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The Sunday Times - Star investor Terry Smith develops a taste for Wingstop

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A fast-food chain that specialises in chicken wings and a rapidly growing pest-control business are the latest stocks to form part of the giant investment trust overseen by the star fund manager Terry Smith.

Smithson investment trust, which is managed by Simon Barnard and is part of Smith’s Fundsmith empire, has stakes in the US companies Wingstop and Rollins.

Wingstop is a fast-growing chain that specialises in Buffalo-style chicken wings and began in Texas in 1994. It works on a franchise model and has more than 1,500 restaurants in South America, Asia, the UAE, France and the UK. Franchisees typically generate 70 per cent returns on their investments in three years, meaning demand for new shops is “enormous”.

Sales at the pest-control company Rollins have grown by 3 per cent a year, but its overall business has grown by 9 per cent as it has snapped up other companies.

Smithson last week said it had underperformed the index that it is benchmarked against for the first time over a six-month period since it floated on the stock market in October 2018.

The investment trust returned 4.1 per cent in the six months to June 30, well below the 12.4 per cent gain from its MSCI World Small and Mid Cap index comparator.

Barnard said that the main reason was that markets were starting to believe that inflation, which has risen this year, would accelerate. This would benefit companies that have low share prices rather than high-quality companies that have seen solid growth in recent years.

A second reason given for the underperformance was the strong growth that economies are experiencing. This, Barnard said, meant that “investors are less willing to pay high valuations for companies that can grow consistently through good times and bad”.

It is a similar sentiment that has hit Terry Smith’s flagship Fundsmith Equity fund, which suffered a short period of underperformance this year. Barnard said that inflation would not cause Smithson a significant problem because the companies that it owns spend less money making their products, so would be less affected by price rises of the raw materials that go into the manufacturing process.

Among its top holdings are the drinks maker Fever-Tree, credit report agency Equifax, the Rightmove property portal and Domino’s Pizza.

“On top of this, the market structure and competitive positioning for many of our companies mean that they would also be in a position to raise prices charged to their customers should the costs of the business increase,” Barnard said. “We therefore believe that a period of higher inflation is not a situation to be feared in terms of business fundamentals.”

Barnard noted that the trust’s underperformance reversed in June once Jerome Powell, the chairman of the US Federal Reserve, acknowledged the rise in inflation but reinforced the view that it is a temporary phenomenon.

Since June 10 Smithson is up by 10 per cent compared with the MSCI World Small and Mid Cap index’s 2.6 per cent.

The trust sold the UK biotechnology business Abcam because its recent decision to change its strategy, while not the wrong decision, “brings elevated risks” alongside a high valuation. “It remains one that we will continue to watch with interest as it progresses through its transformation,” Barnard said.

James Carthew, the head of investment company research at QuotedData, said that whether investors agreed that the switch from growth to value in the first half of 2021 was a short-term phenomenon depended on how strong they thought economies would be over the next 12 months.

Better growth should mean value stays at the vanguard, but a return to slower growth — perhaps because of Covid variant concerns — should play to Smithson’s strengths.

Carthew said: “It is noticeable that Smithson had a better July as investors rushed back towards quality growth stocks on fears that new variants of the virus might derail the global economic recovery.”

Alan Brierley, an analyst at the broker Investec, said Smithson had become one of the leading investment trusts, having grown from the £823 million it raised three years ago to £3 billion.

“Underpinning this success is a clear and simple investment philosophy: buy good companies, don’t overpay and then do nothing, with the power of compounding generating material long-term gains,” Brierley said, telling clients to “buy” the trust.

He added that the investment trust structure — that it has a fixed number of shares so does not have to offload positions if shareholders wish to sell — gave managers “an important competitive advantage” given their focus on smaller companies.

“Smithson has a simple and what is proving to be a highly effective philosophy,” Brierley said.

The article is available to read on The Sunday Times website, here