Fundsmith founder Terry Smith and head of investment research Julian Robins were in good spirits while chatting with AJ Bell’s editor in chief Dan Coatsworth in a video interview.

As usual, Smith was candid and open to discussing various topics from investment strategy to individual stocks and succession planning.

VIDEO – Terry Smith: my future as manager of Fundsmith Equity Fund and thoughts on performance

One of the longer discussions was on the hot topic of obesity drugs and Fundsmith Equity’s (B41YBW7) holding in Danish firm Novo Nordisk (NOVO-B:CPH) which owns the market-leading weight loss treatment Wegovy.

Novo was the third biggest contributor to performance in 2023, adding 3.6% behind Meta Platforms (META:NASDAQ) and long-term holding Microsoft (MSFT:NASDAQ) which contributed 4.6% and 3.9% respectively.

VIDEO – Terry Smith: why I stuck with Meta and what I think of the company now

Smith was quick to point out the fund has held the shares for several years and invested well before the recent excitement around the potential for weight-loss drugs.

Analysts at Goldman Sachs believe the fledgling market for GLP-1 drugs as they are known could grow to more than $100 billion a year by 2030. Obesity, defined as having a BMI (body mass index) above 30, is a growing global crisis with the WHO (World Health Organisation) estimating over four million people die every year due to being overweight or obese.

Smith acknowledges investing in the pharmaceutical sector is not an obvious move given his well-articulated preference for stable and predictable businesses.

However, the team were originally attracted by Novo’s unusual approach to drug discovery and its ownership structure. As the annual letter elaborates: ‘We are not aware of another drug company whose stated aim is the eradication of the ailment from which it derives most of its revenues.’

VIDEO – Fundsmith on weight-loss drugs: Terry Smith and Julian Robins explain the opportunity and where they invest

Smith goes on to explain that a controlling stake held by the Novo Nordisk Foundation helps to promote a genuine long-term approach not often seen in the pharmaceutical industry.

This doesn’t appear to be a case of the manager straying off-piste, or the type of style drift which tripped-up disgraced fund manager Neil Woodford after his foray into biotechnology and private companies.

EARLY INNINGS FOR WEIGHT-LOSS DRUGS

While the initial attractions of Novo were its ethos and company structure, Smith and Robins also have a positive view on the growth outlook for the weight-loss market.

‘We really are in the early innings of the weight loss market,’ commented Robins.

Making his case, Robins notes that Wegovy is only available in a few markets, and is not yet available in Mexico which is the world’s largest market in terms of the prevalence of obesity.

In addition, the only competing product currently is Eli Lilly’s (LLY:NYSE) Zepbound, which was launched in early December 2023 but still managed to rake in $176 million of revenue in the final weeks of the year.

As more competitors enter the market and Novo Nordisk and Eli Lilly scale up production, prices, which are currently prohibitively expensive for many people not on medical insurance, will eventually come down argues Robins.

In addition, both companies are working on oral versions of their weekly injectable treatments which if successful will increase the attractiveness of taking the drug and open the market up to a wider audience. Further down the track there is a good chance weight-loss treatments will be made available over the counter.

Robins says the concept of ‘weight management’ will become an emerging theme and supersede the ‘weight loss’ appeal as these types of drugs become more common place.

He likens their development to drugs such as statins, which are taken regularly by people to manage cholesterol in the blood for the rest of their lives.

ARE PROBLEMS AT DIAGEO A FIXABLE GLITCH?

Two poorly-received trading updates from premium drinks company Diageo (DGE) leave Smith and Robins unsure if they are looking at a fixable glitch or something ‘which speaks to a wider problem’.

The investors raise two issues which remain unresolved at the current juncture. They firstly point out new management are relatively inexperienced in the drinks business.  

Secondly, the huge success of weight-loss drugs seems to be having an impact on alcohol consumption, more so than fast food which is perhaps surprising given most of the public debate and investor concerns have focused on food groups.

Robins cites research undertaken at Virginia Tech which searched for evidence of changing drinking patterns by deploying AI (artificial intelligence) to sieve through social media data. Its findings suggest a ‘significant’ drop in drinking since the introduction of weight-loss drugs.

There are other factors impacting drinking patterns too, including working from home which has reduced the habit of nipping down the pub with colleagues after work for a cheeky pint.

Recalling wise words from Diageo’s former chief executive Ivan Menezes, who said the most important thing in the drinks business is to be close to the customer, Smith worries current management may not be as attentive to emerging consumer trends which may turn a hiccup into something more impactful.

In short, the jury is still out on Diageo for Smith and Robins, but investors can rest assured the pair will continue gathering intelligence and watching for signs the business isn’t losing its way.  

VALUABLE LESSONS AND RETIREMENT

Smith and Robins have more than 80 years of combined investment experience and worked together as banking analysts in the 1980’s. Smith has also been a finance director and chief executive which means he has a unique perspective on investing.

One of the most important lessons in the investing business says Smith is ‘stock prices follow the fundamentals, not the other way around’.

‘Share prices tell you nothing. Only the fundamentals (cash flow growth, return of capital etc.) matter, so try not to be distracted by noise’, he advises.

The main thing is to look at the fundamentals of a business and think about how they might evolve over time.

When asked whether he still gets a kick out of managing money, Smith answered that his enthusiasm remains undimmed. He enjoys the investment process, learning new things, rediscovering old things and ‘being right more often than I’m wrong’.

On the question of retirement, Smith said he intends to continue for a long as he is able although he is not against the idea of retirement.

‘Don’t give up easily on the things that define you, and investing defines me so I intend to do it for as long as I can.’

Once that changes Robins will take over running the fund.

TWEAKING THE INVESTMENT PROCESS

Smith said he and the team admire company managements which embed a culture of continuous improvement, and he tries to do the same at Fundsmith.

Smith and Robins only focus on things within their control and therefore they spend more time on those areas rather than factors beyond their control such as macro-economic events.

Regarding interest rates, Smith said logically the companies in which the fund invests will likely benefit if rates fall given rising rates provided a headwind over the past two years.

One of the areas within the teams’ control is the selling discipline, and Smith believes improvements can be made. He is quick to point out that the fundamental reasons for selling certain positions remain valid, but the timing ‘could have been better’ in some cases.

Having looked at successes such as PayPal (PYPL:NASDAQ), where the shares have fallen since the fund sold, and the ones which didn’t such as Adobe (ADBE:NASDAQ) and Amazon (AMZN:NASDAQ), Smith believes he has found an answer.

The latter two businesses got caught up in the AI craze last year, which provided a tailwind for the shares, and Smith believes had he taken these tailwinds into account he may have waited longer before selling the positions, which would have had a beneficial impact on performance.

NO CLEAR WINNERS IN AI

On the hot topic of AI, Smith argues no-one can know for sure which companies will emerge as the winners from the fast-evolving advancements in AI and large language models.

He points out that betting on the early leaders during past technological advances didn’t always turn out turn well. Names which spring to mind include Yahoo in internet search and MySpace in social media.

VIDEO – AI boom: Fundsmith’s Terry Smith gives his opinion on artificial intelligence

An insightful question which Smith poses is: what competitive advantage does AI bestow? Without a clear answer it is difficult to pick a winner, and as Smith wryly notes it may be the case that no winners emerge.

Food for thought, certainly. 

Disclaimer: AJ Bell, referenced in this article, owns Shares magazine. The author (Martin Gamble) and editor (Ian Conway) own shares in AJ Bell. The editor of this story (Ian Conway) owns shares in Fundsmith Equity.

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