous focus on share price movements to the exclusion of the underlying fundamental economics of the companies is neither healthy nor useful. In the long term one will follow the other, and it is not the fundamentals which will follow the share price.

Returning to the subject of valuation, what are the facts as opposed to commentators’ views? The weighted average Free Cash Flow (‘FCF’) yield of the portfolio (the free cash flow generated by the companies divided by their market value) started the year at 4.5%* and ended it at 4.3%* so the overall portfolio saw little increase in valuation in 2015. Our companies on average grew their free cash flow per share by 9.7%* during the year which was a much more significant contribution to performance.

This 4.3% FCF yield compares with a median FCF yield for the non-financial stocks in the S&P 500 Index of 4.4%+ and a mean of 2.7%+ or a median for the non-financial stocks in the FTSE 100 Index of 3.8%+ and a mean of 3.9%+. Our stocks do not look bad value in comparison to the market especially when their relatively high quality is taken into account. Although of course, both may be expensive, but then both may continue to be so or even become more expensive.

For the year, the top five contributors to the Fund’s performance were: Dr Pepper Snapple + 1.94% Imperial Tobacco + 1.79% Microsoft + 1.69% Sage + 1.36% Reckitt Benckiser + 1.05%

The bottom five were:

Procter & Gamble - 0.22% PayPal - 0.15% 3M - 0.02% Kone + 0.02% Colgate Palmolive + 0.05%

Of the bottom five performers, the only one which gives us significant cause for concern is Procter & Gamble which is on its third internally sourced CEO in as many years.

We sold our holding in Domino’s Pizza during the year since it had reached a valuation which we felt was only justifiable if the current rapid rate of growth is sustainable, which we would doubt. However, we sold it with some regret and trepidation. Regret since it is 4 undoubtedly a fine business and had been our best performing share since the inception of our Fund. Trepidation since selling shares in good companies is something we are justifiably reluctant to do. Still we believe that you ‘make money with old friends’ which is to say that we would be keen to own Domino’s again if the opportunity arises at a valuation which we regard as at least reasonable.

We also sold our holding in Choice Hotels in 2015 as we did not like the risk/reward potential from the company’s investment in developing a third party reservations system called SkyTouch. As we do not do much trading to reallocate the Fund’s capital between our holdings we are reliant on the management of our investee companies to make decisions to reinvest part of their companies’ cash flows for us. When they do things which are different, exciting and outside their core area of competence we become worried. Hence our sale of Choice Hotels.

We also sold the holding in eBay which we obtained when eBay split the eponymous online marketplace business and PayPal, the online payments processor, which we have retained.

During the year we built a holding in Waters Corporation, a US based manufacturer of mass spectrometry, liquid chromatography and thermal imaging equipment, which makes much of its returns from the sales of consumables, service, spares and software to the operators who have installed its equipment. It should have a clear source of growth from the seemingly inexorable trend for more testing and certification of products.

We also began building a stake in another testing company with a similar source of growth and a new consumer staples company, both of which will be revealed in due course.

Minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 2%* during the period. It is perhaps more helpful to know that we spent a total of £496,507 or just 0.014% (1.4 basis points) of the Fund on voluntary dealing which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary.

Why is this important? It helps to minimise costs, and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2015 for the T Class Accumulation shares was 1.07%*. The trouble is that the OCF does not include an important element of costs - the costs of dealing. When a fund manager deals by buying or selling investments for a fund, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, Stamp Duty. This can add significantly to the costs of a fund yet it is not included in the OCF.

We have published our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2015 this amounted to a TCI of 1.13%*, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We think that figure will prove to be low if or when other funds produce comparable numbers, although we are not holding our breath whilst we await this. However, just as we think an obsession with share prices to the exclusion of companies’ fundamental performance is unhealthy, we would caution against becoming obsessed with charges to such an extent that you lose focus on the 5 performance of a fund. It is worth pointing out that the performance of the Fund at the beginning of this letter is after charging all fees, or as someone expressed it more elegantly “You get what you pay for”, or at least you should aim to.

Finally, I wish you a Happy New Year and thank you for your continued support for our Fund. I and my colleagues look forward to seeing many of you at our Annual Shareholders’ Meeting on 1st March and to trying to answer your questions.

Yours sincerely,

Terry Smith CEO Fundsmith LLP

An English language prospectus for the Fundsmith Equity Fund is available on request and via the Fundsmith website and investors should consult this document before purchasing shares in the Fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This letter is intended for owners of the Fundsmith Equity Fund only and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority.

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Source: Fundsmith LLP Source: Bloomberg

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