What caught my eye this week.
The formerly fêted fund manager Terry Smith has had a few rough years in the markets, but last year was a doozy.
The UK investors who once poured money into his flagship Fundsmith vehicle saw their domestic market deliver nearly 26% in 2025.
A global tracker – a better comparison for the free-roaming Fundsmith – delivered roughly 14%.
But Fundsmith managed just a 0.8% return.
Barely there, and handily outpaced by cash in the bank.
Never mind the returns, feel the quality
Now Terry Smith is a big and famously acerbic boy who has rained on many a parade over his long career. While the schadenfreude must be positively Wagnerian in some quarters and it’s never nice to kick a man while he’s down, he doesn’t need me defending him.
I will just a tad though.
Like Nick Train – another once-loved but now seemingly reviled fund manager 1 – Smith invests exclusively in ‘quality’ type shares.
This doesn’t (just) mean ‘quality’ the way a car salesman might quip about that vehicle you’re eyeing up.
The quality factor describes a particular kind of company that boasts – among other things – high returns on equity, strong profit margins, and the ability to turn most of its profit into cash.
And since the reset of 2022, these kinds of companies have been in the doghouse. I know because I favour them with my stock picking myself. Although happily my returns in 2025 were an order of magnitude better than Smith’s. (But now I’m doing the schadenfreude dance…)
Of course, Smith and Train didn’t exactly call out the tailwinds that boosted their returns during the low interest rate era.
Worrywarts like me saw ‘bond proxy’ companies increasingly owned by weak hands who would rather be invested in bonds, and which were thus primed for a fall when interest rates rose.
Train in particular dismissed such concerns, while Smith just continued to talk like you’d need a lobotomy to own anything other than his favoured firms.
But when the reckoning came, those multiples duly corrected – and the share prices went south.
The evils of indexing
The fact that even good investors suffer when their style is out of favour is of course another of the many arguments for passive investing.
I’m one of diminishing band who still believes both Smith and Train have skill. But I also think most people should invest the bulk of their money in index funds, rather than bet their net worth on either the jockey or the horse they’re riding.
However Smith has continued to lend his voice to the chorus warning that those same index funds are part of a wider problem.
In his letter to investors this week, he recapped the now-common argument that the growing share of money invested in index funds is distorting the market, concluding:
…even if we are right in diagnosing this move to index funds as one of the causes of our recent underperformance and it is laying the foundations of a major investment disaster, I have no clue how or when it will end except to say badly.
He would say that, wouldn’t he? He’s an active fund manager.
Well no. The greatest active investor of all-time, Warren Buffett, cheerily urges people – including his wife – to put their money into tracker funds.
For my part, I am not sure exactly what I think.
It’s a 6-7
While Smith’s recap in his letter on the perils of excessive indexing is uncharacteristically muddled, I’ve read more persuasive arguments as to why the weight of money in index funds is distorting prices. At least at the margin and especially for the biggest companies. (Here’s the latest).
I’ve also read comprehensive counters too.
Now you may wonder why someone who has been writing a blog about both active and passive investing for 20 years cannot be more definitive about this?
The truth is the maths is non-trivial and it’d take a good chunk of time to separate theoretical outcomes from any real-world implications. So I’m leaving it to the investing titans to argue it out.
With that said, I’ve mentioned to my co-blogger The Accumulator that, on a gut level, I suspect indexing becoming mainstream will have some kind of downside. Apparent free lunches in investing always do.
But whether they will be enough to make any meaningful difference – let alone be something that should prompt everyday investors to return to paying the known cost of active investing – is another matter altogether.
On a practical level, if I was a passive investor I might favour equal-weighted funds a bit more, though that’s been a losing bet for years. Then I’d wait to see what happens!
There’s no world in which index funds crash while a preponderance of active funds soar, that’s for sure.
Remember, active funds basically are the market. 2 If passive and index investing has been unduly inflating prices, then beyond the edge cases it’s doing it for all investors.
Have a great weekend.
From Monevator
The Slow & Steady Passive Portfolio Update: Q4 2025 – Monevator
The 10 eternally true steps to financial freedom – Monevator
From the archive-ator: How gold is taxed – Monevator
News
UK construction hit by worst run since the global financial crisis – Guardian
Average UK house price fell £1,789 in December – Yahoo Finance
Weight jabs affecting Greggs, boss says – BBC
UK credit card borrowing rises at fastest annual rate in almost two years – Guardian
AI layoffs a corporate fiction masking a darker reality, says Oxford Economics – Fortune
The Saudi stock market is opening up to all – Semafor
Rent control law to ‘knock £11bn’ off commercial property – City AM
Why Polymarket is not paying bets on the US invading Venezuela – Forbes
Europe’s leaders watch silently as Trump torches UN climate treaty – Politico
UK to pass population tipping point in 2026, says think tank – Bloomberg via Yahoo
Products and services
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Halifax, HSBC, and Barclays cut mortgage rates in new year boost for borrowers – This Is Money
Why cancelling your credit card might not stop fraud – Which
Lloyds Bank switch offer: £250 and Disney+ – Be Clever With Your Cash
Get up to £1,500 cashback when you transfer your cash and/or investments to Charles Stanley Direct through this affiliate link. Terms apply – Charles Stanley
Top holiday booking hacks – Be Clever With Your Cash
Is 2026 a good time to buy an annuity? – Which
Get up to £3,000 cashback when you open or switch to an Interactive Investor SIPP. Terms and fees apply, affiliate link – Interactive Investor
NS&I cuts interest rates on fixed bonds: how to respond – Which
Why secondhand is better than new – The Honest Broker
Homes for sale with soaring ceilings, in pictures – Guardian
Comment and opinion
Very modest optimism about UK housing in 2026 – Propegator
Is Britain back? – CNBC
Why some lives feel rich and others only look it – The Root of All
Andrew Ross Sorkin on why the 1929 market crash still matters – Sherwood
More evidence that short-term market forecasts are phooey – Behavioural Investment
Don’t trade where you tweet – Tim Harford
A Q&A with Cullen Roche about Your Perfect Portfolio – Abnormal Returns
Are buy-to-let landlords dying out? – Guardian
Winning the lottery [US but relevant] – We’re Gonna Get Those Bastards
The ‘great broadening’ in the US stock market – Chart Kid Matt
New ways of working mini-special
How Britain is embracing the ‘workation’ – Guardian
Microshifting – Guardian
Naughty corner: Active antics
Michael Cembalest’s widely read outlook: 2026 edition [PDF] – JP Morgan
Buybacks shouldn’t matter, but they do – Klement on Investing
The $2.5 trillion investment opportunity in sports [PDF] – Apollo
Funds that win long-term win short-term, too – Basis Pointing
Artificially inflated [PDF] – GMO
Japan’s bank revival – Verdad
The hidden risks of leveraged single-stock ETFs – Alpha Architect
The stocks that drove the US market gains in 2025 – Morningstar
Kindle book bargains
How to Own the World by Andrew Craig – £0.99 on Kindle
Zero to One: Notes on Startups by Peter Thiel – £0.99 on Kindle
The Four-hour Work Week by Tim Ferriss – £0.99 on Kindle
How to Break Up With Fast Fashion by Lauren Bravo – £0.99 on Kindle
Or pick up one of the all-time great investing classics – Monevator shop
Environmental factors
What will 2026 look like for the UK’s electric vehicle market? – The Conversation
Christmas trees to be replanted to boost sea defences – BBC
Germany’s dying forests are losing their ability to absorb CO2 – Guardian
Project to return wild elk to UK moves forward – BBC
The spread of invasive plants and animals across Europe, in pictures – Guardian
Robot overlord roundup
Artificial intelligence and the human condition – Stratechery
Putting the AI boom(let) into perspective [Paywall] – FT
Copywriting R.I.P. – Blood in the Machine
Gmail’s first lunge at stabbing email to death with AI – Spyglass
AI capex: built on options, priced as certainty – Dave Friedman
nVidia’s autonomous tech enables other carmakers to challenge Tesla – Sherwood
Not at the dinner table
What’s behind Starmer’s notable shift on closer ties to Europe? – BBC
Donald Trump wants you to forget 6 January happened – The Atlantic
We are the bad guys: the US threat to global stability – How Things Work
Our ‘just take it’ era – Riskgaming
Neo-royalism and the emerging international system [Research] – Cambridge Press
America’s export controls are working – Noahpinion
The politicised US economy is not in great shape – The Bulwark
New you mini-special
Oliver Burkeman: the secret to happiness in 2026 – Guardian
The myth of willpower – BBC
So you wanna de-bog yourself – Experimental History
The leaf leafs anyway – Of Dollars and Data
How to meet your future self – White Coat Investor
Off our beat
A great British toilet revolution could be on the way – Guardian
Autonomous killer drones have come to Ukraine – NYT [h/t Abnormal Returns]
Climate change and migration – Grist
Why smaller houses can lead to happier lives – WSJ via MSN
How a sudden winter storm in 1617 sparked Norway’s deadliest witch hunt – Smithsonian
The Score is a warning about the gamification of everyday life – Guardian
And finally…
“I have come to understand that if successful property investing is all about ‘location, location, location’, success in equity investing is all about ‘execution, execution, execution’.”
– Lee Freeman-Shor, The Art of Execution
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![Quality street [Members]](https://monevator.com/wp-content/uploads/2024/01/consumer-goods-EV-gross-profit-ten-years-1024x637.jpg "Quality street [Members]")
Surely this idea that indexing is causing overvalution is absolute nonsense?
Like before indexing we never had overvaluation/ undervaluation in the market?
Look at 1929, and more recently the late 1990s bubble and the subsequent drop after 1999.
Human nature causes bubbles and their collapse, not indexing.
@Indexing — Agree with the historical perspective. I’d have a read of the literature though before using the phrase “absolute nonsense”.
If I was going to redux the argument down, it’s something like passive investing flows into the very largest index funds are sort of like a valuation agnostic active momentum fund funelling money into the market. (Remember, even index funds are ‘active’ in that they follow rules as to what firms to include and exclude, and in what weightings).
So in that sense it’s the same as it ever was — just like big active funds in the 1960s or the late 1990s — but under a new guise.
There’s then a bunch of maths overlaid onto that about demand/supply inelasticity and whatnot.
In a simple world as I understood it, index funds just bought ‘the market’ and active funds traded against each other and were the market. But there are coherent arguments that at this scale quantity has a quality all of its own, as Napoleon said.
Still, as noted in the piece, I’m not persuaded it’s an argument for active investing unless you want to go *very* active (e.g. buying small cap active funds to avoid an alleged large cap bubble) and that comes with a plethora of very known and real issues.
If any bubble pops, however it was caused, then everyone will go down together, more or less, though no doubt some funds will do relatively better (including, perhaps, quality and value focused funds, which have struggled for so long versus tech/growth…)
Fair enough, absolute nonsense is probably a bit harsh. But the idea bubbles are caused by indexing I think is a mistake.
Bubbles or extreme price moves in both directions have occurred in all markets, not just stocks, since records began. Most of these markets did not have any form of indexing.
On my long investing journey (am now 80) I remember my first convincing star manager Ian Rutherford of Personal Assets Trust whose investing outlook perfectly fitted my conservative investing feelings.Alas he was taken from us too soon -rather emphasising one of the problems of relying on “star” managers
Various other heroes like Jim Slater shot briefly and brightly across the investing firmament -there were many of his ilk
Realising that putting faith in one person was a fraught investing policy-how does a mere amateur investor pick the winners?
Index investing eventually came to the rescue via Vanguard and John Bogle to my great investing relief-no educated guesswork needed
I very much enjoy reading about the success of Terry Smith etc but then a Woodford comes along………
Index investing is very boring but retirement finances need to be 100% successful-so boring is OK with me
Indexing has done the job for me-so far!-However I keep reading financial news-Monevator etc-but so far all it does is reinforce my current conservative investing policy but who knows down the line what might appear……..
xxd09
A very good article The Investor, which I thought was very balanced. Thank you.
I have to confess that Fundsmith is the only active fund that I currently hold in my portfolio (less than 5% of it), with everything else being trackers (apart from one ‘fun’ individual company share).
I have had it a long while now and, in the past, it has been good to me (186% up). I invested in it because I like Terry Smith (the UK’s Warren Buffet- we hoped) and how he talks. Although for the last five years his defence of his track record has become less and less convincing. I am curious to see what happens in the future. If in the next few years, he hugely underperforms the market does he decide that reducing the funds 1% management charge might be in order? ( I think Warren Buffet would).
In fairness to him he does have integrity and is rich enough not to care about what other people think of him. A while back, buoyed by the success of Fundsmith, I invested in his FEET fund, basically Fundsmith in Emerging Markets. It was not a success (better to have bought an EM tracker). He run it for a few years before handing over to two of his team (who couldn’t improve it). He wound up FEET BUT the pay out was generous compared to the final share price (from memory I don’t think I lost any money on it apart from opportunity cost).
With regard to his latest tirade against the unfairness of the all-encompassing passive trackers (I admit I haven’t actually read his words) I think he is on a sticky wicket. Passive trackers are here to stay – too bad, get over it. There is a truism in economics – You can never buck a trend!
Seems to make some sense that passive flows could distort the stock market and lead to some misallocation of capital. But then, this should create opportunities that active managers can exploit, and we’re not seeing that. Active managers still underperform the market on average, and afaik the level of underperformance has been roughly the same over the past decades (and the rise of index funds).
Academic economists usually work with “spherical horse in vacuum”-type assumptions. I think we’re better off relying on practical observations. Index funds it is for me, until I see active stock managers actually outperform.
That said, if quality-factor stocks are so unloved at the moment, maybe it’s a good time to take a punt.
@indexing #1 & #3: that’s not a claim being made under the Inelastic Markets Hypothesis (it’s a straw man point).
The IMH does not postulate that passive flows ’cause’ overvaluation and/or crashes (at least per se).
Rather, the IMH merely claims that, beyond a certain point, due to both increasing net passive flows and increasing passive share (dominance), public markets become increasingly less elastic, less informationally efficient (in terms of informed price discovery) and that larger caps weight stocks become progressively overweighted compared to their effective crisis liquidity (i.e. ever less effective liquidity under stress per unit of capitalisation): See Monevator here:
“Why market cap investing still works”. March 4, 2025, @me #80
Here:
“Passive investing, edge, and market efficiency: winners need losers”, September 19, 2024, @me #11
Here:
“Weekend reading: oh what can ail thee, knight-at-arms?” September 7, 2024, @ZX #16 and immediately following.
Here:
“Weekend reading: Fama and fortune”. August 31, 2024, @me #3 and #9
And here:
“Weekend reading: We all feel the pain of active fund managers now.” February 9, 2024, @ZX #16 and @me #37
For the avoidance of doubt IMH is not an argument for active management.
Index investing will clearly follow a trend and NEW money will reinforce that trend.
In the present market we can underweight the stocks / region that we perceive as overvalued.
At some point the markets fall, is that the correction or just a dip….
Given we feel the market has fallen, how do we respond ?
A logical answer is that a tracker is the route out , we don’t know what will rise again most quickly , “if you can’t find the needle buy the haystack “
So we need to veer away from the market tracker and then head back in, timing is tough.
It’s worth thinking back to 1988/89 Japanese market was very expensive and was 45% of the world index (iirc) and USA was 25% but when it crashed big time in 1989 , the world index fell but within a couple of years the index had largely recovered…
Perhaps that might point to how the AI excitement might play out ?
Peter Thiel, seriously?
@Ian — It’s an excellent book. I don’t share the man’s politics but he understands 21st Century business!
Terry Smith and Nick train get a lot of credit for their factor happening to outperform in the early days of their funds’ launch.
Terry Smith’s long term track record (and short term track record for that matter) looks a lot less impressive if you pick an appropriate benchmark with a similar factor exposure (the MSCI World Quality index say, rather that the MSCI World).
I would say that index funds exaggerate (and perhaps highlight?) strongly held beliefs.
So the US Exceptionalism concept has a key impact on the allocation of the global trackers.
Then at a lower level in the UK you do have shares at very unusually low valuations (for example, retail is generally trading both on low earnings and earnings multipliers). With others at better values.
These are both beliefs about where value should or shouldn’t be, but both could be temporary. And index funds are led by the hand by these beliefs.
The advantage of the active investor or an investor in industry ETFs is they can go against these preconceptions, which may work well IF they are right (this is basically Buffet, Graham etc).
At its core – index funds are not God – they contain mistakes, but at its core they can be reduced to generalizations, and understood.
The problem is it takes a lot of time and energy to understand the generalizations in an index, and with most market commentary being misleading at best, the question is whether it’s worth extra time of effort.
That I think will forever be debated – but there will be cycles where indexes outperform, and cycles where they don’t.
The smaller houses lead to happier lives article is interesting. There’s a lot to be said for living in a good community. I think i heard Naval say similar on a podcast they’ve purposely chosen to live in a smaller house in a nice community rather than a remote mansion. It’s hard deciding on size of home more space isn’t always better seem to get filled with junk.
The population chart isn’t good. Without wanting to bring the b word into it if that was a vote for sovereignty then the Boris wave was a proper kick in the teeth. Now we seem to be in a situation where we have a brain drain of talent and a policy of importing less desirable (pc term) low skilled people. When are we going to see govt embrace autonomous driving and lay off importing uber drivers?
Re “With that said, I’ve mentioned to my co-blogger The Accumulator that, on a gut level, I suspect indexing becoming mainstream will have some kind of downside. Apparent free lunches in investing always do.”
I think your gut-level theory falls down on the point of equating index investing with a free lunch.
Most active participants are trying to beat the market, indexers are accepting average which I don’t see as a free lunch. They’re already resigned to the fact they won’t beat the market, but are happy to settle for that, knowing they’ll have lower costs, less mental work, etc.
@Scott — the free lunch here would be relying on the work of active investors to analyse and try to put the correct value on shares. “The market” is a result of that work at any moment in time (plus or minus any disputed in elasticity effects…)
I suppose one could argue that the active investors are effectively squabbling over the bill themselves in terms of the Gains/losses netting out, but nevertheless there’s billions of dollars of work here index investors aren’t paying for.
Of course how many billions are required to keep a market efficient is open to debate. I’d be very open to believing it’s a lot less than is still being paid today! 🙂
Enjoyed the BBC piece on willpower. There are so many mysteries in obesity which get little attention as we’re still stuck on the now discredited calories in, calories out model. It’s the only large scale public health intervention which has not only not worked but gotten worse (including other interventions which also require ‘willpower’ like smoking cessation).
On The Root of All article, symbols and ritual are thought to have a role in nourishing the non-propositional machinery beneath the intellectual abstract world we consciously inhabit.
There has in a way always been tracker funds and a lot of money in them.
Just a different name, closet trackers, basically a tracker fund where an a manager fiddled around the edges and called it an active fund.
If you went to your local bank you tended to end up in one of those. There will always be actively managed funds, hope springs eternal.
I’m not surprised Terry Smith is blaming his poor performance on index trackers its a common practice by politicians etc, blame someone/something else. That way you get your customers to shift their focus away from your poor performance.
I wonder how the active v passive argument will play out once the much predicted correction occurs. I suspect that global trackers stuffed to the gills with AI plays may fall more significantly than Train/Smith – making the active plays ironically but temporarily the low volatily choice.
On a somewhat different note I would be really interested in Monevators opinions on Cedebergs July 2025 paper “Beyond the Status Quo A critical assessment of lifestyle investment advice”. Also any comments on Morningstar’s paper “The state of retirement income for 2026” that outlines alternatives to the fixed withdrawal rate e.g guardrails approach would be very welcome.
So the Trump administration has fully escalated the battle with the Fed. Its going to be a long week
Nassim Nicholas Taleb recounted the time he worked as a trader for some large bank in New York, and at the weekly team meeting, he was asked for his view on whether the market would rise or fall in the coming week. He replied that he expected the market to rise, on balance of probabilities, as it had done for many weeks.
One of his colleagues “called him out” (or whatever this kind of misbehaviour was called in the 1980s), demanding to know why Taleb held a short position in the market, if he believed that it would rise in the coming week.
Taleb calmly repeated his stated position that the market was likely to rise over the coming week, but if it didn’t, then it would fall a long way, and then he would profit handsomely.
Many investors are asking the wrong question (“will the market rise over the next week?”), rather than looking at how to make rich returns from other people’s preference for steady return.
It might be a good time to buy some call options on Iranian equities.
@TI, ‘There’s no such thing as a free lunch’… I’d guess for a couple of reasons. 1. The passive flows mimic the active ones by rule, providing a leveraging effect to the active stake. Risk free leverage sounds pretty good. 2. Passive contributions add a degree of slower moving liquidity. Surely some advantages to the actives here.. or not, apparently!
IC covering Fundsmith today.
Fundsmith still has, for all the under performing, a 30% Tech exposure, and that’s despite trimming Meta (but retaining Alphabet).
Only 20% in consumer staples.
But I thought low cyclicality and volatility consumer staples was the strategy……..
Interesting to see Terry’s retention of Fundsmith’s stock position on Alphabet.
It leads now, or is in pole position, on so many vectors.
Tensor Processing Units as an alternative to Nvidia GPUs; Android OS dominance, leads on user experience (perhaps level with Claude) with Gemini, Gemini chosen by Apple for Siri etc, Chrome browser dominance, 90% global search share, leads of ‘AI’ search summary, Waymo LiDAR far more reliable for FSD than Tesla visual systems (human intervention once every thousands of driver miles versus dozens), Weymo partnering with Uber, Google Cloud holding own with AWS, Azure etc.
Just on that Alphabet point:
https://substack.com/@tacticzhazel/note/c-200877760?r=2kxl2k
And here’s the passive = eventual doom argument in all its glory:
https://youtu.be/dkL4oz8iEg4?si=9_yfIOZjueXHoWAX