HOW STEVE KNOWS THE GUEST

Smith offered Steve a job at Collins Stewart many years ago but Steve went elsewhere and they have had very little contact. Last year, Steve bumped into Terry at his Annual Shareholders Meeting and asked him to come on the podcast. They waited until Terry’s next trip to London. Steve is now hoping for an invite to the opening of Terry’s automotive museum in Mauritius.

Contents

00:02 – Introduction to investing insights
09:03 – Communication in investment teams
16:14 – Analyzing market opportunities
23:59 – Interest rates and market trends
34:12 – The future of technology investments
46:43 – Challenges in financial analysis
54:35 – Predictability in investment choices
01:06:47 – Building a car museum
01:22:50 – Terry Smith: A human investor

Transcript

STEPHEN CLAPHAM: Hi, I’m Steve Clapham and welcome to the Behind The Balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of successful investors’ strategies and tactics.

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TERRY SMITH: He’s been called Britain’s answer to Buffett.

STEPHEN CLAPHAM: And the Financial Times described him as “Britain’s most popular stock picker.” I’m not sure about either moniker, and in the course of my research, I heard him described as smug and arrogant. I heard stories like he wrote a sell note on his employer in his first week, and even that he headbutted a client at a black-tie dinner. My guest is of course Terry Smith.

STEPHEN CLAPHAM: And yes, he did publish that sell note on Barclays as the bank’s analyst at its subsidiary BZW. But definitely not in his first week. And no of course, he didn’t headbutt anyone. Terry attracted criticism and is the envy of his peers because he has produced a stellar track record using an extremely simple philosophy which he markets more effectively than other fund managers.

STEPHEN CLAPHAM: In our discussion he explains why he was underperformed for 5 years and why he isn’t doing anything about that. Why he thinks we’re overdue in economic correction. Why passive has gone too far. Why returns from his fund are unlikely to be as good going forward, as they were in its first decade. What he thinks about AI.

STEPHEN CLAPHAM: Why his team think when he emerges frustrated from a meeting with management, that’s a good signal to sell the stock. Why reading the accounts is a technique that everybody should employ, and almost nobody does, a subject close to my heart. And why he collected 230 cars, and is building a museum to house them. I waited a long time to have this conversation in person, which meant donning a suit and tie.

STEPHEN CLAPHAM: Which is a rare event in my business life. It was worth waiting for. I’m so glad Terry gave up time on a visit to London for a conversation which you are sure to enjoy.

STEPHEN CLAPHAM: So, Terry, listen, thank you for doing this. I’ve really been looking forward to it and I normally start by asking people, did you always want to be an investor? But I know that’s not true for you because you’ve had an amazing career. You Been successful as a number one banks analyst, which was a difficult sector, not an easy thing to achieve.

STEPHEN CLAPHAM: You’re the CEO of two public companies. You even did an LBO of a broking firm, which I imagine made you a lot of money, and as an investor and the founder of Fundsmith. Four successful areas, if you count writing books. So what is it that’s made you so successful?

TERRY SMITH: Hard work, a desire to succeed, I suppose. Luck, never write it off.

TERRY SMITH: I’m rather interested in movies amongst other things. And I’ve often been asked, what was the inspiration for you? So I grew up in East London in quite very poor circumstances. I mean, it’s not a lassy story, but I grew up in a house with my grandparents and my parents with no running water or indoor bathroom or any of that sort of thing.

TERRY SMITH: And then in 1968, I went to the ABC Cinema in Upton Park, which is where West Ham used to be, West Ham United used to be. And I watched a movie called The Thomas Crown Affair.

TERRY SMITH: And in it, Steve McQueen is a hedge fund manager basically who organises a bank robbery, as I’m sure you’re aware from the plot. But more importantly from a young lad from East London, he wore Savile Row suits, got to drive a Rolls Royce, fly a glider and have sex with Faye Dunaway.

TERRY SMITH: And I thought, well there’s nothing to dislike about all that really, is there? And I guess what it did was it made me realise there’s another world out there. Because it’s very difficult I think if you go up in those circumstances because you’ve got… no one to tell you that there’s another world out there. Of course, yeah.

TERRY SMITH: And so really that was the inspiration to go and do something. And then I’m often asked by young people now, what should I do? I said, join an organization that will give you as much training as you can absorb and take it.

TERRY SMITH: Lucy Kellaway wrote a really good article for the Financial Times, many good articles for the Financial Times some considerable time back in which she said the sort of the dot-com era and the gig economy and so on have done a great disservice to some young people because they all want to start their own business. The reality is most of them will fail because that’s what happens with all people who start businesses actually.

TERRY SMITH: What you should really do is go and get a lot of experience first, get somebody else to pay you whilst you go and get trained and you get on the ground experience. Then maybe you can set your own business up and start going out there and do your own thing.

TERRY SMITH: And that’s what really gave me the impetus to go and do that. And that’s what I did. I went and got a lot of training and experience before I got to do running businesses or leverage buyouts or any of the other things that you’ve described.

STEPHEN CLAPHAM: But is it just drive that made you so successful?

TERRY SMITH: It’s a long… I mean.

STEPHEN CLAPHAM: You’re obviously quite smart.

TERRY SMITH: That’s for others to judge. Opinions about yourself are not really objective. So I’ll leave you to make your mind up about that or you and others to make your mind up about that. But yeah, drive is a large part of it. The desire to succeed is something. And it’s a peculiar thing.

TERRY SMITH: I actually believe in a concept called obliquity, which is when I first encountered the word, I didn’t believe it was a real word, but I assure you it is. And it’s about… Getting a great result by not aiming for the money shop that people who go I would just want to be rich That’s what I want to be. I want to be that’s not really what it was about.

TERRY SMITH: It was a desire to succeed actually Was really the thing when I go back and think about it and analyze it and and that that persists I think you know we understand we might talk about cars later one of the the cars that I think is one that I most admire is the McLaren f1 the road car and I The thing that makes it so great is Gordon Murray designed it, A, without limits and B, everybody involved in it assures me and everybody else that they never made a single calculation of what its top speed would be.

STEPHEN CLAPHAM: Oh, sure.

TERRY SMITH: But it does 240 miles an hour. They just wanted to make the best car that had ever been made, as it were, of that type. And I think that’s really what it gave me was a desire to do things like that.

STEPHEN CLAPHAM: And is that you want to be the best? Is that a big driver?

TERRY SMITH: Yes. Yeah. Yeah. Yeah, and I think it’s important to externalize that to a degree. I think if you keep that as a deep dark secret that you want to be the best, it probably doesn’t work. You’ve got to sort of almost set yourself up for the possibility of failure by saying you want to be the best, by making it clear you want to be the best.

TERRY SMITH: There’s a quote from Theodore Roosevelt. I’m a historian by training. I’ve got a history degree. And his period, the progressive era in politics in America, was actually one of my main subjects for my degree. And he’s got this speech, The Man in the Arena. Yeah.

TERRY SMITH: I don’t know if you’ve ever come across it where he says, “It’s not the critic who counts. It’s the man in the arena.” “It’s the man who’s actually striving to do the great things who comes up short.” And he says, “And even if he fails, at least he won’t be like those timid souls who never know either victory nor defeat.” And I think he’s absolutely right.

TERRY SMITH: It’s about saying, “I want to do really important good, great whatever-it-is things,” and being clear about that to everybody who works with you and for you and the people that you interact with as customers. And in so doing, I’m afraid, like the man in the arena, giving rise to the possibility that you may fail and be laughed at.

STEPHEN CLAPHAM: But that doesn’t bother you?

TERRY SMITH: I wouldn’t say it doesn’t bother me at all. Of course, it bothers me, but I don’t see another way.

STEPHEN CLAPHAM: So look, you live in Mauritius now. What does your typical day look like?

TERRY SMITH: Pretty much like everybody else’s typical day, except the sun shines more, I would say. Which, by the way, I probably go on the beach less than the average person who goes on a holiday once a year because I live there, basically. Right. I get up fairly obviously and the nice thing is I’m three or four hours ahead of London, depending on where the clocks are, four hours at the moment.

TERRY SMITH: And so I can sort of do my ablutions and have some breakfast and read anything that’s coming overnight. And then I typically if I can slip off and do an hour of Mai Tai training to get me going. That’s something I enjoy doing.

TERRY SMITH: And then I get stuck into reading London as it opens. I get news in from my colleagues there about what’s going on if anything in London, Europe and so on. And then by the time I finish with that, I’m ready for Wall Street. My colleagues who are sitting in Connecticut to tell me what’s going to happen or is happening there.

TERRY SMITH: And I deal with that. And I get the flows in or out of the fund also in the middle of the afternoon. So I deal with that. And then sometime around sort of dinner time, I’ll sign off and hope that I won’t have to be having anything to do again unless something comes up. And if it does, well, the phone will ring.

TERRY SMITH: And they’ll say, look, this has happened and you just ought to know about it really. And that’s fine any time, night or day of that. But, you know, I suppose my working day probably starts in terms of me sitting down at the desk a little bit later than most people as a result of that and ends a bit later as well.

STEPHEN CLAPHAM: How do you manage the communication across the team? Because you’ve got, I don’t know, you’ve got three analysts. There’s you in Mauritius. There’s rather more than that.

TERRY SMITH: There’s rather more than that now. We’ve got a few more analysts. There’s half a dozen of us on the analytical team.

STEPHEN CLAPHAM: And you say of ours. Do you count yourself as an analyst?

TERRY SMITH: Yes. I count myself as an analyst. And we, I mean, you know, there’s this new thing called the internet. I mean, it’s a marvellous thing. And the telephone. Really? Yeah, yeah. Your emails and all that kind of thing. Look, we went to the cloud. I need to go back and look it up.

TERRY SMITH: I’m going to say about eight years ago, something like that. We were operating out of three locations, London, Mauritius, and Connecticut. We realised, you know, it’s quite important for us to be able to log on to the system and have the whole thing, whatever we’re looking at, come up on a screen exactly the same, whether I’m sitting in London or Connecticut or Mauritius and anybody else in the firm.

TERRY SMITH: And that if we all want to discuss Diageo, because there’s new TV earlier, we can all look at our Diageo notes and our Diageo figures. And we can all do it at the same time online.

TERRY SMITH: And that’s what we do. And then typically we meet in, physically about once a month as well. So we get together in London cause that’s a pretty central point between Connecticut and Mauritius, but sometimes it’s in Mauritius and sometimes it’s in Connecticut.

TERRY SMITH: And we physically meet them because there’s no substitute for that in the end. But, no, communications is I mean, even if I was sitting in the UK still, I doubt whether I would go to the office every single day because what I’m actually really being paid to do is to read things and think.

TERRY SMITH: Going to the office is great. I can drink coffee and talk to people. It’s wonderful and necessary from time to time. But, actually, the reality is we’re really They’re to read, absorb, think, analyze. That’s the real job.

STEPHEN CLAPHAM: And is that the same for the analysts? So they can sit at home and…

TERRY SMITH: No, no, no, sit at home. I mean, mostly we do go to the office. But, you know, it’s… I’m just saying, you know, I don’t think there’s any difference in terms of what I do between whether I… People think there is an enormous difference. I mean, I don’t know why, but there isn’t between being there or being here or being in Connecticut.

STEPHEN CLAPHAM: Yeah.

STEPHEN CLAPHAM: So when you started Fundsmith, you were able to buy some amazing quality stock really quite attractive prices when we look back so in your first letter i think you said your average free cash flow yield in your portfolio was seven percent that way heading that way yes and if you did that today it would be three yeah i can’t do the maths in my head from seven to three three to 1.2 or something i suppose we could go there but unlikely i mean does that mean that Your investors should resign themselves to making not quite as stellar returns as they have.

STEPHEN CLAPHAM: In the first 10 years of the fund?

TERRY SMITH: Yeah, probably. There’s a lot of ways of making a return. The way I always do it as a rule of thumb is to take the yield at whatever level you want. You can take the dividend yield if you want or the earnings yield or the free cash.

TERRY SMITH: I think the free cash flow yield is the best in many respects for reasons I can go into if you wish. And you add what you think is the medium-term growth rate, so five years out, something like that. And when you add those two together, that should give you your expected return.

TERRY SMITH: Let’s call it 8% per annum, and there’s a 6% starting yield. Well, 14% might be the number. Funnily enough, 15% is what we’ve done. There we go. And if it’s now 3%, and they’re capable of growing at 8% still, well, it’s probably 11%, isn’t it? Now, there are things that can change in relation to that.

TERRY SMITH: Obviously, the growth rate can change. And from time to time, one of the things that helps is– we’re talking about the average free cash flow yield on the portfolio being six and being three in a bit. Is occasionally the market, not very often, comes along with a great company and offers it to us at 10% or 12% free cash flow yield.

TERRY SMITH: They did it with Microsoft, right? At $25 back a decade ago. And we sit there and go, have we gone completely mad and missed something here? And we usually try and analyze it from the angle of, well, what does everybody else who’s saying that you shouldn’t buy at $25 think? What’s their reasons?

TERRY SMITH: And we try and analyze what people are saying the other way. But then if you buy it at a 12% free cash flow yield, I mean, you’ve then you’re off to the races, aren’t you, if you really have got a good business that can grow. But that doesn’t happen all that much.

TERRY SMITH: I mean, markets are not perfect in my view, but they’re not totally imperfect either. And so it doesn’t make you very many offers of reasonably large, great businesses knock out valuations. But when it does, that gives you the opportunity to get from the kind of calculation of, oh, well, Terry, so it’s three and a bit, which it is at the moment, plus eight, so it gets you to 11 or 12.

TERRY SMITH: That’s a bit lower than 14 or 15, isn’t it? Yes, it is. But that’s the way life is sometimes. If you’ve had that change in valuation, you’ve absorbed some of the future return almost certainly.

TERRY SMITH: But then, of course, there’s a possibility that I’ll come in and somebody will go, well, actually, something, I don’t know what it is, is sitting there on a massive free cash flow yield. You know, our friends at Diageo who are in the news, they’ve got a new chief executive. They’ve definitely got a free cash flow yield above 6% at the moment. Discuss. Do I want to buy that or not?

STEPHEN CLAPHAM: Do you?

TERRY SMITH: No, I don’t think I do. But yeah, but… But that doesn’t mean I won’t think about it.

STEPHEN CLAPHAM: I mean, Dave Lewis has got an impressive track record. Funny enough, he came into Tesco and I was doing some work in Tesco. So I went along to the analyst meeting and all the analysts, of course, were crowded around the CFO, Alan, whom I knew anyway. So I didn’t need to speak to him. And I had like maybe 20 minutes. It was me and a guy from Lloyd’s Bank and Dave Lewis. And he was incredibly impressive.

TERRY SMITH: I don’t know him. So I couldn’t comment. I mean, obviously, I’ve seen the record at Tesco. But I am mindful before we go down that route of that great Buffett quote. I mean, there are many great Buffett quotes. So you spend the entire interview on the remainder of them. But when a business with a bad reputation meets a manager with a good reputation, the reputation of the business usually survives intact.

TERRY SMITH: And I think that you can see so many examples of that across the world. It’s true. Changing things, the basic business is not all that easy, is it? And there are certainly in the drink sector… a number of sort of possibly structural problems at the moment that they’ve got to address.

STEPHEN CLAPHAM: So you’re quite negative now because you sold Diageo.

TERRY SMITH: Yes, indeed.

STEPHEN CLAPHAM: You trimmed Branforma and now you’ve sold…

TERRY SMITH: We’re out of Branforma.

STEPHEN CLAPHAM: But as of six months ago…

TERRY SMITH: As of on the drinks companies right now. And we follow five drinks companies in our investable universal portfolio. So we don’t currently have any drinks companies.

STEPHEN CLAPHAM: But you didn’t knock out… Do you add your own Brown Foreman at the same time?

TERRY SMITH: No, no. Well, for one thing, we sometimes move a bit gradually because, you know, this will probably shock you, but sometimes we’re wrong. And so before we go 100% out here, this is a sector which historically has been quite good.

TERRY SMITH: And then we hang on to the Brown Foreman in part because it’s a family-controlled business and one can always be as we are generally optimistic of good long-term decisions out of family businesses.

TERRY SMITH: As I say, secular structural headwinds at the moment for us to own anything there.

STEPHEN CLAPHAM: I mean that’s the Generation Z, not drinking as much, there’s the Zempic weight loss drug impact.

TERRY SMITH: Yeah if you look we last time I looked we had data on 150,000 households over two years who had a household where at least one member was taking one of the weight loss drugs and they analyze their spending from their card bills and such like and there’s no doubt the very first thing to go is alcoholic drinks.

TERRY SMITH: So there’s that and actually generations and of course the rise of cannabis. You know, cannabis is legal in virtually every state in the Union in one form or another now in the United States Of America.

TERRY SMITH: If you visit Thailand, I mean, you can’t go down a street in Thailand without a cannabis shop appearing in front of you. And it’s clearly another… I’m not saying it’s good or bad. I’m not making any judgment on it at all. I’m just saying it’s a thing.

STEPHEN CLAPHAM: And it’s an alternative. So I got sidetracked slightly on Diageo. I think this is a fascinating case study. One of your mantras is “do nothing”, which is fine when things are going well, right? I mean, things are going up and you can sit back. I just wanted to get your thoughts on what happens when things are going less smoothly.

STEPHEN CLAPHAM: So in this seat that you’re sitting in, Nick Train was sitting a couple of months ago, a very good investor, a very smart guy. And if we’d been having the conversation in July 2019, when I think his fund peaked relative, but he’d done phenomenally well. He’d done two and a half times the benchmark. And then the last six years, he’s done half the benchmark returns.

TERRY SMITH: Well, perhaps he’s become an idiot.

TERRY SMITH: That’s one possibility, I suppose. I’ve got to say I regard it as a little unlikely.

STEPHEN CLAPHAM: But I just wanted to get your thoughts on this. I mean you’ve had a similar experience not nearly as extreme as Nick’s.

TERRY SMITH: No, no. I sympathize with Nick for that reason. I think there are a lot of things to say about it. One of them is let’s analyze the causes of it and see what we think about that. And I can come back and do that. And I’m very happy to try and do that if you wish. But the other one is to say, you know, someone once said Underperformance in a strategy is a feature, not a failure.

TERRY SMITH: It is absolutely inevitable that it will occur. It’s just how you deal with it, actually. That’s really what this comes down to. And so I think the idea that you can have a strategy where this never occurs is… Well, Bernie Madoff managed it for quite a while, but leaving aside that one methodology, I don’t think it’s possible.

TERRY SMITH: So you have to accept that it’s going to occur and how you’re going to deal with it. And look, yes, it does involve a degree of introspection to… What could we have done better? Because undoubtedly, there’s some human error in these things. What could we have done better? And again, I’m happy to go through that because we do.

TERRY SMITH: We sit there and go, what is it we could have bought that we didn’t buy? What is it we could have sold that we didn’t sell in time? And so on. And we do that. But you just have to accept that there are these phases in markets and that they will knock you off course. And if you decide to change strategy in the middle of them, you may be knocked off course forever, actually.

STEPHEN CLAPHAM: Well, that’s a problem, isn’t it?

STEPHEN CLAPHAM: Once it goes on, so for Nick it’s gone on for six years, and he was so uncomfortable talking about it and he was obviously very distressed for his clients, which I know credit to him.

TERRY SMITH: Well, I think Nick’s in a similar position to me. I don’t know. Neither of us is probably doing it for the next pound, I think. No, sure, yeah. The pair of us are doing it because it’s what we want to do actually.

TERRY SMITH: And one of my clients gave a speech at a breakfast I sponsored on one occasion very kindly, and he said The thing that he’d worked out about me over time was that the thing that would most upset me wasn’t losing money, it would be letting people down. And I think that’s why Nick is probably distressed, that’s why it causes me a degree of literally sleepless nights sometimes.

TERRY SMITH: It does, thinking about, you know, because I’ve got one of our annual meetings, we have an annual meeting one year, a guy came up to me and said, I bet you don’t recognise me. And I said, your first name is Ken, you lived in Field Road in Forest Gate, and you sat next to me on our first day in school in Odessa Road Primary School.

TERRY SMITH: And I’m bloated if I can remember your surname. And he said, Devereux. And I said, Ken Devereux. Got you. And we had a little chat and that was it. And he wrote me an email or something afterwards saying, you know, I’ve been with various charlatans who charged me 3% fees and produced terrible results.

TERRY SMITH: And the difference is now my family feel that our retirement is secure because of what you’ve done in terms of the money. And, you know, I don’t want people to think that I’m not a capitalist because I am. The day I say, you know, I’m not interested in all of that is the day you should run away with your hair on fire. Of course.

TERRY SMITH: I think capitalism works, and I’m in it. But it gives me a good feeling to feel that there are people like that that we’re doing that for. It gives me a very bad feeling to think, you know, that they might have got to the point where they feel, well, blimey, that’s not very good, is it? I don’t like it.

STEPHEN CLAPHAM: And it goes on for an extended period. So let’s just take a hypothetical situation where it went on for an extended period.

TERRY SMITH: Well, it already has, I think. We’re in about the fifth year, roughly.

STEPHEN CLAPHAM: But, well, so I mean, you know, after a few years, you’ve got to think, well, hang on a second. Is there a structural change? So how do you go about thinking through that? One of the things that Nick has done is to try and shift away from like, you know, the biggest emphasis on the consumer and shift away to some AI peripheral beneficiaries, that sort of thing.

TERRY SMITH: We did that some time back. I mean we’ve been in Microsoft and the old Facebook and Alphabet for quite some time. We’ve already done that. I think it’s a bit like this. Why do we have postmortems for human beings? Well, is it because people like messing around with cadavers?

TERRY SMITH: Well, maybe they do but that’s not really it, is it? Somebody dies in circumstances where we don’t know what it is. We have an autopsy. In order to determine the cause of death, because there might be something we need to do about it. It might be foul play. It might be a virus that we have. That’s what we do.

TERRY SMITH: We tend to go through and have an autopsy and look at what the causes are to see whether or not the causes are us in terms of execution, whether the causes are the strategy no longer functioning in some way that we hadn’t foreseen, or whether it’s other factors which are important but not likely to persist.

TERRY SMITH: Grit our teeth, bite down on our gum shield and keep going. And we tend to try and analyse into those factors and say, well, what’s the biggest part of this?

TERRY SMITH: And that’s what we’ve done over the last few years, basically.

TERRY SMITH: And I think there are a lot of things that have gone on here which helped cause all this. And I’m perfectly willing to talk through the mistakes we’ve made because, believe me, there are a few.

TERRY SMITH: That’s not the biggest part of it by far. The biggest part of it are…

TERRY SMITH: The rise in interest rates, which is problematic in a quality strategy because we are owning the equivalent of long-dated bonds. We’re always the things that we won’t own, the cyclicals and those financials are going to rise. So that happened in 2022, 2023. And then just as we were breathing a sigh of relief, well, the rates seem to have peaked. Guess what happened?

TERRY SMITH: Suddenly, the magnificent seven arose. I mean literally in like May of 2023, that phrase was coined, which was telling you there were these seven companies which were all conquering in the eyes of the market in terms of their performance. And then that was 2023 to 2024 gone, and you might think, well, we’ve seen an awful lot of that, maybe that won’t be perfect.

TERRY SMITH: Jensen Huang, the CEO of NVIDIA, got up in May of 2024 and said, AI. And then we’re off to an arms race in terms of capital spending and share price performance. And we’ve got to the point where the top 10 companies in the S&P are now two-thirds of the return of the S&P. And some other interesting statistics, probably the whole of the GDP growth of America is AI spending.

TERRY SMITH: It’s like wow these are kind of interesting statistics. And so we had interest rate rise, Magnificent Seven, AI and then as well as all these events that were going on we had this huge tailwind that was going on at the same time which was the rise of index funds. So the last time we had an episode like this was the dot-com era.

TERRY SMITH: And that was brilliant. Pretty interesting for people running money at the time. We were trying to follow a discipline of the sort that we’re following. They had exactly the same set of problems. I think it’s more extreme this time because in 2000, when we were running into the peak of the dot-com, early 2000, the proportion of assets under management in index funds was under 10%. It’s now over 50%.

TERRY SMITH: And people think, we don’t help ourselves in investment with the labels that we use sometimes. People say, oh, these are passives. Well, they’re passive in the sense there’s no fund managers, no Nick Train or Terry Smith, you know, pulling the trigger on making decisions.

TERRY SMITH: Yeah. It’s not a passive strategy. It’s a momentum strategy. If you get fed up with me and take your money out of my fund at the end of this and put it into, or your listeners do, put it into an index fund, it’s going to go in the index fund in proportion to the size of the companies in the market, which means NVIDIA is going to get the most.

TERRY SMITH: And I don’t own any NVIDIA. So guess what that’s going to do to the share price of NVIDIA, particularly when you start looking at the size of the flows.

TERRY SMITH: That’s the backdrop to all this. As we had this whole Magnificent Seven AI boom hype coming through, we also had the flow of funds going into passives, which were giving it a momentum, basically. John Bogle, the founder of Vanguard, who was, of course, in many ways the pioneer of index investing, was interviewed in 2017 at the Berkshire Hathaway annual meeting. You can still find it online.

TERRY SMITH: And he was asked, do you think there will be a level of AUM that’s in index funds which will distort markets and he said oh certainly and then they said can you tell us how much he had a guess he said but no it’s just a pure guess he’s I’m anywhere scientifically – I think we may already have found that where money is going into these companies that they are delivering two thirds of the market’s return and it’s going into them irrespective of their quality or valuation and the I mean once you’ve got me started this you may not need to speak for made an interview The problem that it’s causing is one of capital allocation.

TERRY SMITH: When you get these crazes in markets that go on, capital allocation will distort. So the stock market isn’t there to provide an alternative to online casinos. That’s not actually its function. Really? Yeah, I know that’s a shock for a lot of people.

TERRY SMITH: It’s there as a mechanism for capital raising and liquidity and to provide a valuation as a basis for those things. And once we start distorting these things, you get some very, very interesting results basically because the People start making decisions on how to allocate capital based upon share prices, not the other way around.

TERRY SMITH: Share prices should follow what’s being made in capital allocation, not the other way around. And people get all kinds of mad at this. If you go back to the dot-com, one of the heights of the dot-com, you may recall, was Vodafone bidding for management. Vodafone was on a PE of over 50 and so was management.

TERRY SMITH: At Vodafone, the share price when they bid was about 570p. It’s 88p now. Still, it’s that high. Yeah, I know, shock isn’t it? It’s rallied a bit. But wow, that’s what happens if you destroy a couple of hundred billion euros of capital by doing this. And people come up with all kinds of…

TERRY SMITH: When these manias are running, people come up with all kinds of explanation. They never just say… It might be a mania because then you’re kind of standing out for the crowd and you’ve got this risk of looking very stupid And so they never do that.

TERRY SMITH: They rationalize it don’t know It’s always because go back you don’t have to look at the stock market in the dot-com or what we’ve got now Go back to Japan the late 1980s the Nikkei peaked In 1989 on a p of over 50 that was because Japanese company accounting was very conservative.

TERRY SMITH: No, it was just over actually and it took I think 24 years to regain its peak and People forget, you get these long periods when destruction of the salt that this may lead to produces some very bad results. I mean, the S&P peaked in 2000, I think, along with the NASDAQ. The NASDAQ was more extreme, but the S&P now, right?

TERRY SMITH: So sort of an index with a lot of other stuff in it peaked in 2000. It just about regained that peak in 2007 and then it fell over again. In the credit crisis and didn’t get back. I mean, the reality is it took till 2013 to get back to where it was in 2000 in a persistent upwards movement.

TERRY SMITH: That’s what happens because that’s what this leads to or can lead to.

STEPHEN CLAPHAM: – there’s all sorts of things you- – You wish you had started me now, don’t you? – no, no, I’m just trying to work out what to ask you. I mean, do you think we’re overdue for a big correction?

TERRY SMITH: – oh, massively overdue I think, yeah. I mean, look, The last economic downturn, try and bear in mind, was in 2008-9. So we’re already 16 years out from that. It’s quite a long time, isn’t it, in economic cycle terms?

STEPHEN CLAPHAM: Well, I always look back and say, well, actually the last normal economic downturn was 2002-2003. Yes. Because in 2008, the world stopped.

TERRY SMITH: I’m not even sure that was normal. I mean, the last you’ve got to go back quite a long I reckon you probably got to go back. The last one which was not in some way around a stock market bubble unraveling or a credit crisis like we had in 2000 was probably the 1990-1992 one that followed the invasion of Kuwait by Iraq.

TERRY SMITH: And then we had the whole green span sort of saving every time the market fell. And then we had the dot-com meltdown. Yes, but was it really here’s a question I always ask people. Other than Lehman Brothers… Name a company that went bust in the credit crisis.

TERRY SMITH: I’ll go and get myself a cup of coffee while you’re having a think about it.

STEPHEN CLAPHAM: Yeah, I’m not sure if I’ve got reception in here. I don’t care if you’ve got reception or not.

TERRY SMITH: The answer will be the same even if you have reception. There aren’t any.

STEPHEN CLAPHAM: There aren’t any, no, of course.

TERRY SMITH: Well, that’s not natural. It’s not normal. We’ve been saved from the consequence of this and capitalism does need its creative destruction, which is… Very painful for the people involved in the creative destruction.

TERRY SMITH: And if we don’t have, and I’m a great believer, and we should have sympathy for them, right? We do need a safe connect. I’m not sort of Robert Barron, believe it or don’t. But I do think that it’s necessary to have it.

STEPHEN CLAPHAM: Yeah. Well, we’ll soon see.

TERRY SMITH: Well, not soon. We might still be sitting for a while. I mean, typically, of course, what happens is I was reasonably friendly with Tony Dyke because I’ve been at UBS when he ran PDFF.

TERRY SMITH: And of course, I think if we look it up, it was almost to the day that he was fired from and PDFM, the dot-com boom collapsed. Yes, it was very, very close. Presumably somebody has got to fall on their sword in terms of pursuing our strategy or something like it to Mark the end of this one.

STEPHEN CLAPHAM: Interestingly, there’s two things just to mention about the gamification. Richard Thaler, the guy who wrote the book Nudge, was speaking in London. He was interviewed by Tim Harford 10 days ago. And I went along and he actually said that on Robinhood, the most popular product is weekly options.

TERRY SMITH: Bit long. Bit long term.

STEPHEN CLAPHAM: Yeah.

STEPHEN CLAPHAM: I prefer the bet on it by then. But I was shocked by that. I don’t know why I was shocked. I mean, I’m not really surprised, but it does tell you quite a lot about the state of the market.

STEPHEN CLAPHAM: The other point I was going to make, I don’t know if you’ve ever read anything by Michael Green of Simplify. But he’s done a lot of work on passive investing. I’ll send you the stuff. And he reckons that a dollar into NVIDIA has an $8 impact on valuation.

TERRY SMITH: I’ve seen the basic research on which this is based. There’s a National Bureau Of Economic Research, the MBER paper on it, in recent years, a couple of years back, which they came up with a multiplier of a dollar invested into the funds going into NVIDIA like that There’s something we multiply somewhere between three times and eight times.

STEPHEN CLAPHAM: Yeah.

TERRY SMITH: Because they point out that there are very few people who can go the other way because first of all the majority of assets are now indexed so they can’t go the other way can they? Secondly, even out of the active people a lot of people of course are closet indexers.

TERRY SMITH: They’re hugging the index and frankly given how it feels not to who can blame them? No absolutely. I mean I hope we’re reasonably honest about it. We say to people if you want the index go buy the index. It’s cheaper.

TERRY SMITH: You’ll at least get the exact result there but yeah those numbers are pretty awe inspiring aren’t they in terms of the multiplier effect?

STEPHEN CLAPHAM: Well, it will be awe-inspiring if it goes the other way.

TERRY SMITH: Well, it will be. No, I think my view is it will definitely be awe-inspiring at some point when it goes the other way. I just don’t know when that will happen or how that will happen.

STEPHEN CLAPHAM: No.

TERRY SMITH: But I’m fairly certain it will. I mean, in many ways, the dream of the active manager should be to be the last active manager left. But I think it could be rather painful getting there.

STEPHEN CLAPHAM: I’m not sure that it would be good because if you were the last active manager, there’s no price discovery.

TERRY SMITH: No. Well, you are the price discoverer at that point, aren’t you?

STEPHEN CLAPHAM: Yeah. That would be a dreadful… But I mean, we have gone too far. That was the conclusion.

TERRY SMITH: I have no doubt about that. Of course, that doesn’t mean we can’t go farther. It’s like selling things when they get overvalued or even buying things when they get undervalued.

TERRY SMITH: You have to accept that if your calculations, your analysis is right and If they’re undervalued, they could become more undervalued, couldn’t they? There’s nothing to stop them. There’s no sort of, well, it’s got that far at the moment that I think it’s going to stop here. Why?

STEPHEN CLAPHAM: And there’s no correction mechanism because even if we all accepted that indexing had gone too far, there’s nothing to reverse.

TERRY SMITH: Nothing that I can see.

STEPHEN CLAPHAM: No, which is actually a bit of a worry.

TERRY SMITH: Yeah. Yeah, I think it is, yeah.

STEPHEN CLAPHAM: Why did you choose this role?

TERRY SMITH: I don’t know. It seemed like a good idea at the time.

STEPHEN CLAPHAM: So you mentioned that unlike, Nick, you’ve had quite a big exposure to tech. But your exposure, if I look back, your exposure was like 20-something percent. It depends what you count as tech.

TERRY SMITH: It was your definition. You’ve got to be a little careful with the definition because it doesn’t involve communication. So Facebook’s not in there, for example. And so you’ve got to be a little bit careful.

STEPHEN CLAPHAM: But have you changed your definitions?

TERRY SMITH: No, no, no. But when you rely on so Visa is a Financial according to the sectors. Really? No, it’s actually tech. I mean, Visa is really tech. No, no, sure. Automatic data processing is really, you know, payroll processing. It’s really, I mean, the name’s a clue, automatic data processing. But today… They’re not the commanding heights of AI and hyperscaling, but they’re definitely technology businesses.

STEPHEN CLAPHAM: No, of course. But today you’ve got 10% in tech, and that excludes Meta and excludes those companies. Yeah. But, I don’t know, maybe five years ago you had.

TERRY SMITH: 20… 20-something percent.

STEPHEN CLAPHAM: So if you’d kept the 20-something percent, would you have done better?

TERRY SMITH: Yeah.

STEPHEN CLAPHAM: So what was the rationale for that then?

TERRY SMITH: The thinking that things had probably gone a little too far in some cases and that some of the investment… We bought the companies that were tech, which had fantastic returns on capital because they were pretty capital-like businesses.

TERRY SMITH: And that’s after all one thing we’re seeking. And good growth rates. And quite honestly, very big market power. You know, Facebook or Meta as it now is, was really the dominant communications technology company in terms of social media.

TERRY SMITH: Google, Alphabet as it now is, was the dominant search engine and the advertising that goes with it. Microsoft was the dominant business operating systems company. We’re all looking good at the moment.

TERRY SMITH: Then this started to change with hyperscaling in terms of data centers and now with AI. We’re heading rapidly towards companies which are not very capitalized at all. They’ve got lots and lots of capex going there. Hundreds of billions of dollars. And I think I’ve seen the future of trying to is a bit of a mugs guy.

TERRY SMITH: I think what will happen is either the returns will come down very significantly, which I think is quite likely at the moment, in which case they won’t look anything like the companies that we sought to invest in. So it’s kind of okay to be out there, notwithstanding what’s going on.

TERRY SMITH: Or the promised land of AI won’t arrive in anything like the timescale or manner that people think in terms of generating revenues and they’ll stop it. I think that would be rather ironic because what will happen is their profitability will go back up again and I think their share prices will collapse. Yeah. Somebody will go, oh, yeah, hi. It’s not happening.

STEPHEN CLAPHAM: But I mean, it seems blindingly obvious. I mean, I’ve had this conversation with a couple of guests on the podcast. You know, the amount of money going in, there’s no return. So the returns arithmetically have to go down. But the stock market is completely ignored in it.

TERRY SMITH: Yeah. Plus, look, the size of what we’re doing now, there’s something else to bear in mind. If you go back to when we had 20-something percent in tech and go back a few years, you know, the size of the technology sector in terms of spend by individuals and companies is significantly higher than it was back then.

TERRY SMITH: By 10, 15 years ago. So if we do get an economic cycle, and I’m sure we’re going to get one at some point, do we think tech is more or less cyclical than it was in the past, given that we now have.

TERRY SMITH: Big fixed asset investments, and it’s a bigger proportion of business and personal spend. I think it’s going to be a lot more cyclical.

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STEPHEN CLAPHAM: Now I wanted to ask you, the fund is probably what half where it was at the peak.

TERRY SMITH: In terms of what size?

STEPHEN CLAPHAM: Yeah.

TERRY SMITH: A bit over, a bit over half.

STEPHEN CLAPHAM: And you’ve got sort of a billion dollars in each position. So you’re still… Pretty constrained. I want to ask you about position sizing.

STEPHEN CLAPHAM: How do you do it? Because you’ve got to own very big stocks, and OK, you could have as much as you want of Microsoft, I suppose.

TERRY SMITH: But interestingly, ironically, that hasn’t really been a handicap in recent times because what we should have owned is the biggest stocks of all, which comes back to analyzing what the market’s doing.

TERRY SMITH: The way forward wouldn’t have been to find that gem down in the mid-cap area, which was limited liquidity, and therefore go, oh, I’d really like to own that, but I can’t because it’s too small. No, I should have just gone and bought NVIDIA. $5 trillion company, shouldn’t I? Which is kind of isn’t that an interesting reflection, I think?

TERRY SMITH: But on position sizing, we can’t really own because you’re just right, a billion dollars is about where we’re at. We can’t therefore own anything under about $10 billion market value because we don’t own 10% of the company and we don’t want to own 10% of the company because we’re an open-ended daily dealing fund, right?

TERRY SMITH: For good or ill, that’s what the market wants and that’s what the market’s got, I think. By the way, as a structure, that’s nonsense personally for an awful lot of strategies. But that’s what the market wants. That’s what it has.

TERRY SMITH: And therefore, we’ve got to be able to provide liquidity because people have destruction tested open-ended dealing funds with no liquidity. And we all know what happens next. Yes. So we’re not going to do that, are we? So we are not going to buy anything under about $10 billion or a bit above that.

TERRY SMITH: But there’s quite a lot of companies out there that you know, we get terribly worked up in the UK about sites. Terry Smith’s got sort of $35 billion in his funds and his position size is a billion dollars. I mean, we could put the entire lot into Microsoft, the entire fund, and have a disclosable position.

STEPHEN CLAPHAM: I didn’t mean so much that. I meant more about how you sized individual positions, how you’re weighting.

TERRY SMITH: Differently. Differently is the answer. Look, we’ll never own more than 30 stocks. Right. We’ll put that down. We’ll never own less than 20 stocks. Right.

TERRY SMITH: You can’t make the concentration limits that are mandated. If you work with 20 stocks, it’s impossible. So it’s 20-something stocks, okay? So you look at that and say, yeah, well, on what I’ve just described to you, we’re going to have an average position of about a billion and a half dollars actually.

TERRY SMITH: And then it depends how confident I feel about things when I’m sitting looking at what to do. So if you look back, we bought our L’Oreal position because we really liked L’Oreal. And then there was a bit of a family spat involving the Bettencourt family when the matriarch of it, Lillian Bettencourt, was sued by her daughter and there was a bit of sort of how is this going to work out in terms of the family controlling stake?

TERRY SMITH: So that was under a bit of a cloud from that. And at the same time, Clorox was bid for by Carl Icahn, which makes bleach essentially. And we looked at the two valuations and went, The thing you should never think, this is a no-brainer. And so we sold all of our Clorox and bought all of the L’Oreal on the spot.

TERRY SMITH: I said, right, I want that out and I want that in, in size now. Go and do me a bulk deal if you can to get as much. And we did. I mean it was almost in an instant we were from one to the other. Good. And then you get something like Fortinet which we own, which makes FortiGate routers, internet security. And they were growing at 20% per annum or something like that.

TERRY SMITH: And that was good. And then along came COVID, and we all had to work from home. So all of us I certainly had my IT man putting a 40-gauge router into the cupboard in my study. And everybody in work had one of those. And so growth went up to 40%. And then the old stock market is a funny thing, isn’t it?

TERRY SMITH: When COVID subsided, growth went down to 10%. So, of course, we had to have a mass panic then, didn’t we? The share price halved, and we bought a load of it. But we bought it in three stages because the way that the drop from 40% growth to 10%, it wasn’t that one day they said, well, we’re going to 10%. It went from 40% to sort of 30% to 20% to 10%.

TERRY SMITH: And, of course, every time there was a warning, it had another step downwards. So I said, look, these things come in threes. We all know these things come in threes. So I’m going to buy about a third of our stake off this. And then a bit later on, I’m going to buy another third and then I’m going to buy another third. And then if it’s still going down, I’m going to decide I’m wrong.

TERRY SMITH: They’re going to stop there. But that’s how I’m going to do it. And so it depends, there’s no one methodology of buying things. And sometimes if they perform very well, they might go to 10% of the fund. I mean, Microsoft and Meta, we didn’t buy 10% of the fund, did it? We bought 3% of the fund. And then it went to 10%.

STEPHEN CLAPHAM: And you’ve got a hard stop at 10. We’ve got a hard stop at 10.

TERRY SMITH: Which is mandated in and usage also says that we can’t have more than 40% in stocks that are over 5%. That’s, that’s hardwired into it as well.

STEPHEN CLAPHAM: All right. Okay, I didn’t know that.

TERRY SMITH: Yeah, it is.

STEPHEN CLAPHAM: Yeah. If you didn’t have the 10% hardwired, would you be happy owning a position that was more than 10%? Would you just let the winners run?

TERRY SMITH: Yeah. I’d be willing to. I’m not saying I would always let a winner run. No, no, no. I’m just saying I’d be prepared to take the concentration risk involved in that. Yes. Yes.

STEPHEN CLAPHAM: Interesting.

TERRY SMITH: Now, I don’t think the design of usage is particularly friendly to the investor. You know, like the concentration limit. So, you know, if something goes through 10%, or if… the ones over 5% go for 40%, I’ve got to sell stock. And as I explained it to our regulator on one occasion, I said, I come in some days and I’m worried that my biggest stocks will perform well. Do you think that’s sensible?

TERRY SMITH: I’m just saying, I think the way we should handle concentration is not by having hardwired limits. I think we should just give people information. We should say, here’s what our concentration is. And if they think that’s too much of a risk, then take their money away. Just give them information on what we’re doing so that they can make a make an informed decision about whether they want to run that concentration risk.

STEPHEN CLAPHAM: But the regulators are pretty clueless, aren’t they?

STEPHEN CLAPHAM: I was going to say I was going to ask you, the regulators are pretty clueless, but you perhaps don’t want to I couldn’t possibly comment. You perhaps wouldn’t want to answer that question.

TERRY SMITH: If you wish to say that about the regulators, then you can say it.

STEPHEN CLAPHAM: I wouldn’t But we arrived in the city at a time when it was all principles-based, where your word was your bond and you were trusted. So when I started, I was a Southside analyst, and I was given inside information And a client would call up and I used to write down what the client had said to the client before I was given the inside information.

STEPHEN CLAPHAM: And I just used to say the same thing. And nobody thought there was anything wrong with that. And I was an honest individual. And it worked fine. But now we seem to regulate everything down to the nth degree.

TERRY SMITH: I agree. I had a conversation when I was running Telet Prebond, the money broker at the. Tail end of the credit crisis with the deputy governor at the Bank Of England.

TERRY SMITH: We had a lot of interaction with the bank over time and we were talking about, you know, how things had gone during the credit crisis because we were sitting at the center of the banking system doing trades with banks in deposits and interest rate swaps and bonds and foreign exchange and so on.

TERRY SMITH: So we could see this very much and, you know, literally some of the things could affect us here in terms of settlement and so on with Lehman going bust and how do we handle all that? And he said something along the lines, he said, yeah, because he said you’ve come from another world really in coming into this.

TERRY SMITH: You come from a world where you were a partner in a broking firm and it was your money and your reputation. You think about this as an owner. He said that’s now something that doesn’t happen.

TERRY SMITH: He said the majority of the people you’re dealing with are salaried and highly bonused individuals who are guns for hire. He said and it’s a different world that we’re operating in now. He said you… You’re kind of, you know, you’re old school. It’s a principles versus agent.

TERRY SMITH: Yeah, and principles were the thing. He was roughly saying that. He said it’s about principles, about, you know, we don’t need to have a rule book that runs to 300 pages to decide whether what you just did was right or wrong, do we?

STEPHEN CLAPHAM: So I want to talk a little bit about accounting because it’s interesting. Both of us. And, you know, my perception is that earnings management is very prevalent these days. I mean, much, much greater than it ever used to be.

TERRY SMITH: Yeah.

STEPHEN CLAPHAM: So given that, why don’t people read the accounts? I mean, it’s pretty obvious that they don’t.

TERRY SMITH: It’s blindingly obvious that they don’t read the accounts. I mean, there’s many examples of that as you can sit here and listen to.

STEPHEN CLAPHAM: Well, the IBM cash flow example. The IBM cash flow is a cracker. I emailed them. You at least got a response. I didn’t even get a response.

TERRY SMITH: There are plenty more where that’s coming from in terms of people not reading the account.

STEPHEN CLAPHAM: I mean, it’s perhaps an unfair question, but do you have a theory why people don’t do this? Well, I think it’s… It seems plainly obvious that you should.

TERRY SMITH: Like most things, I think it’s a combination of factors. It normally is in human. And one of them is sort of a bit of… laziness really. Why do that when you’ve got the management presentation that they’ve given you? Of course, the management presentation has that little asterisk and it says adjusted for all the bad stuff and so on.

TERRY SMITH: And the problem is if you’re the one guy who reads the accounts, you can become like that old joke about the mum who went to the passing out parade at Sandhurst. And at the end of it, one of the officers said to her, what did you think? She said, it was a wonderful occasion just that everybody was out of step except my Johnny.

TERRY SMITH: You could become like that. Because if everybody else is not reading accounts and using a management presentation, and if the headlining that’s come up from what they say on Bloomberg is going that way, you’re the one going that way, how does this help exactly?

TERRY SMITH: And so I think it’s a bit of a mugger’s game in terms of people doing good old-fashioned analysis where they take the 10K or the reporting accounts and do some proper analysis and do some numbers. Quite often, they’ll find that they’re heading in what seemingly is the wrong direction.

TERRY SMITH: I think that’s part of it. We’re partly dealing with the same sort of thing that we’ve discussed already about the nature of markets now.

STEPHEN CLAPHAM: And the whole sort of reliance on adjusted EBITDA and adjustments for the run rate of cost savings. I mean, I had Greg Peters on the podcast. He manages, he’s the CIO of PGM, which manages, I think, $700 billion of credit. And I said to him, why do you put up with this?

STEPHEN CLAPHAM: And he said, well, you know, the thing is that there’s so much capital chasing the opportunity to lend to these companies. Private equity firms are basically borrowing the money. They dictate what the governance will be and the providers of capital don’t have the power. It seems like a bizarre situation, doesn’t it?

TERRY SMITH: It seems like it to me too, yes. I mean, of course. How does it end? Where I’m coming from, having written a book on accounting and having been an analyst and so on, I’m flabbergasted by it. But I mean, we quite often in you mentioned earlier how do we deal with each other.

TERRY SMITH: We do write quite a lot down in terms of really our research drives have gotten better. I don’t know, millions and millions of words, tables, and we write things down each day because otherwise your memory can play tricks on you.

TERRY SMITH: And very often we’ll say in something we’ve written to each other, even though we’re the only people who are concerned with it, share-based compensation, SBC. The number of people who X that out from their earnings, what is it then exactly? And not only that, it distorts the cash flow as well.

STEPHEN CLAPHAM: It really distorts the cash flow. Really.

TERRY SMITH: You can get some interesting cash conversion numbers if you pay everybody with your stock, right?

STEPHEN CLAPHAM: My favorite was Twitter. Where they i think they’d reported the final year before mr musk took them over it reported 650 million of operating cash flow unfortunately stock-based comp was 648 yeah so there wasn’t any no there.

TERRY SMITH: Wasn’t any cash flow wasn’t any cash in any normal business method so yeah i mean the number and we say we’re the only people who are concerned about this aren’t we there is nobody out there else we know from listening to the analyst calls with the companies right reading the material, going to company meetings and so on. We’re the only people talking to them about this.

TERRY SMITH: There are so many things that way. We’re the only people talking to them about it. And I mean, another area which you’ve not raised, but it’s the sort of corporate governance thing in voting on proxies on remuneration statements, right? We vote on every remuneration statement. We don’t use an outside proxy agency.

TERRY SMITH: We do our own analysis and we try and talk to management about our views on what should be in there, what shouldn’t be in there. But we quickly realize we’re kind of on our own where nobody else is doing this stuff. The one thing that you think I’d really like to think about now is how these people will be paid so I can try and guide them in how I wish them to run the business.

TERRY SMITH: We’re on our own.

STEPHEN CLAPHAM: It’s astonishing, though.

TERRY SMITH: It is, isn’t it? We’re literally completely on… It seems that we’re the only people out there doing this sometimes.

STEPHEN CLAPHAM: I mean, these are for large US companies.

TERRY SMITH: And large UK companies as well. I mean, we talked to them and we said… By the way, we say we’re not interested in quantum. The quantum is not important to us. The methodology is what’s important to us.

TERRY SMITH: We need these factors in the methodology. And they say, well, that’s great, but they want this. And I say, how do they think that will translate into the business performance? They say, well, that really asks us about that. Oh, okay then.

STEPHEN CLAPHAM: Well, it’s a bit depressing.

TERRY SMITH: Well, I mean, it is and it isn’t. Like I said earlier, I think if you’re reasonably convinced that you’re rational and everybody or most other people out there are irrational, I think the thing is that you just have to try and survive, don’t you? It’s important to try and still be there at the end of the game basically.

STEPHEN CLAPHAM: And to operate according to your principles. Yeah. I think it’s very important. We’ve had a few frauds recently. I don’t know if you’ve followed like Tricolor Holdings and First Brands. It’s only periphery.

TERRY SMITH: They’re not things I would ever invest in.

STEPHEN CLAPHAM: No, no, of course. But I was just curious if you had a view about the fact that they’re happening now. Because normally the frauds happen once the downturn happens. Now you could argue there’s already a downturn happening in the US. Could do. I mean, do you have any thoughts about that?

TERRY SMITH: Not anything great. I mean, the one I would say in relation to it is, of course, what we’ve got that’s different is the advent of private credit.

STEPHEN CLAPHAM: Yeah.

TERRY SMITH: And so it may be that standards have changed significantly in some respects as a result of private credit arriving on the scene.

TERRY SMITH: Banks have got lots of faults, I’ll grant you that, but the idea that either private credit or crowdfunding or peer-to-peer lending is better, they’ll always tell you they’re better. We’ve got better data, you know. They always say, “We’ve got better data. Our buy now pay later uses better data than the banks have got.” Really? Banks have got quite a lot of data on their clients as well.

TERRY SMITH: And they’ve got quite a long experience doing it. So I’m not convinced. I think it may be the advent of because banks was my sector. I mean, I worked in a bank for a number of years. I helped run the finances of the bank that I worked in, and I ended up as a bank analyst for a number of years.

TERRY SMITH: And the banking sector has been quite substantially picked apart by peer-to-peer lending, by private credit, by payment processes, which have taken away an awful lot of the things that banks traditionally did in a number of cases. But it doesn’t necessarily mean in every case they’re doing it better. Because as you know from history, when some banks have occasionally gone for market share, it only ever has one ending.

TERRY SMITH: Because what they’re picking up once they go beyond their natural market share is something that somebody else didn’t want.

STEPHEN CLAPHAM: Well, if you see growth in finance and in credit, it’s usually bad.

TERRY SMITH: Well, once it gets above a certain level, it’s rather like money supply, isn’t it? If you think about money supply, if you go back to the days of the Thatcher government and monetarism, we looked at the money supply.

TERRY SMITH: You’d look at what M3 was doing and you’d say, well, if M3 is going up at 10%, it’s a bit of a problem, isn’t it? And then we got to the point where in 2007 running into the credit crisis, we had money supply growth in the low teens but we didn’t have inflation because the CPI was all right.

TERRY SMITH: We go, well, no, if you look towards what’s happened to assets over there, it’s like, oh, yes. If you let anything, any of these things which are in the cycle of money creation and credit run out of kilter with the natural growth of the economy, you’re clearly going to create a problem.

STEPHEN CLAPHAM: You talked recently that you were looking at buying a bank. Now, I don’t want to know which one.

STEPHEN CLAPHAM: But I was quite puzzled about that because you’ve made this very clear what your philosophy is.

STEPHEN CLAPHAM: I mean implicit in that, I thought was, “Oh, I’ll never own a bank.” Well, I still don’t own a bank to be fair. I’m just thinking about it. But you’re thinking about it.

TERRY SMITH: I’m allowed to think about things, aren’t I?

STEPHEN CLAPHAM: No, I think it’s commendable in a way that you can be flexible.

TERRY SMITH: We go back and examine things. We do. We go back and examine things.

STEPHEN CLAPHAM: But I just wondered how you weighed this up because if you bought that bank and it went wrong, you’d be crucified. Yeah, probably.

TERRY SMITH: But then on the other hand, if you think it’s a real opportunity when you’ve analyzed it and you don’t do it simply because you come in for criticism if you don’t do it, I don’t think that’s a good thing either.

TERRY SMITH: You know, you’ve got to, I think, try and imagine if you’re doing things, not how will I deal with the criticism if it goes wrong, but how will I deal with the fact which only I have got to contemplate, which is I didn’t do it and I could have made money for the clients and I didn’t because I was afraid about my reputation.

TERRY SMITH: Comes back to the Theodore Roosevelt quote, the man in the arena, you know? Don’t be the timid soul who knows neither victory nor defeat. If you’re convinced that you should do something, even if you said historically it’s something and you’re against it, do it.

TERRY SMITH: And live with the consequences in either direction of doing so.

STEPHEN CLAPHAM: I think you’re safe because as soon as you buy it, there’s going to be a flood of money into it because people will be convinced that it must be such a good opportunity. Maybe.

TERRY SMITH: Maybe I bought it so we may never know.

STEPHEN CLAPHAM: We may never know. Hopefully you’ll come.

TERRY SMITH: I’ve got stocks that I’ve been analyzing for 15 years and I’ve never bought, right?

STEPHEN CLAPHAM: Yeah. So I want to ask you about AI because it’s obviously the topic du jour. And I’ve got three questions around AI. First, I just was curious. I always ask people now, how are you using AI internally within your organization?

STEPHEN CLAPHAM: And let’s just explore what the money being spent by the hyperscalers. But I was also interested, when you’re looking at a new investment, how are you thinking about the opportunity and risks presented by AI?

STEPHEN CLAPHAM: I mean, looking at something like Amazon, it’s perfectly obvious they’ve already got a million robots, and they’ll have two million in a couple of years, and there’s a huge opportunity for them with the work they’re doing in the warehouses. Can you talk a little bit about those?

TERRY SMITH: Well, I mean, we try to concentrate on a few things. One of them is a degree of certainty. In what we’re trying to invest in, things which we think are relatively predictable.

TERRY SMITH: And so a lot of the things that we invest in, whether it’s payroll processing or consumer goods or cosmetics amongst the consumer goods or installed bases of equipment like elevators or operating systems on computers are pretty predictable actually. Yeah. This is not at all predictable. I mean, you know, before Jensen Wang got up in May of 2024 Was anyone talking about this?

TERRY SMITH: Did you know anyone who was talking about it? And I’ve actually got a book from 10 years ago called AI Superpowers. Oh, really? So I read it 10 years ago. And of course what I should have done is read it and made mental note to self that the first time somebody pops up and says this, I should go out there and buy the lot. But yeah, look it up, AI Superpowers. I read it 10 years ago, I think.

TERRY SMITH: It’s not very predictable, is it? No way. It’s really very In that regard it’s not for us at the moment.

TERRY SMITH: I mean, I’m not saying never will be And the other thing I would say about developments of this sort is looking back on history you talk about, you know robots in Amazon warehouses and yeah and and the use of AI for targeting advertising on social media and internet search Yeah, yeah, yeah, it’s a lot My experience historically it’s a lot easier to pick the losers than the winners.

TERRY SMITH: Okay, well because at the moment we’ve got a You know, massive AI spending by OpenAI, fairly obviously, and also by Amazon and their Amazon Web Services business, and by Microsoft, and by Meta, and by Alphabet and Google, and by Oracle, and by CoreWeave. And I mean, I’m not really groping here to get out into the so I’ve given you a good seven or eight massive companies there.

TERRY SMITH: And in my experience, for things to really produce a great result, particularly if it’s something you’re giving away at the beginning Because that’s what that’s happening. It’s being given away. It’s very difficult to raise prices from zero.

TERRY SMITH: So the internet was given away. People have made lots of money, but they haven’t made it directly. They’ve made it by using the data to sell, by internet search and so on.

TERRY SMITH: That’s only possible, I think, where you’ve got a dominant market position.

TERRY SMITH: At the moment, there’s no sign of anybody having a dominant market position. I mean, even amongst the companies that I’ve renamed. Never mind once we bring the Chinese into focus here. Dominant market position? No sign of it. I think it’s a lot easier to look around and see people who are going to lose from this.

TERRY SMITH: And the market is reasonably good at that. Have a look at the prices of WPP in advertising agencies, right? And see what it’s been doing. I mean, they’re at sixes and sevens because people can see, actually, do we really need them to devise our next advert?

TERRY SMITH: Either in terms of the graphics that are involved in it or the videos that are involved in it or in terms of the placement. Do we really need their help to work out placement? No, we can actually use… A piece of machine learning or AI to help us with where the place is because we can see the feedback on it.

STEPHEN CLAPHAM: Have you any other examples like WPP?

TERRY SMITH: In terms of people that have been overturned by no, not at the moment, no. But I mean that’s the one that most obviously springs to mind is people who are clearly going to be on the receiving end of this because there will be others if you think of where it’s going at the moment.

TERRY SMITH: I mean it may be that some of the losing parties, of course, are not companies but people. Yeah. Cab drivers, I mean, I don’t know. You know delivery drivers people who work in those Amazon warehouses Yeah, it’s not necessarily just companies here. It’s people that get displaced as we’ve seen right through from the Industrial Revolution Yeah.

STEPHEN CLAPHAM: You know inevitably and are you using AI much?

TERRY SMITH: No, not really I mean We’ve got Microsoft Co pilot and when he tells me that I’m using Microsoft Co pilot when he answers things when I was Looking up Kagura summer this morning and looking at where it was in Which is one of the novo nordisk a drug that’s in phase three trials.

TERRY SMITH: I was just getting an update on it and it gave me a nice AI thing, but I’m always a bit worried about this because I realize people say “that’s not AI, man doesn’t know what he’s talking about.” When we talk about what it’s going to do, I’ve got Android Auto in my car and when it drives along and somebody sends me a text, it plays it.

TERRY SMITH: And then when it says “do you want to reply?” and I say no, it can’t understand no. And I think I’m quite clear when I say no.

TERRY SMITH: It keeps saying, “Well, I didn’t get that. Could you say it again?” Which of course only leads to the possibility of road rage against your own vehicle.

TERRY SMITH: But maybe it’s a cheap version.

STEPHEN CLAPHAM: I can imagine it is a cheap version. -i’m sure you drive a nice car.

TERRY SMITH: -it’s a Ford.

STEPHEN CLAPHAM: Oh, I’m so disappointed.

TERRY SMITH: Well, it’s not my only car fairly obviously. Not my only car but it is my daily driver.

STEPHEN CLAPHAM: Just on the AI thing, and I’ll promise to finish that in a minute. But one of the things I’ve been writing about is the server lives. So Amazon shortened the server life and Meta lengthened the server life.

STEPHEN CLAPHAM: So Meta went from five to five and a half. Amazon went from six to five. And everybody else is on six, which we know. I mean, I don’t know. I wouldn’t know a server if it punched me in the face. But I know the life isn’t. Six years.

TERRY SMITH: I mean, Joe The depreciation charge is clearly about to impact the returns, isn’t it? That’s what that’s telling you.

STEPHEN CLAPHAM: Of course.

TERRY SMITH: So we’re late for the life. The depreciation charge goes down. Yeah. Which is why we deal with cash. We can’t bid these businesses like this. Then we don’t have to worry about it. All the accrual account a very good accountant once taught me all the accrual accounting is is a means of spreading cash flows between reporting periods.

TERRY SMITH: Yeah. He’s right. And, you know, if we take that out of the equation here by saying, I don’t know what a server life is and you don’t either. I’m deeply suspicious when people put it up, not down. Funny old, you know, funny old world. Yeah, it’s strange.

TERRY SMITH: And you say, well, that being the case, I think that’s a bit of a warning signal. But in any case, let’s just look at the cash flow. Oh, there isn’t any because there’s cash going out on this at the moment. At one point, British Airports Authority put the runway life up for runways to 100 years some years ago.

TERRY SMITH: Now that was interesting because they did it at a time when there hadn’t been a powered flight for 100 years. So I was rather suspicious about their ability to predict the life of this thing 100 years forward. And they then, of course, I’m sure the two events were in no way connected, had a bloody great profit warning.

STEPHEN CLAPHAM: It’s very funny because we had this weasel finance director, whose name escapes me.

TERRY SMITH: Doesn’t narrow it down a lot.

STEPHEN CLAPHAM: They came to the stock market in 1987 and the runways were depreciated over 23.5 years.

TERRY SMITH: Is that right? You’ve got a better memory for these things.

STEPHEN CLAPHAM: In 1988, they lengthened life to 40 years. Then in 1989, they bought Linton, the property company. And in order to avoid the earnings dilutions, He lengthened the runway life to the 100 years. Is that what they did the 100 years? I forgot that. That was the reason that they did it. But he said…

TERRY SMITH: Once you start doing things like this, it’s a slippery slope. You see, I’m not saying the profit warning and that all directly correlate. I’m just saying it’s a slippery slope.

STEPHEN CLAPHAM: You eventually run out of road or runway as a result of doing those things. No, absolutely. Or runway. And it’s very good. Runway.

STEPHEN CLAPHAM: They said, in the light of recent technological advances, and of course that hadn’t been a technological advance for 50 years, and improved availability of data, well they knew to the pound how much it cost them to resurface. It was complete nonsense and it was complete jiggery pokery.

STEPHEN CLAPHAM: I wanted to ask you about selling because anybody can buy cheap stock, right?

TERRY SMITH: Well, you say that. Well, go on.

STEPHEN CLAPHAM: It’s slightly controversial. I had a guest, my guest last month said it’s not that difficult to beat the index, which is very controversial. But I think selling is much harder and you’ve done it extremely well. So Estee Lauder, Reckitts, Diageo were all great sales. And you’re a couple into Adobe. You might have timed them better.

TERRY SMITH: But they’re still good. But we were right about Adobe. But the thing is, the AI thing was behind it and we should have stood out of the way while that. Ran its course for a few months.

STEPHEN CLAPHAM: But, I mean, you make fewer decisions than most. So why is your hit rate so good? Is it because you’re making fewer decisions?

TERRY SMITH: Partly. Yeah. I mean, that’s probably it. My colleagues, if you had Julian sitting here, I had a researcher other than me, he would tell you the single most important factor they think in selling a stock is when I get pissed off with the management.

TERRY SMITH: When Terry gets… He just says… You’ve got good instincts. I don’t know where or how this all developed, but when you come out of a meeting and you go, we know that there’s something for us to think about here. On PayPal, yeah?

TERRY SMITH: It had a prime position in online payments basically, having been spun out from EBay and so on. And then it lost its way. It started acquiring other businesses. It didn’t focus on growing the core business. The take rate from transactions was going down. Expenses were going up. It was kind of all over the place. And we had a meeting which was not one-on-one. It was actually a group meeting.

TERRY SMITH: And the chief executive got up and he said he was dismayed. Now, by now, the share price has already peaked a bit. And we could see all these fundamental statistics pointing the wrong way, right? And the only transactions that were growing at a clip anymore were the white label ones, which are clearly the low margin ones. And they hadn’t broken through into checkout, which they wanted to do.

TERRY SMITH: And quite honestly, we were a bit puzzled as to why they wanted to break into checkout anyway because Visa and Moscow got that one already. You’re the online guys, right? Anyway, the… And the chief executive said he was dismayed. We thought, oh, here we go. We’re going to hear now what’s the problem and how he’s going to deal with it. He said he was dismayed by events in the Ukraine.

TERRY SMITH: And of course, yours truly came out of this meeting with, shall we say, a bit of a bad mood.

TERRY SMITH: My colleague said, Terry, I think we’re going to sell it, aren’t we now? I said, I think we are. We’ve clearly got somebody who’s focused on entirely the wrong things here.

TERRY SMITH: I would say it’s difficult enough to run a business if you’re focused on the right things. If you’re focused on the wrong things, you’ve got no hope.

STEPHEN CLAPHAM: It’s interesting. Have you always met management? Did you never say that you didn’t like meeting management?

TERRY SMITH: We’ve always met management and we don’t dismiss meeting management. I’m just saying it’s not the primary thing. When you’re analyzing a company, the first thing is the numbers. Let’s go and see what’s the organic growth. Growth rate in revenues, what are the gross margins, what are the operating margins, what’s the cash conversion of this company, what’s the capex input into it? Where is the source of growth?

TERRY SMITH: Where is this coming from? What’s their incremental return rate, not just the overall return rate. Let’s work out what the incremental cash flow is, what’s happening at the increment because if you do Tesco in the pre-the Lewis rescue, as it were, of the whole thing and looked at it, You know, the incremental run rate must have been bad because they came from a return on capital of 18% down to about 12.

TERRY SMITH: It’s like, blimey, what was happening to the incremental stuff then? Because the stuff making 18 was still in there.

STEPHEN CLAPHAM: Yeah.

TERRY SMITH: And so we do a lot of work like that before we get to have a conversation. And I think, you know, it is important to get to know something about them and talk to them.

TERRY SMITH: But really when it comes down to it, if people invest with us… They’re subcontracting the management of some of their wealth, their capital to us. And then we subcontract it onto companies. That’s what it amounts to. And so we’d really like to know how they think about that.

TERRY SMITH: Somewhere amongst all the questions, obviously, do we want to know how they’re trading? Yes. Not particularly. We’re not going to make a decision in five minutes on these things. Yes, yes, obviously, we’d like to know. But we always kind of say, well, look, this is not really how we are this quarter. We don’t want to ask, oh, what’s the…

TERRY SMITH: What we want to know is at the end of the year, you’ve got this… Cash that arrives, you can pay a dividend, buy back shares, invest in the business, buy another business. How do you decide between those? What methodology do you use? What metrics do you use? That’s quite a very important part of what we’re trying to get out of this.

STEPHEN CLAPHAM: Interesting. So, Luke, we’ve talked a lot about work. I’d like to talk about something more interesting, which is cars.

TERRY SMITH: Cars, good.

STEPHEN CLAPHAM: You’re building a car museum. Are you building it in Mauritius?

TERRY SMITH: Yes, not personally. I mean, I’m not actually doing any of the construction, you might understand.

STEPHEN CLAPHAM: But why are you doing it in Mauritius?

TERRY SMITH: Well, that’s where I live.

STEPHEN CLAPHAM: Yeah, but it’s not where I live.

TERRY SMITH: Well, I’m terribly sorry. You can always come there, can’t you? And then hopefully the governor of Mauritius will appreciate my work and that will be very nice, won’t it?

STEPHEN CLAPHAM: There’s what, a million people in Mauritius?

TERRY SMITH: One and a quarter million.

STEPHEN CLAPHAM: One and a quarter million people.

TERRY SMITH: It’s about the same number of visitors per annum as well. It’s a big tourist destination. And if you went have you ever been to Mauritius? No.

STEPHEN CLAPHAM: No, I haven’t.

TERRY SMITH: Then you’re not allowed to make comments about Mauritius. I’m not making any comments about Mauritius. People say to us, why do you live in Mauritius? And the first thing we say in reply is, have you been there? It’s a lovely place. Oh, I’m sure it is. It’s a lovely place. Tropical island. People are very nice, et cetera, et cetera. I have a car collection and it’s built up over the years.

TERRY SMITH: 30 years ago, I bought the first car that I was interested in for all this. And I could tell you a lot about the collection. One of the things about… decision to build a museum is I don’t run it. I’ve got a full-time curator, a mechanical team, I’ve got project managers, all of those sort of things. So they run it. I don’t have anything to do with it really.

TERRY SMITH: And I decided… That I was going to put this somewhere, to open it to the public. So it would be rather nice thing to do actually.

TERRY SMITH: And because I think cars are about stories, about their interaction with human beings. There’s a chap in Naples in Florida who’s got a museum called the Revs Institute and he’s got a coffee table book called The Archaeological Automobile. It’s slightly profound but his thesis is that the thing, the object that’s most interactive with human beings and changed their lives in the 20th century was the car.

STEPHEN CLAPHAM: Yeah.

TERRY SMITH: It’s got a point.

STEPHEN CLAPHAM: Yeah, absolutely, yeah.

TERRY SMITH: Got a point. And anyway, so I like all that. So I thought, where should I put it? Well, I started with the UK some years back, but getting planning consent in the UK to do something like this is like, wow. Oh, my God.

TERRY SMITH: And then I moved on to other places to think about it. So I talked to the United Arab Emirates, to Dubai and so on, and they were absolutely great. They said, fly in. We’ll look at four sites a day after you get here. Choose one.

TERRY SMITH: We’ll get it for you we’ll give you planning consent you know pretty much on the spot after the champion charge has got to sign it and then we’ll get it built in a year and we have 17 million visitors a year it will be the greatest triumph we’ve ever seen I said all of that is I said I believe every word you’ve said because I’ve seen the place obviously I said there’s one small problem I said I don’t live in Dubai and I’d like to occasionally be able to drop in and it’s exactly and then there was somewhere out in Malaysia that was put up as a possibility and then there was somewhere in Europe Austria that came up and But the trouble is dealing with EU regulations on classic cars on the road is a nightmare.

TERRY SMITH: I do live in Mauritius, and there is a big car culture in Mauritius. Apart from tourists, the 1.25 million tourists who come every year, there is a big car culture in Mauritius. There are over 600,000 cars in Mauritius, which is a lot for 1.2 million people.

TERRY SMITH: You’ll see the traffic jams sometimes, right? It’s impressive. And the way I illustrate the car culture is to say you’ll sometimes be driving along behind a bus or a Nissan March or something like that, and you’ll see plastered on it NISMO. You know what NISMO stands for?

STEPHEN CLAPHAM: That’s the Nissan Performance.

TERRY SMITH: It’s Nissan Motorsport, right? Yeah. These guys have it on buses, right? They’re stuck on diesel buses. They like cars. They’re very keen on their cars. And so, you know, I think this could work.

TERRY SMITH: And so I decided to try and put it there. So I bought some land from one of the sugar plantation companies on a hill looking out over the ocean and started constructing a museum and shifting the cars. And we’re hoping that about this time next year we’ll have an operating museum.

STEPHEN CLAPHAM: Oh, really? So will I get an invite to the opening?

TERRY SMITH: If you want.

STEPHEN CLAPHAM: I’d love to do that. So you’ve got an F1 McLaren. A McLaren F1, yes. It’s always been my dream car. I’ve sat in one, but that’s… And I met somebody who’s got one and he said he was in a race with Rowan Atkinson to put 100,000 miles on it.

TERRY SMITH: Yeah, well, Atkinson famously has driven his car. I don’t know if he’s still got it because he’s crashed it twice as well. There are a lot of famous crashes. Yeah, yeah. My one was the one that was… Ron Dennis’ car was due to be done. But he then decided he didn’t want it when I got another one, and just as well because he crashed the other one.

TERRY SMITH: I think he was driving his pace car in a race and managed it because it’s I’m sure you’re familiar with it, but the thing is there are no driver aids whatsoever. No, of course not. There’s no power steering. There are no power brakes. There’s no traction control. There’s no four-wheel drive. It’s you on a 6.1-litre V12 normally aspirated BMW engine in a carbon fibre monocoque. Good luck.

STEPHEN CLAPHAM: Is that your favorite?

TERRY SMITH: I find it hard.

STEPHEN CLAPHAM: Favorite child?

TERRY SMITH: I don’t know. The one that it vies with, and I think this is I’ve got a Ford GT40.

STEPHEN CLAPHAM: All right.

TERRY SMITH: And I remember the GT40 from when I was a child.

TERRY SMITH: The win at Le Mans in 66 and the subsequent wins by the GT40 were a big thing. People don’t realize now, Le Mans was a much bigger thing than Formula 1. Formula 1 was nothing compared to Le Mans and the other endurance races at that time, the Tag Of Florio the Mille Miglia, Daytona were much bigger things for manufacturers than Formula One at that time.

TERRY SMITH: So it was a big thing. And it just was a dramatic story. I like the fact that Enzo Ferrari managed to cause at least three successful cars to be built by pissing people off. He pissed off Lamborghini, which led to the Miura.

TERRY SMITH: He pissed off Carroll Shelby, which led to the Cobra. And then he pissed off Henry Ford that led to the Ford GT40. And I really like that. And I really like the car. The car is… I like it. And I like how pure it is in many respects in terms of what it is. It’s a wild animal, basically. Yeah. You’re sitting inside.

STEPHEN CLAPHAM: And you won’t have a track.

TERRY SMITH: We’ll have an exercise track around the perimeter. So we’ll have a four-kilometer exercise track. But it is very much not a racetrack. So we can take cars out on there rather than taking them around. I mean, we drive all our cars.

TERRY SMITH: If you don’t drive cars, they go wrong. Yeah. But we’ve got some cars that you probably shouldn’t take. We’ve got a 1903 Oldsmobile Curved Dash, which has got a tiller instead of a steering wheel, which I’ve driven. But you’re not going to take it out on the road.

TERRY SMITH: So yeah, we’ve got a track, but it’s an exercise, not a race track.

STEPHEN CLAPHAM: I went to Monsieur Bardinot’s museum and racetrack in the centre of France. I’ve forgotten the town, near the Bayeux tapestries.

STEPHEN CLAPHAM: And it was the most amazing museum. And the racetrack was fantastic as well. It was very undulating.

TERRY SMITH: Some South Africans have got a plan to build a racetrack just to the west of us, between us and the coast, which may come off or it may not. I mean, I really obviously hope that it does because it would be great to have an adjacent racetrack because some of our cars are race cars. I mean, the GT40 is road legal. Yeah. But, I mean, it bottoms out on the camper. On the road. Yeah.

STEPHEN CLAPHAM: Listen, it’s been such an interesting conversation. I always ask people to finish off to recommend a book. Now, you’ve published, written two best-selling books. It’s really amazing.

TERRY SMITH: We can forget those, right?

SPEAKER 6: I mean, I really enjoyed both books. And I remember reading Accounting for Growth, and it was extraordinary how many it sold, right? Yeah. For an accounting book.

TERRY SMITH: That’s because UBS fired me and sued me. Yes. Nobody would have bought it at all. It was like Spycatcher. Remember Spycatcher? When Mrs. Thatcher tried to get the book banned, everybody bought it. It’s the same thing. Nobody had heard of it if they hadn’t done that. I’m sure nobody would have heard of it.

STEPHEN CLAPHAM: But is there a book you’re reading now or a book you’d like to recommend to a young person?

TERRY SMITH: I tend to have because I’m a bit organized, I have a rotation. If you looked at my bookshelves in my place, I have finance books, investment finance books. I have history books. I have sports books and I have other. And I tend to try and work away. It doesn’t work. And so the last book I booked was actually a history book.

TERRY SMITH: It was Richard Holmes’ biography of Wellington. I thought it was very good. Richard is a military historian. He’s dead now. And he came and he did an offsite for me when I ran Tullock Pre-Bomb and gave us a talk on leadership. And I thought it was excellent. And I think his book on Wellington is excellent as well.

TERRY SMITH: There’s some great lessons and episodes involving the Iron Duke, which just it’s worth a read. I think just because, you know, one can debate who was the greatest military commander ever in British history. And I mean, he’s certainly on the podium at the very minimum, I would say. And I found it a great read.

TERRY SMITH: I mean, on investment books, I do give a reading list to people who come and work for us if they’re training and to other people who ask me from time to time. And I tend to alternate between books that are a bit serious about investment. So things like Edward Chancellor’s The Price Of Time. Or Robert Hagstrom’s The Warren Buffett Way, and books on the animal spirits of markets.

TERRY SMITH: So you can find out how it really works. It’s great to have a theory. So Connie Brooke, The Creditor’s Ball about the junk bond boom, or Michael Lewis’s Liar’s Poker, or his more recent works like The Big Short or Flash Boys. Because I think it’s one thing to learn about finance from learning about the capital asset pricing model and cash conversion and accounting.

TERRY SMITH: Isn’t that great? But you also need to realize there’s another side to all this out there. And I think I like people to try and read bits of both because apart from anything else, you get very bored if you didn’t read the other bits. I tend to tend to alternate between. And yeah.

STEPHEN CLAPHAM: Terry, that’s great advice. Thank you so much for doing this. I really enjoyed your conversation. Thank you. Thank you very much.

STEPHEN CLAPHAM: What you see is what you get with Terry Smith. His peers dislike his success. Especially because it appears relatively effortless. But there isn’t a question that, in spite of his personal wealth, he is a billionaire. Smith takes the responsibility of looking after his clients’ money extremely seriously.

STEPHEN CLAPHAM: I was surprised to hear that he has had sleepless nights. In a way, I’m kind of glad. Not because I dislike him. Far from it. He’s very personable. But because it makes him seem more human. His record as an investor is impressive. But I think his real achievement is to have excelled at each endeavour he’s undertaken.

STEPHEN CLAPHAM: Yes, he is a formidable intellect, but he’s also clearly an excellent manager of people as well as money, and an incredibly driven individual. That last is a trait we can all emulate. Thanks, as ever, for listening.

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