Active Investing in a Passive World: Reflections on Terry Smith's 2024 Letter
Can Fundsmith's "Buy, Don't Overpay, Do Nothing" strategy keep up?
Terry Smith’s latest annual letter to Fundsmith Equity Fund shareholders dives into the fund’s 2024 performance, delivering both a narrative on the year’s investing climate and an implicit defense of active management. The fund achieved an 8.9% return in 2024, under-performing the MSCI World Index’s 20.8% rise. This divergence is explained away, in part, by the outsized influence of a few mega-cap tech stocks driving index performance, what Smith terms the “Fab Five” (Nvidia, Apple, Meta, Microsoft, and Amazon). Yet, as much as Smith provides an analysis of market dynamics, his letter can also be read as an excuse for Fundsmith’s under-performance.
The Performance Defense

Smith leans heavily on long-term metrics to soften the blow of underwhelming short-term results. Since its inception in 2010, the Fundsmith Equity Fund has delivered 2.7% per year more than the MSCI World Index (£ net), with significantly lower downside volatility. This is, without question, an admirable track record. However, his focus on the structural challenges facing active managers in a market dominated by market-cap-weighted indices feels like a veiled critique of passive investing without directly naming it as the culprit.
Smith points out that passive index funds now control more than half of all assets under management, compared to just 10% during the Dotcom boom in in early 2000. He argues that the flows into passive funds create a “self-reinforcing feedback loop”, disproportionately favoring the largest companies. This momentum-driven phenomenon makes it harder for active managers to compete unless they mirror the indices, which goes against Fundsmith’s philosophy. While this observation is accurate, one might argue that pointing to market structure as an explanation for under-performance feels like a convenient deflection.
AI Boom or Bubble?
Smith’s commentary on artificial intelligence is one of the most compelling aspects of the letter. He draws a parallel between today’s AI boom and the Dotcom bubble. While acknowledging some hype, he highlights key differences, particularly Nvidia’s profitability, which stands in stark contrast to the speculative nature of many Dotcom-era pre-revenue companies.
However, Smith is cautious about Nvidia’s current valuation and reliance on a handful of hyper-scalers building AI data centers. This narrow customer base, combined with the capital-intensive nature of Nvidia’s products, makes the company more vulnerable to economic downturns compared to consumer-focused businesses. Smith’s skepticism of Nvidia’s meteoric rise echoes his cautious investment philosophy, emphasizing “a high likelihood of satisfactory returns” over the pursuit of speculative gains.
Stock Picks and Missteps
Smith offers a detailed account of the fund’s best and worst performers in 2024. Meta Platforms, Microsoft, and Philip Morris were standout contributors, while L’Oréal, IDEXX, and Nike detracted from performance. He defends these under-performing holdings as fundamentally sound businesses facing temporary challenges, demonstrating his commitment to a long-term approach.
The fund exited its positions in Diageo, McCormick, and Apple. The sale of Diageo, a holding since inception in 2010, was attributed to management issues and the emerging threat of weight-loss drugs impacting alcohol consumption. Similarly, McCormick was let go due to slow pricing adjustments and competitive pressures. The Apple sale was framed as a decision driven by valuation concerns, with Smith unwilling to hold a stock with stagnant growth trading at a 50% premium to the S&P 500.
The Case for Consumer Companies and Rethinking Volatility
Smith offers two insights in particular that resonate deeply with me: his views on the resilience of consumer companies and his nuanced take on volatility.
On consumer companies, Smith delivers a sharp observation about their relative stability during economic downturns, emphasizing their proximity to end consumers. He explains:
“People sometimes ask us whether it is dangerous to own consumer stocks in an economic downturn. To which we reply yes, but it is not as dangerous as not being close to the consumer in those circumstances. If you think the performance of consumer companies is a worry in a downturn, wait until you see what happens to their suppliers, especially the suppliers of capital equipment like factory machinery.”
This insight highlights the importance of understanding the value chain. While consumer-facing businesses might face challenges during tough economic times, they are more resilient than their upstream suppliers, who often experience amplified disruptions. This is a key takeaway for investors navigating uncertain markets, staying closer to the consumer can act as a buffer against broader economic uncertainty.
Speaking of volatility, Smith also challenges the conventional wisdom surrounding its measurement. He critiques commonly used metrics like the Sharpe and Sortino ratios, which focus on price volatility, as insufficient to capture the true nature of risk. Instead, he urges investors to focus on the fundamental value of businesses and accept price volatility if it leads to higher long-term returns. As he aptly puts it:
“Whilst investors should rationally focus on volatility in the fundamental value of the businesses they invest in and accept higher price volatility if this leads to higher returns, it is easier said than done. One problem is that it is difficult to remain calm and focus on the fundamental characteristics when the price volatility is sharply negative.”
This perspective serves as a powerful reminder that volatility, often misunderstood as risk, is a necessary trade-off for achieving superior returns. For disciplined, level-headed investors, the ability to stay calm during sharp price swings is essential. I have previously shared my views on the decoupling of volatility from risk in another article, which you can read here.
Conclusion
Smith’s 2024 letter serves both as a defense of his investment strategy and a reflection on market dynamics. His views into the challenges posed by index-dominated markets are thought-provoking, but they may also be interpreted as a justification for the fund’s under-performance. While it’s evident that Fundsmith remains steadfast in its “buy good companies, don’t overpay, do nothing” mantra, the letter prompts me to question whether the emphasis on low turnover can keep competing effectively in today’s and tomorrow’s market. Nonetheless, for level-headed investors who value investing grounded in fundamental analysis, Smith’s letters, interviews, and annual shareholders’ meetings throughout the years remain a cornerstone of quality investing.
To conclude, I recommend a recent and entertaining interview with Smith on The Financial Planner Life podcast, where he shares his fascinating journey from his early days at Barclays Bank to becoming one of the most respected figures in the financial world. Hosted by Chris Ball, the episode explores pivotal moments in Smith’s career, including the controversial publication of Accounting for Growth, his entrepreneurial leap into brokerage, and the creation of Fundsmith. Packed with insights on integrity, disciplined investing, and leadership, this episode is a must-listen for anyone seeking inspiration and wisdom from one of the UK’s finest financial minds.