The era of effortless outperformance may be facing a structural reckoning, prompting one of the world’s most closely watched fund managers to issue a stark reminder to the investing public: consistent annual gains are neither a guarantee nor a prerequisite for long-term wealth creation. Terry Smith, the founder of Fundsmith and often dubbed "the UK’s answer to Warren Buffett," has signaled a shift in the narrative surrounding his £20-plus billion flagship fund. By cautioning investors not to expect positive returns every single calendar year, Smith is addressing a fundamental tension in modern finance—the friction between the slow-burning compounding of high-quality businesses and the frantic, high-octane volatility of a market increasingly dominated by a handful of technology giants and shifting macroeconomic regimes.
For more than a decade, Smith’s mantra of "Buy good companies, don’t overpay, do nothing" served as a golden rule for retail and institutional investors alike. Since its inception in 2010, the Fundsmith Equity Fund has delivered returns that significantly outpaced the MSCI World Index, driven by a concentrated portfolio of resilient, high-margin businesses like Microsoft, L’Oréal, and Novo Nordisk. However, the investment landscape has grown increasingly complex. The post-pandemic inflationary spike, the subsequent aggressive hiking of interest rates by central banks, and the explosive rise of Artificial Intelligence have created a market environment where the traditional "quality" factor—defined by high returns on capital and predictable cash flows—sometimes finds itself out of step with the prevailing momentum.
The core of Smith’s recent communication centers on the psychological resilience required to endure periods of underperformance. In the world of professional asset management, a "down year" or even a year of "underperforming the benchmark" is often treated as a systemic failure. Yet, from a fundamental economic perspective, the intrinsic value of a high-quality corporation does not evaporate simply because its share price stagnates for twelve months. Smith’s intervention is an attempt to de-link the short-term movements of the stock ticker from the long-term health of the underlying enterprises. He argues that the obsession with annual performance tables encourages "short-termism," a malaise that leads investors to sell great companies at the wrong time, usually just as they are about to begin their next leg of growth.
To understand why a veteran like Smith is managing expectations now, one must look at the "Magnificent Seven" phenomenon that has skewed global indices. In recent years, the performance of the MSCI World and the S&P 500 has been disproportionately driven by a tiny cohort of mega-cap tech stocks, most notably Nvidia. For an active manager who maintains a disciplined valuation framework, the choice is often between chasing these "momentum" stocks at high multiples or sticking to a diversified selection of quality names that may currently be out of favor. Smith has historically avoided sectors like banking, airlines, and heavy industry due to their cyclical nature and poor return on capital. While this protected his investors during various downturns, it means the fund can lag when the market is led by a narrow, speculative surge in a single sector.
Market data reflects this divergence. While the broader indices have hit record highs, many of the "steady-eddy" consumer staples and healthcare stocks that form the backbone of quality-investing portfolios have faced headwinds. Companies like Estée Lauder and Unilever have grappled with a slowing recovery in China and the erosion of consumer purchasing power due to inflation. When these stalwarts underperform, the funds that hold them inevitably feel the heat. Smith’s message is that this is a feature, not a bug, of a concentrated investment strategy. To capture the long-term benefits of compounding, one must be willing to look "wrong" in the short term.
The economic impact of higher interest rates has also played a pivotal role in this narrative shift. For the better part of the 2010s, near-zero interest rates acted as a tailwind for growth-oriented quality stocks. When the "risk-free rate" is negligible, the future cash flows of high-growth companies are valued more highly in today’s terms. However, as the Federal Reserve and the Bank of England pushed rates toward 5%, the mathematical "discount rate" applied to those future earnings increased, leading to a natural compression of price-to-earnings (P/E) multiples. Smith’s portfolio, which trades at a premium to the market because of the superior quality of its holdings, is particularly sensitive to these valuation shifts. By telling investors not to expect a "win" every year, he is acknowledging that the tailwinds of the last decade have transformed into the crosswinds of the current one.
Global comparisons further illustrate the challenge facing active managers. Across the Atlantic, Berkshire Hathaway’s Charlie Munger and Warren Buffett frequently reminded shareholders that the road to riches is paved with periods of boredom and occasional 50% drawdowns. Smith is aligning himself with this "old school" philosophy of capital preservation and patience. In an era of high-frequency trading and retail "meme stock" frenzies, the idea of doing nothing—even when your portfolio is flat for a year—is an increasingly radical act. Smith’s critique of the industry suggests that many investors have been conditioned by a long bull market to view 15% annual returns as a baseline right, rather than a historical anomaly.
Expert insights into the "quality" factor suggest that while it may underperform during periods of rapid economic acceleration or "junk rallies" (where the lowest-quality companies see the biggest price jumps), it tends to provide superior risk-adjusted returns over a full market cycle. The difficulty for the average investor lies in the "full cycle" part of that equation. Most retail portfolios have a turnover rate that is far too high, driven by the fear of missing out (FOMO) on the latest trend. By being transparent about the inevitability of flat or negative years, Smith is attempting to "filter" his investor base, favoring those with a five-to-ten-year horizon over those looking for a quick quarterly gain.
Furthermore, the operational performance of the companies within the Fundsmith portfolio remains robust, which is the primary metric Smith uses to defend his stance. If a company’s Return on Capital Employed (ROCE) remains at 25% or 30%, and its profit margins are expanding, Smith argues that the eventual stock price will reflect that reality, regardless of what happens in any specific calendar year. The danger, he suggests, is in reacting to the "noise" of the market rather than the "signal" of corporate earnings. For example, Novo Nordisk’s dominance in the GLP-1 weight-loss drug market is a fundamental shift in healthcare economics that will play out over decades, not months.
The broader economic analysis suggests that we are entering a "stock-picker’s market," where the tide no longer lifts all boats equally. In the era of quantitative easing, index tracking was a foolproof strategy. In the current era of "higher-for-longer" rates and geopolitical fragmentation, the dispersion between winners and losers is widening. Smith’s insistence on patience is a bet that his selection of "winners"—businesses with high barriers to entry and significant pricing power—will eventually decouple from the volatility of the macro environment.
Ultimately, the message from the Fundsmith founder is a call for a return to investment sanity. In a financial world that often feels like a casino, the reminder that equity investing involves genuine risk—including the risk of time—is necessary, if unpopular. Smith’s legacy will likely be defined not by whether he beat the market in 2024 or 2025, but by whether his philosophy of disciplined, long-term ownership can survive a world that has forgotten how to wait. As he prepares his investors for a potentially bumpier ride, the underlying thesis remains unchanged: the best way to grow wealth is to own a piece of the world’s best businesses and have the stomach to stay the course when the rest of the market is running for the exits. The true test for investors will not be their ability to pick the next winner, but their ability to do nothing when their current winners are temporarily out of fashion.
