Terry Smith’s recent performance issues highlight the challenges of distinguishing skill from luck in fund management. Initially, Smith attributed his fund’s underperformance to various external factors like tech stock distortions and monetary policy, eventually blaming Novo Nordisk for its struggles in the weight-loss drug market. However, this pattern of finding scapegoats raises questions about the sustainability of his early success, which may have been more about favorable market conditions than genuine skill.
Research indicates that proving a fund manager’s skill requires an extensive track record, often unattainable within a typical investment horizon. Smith’s 14-year history with Fundsmith Equity is insufficient to statistically validate his prowess. The fund’s early outperformance against the MSCI World Index, often by significant margins, seemed to endorse Smith’s strategy of holding high-quality companies long-term. Yet, recent years have seen underperformance, with significant outflows of capital.
The difficulty in assessing true skill is underscored by studies such as those by Eugene Fama and Kenneth French, showing that most fund outperformance is indistinguishable from luck. This is exacerbated by survivorship bias, where only successful managers remain in the spotlight, overshadowing numerous failures. Smith’s avoidance of NVIDIA, despite its massive gains driven by an AI boom, was consistent with his philosophy of investing in predictable businesses. His underweighting of Apple and concentration in Novo Nordisk illustrate the risks of a concentrated portfolio.
Currency fluctuations and market dynamics beyond Smith’s control also impact performance, demonstrating how external factors often dictate results more than managerial decisions. Despite evidence against active management, investors continue to chase “star” managers, driven by human biases for pattern recognition and survivorship bias. This creates a cycle where funds attract inflows during good times, only to see outflows when performance declines.
Smith’s legacy will be tested by the loyalty of his remaining investors, who face the psychological challenge of maintaining conviction during underperformance. As Smith nears retirement age, questions about succession add uncertainty. The dynamics of his investor base are shifting, with new investors hoping for a rebound. The irony is that market returns are available to anyone through low-cost index funds, rendering Smith’s challenges a cautionary tale of mistaking luck for skill. For investors, the lesson is clear: consider simpler, more reliable strategies for long-term wealth accumulation.
