Is Terry Smith genuinely skilled or did he just get lucky?
- Robin Powell
- 2 hours ago
- 7 min read
Terry Smith has run out of culprits. First, it was the "Magnificent Seven" tech stocks distorting the market. Then it was the Federal Reserve's monetary policy. Now, in his latest investor letter, the celebrity fund manager has found a new scapegoat for his Fundsmith Equity fund's dismal performance: Danish pharmaceutical giant Novo Nordisk, which he accuses of snatching defeat from the jaws of victory in the weight-loss drug market.
For Britain's most famous stock-picker, a man who once commanded rock-star status in investment circles and managed over £25 billion at his peak, the steady procession of excuses raises an uncomfortable question. After four years of underperformance, including the fund's worst-ever monthly loss of 10.3% this past March, are we witnessing the inevitable unravelling of a manager whose early success was built more on luck than skill?
The answer, according to decades of academic research, is far more unsettling than most investors realise. To prove with statistical confidence that a fund manager possesses real skill rather than benefiting from a fortunate run, you would need to observe their performance for somewhere between 20 and 800 years. Fundsmith Equity, launched in November 2010, hasn't even reached its 15th birthday.
The rise and fall of a star
When Terry Smith launched Fundsmith Equity in November 2010, he seemed to have cracked the code. His simple philosophy of buying high-quality companies and holding them for the long term delivered spectacular results. The fund outperformed the MSCI World Index in nine of its first eleven years, often by substantial margins. In 2011, while global markets fell 1%, Smith delivered 8.4%. In 2013, he returned 25.3% against the index's 23.9%.
The financial press loved him. Here was a manager who eschewed the frantic trading and complex strategies of his peers, instead focusing on companies with strong brands, predictable cash flows, and sustainable competitive advantages. By 2021, Fundsmith Equity had grown to manage over £25 billion, making Smith one of Britain's most successful fund managers.
But then something changed. Since 2021, the fund has underperformed the MSCI World Index in three of the last four years, with 2024 delivering a disappointing 8.98% return against the index's 20.8%. This March saw the fund's worst-ever monthly performance, losing 10.3% as Smith's quality growth stocks fell out of favour.
The money has followed the performance. Since mid-2022, not a single month has seen net inflows into the fund. In total, £4.6 billion has fled since 2024, with £1.5 billion withdrawn in the first half of 2025 alone, pushing assets under management below £20 billion.
As the performance deteriorated, so did Smith's explanations. Initially, he blamed the market's obsession with the "Magnificent Seven" tech stocks. When that bubble burst and his fund continued to struggle, he pivoted to blaming individual holdings. The confident fund manager who once seemed to have all the answers now appeared to be grasping for explanations.
Why 800 years isn't long enough
While investors debate whether Smith's struggles represent a temporary blip or permanent decline, academic research suggests the question itself may be unanswerable. According to research by Brad Steiman at Dimensional Fund Advisors, proving that a manager possesses genuine skill requires an almost impossibly long track record.
For a fund manager generating a modest 2% annual outperformance with typical volatility, it would take 36 years of data to be 95% confident that their success isn't simply due to chance. If that manager's alpha drops to just 1%, the required timeframe balloons to 144 years. Even a manager delivering a substantial 4% annual alpha would need nine years to reach statistical significance.
Fundsmith Equity's 14-year track record, impressive as it may seem to investors, is statistically meaningless from this perspective. Smith could have been the greatest stock-picker of his generation during those early glory years, or he could have simply been the beneficiary of a fortunate sequence of market conditions.
This harsh reality was crystallised in groundbreaking research by Nobel laureates Eugene Fama and Kenneth French. Their comprehensive study of US mutual funds found that most fund outperformance was indistinguishable from pure luck. Even more damning, they concluded it was "impossible to tell whether an active fund manager's stellar performance is due to skill or just sheer luck" for the vast majority of managers.
Did Terry Smith really make a mistake with NVIDIA?
Smith's recent struggles provide a perfect case study in how random market movements can masquerade as investment errors. Take his decision to avoid NVIDIA, the chip giant whose shares have soared over 2,000% since early 2023. To critics, this looks like a classic stockpicking blunder.
But consider the alternative perspective: Smith's investment philosophy has always focused on predictable, cash-generative businesses. NVIDIA's extraordinary gains were driven by an AI boom that few predicted and fewer still understood. From Smith's framework, avoiding an unpredictable technology stock was entirely consistent with his stated approach. That this particular unpredictable stock happened to become the market's biggest winner says nothing about Smith's skill.
The same logic applies to his other apparent missteps. His underweighting of Apple, where the fund holds just 1.4% compared to the stock's 6.6% weighting in the S&P 500, cost performance as Apple shares rose 23% in the first half of 2024. His concentration in Novo Nordisk, which makes up 5.5% of the portfolio and has fallen over 52% in the past year, looks like poor stock selection but may simply reflect the unavoidable risks of running a concentrated portfolio.
Research by Hendrik Bessembinder has shown that market returns are driven by just 4% of stocks. Missing these few mega-winners, or holding too little of them, can destroy performance regardless of how well a manager selects their other holdings.
Perhaps most revealing is Smith's complaint about currency headwinds. He noted that the pound's appreciation hurt returns since most of his holdings are US companies. This inadvertently highlights how much of fund performance is determined by factors entirely outside a manager's control.
Why we keep falling for star managers
Despite the overwhelming statistical evidence against active management, investors continue to flock to "star" managers like moths to a flame. We instinctively seek patterns and explanations, even in random events. Smith's decade-long outperformance seemed to confirm his prowess, but it may have simply been luck masquerading as genius.
This psychological bias is amplified by survivorship bias, one of the most pernicious distortions in the fund management industry. We only hear about the Terry Smiths who succeeded; the thousands of managers who failed are quietly swept away through fund closures and mergers. According to Boston Consulting Group, only 37% of funds launched in 2013 still existed by 2023.
The fund management industry expertly exploits these psychological weaknesses. Marketing departments craft compelling narratives around their star managers, emphasising their investment philosophy and unique insights. These stories are far more persuasive than statistical warnings about the impossibility of distinguishing skill from luck over realistic timeframes.
This creates a destructive cycle of performance chasing. Money poured into Fundsmith Equity as Smith's reputation grew, with many investors arriving just in time for the recent period of underperformance. Now, as assets haemorrhage from the fund, these same investors are crystallising their losses while searching for the next star manager to follow.
How long will his investors keep believing?
The real test of Terry Smith's legacy isn't in the performance tables but in the psychology of his remaining investors. Investment conviction during prolonged periods of poor returns presents one of the most severe psychological challenges in finance. Research from Morningstar shows that even funds which ultimately outperformed over 15-year periods typically endured stretches of underperformance lasting 9 to 11 years.
Smith's remaining investors must convince themselves that the man who once seemed infallible hasn't lost his touch, that his quality-focused approach will eventually reassert itself. Meanwhile, friends and colleagues investing in simple index funds watch their portfolios steadily compound without drama or disappointment.
Smith's age adds another layer of uncertainty. At 72, he's approaching typical retirement age, raising inevitable questions about succession and continuity. The track record that investors are backing isn't just Smith's investment philosophy but Smith himself.
As assets continue to haemorrhage, the character of the remaining investor base may be changing. Early believers drawn by Smith's track record are being replaced by those simply hoping for a rebound. This shift could fundamentally alter the fund's dynamics, creating additional pressure for short-term performance that conflicts with the long-term approach that originally made Smith successful.
The market's verdict
The cruel irony of Terry Smith's predicament is that while he struggles to beat the market, the market returns he's failing to match are available to any investor for a fraction of his fees. A simple global index fund would have delivered exactly the performance that Smith's investors are missing, with no drama, no excuses, and no need to maintain faith through years of underperformance.
Smith's early success, viewed through the lens of statistical analysis, appears less like evidence of exceptional skill and more like a fortunate sequence of market conditions that aligned with his investment style. His subsequent struggles don't necessarily represent a decline in ability but rather the natural reversion to randomness that statistical theory predicts.
For investors still clinging to the belief that they can identify the next Terry Smith before his period of outperformance begins, the mathematics remain unforgiving. By the time you have enough data to prove a manager possesses genuine skill, decades will have passed and simpler alternatives will have compounded wealth more reliably.
Terry Smith's story isn't one of rise and fall; it's a cautionary tale about the illusions we buy into when markets reward us. Luck masquerades as genius, and hindsight makes randomness look like design. In investing, the smartest move is often the simplest: accept the market's gift and move on.
PREVIOUSLY ON TEBI
WANT TO LEARN MORE ABOUT EVIDENCE-BASED INVESTING?
When it comes to planning your financial future, you need a strategy that’s based on solid foundations.
In their award-winning book, How to Fund the Life You Want, Robin Powell and Jonathan Hollow explain how evidence-based investing works, and the practical steps you need to take to implement an evidence-based investment strategy.
It’s published by Bloomsbury and is primarily intended for a UK audience.
You can buy the book on Amazon, on Bookshop.org, and in all good bookshops. There are eBook and audio book versions as well.
