Is Lindsell Train running out of steam?

Laith Khalaf, head of Investment analysis at AJ Bell, looks at the recent poor performance of Lindsell Train funds and what the future might hold.

“It’s been a tough year for investors in Lindsell Train funds. What’s made significant underperformance this year particularly painful is that investors simply aren’t used to it, given the exceptional track record of the managers. The previous gains made by Lindsell Train for investors should cushion the blow of a dismal year, but it’s nonetheless unsettling when a high-flying fund manager comes unstuck, and inevitably leads to questions about whether they’ve lost their mojo.

“Lindsell Train is named after its two founders and primary investment managers, Nick Train and Michael Lindsell. The duo have a very long term buy and hold approach, following in the footsteps of Warren Buffett, who famously said his favourite period for holding a stock was forever. Lindsell Train is known for encouraging analysts to do antiquated things like “reading books” and “thinking”, rather than simply mashing numbers through a spreadsheet. They even have a library in their office to facilitate such curiously old-fashioned methods. This approach, combined with a steadfast focus on businesses with wide economic moats (another Buffettism), has driven exceptional returns for investors. But then 2021 came along.

“The two big flagship funds run by Lindsell Train have had a bleak year. Over the last twelve months, the UK Equity fund has returned 10%, compared to 17% from the FTSE All Share (see table below). Pretty grim, but not a total disaster. The Global Equity fund has had an annus horribilis though, with the fund returning 3% for investors, while the global stock market has increased in value by 24%. This now leaves the fund slightly behind its benchmark index over 5 years, though it’s still comfortably ahead over the last decade.

“There are a few trends which explain this weak recent performance. Certain areas of the market where Lindsell Train has no or low exposure have done well in the last twelve months, most notably energy and tech stocks. Lindsell Train does have a bit of exposure to tech, but one of its three picks in the area, Paypal, has not been having a good time of it recently. Generally speaking, the stocks Lindsell Train likes to buy are masters of their own destiny. When economic growth is very favourable, as it has been this year, companies like these that can grow in many conditions fall out of favour. That’s because corporate prosperity is plentiful, and investors are willing to shed their reliable all-weather waterproof in a heatwave.

“The Lindsell Train approach naturally leads to a portfolio which is skewed towards consumer goods giants like Unilever, PepsiCo, and Mondelez. Supply chain bottlenecks and cost inflation are leading these companies to raise prices, and there are some doubts over whether consumers will stomach higher bills, or switch to cheaper unbranded substitutes. Mondelez, the maker of Oreos and Ritz Crackers, reckons it will have to raise prices in the US by as much as 7% next year. For many consumers already facing higher energy bills, that will really take the biscuit.

“Lindsell Train funds are also heavily invested in what have been called ‘bond proxies’. These are companies that are reliable growth compounders, including consumer goods giants, which have found favour with traditional bond investors, because exceptionally low yields have driven them to look for alternative homes for their money. There is some concern in the market that potential interest rates rises could prove a headwind for these stocks, as that may tempt some investors back into their natural habitat of bonds.

“Lindsell Train also run very highly concentrated funds, typically only holding 25 to 30 stocks. This helps amplify outperformance when things are going well, and works in the opposite direction when the chips are down. It’s a high octane approach to investment management and not for the feint-hearted, because it means big positions in a small number of companies. Just a few turning sour can therefore have a big effect on the portfolio as a whole. Investors need to be comfortable with this high conviction approach, which can mean big deviations in performance compared to the benchmark index.

“The big question facing investors is, of course, should they stay or should they go? The bear case is that Lindsell Train’s investment style has had its day in the sun, and that rising interest rates will mean less demand for the reliable compounding stocks they favour. This assessment seems premature after such a short, admittedly painful, period of underperformance. Nor should it carry too much weight in a truly balanced portfolio that encompasses a range of fund manager styles.

“Lindsell Train has a very particular investment philosophy which focuses on companies with robust brands, balance sheets and earnings streams, and this style can be expected to move out of step with the wider market, sometimes for better, sometimes for worse. The managers have earned plenty of credit in the bank, which will likely mean most investors stay on board with Lindsell Train for now. As with any active manager though, it pays to make sure you don’t have too much of your portfolio riding on it.”