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On this page

Speakers & Credentials

  • Speakers & Credentials
  • 1. Executive Summary
  • 2. Chronological Table of Contents
  • 3. Detailed Thematic Summary
  • The Reference Vault [00:00:20]
  • 4. Data & Figures [00:00:20]
  • 5. Core Frameworks & Mental Models
  • 6. Anecdotes [00:00:20]
  • 7. References & Recommendations [00:00:20]
  • 8. Actionable Next Steps [00:00:20]

On this page

  • Speakers & Credentials
  • 1. Executive Summary
  • 2. Chronological Table of Contents
  • 3. Detailed Thematic Summary
  • The Reference Vault [00:00:20]
  • 4. Data & Figures [00:00:20]
  • 5. Core Frameworks & Mental Models
  • 6. Anecdotes [00:00:20]
  • 7. References & Recommendations [00:00:20]
  • 8. Actionable Next Steps [00:00:20]
Equity/March 21, 2026/11 min read/youtu.be

Fundsmith | Annual Shareholders' Meeting | February 2026

Source
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Watch on YouTube ↗

"we're not making any excuses we're not trying to blame anyone or anything blame me if you want to blame anyone" - Terry Smith [00:03:25]

"if you do 22% who cares what the market does" - Terry Smith [00:02:55]

"when you took your money out of us and the dollar went into Nvidia the effect on the Nvidia price was somewhere between $3 and $8 on average $5" - []

References

  1. Original source (youtu.be)

Disclaimer: Orignal content owned by or sourced from third parties. It does not represent the views of 'Nuggets' platform or it's team. AI is used extensively across this platform including for summaries. Accuracy is not guaranteed, there can be mistakes. Any info or content on this platform is not a financial, legal, or investment advice. Do your own research. Refer for complete disclosures:- Terms of Use · Full Disclaimer

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Reading

Published
March 21, 2026
Read time
11 min read
Progress0%
Terry Smith
00:17:28

"the internet is not just a new technology it's a new world the old metrics of valuation are as obsolete as the horse and buggy" - George Gilder (Quote referenced by Terry Smith) [00:40:31]

"any period when you don't tear up one of your long-held beliefs is a wasted period" - Terry Smith (quoting Charlie Munger) [01:17:09]

"whoever said if you build a better mousetrap the world will beat a path to your door is an idiot... you've got to actually go and sell them the mousetrap" - Terry Smith [01:25:02]


Speakers & Credentials

  • Terry Smith: Chief Investment Officer and Founder of Fundsmith LLP. Highly regarded for his quality-growth investment philosophy.
  • Julian: Portfolio Manager / Senior Executive at Fundsmith, assisting in quantitative and portfolio analysis.
  • Ian King: Master of Ceremonies (MC), moderator of the Shareholder Meeting Q&A.

1. Executive Summary

  • Fundsmith recently experienced a period of relative underperformance, driven largely by extreme market concentration where the top 10 S&P 500 companies now account for 34% of the index's weight and two-thirds of its returns.
  • Terry Smith argues that the massive inflows into passive index funds (now exceeding 50% of market capital) have created an irrational momentum trade that breaks standard valuation metrics, driving an "inelastic market" dynamic.
  • Despite index underperformance, Fundsmith’s portfolio companies fundamentally eclipse the wider market, boasting a massive 31% return on capital employed (ROCE), 62% gross margins, and deeply conservative interest coverage.
  • The portfolio has systematically reduced exposure to the massive capital expenditures of the AI arms race, slashing positions in big tech (like Microsoft) where spending is eclipsing rational free cash flow forecasts.
  • Fundsmith remains resolute in its core philosophy of buying high-quality, cash-generative companies, actively avoiding the "magnificent seven" momentum trap and pivoting towards stable sectors like MedTech and proprietary data.

2. Chronological Table of Contents

  • [00:00:20] - Introduction and Ground Rules
  • [00:02:24] - Performance Review: Explanation of Underperformance
  • [00:04:30] - Portfolio Breakdown: Top Performers and Detractors
  • [00:12:08] - The Concentration of Market Performance & Index Funds
  • [00:22:54] - Investment Strategy, Portfolio Fundamentals, & Valuation
  • [00:27:44] - Portfolio Turnover: Buys, Sells, and Rationales
  • [00:33:51] - Q&A: Assessing the "Magnificent Seven" Fundamentals
  • [00:38:51] - Q&A: The Attention Economy and the Dotcom Comparisons
  • [00:42:51] - Q&A: The Massive AI Arms Race & Capital Expenditure
  • [00:51:45] - Q&A: Liquidity, Redemptions, and Portfolio Trimming
  • [00:53:27] - Q&A: The Rationale Behind Slashing the Microsoft Position
  • [00:58:26] - Q&A: The Psychological Toll of Benchmark Underperformance
  • [01:02:08] - Q&A: Passive Fund Reversals and Defensive Positioning
  • [01:08:34] - Q&A: The Myth of De-dollarization & US Equity Weighting
  • [01:16:40] - Q&A: Doing Nothing vs. Changing Fundamental Beliefs
  • [01:20:22] - Q&A: The Most Admired Portfolio CEOs
  • [01:25:12] - Q&A: Lighthearted Closing on Names

3. Detailed Thematic Summary

Market Concentration and the Index Fund Trap [00:12:08]

  • Historical Concentration: The top 10 companies by market value now comprise 34% of the S&P 500 index [00:12:37]. The last time concentration breached 35% was right before the crash of 1929 [00:13:19].
  • Passive Flows as Momentum Drivers: Assets in index funds have skyrocketed from around 10% during the dotcom boom to over 50% in 2023 [00:14:10]. Smith emphasizes that passive investing is practically a pure momentum strategy; when money flows out of active management and into ETFs, it blindly buys the largest stocks (e.g., Nvidia) regardless of valuation [00:14:41].
  • Inelastic Markets Hypothesis: Referencing an academic paper, Smith reveals that moving $1 from an active fund to a passive index security forces a multiplier effect on the stock's price, driving the market cap up by $3 to $8 (average $5) [00:17:28]. This destroys traditional liquidity assumptions.
  • Extreme Daily Volatility: The market is behaving erratically due to inelasticity. Oracle, a near-trillion-dollar firm, surged 36% in a single day on vague AI data center commitments from OpenAI [00:20:25]. By contrast, a 20% move over an entire year was historically considered massive [00:20:41].

Portfolio Fundamentals & Valuation Resilience [00:22:54]

  • Superior Return on Capital: The underlying Fundsmith portfolio boasts a 31% Return on Capital Employed (ROCE), dwarfing the S&P 500 average of 17% [00:24:33].
  • Bulletproof Margins & Finance: Portfolio companies generate a 62% gross margin (versus 43% for the index), and maintain a fortress balance sheet with interest cover of 29x compared to the market’s 8x-9x [00:25:23].
  • Historic Valuation Shift: For the first time in the fund's 15-year history, the portfolio is currently valued cheaper than the S&P 500, ending the year with a 3.7% free cash flow yield [00:26:04]. Meanwhile, free cash flow across portfolio holdings actually grew by an explosive 16% [00:26:31].

The AI Arms Race & The Big Tech Pivot [00:42:51]

  • Historical Scale: The AI hardware buildout dwarfs prior speculative bubbles. The total market cap of the top 5 AI hyperscalers and top 5 semiconductors is roughly $20 trillion ($11.2T + $8.8T) [00:47:06], easily overshadowing the entire NASDAQ peak of $12 trillion during the dotcom bubble [00:47:12].
  • Unsustainable Capex Ratios: Hyperscalers are blowing out capital expenditure. Alphabet's 2026 capex commitments are 97% of its free cash flow, Meta's are 91%, Amazon is spending >100%, and Oracle is spending 200% [00:45:50]. CoreWeave leads the pack with commitments at 567% of its free cash flow [00:46:06].
  • The Return on Capital Math Problem: With an estimated $600 billion per annum being spent by the big 4 tech giants on AI infrastructure, they must generate an entirely new $180 billion in incremental cash flow annually just to meet a base 30% return target [00:54:14].
  • Position Sizing Action: Due to these unproven returns, Fundsmith aggressively reduced its Microsoft position from 5.2 million shares (7.4% of the fund) down to under 2 million shares, realizing massive gains before capital intensity destroys ROCE [00:57:50].

Geopolitics, US Dominance & De-Dollarization [01:08:34]

  • The Myth of De-Dollarization: While the US Dollar value has dipped (114 down to 137 against the Pound over a macro period), institutional de-dollarization is largely a myth due to the lack of viable, convertible alternatives [01:09:08]. China's Renminbi strictly requires a Bank of China account to clear, making it non-viable for global reserves [01:10:07].
  • US Economic Scale: The sheer size of the US economy remains a structural moat, being larger than Brazil, Canada, Russia, Italy, France, the UK, Japan, and India combined [01:12:14]. Nvidia alone represents a market cap larger than the economies of India and Japan [01:13:04].
  • Fund Allocation Justification: Fundsmith intentionally maintains ~70% of the portfolio listed in the US [01:11:51], largely because 8 of the top 10 MedTech companies and the world's leading payment processors are American [01:13:53].

Psychological Toll & Firing the Manager [00:58:26]

  • The NASDAQ Precedent: Terry shows a chart tracing 1998-2000, where quality and value stocks were totally decoupled from the surging tech market, creating immense mental strain, only to drastically reverse in March 2000 [00:59:29].
  • The "Tony Dye" Indicator: Dye, famously skeptical of the dotcom boom, was fired from UBS on March 1, 2000—literally the exact day the NASDAQ topped and commenced its historical crash [01:03:53].
  • Quantitative Data on Firings: Morningstar and Cambridge Associates data prove that institutions universally fire underperforming managers exactly at the wrong time; post-firing, the "fired" managers typically rebound to outperform their "hired" replacements massively [01:05:09].

The Reference Vault [00:00:20]

4. Data & Figures [00:00:20]

Data PointValueContextTimestamp
S&P 500 Top 10 Concentration34% / 35%The top 10 companies' share of the index's market capitalization; matching 1929 levels.[00:12:37]
Index Fund Market Share>50%The percentage of market assets now controlled by passive index strategies (up from ~10%).[00:14:10]
Inelastic Multiplier3x to 8xThe multiplier effect on market cap per $1 of inflows driven by inelastic index mechanisms.[00:17:23]
Oracle Daily Share Move+36%Oracle added nearly $250B+ in a single day, reaching $933B market cap on vague AI news.[00:20:25]

5. Core Frameworks & Mental Models

  1. The Inelastic Markets Hypothesis: [00:17:28]
    • Concept: Capital flows into purely passive, non-price-sensitive vehicles (ETFs/Index Funds) generate extreme multiplier effects (3x to 8x) on underlying stock market caps, rather than a 1:1 fundamental asset swap.
    • Application: Smith uses this to explain why the "Magnificent Seven" prices have skyrocketed disproportionately and why trillion-dollar companies exhibit penny-stock daily volatility.
  2. The K-Shaped Economy: [00:09:15]
    • Concept: Economic bifurcations where high-income consumers thrive and trade up, while low-income consumers suffer and aggressively trade down to non-branded or strictly discount goods.
    • Application: Applied to Church & Dwight's surprise underperformance; the top of the "K" isn't buying discount Arm & Hammer, and the bottom is trading out of the category completely.
  3. The "Idiot-Proof" Fallacy (Torn Up): [01:17:25]
    • Concept: A traditional Fundsmith rule—buy companies so good an idiot could run them, because eventually, one will (A Charlie Munger mantra).
    • Application: After Novo Nordisk's management severely botched their competitive landscape against Eli Lilly and compounders, Smith officially discarded this rule, conceding that incompetent management can indeed cause immense damage to even the best structural moat.
  4. Capex vs. ROCE Hurdle Rate Math: [00:54:14]
    • Concept: Capital expenditure must be justified by dividing the expected return on capital by the absolute spend.
    • Application: By tracking the $600B combined AI capex, Smith mathematically maps out that hyperscalers need an impossible $180B per year in new free cash flow to justify their spending, concluding it is a bubble.

6. Anecdotes [00:00:20]

  • The Firing of Tony Dye (The Ultimate Bear Market Indicator): [01:03:53] Terry recounted having lunches with Tony Dye, CIO of Phillips & Drew at UBS, who stubbornly refused to buy dotcom stocks in the late 90s despite agonizing underperformance. Dye was fired on March 1, 2000. That literal day ended up marking the exact absolute peak of the NASDAQ before the historic crash, perfectly illustrating the point of peak capitulation.
  • The Wright Brothers and Zero Aviation Profits: [00:44:43] To illustrate that world-changing technology does not equal shareholder returns, Terry quoted Warren Buffett regarding the Wright brothers' historic flight at Kitty Hawk. Buffett joked that a true capitalist at Kitty Hawk should have shot the plane down, as almost no one has ever made sustainable profits operating airplanes in the following century.
  • Dr. Udit Batra's Anti-Consultant Playbook at Waters: [01:21:07] Julian praised the CEO of Waters Corp for completely ignoring the standard "new CEO playbook" (firing up the corporate jet, hiring consultants, launching "Project Galactica 2040"). Instead, Dr. Batra simply showed up in 2020, quietly tracked down the company's aging hardware deployments, and pragmatically asked the sales team to go sell replacements, driving immediate organic success.

7. References & Recommendations [00:00:20]

  • "The origins of financial fluctuations: the inelastic markets hypothesis" - Academic paper cited to explain the multiplier effect of index fund inflows.
  • Charlie Munger / Warren Buffett - Quoted heavily on destroying long-held beliefs and evaluating the profitability of frontier technologies.
  • Mary Meeker / George Gilder - Referenced as the hyper-bullish "new era" analysts of the 1999 dotcom bubble, used as a direct parallel to today's AI commentators.
  • Quest by Canaccord (and Jimmy Cotton) - The fundamental valuation and cash flow modeling tool used by Fundsmith's team since their early broking days.
  • Cambridge Associates & Research Associates (Morningstar Data) - Cited for their quantitative studies proving that firing an underperforming fund manager historically results in missing massive performance reversals.
  • Tony Dye (UBS Phillips & Drew) - Referenced regarding dotcom bubble skepticism and peak capitulation timing.
  • Robert Sanborn (Oakmark Fund) & Andy Brown (Cedar Rock) - Referenced regarding the mental health aspects and psychological toll of running actively managed money differently from the benchmark.

8. Actionable Next Steps [00:00:20]

  1. Aggressively Monitor AI Capex-to-FCF Ratios: Track hyperscalers (Alphabet, Meta, Microsoft, Oracle) explicitly on the metric of their forward Capex commitments as a percentage of trailing free cash flow. Divest immediately if structural ROCE mathematically cannot clear a 20-30% hurdle rate on the new capital base.
  2. Pivot from FMCG to Healthcare & Proprietary Data Moats: Rotate capital out of traditional consumer packaged goods and beverages (like PepsiCo/Brown-Forman) that are structurally exposed to Gen-Z habit shifts and GLP-1 weight-loss drugs. Redirect into localized monopolies with physical or legal-data moats (e.g., Stryker for orthopedics, Wolters Kluwer for proprietary peer-reviewed data).
  3. Exploit the "Inelastic/Passive" Reversal Trap: Prepare a whitelist of ultra-high-quality, high ROCE companies to aggressively buy during a passive index outflow event. When momentum breaks, passive selling will hit the index indiscriminately, creating massive discounts on currently perfectly executing mid-to-large cap quality stocks.

Full Episode: The AI Industrial Revolution | 2 Jun 2026 | Naval and Nivi

Context: Host Naval Ravikant introduces a roundtable discussion on the "AI Industrial Revolution" with three frontier deep tech and software founders who build their own physical factories and tech infrastructure from first principles rath…

Fundsmith ROCE31%Return on Capital Employed for Fundsmith's portfolio (vs. 17% S&P 500).[00:24:33]
Fundsmith Gross Margin62%Portfolio companies' gross margins (vs. 43% S&P 500).[00:24:45]
Fundsmith Interest Cover29xFundsmith portfolio interest coverage (vs. 8x-9x S&P 500).[00:25:23]
Fundsmith FCF Yield3.7%Free Cash Flow yield (rising from 3.1%), making it cheaper than the broader S&P 500.[00:26:04]
Fundsmith FCF Growth16%Year-over-year growth in free cash flow across the portfolio companies.[00:26:31]
Portfolio Turnover12.7%The turnover rate for the last year, costing merely £1.7M (0.009% of AUM).[00:33:30]
CoreWeave Capex / FCF567%Expected 2026 AI capital expenditure as a percentage of free cash flow.[00:46:06]
AI Cap vs. Dotcom Peak$20T vs $12TMarket cap of top 10 AI/Semi companies today vs. total NASDAQ peak in 2000.[00:47:06]
Big Tech AI Spend Need$180 BillionIncremental annual cash flow needed to justify the $600B in annual big tech AI capex at a 30% ROCE.[00:54:14]
Microsoft Position Cut-60%+Reduced MSFT holding from 5.2M shares to under 2M shares over capex concerns.[00:57:50]