Terry Smith

Fundsmith LLP is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales: OC354233. Registered office: 33 Cavendish Square, London, W1G 0PW. January 2026 Dear Fellow Investor, This is the eighth annual letter to owners of the Fundsmith Stewardship Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2017 and various comparators. % Total Return 1st Jan to 31st Dec 2025 Inception to 31st Dec 2025 Sortino Ratio6 Cumulative Annualised Fundsmith Stewardship Fund1 -6.0 +86.3 +7.9 0.31 Equities2 +12.8 +145.0 +11.6 0.49 IA Global Sector3 +10.8 +98.9 +8.8 0.35 UK Bonds4 +6.1 -1.2 -0.1 n/a Cash5 +4.2 +18.4 +2.1 n/a The Fund is not managed with reference to any benchmark, the above comparators are provided for information purposes only. 1 I Class Accumulation shares, net of fees, priced at noon UK time, source: Bloomberg. 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg. 3 Source: Financial Express Analytics. 4 Bloomberg Series-E UK Govt 5-10 yr Bond Index, source: Bloomberg. 5 £ Interest Rate, source: Bloomberg. 6 Sortino Ratio is since inception to 31.12.25, 3.5% risk free rate, source: Financial Express Analytics. The table shows the performance of the I Class Accumulation shares which fell by 6.0% in 2025 and compares with a rise of 12.8% for the MSCI World Index (‘Index’) in sterling with dividends reinvested.

reporting period, and outperforming the market was challenging once again in 2025. Before I turn to the reasons for the performance I should explain that contrary to the suggestion of some commentators I am not seeking to ‘blame’ anyone or anything for our Fund’s relative performance. What I am seeking to do is explain it so that our investors have a clear understanding of what has happened and why. An explanation is not an excuse. I wonder how those commentators or our investors would view it if we offered no explanation. I see three main issues at play. 1. Index Concentration The domination of returns by a small group of major ‘technology’ stocks became so pronounced by 2023 that it gave rise to one of those snappy descriptors that market commentators favour with the so-called Magnificent Seven: Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla. This continued in 2024 after Jensen Huang, the CEO of Nvidia, made several public appearances at which he extolled the upcoming transformation of computing by Artificial Intelligence (‘AI’), powered of course by Nvidia’s chips. The result was akin to firing the starting gun in a race in which capital expenditure on semiconductor chips and data centers by the major tech companies — the so-called hyperscalers — spiralled upwards in an arms race matched only by the performance of their shares.2025

It continued in 2025 and as a consequence, the top ten stocks were 39% of the value of the S&P 500 Index (‘S&P’) at the end of 2025 and provided 50% of the total return it delivered in USD. Is this different to the past? US Market Concentration Over Last 125 years Source: UBS Global Investment Returns Yearbook 2025 This second chart shows that the last time the US market value was this concentrated was in 1930. What happened next? It took until 1954 for the S&P to regain its 1930 high. Although this is regarded as prehistoric by most investors today it is wise to remember that the S&P (not the NASDAQ) did not regain its 2000 high until 2007 and then promptly lost it again in the Credit Crisis until 2013. When bubbles burst they can cause many lost years or even decades. It was difficult to even perform in line with the index in recent years if you did not own most of these stocks in their market weightings, and we would not do so even if we became convinced that they were all good companies of the sort we seek to invest in, which we are not. It would in our view represent too much of a portfolio risk to own them all, just as we would not own all five of the drinks companies we have in our Investible Universe even if we thought that prospects for the sector were good. Our Fund is a portfolio, not a sectoral bet. 2. The Growth of Assets in Index Funds The rise of the Magnificent Seven and the AI stocks also had a strong tailwind from the increase in assets held in index funds.

Active vs Passive Fund Share of US Equity Fund Assets Source: Research Affiliates, Data as at 31st Dec 2024 The financial services industry sometimes does not aid understanding with the labels it employs. Index funds and index ETFs are often labelled ‘passives’ in contrast with ‘active’ funds, like Fundsmith Stewardship Fund, which have a fund manager making investment decisions. The ‘passives’ mostly track the index they invest in by holding the stocks in proportion to their market value. Far from being passive in any normally accepted sense of the word, this makes them a momentum strategy. A momentum investment strategy is one in which the investor buys stocks which are performing strongly. If you redeem money from an active fund like Fundsmith and invest it in an S&P 500 Index tracker fund your new fund will buy the index stocks in proportion to their market value. Currently about 7% of it will go into Nvidia which we do not own. About 35% will go into the Magnificent Seven of which we own only three stocks — Alphabet, Meta and Microsoft. This gives added momentum to those stocks we do not own which are a major part of the index. John Bogle, the pioneer of index investing who founded Vanguard, the index fund manager, was asked at the 2017 Berkshire Hathaway annual meeting if there was a level of assets in index funds which would distort markets and he agreed that there was, although he had no method of determining that level. We may already have reached it.markets

hypothesis’. You may not have heard of this as it is not the sort of thing to take for a read on a long flight. However, it has some startling revelations which are relevant to the current market. It starts with the seemingly uncontroversial assertion that $1 (or $1m or $1bn) switched between either stocks or bonds (or any other switch) does not affect the intrinsic value of either. If you redeem funds from an active fund like Fundsmith to place them in an index fund it does not alter the valuation of the stocks we have to sell to fund the redemption or the stocks that the index fund buys. However, the NBER paper shows that in reality such a switch has a multiplier effect of anything from 3:1 to 8:1, an average of about 5.5:1. The inflow from such switches pushes up the value of the stocks purchased by an average of five times the amount invested. To say this flies in the face of fundamental investment theory would be a masterly understatement. The NBER paper attributes this to the inelasticity of demand and supply for equities. Over 50% of equities are in index funds which have no discretion over what they buy. Moreover, some portion of the so-called active funds which are left are managed in a way that makes them unlikely to bet against what is happening in the index. Apart from any mandate restrictions, fund managers have long realised the career preserving nature of so-called closet indexation in which they do not stray far from the index weightings.

Given our experience in recent years, who can blame them? The NBER research could in one sense be regarded as a statement of the blindingly obvious impact of the rise of index funds, but what is far from obvious is the scale of that impact. Nor does the fact that something may seem obvious, once it is explained, mean that it should then be ignored. It may make no fundamental sense to buy Tesla shares on a Price Earnings Ratio (‘PE’) of 327 (which is its current rating) but it is the ninth largest company in the S&P 500 Index by value so not holding it is a perilous position to take when money is flowing into index funds. John Bogle was right. The increasing proportion of equities held by index funds are invested without any regard to the quality or valuation of the shares bought which produces dangerous distortions. Contrary to popular belief, the stock market is not a substitute for online casinos but rather a mechanism for valuing companies, raising capital and providing liquidity. When this becomes distorted the result is often a major misallocation of capital.

Sir John Templeton, who founded the eponymous investment management group, once said, ‘The four most dangerous words in investing are: This time it’s different’. He was pointing out that there are always people who are willing to rationalise outbursts of investment mania but they are always proven wrong when the bubble bursts and investment fundamentals reassert themselves. We have seen this before, not only in the Dotcom boom and bust, but in other examples such as the Japanese market in the late 1980s. Then we were told that the PE of over 50 on the Nikkei Index was OK because Japanese accounting was conservative. In fact the market was just over-valued. After the subsequent fall in the Nikkei it took until 2024 for the index to regain the peak it attained in 1989. When companies and/or investors are encouraged by soaring share prices and valuations to believe that capital is almost free, some disastrous investment decisions follow. They seem to act as though the cost of the capital that companies are investing is to some degree the reciprocal of their PE ratio. So, a PE of 50 equates to a cost of capital of 2% (100÷50). This is utter nonsense. The cost of equity does not vary inversely with the valuation and is perhaps best estimated by the cost of so-called risk-free capital, being the yield on long-dated government bonds plus what is called an equity risk premium.

It is not a bad starting point when trying to estimate a cost of equity capital to look at the long-term return on equities as it is in effect an opportunity cost: what return should an investor expect from equity investment over the long term? That is what they should demand as a cost of supplying equity by owning shares — the cost of equity capital. US equities have averaged a return of about 9% p.a. over the past century. It certainly isn’t 2%. If companies or investors start making decisions which deviate much from that assumption based upon soaring share valuations the outcome will be disastrous. In 2000 Vodafone, the UK based mobile phone operator which was one of the leaders in the Dotcom boom, bid for Mannesmann, the German mobile operator. At the time Vodafone was on a PE of 54 and Mannesmann was on a PE of 56. That points to another fallacy — managements often justify what they are paying for assets in booms and bubbles by the fact that they are paying by issuing over-valued or highly-valued shares. Hang on a minute, what does that imply for investors? We can see the results insofar as Vodafone’s shares peaked at a value of 570p in 2000 when it bid for Mannesmann and they are now trading at 99p. When value is destroyed by bad capital investment decisions there is always a reckoning.

Perhaps the executives running some of the leading AI companies have a clear view of the future and can foresee that AI will produce not just a transformation in our lives and the way we work but also incremental cash flows such that the returns on the humongous amounts of capital they are investing will be adequate or better than adequate. But if not, we can expect Sir John Templeton’s adage to be proven to be right once again, albeit maybe after a longer period and larger scale of irrational exuberance than we have seen in the past, driven by the momentum of index investing. However, 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. With sincere respect to the late Sir John Templeton whom I quoted earlier, I think this time it may be different. Not in the sense that the Magnificent Seven/AI boom is different but rather in the scale it may attain and how long it may persist. When we had the Dotcom boom the proportion of AUM which was in index funds was under 10%. The dominance of index funds now makes the rise of these large stocks a self-fulfilling prophecy. 3. Dollar weakness Just to add to the headwinds, the US dollar fell against the pound from about $1.25/GBP at the start of the year to $1.35 at year end: USD vs GBP Exchange Rate Source: Bloomberg

I doubt this reflects relative strength of the UK economy or satisfaction with government policy. The Trump administration is obviously keen to see interest rates lower and to reduce the trade deficit. Neither of these aims is compatible with a strong dollar. Dollar weakness can also be seen in the price of gold which is at a 50 year high of $4319 per ounce. There is lots of speculation about the reasons for the strength of the gold price but to some extent I view it as an expression of weakness in the currency in which gold is priced. This affects the GBP value of our Fund since the majority of the companies are listed in the United States and more importantly that is their biggest single source of revenue. I hope that all of this may go some way towards explaining what we have been facing in terms of competition from index funds and the performance of large tech companies in particular in recent years with the added handicap of dollar weakness. These events have convinced me that Tommy Docherty was an optimist. In the week when he was fired as manager of Manchester United and his wife filed for divorce he said, ‘In life when one door closes, another slams in your face’. I think I know how he felt. Perhaps a more pertinent question is what are we going to do about it? We could: 1. Start buying stocks in all the large companies which dominate the indices, and/or 2. Become momentum investors who buy shares which are performing strongly irrespective of their fundamental merits.

We are not going to do either. If you want an index fund you can buy one with much lower costs than we or any other active investment manager apply. Nor are we momentum investors and there are better exponents of this investment strategy than us. I would just offer one note of caution if you are thinking of taking this approach. Good momentum investors in my experience buy shares which are going up and sell them when they start going down. They do not convince themselves, for example, that because they have bought Nvidia shares when they are going up, they know what is going to happen with AI or GPUs.

We won’t be buying shares in companies simply because they are large and dominate the index weightings and performance unless we become convinced that they are good businesses of the sort we wish to own which have long term relatively predictable sources of growth and more than adequate returns on the capital they invest. Whilst we are going to stick to our investment strategy we will of course seek to do it better. We are fans of many of the late Charlie Munger’s pronouncements but the one which best applies here is ‘Any year that you don't destroy one of your best-loved ideas is probably a wasted year.’ More to follow. Looking at individual stock contribution to performance in 2025 as usual I prefer to start with the problems. The bottom five detractors from the Fund’s performance in 2025 were: Stock Attribution Novo Nordisk -2.0% Greggs -1.7% Church & Dwight -1.5% Zoetis -1.2% Procter & Gamble -1.0% Source: State Street Novo Nordisk managed to reaffirm my belief that you should never say ‘Things can’t get any worse’. The company has parlayed a market leading position in what is probably the most exciting drug development for about three decades into a secondary position and has failed to prevent illegal generic competition in its core US market. One of our mantras has been that we should always invest in businesses which could be run by an idiot so that performance is not heavily reliant upon management.

We have been made painfully aware that the range of businesses which can be run by an idiot is much more limited than we thought and hereafter we will aim to be more aware of the impact that poor management can have. Our experience also suggests that when we encounter poor management, engagement to change it is less effective than selling the shares. Meanwhile Novo Nordisk has appointed a new CEO and made wholesale board changes and the present rating (a PE of 13) appears to us to be expecting very little. If we did not already own it I suspect we would contemplate buying it as a good business which has been depressed by a ‘glitch’, albeit a rather large glitch. Greggs has suffered in the general malaise surrounding the UK hospitality sector. Although the shares look cheap to us on a PE of 11 with still growing units and sales, they have become cheaper whilst we held them.

Church & Dwight, the consumer staples business, seems to be suffering from the fact that the mixed fortunes of different groups of consumers in the US economy, far from driving consumers towards its discount products, is instead impoverishing those consumers who naturally gravitate towards them. Zoetis is the leading maker of veterinary pharmaceuticals. We began buying after concerns had surfaced about side effects from its drug for pain in osteoarthritis in dogs. The shares have continued to be weak but we feel sure that the secular tailwinds from increased spending on pets’ medical care will support the business. Procter & Gamble was caught up in the general malaise surrounding consumer staples which have been adversely affected as the air has been sucked out of the room by the race to invest in AI. In an age in which analysts rely on spoon fed forecasts in the form of ‘guidance’ and there is limited liquidity as the NBER paper suggests, results which fall short of optimistic guidance can produce spectacularly bad share price movements. For the year, the top five contributors to the Fund’s performance were: Stock Attribution Alphabet +2.3% IDEXX +2.1% L’Oréal +0.9% Microsoft +0.6% Mettler-Toledo +0.4% Source: State Street Alphabet makes its third appearance.

IDEXX, the veterinary diagnostic equipment business, makes its fourth appearance having resurrected its position from being a detractor last year when it was suffering from the ebbing of the Covid era mania for pet adoption. L’Oréal appears for the second time and benefitted from the recovery in the China market and outperformed the beauty category in sales performance, as usual. Microsoft enters the top five contributors for the six time. Whilst we gratefully accept this performance we remain wary of the impact of the AI hype/boom.

Mettler Toledo has begun to bounce back for the effects of it its logistics problem in Europe and the downturn in China. We continue to apply a simple four step investment strategy: • Buy good companies • ESG screen • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first and most important of these — whether we own good companies — by giving you the following table which shows what Fundsmith Stewardship Fund would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look- through’ basis, and compares this with the market, in this case the FTSE 100 and the S&P 500 Index. This also shows you how the portfolio has evolved over time. Year ended Fundsmith Stewardship Fund Portfolio S&P FTSE 2019 2020 2021 2022 2023 2024 2025 2025 2025 ROCE 29% 23% 28% 31% 34% 32% 30% 17% 17% Gross Margin 65% 61% 61% 61% 60% 60% 60% 45% 43% Operating Margin 26% 21% 25% 26% 29% 27% 26% 18% 17% Cash Conversion 99% 102% 97% 88% 93% 92% 94% 89% 99% Interest Cover 17x 16x 20x 19x 20x 24x 34x 9x 8x Source: Fundsmith LLP/Bloomberg. ROCE (Return on Capital Employed), Gross Margin, Operating Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Stewardship Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. Interest Cover is median.

2019 ratios are based on last reported fiscal year accounts as of 31st December and for 2020–25 are Trailing Twelve Months and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. In 2025 return on capital, gross margins and operating profit margins were all high and steady. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2025? The weighted median free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 13%. From a fundamental perspective, which is what we seek to focus on, we are confident that our portfolio companies will continue to perform well over the business and market cycles.portfolio

companies is as high as it has ever been and collectively they continue to grow free cash flow quicker than the historical average of the portfolio. The underlying business performance remains our primary focus. If we get that right then our Fund will emerge with the intrinsic value of its investments maintained or enhanced, as sooner or later, share prices reflect fundamentals, not the other way around. Encouragingly, the average year of foundation of our portfolio companies at the year-end was 1926. Collectively they are a little under a century old. The only metric which continues to lag its historical performance is cash conversion — the degree to which profits are delivered in cash. Although this recovered slightly to 94% in 2025, this is still below its historical level of around 100%. This was due to a sharp rise in capital expenditure at a small group of companies: Alphabet and Microsoft. The tech companies are in a race to build capacity for AI in the form of GPU chips and data centres. Whether this arms race produces adequate profits and returns for the amounts expended remains an open question. As we can see, our tech companies are ramping up of capital expenditure along with Amazon and Meta: Capex For Major Tech Companies And this table does not include some companies which have major capex commitments like Oracle which has announced it will spend some $50 billion in 2025/6 or CoreWeave which is predicting around $25 billion of capex in 2026.

adequate return or that returns will gravitate to the present incumbents. One company which intrigues us in this respect is Apple. Depending upon your point of view it has either been left behind in the scramble to build Large Language Models (‘LLMs’) and hyperscale to provide AI infrastructure or it has opted out of the race. As a result, its capital expenditure in 2025 was a mere $12 billion which pales into insignificance in comparison with the companies in the table above. It may be making a virtue of necessity but maybe Tim Cook the CEO is working on an old adage, ‘You don’t have to own a cow to sell milk’. Apple has its devices and about a billion mostly high-end consumers locked into them and increasingly into its services. It seems unlikely that there will be a shortage of LLMs that the hyperscalers will want to offer Apple for iPhone users. If this is indeed the business model Apple is relying on it may not bode well for the LLM developers and/or hyperscalers’ profitability. The second leg of our strategy is to employ a negative sector-based sustainability screen, excluding companies operating in sectors with excessive sustainability-related risk (aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco).

We then assess company sustainability in the widest sense, evaluating a business’s handling of risks and opportunities and their policies and practices covering research and development, new product innovation, dividend payments, and the adequacy and productivity of capital investment. One of the metrics we use to assess sustainability risks is RepRisk’s RepRisk Index (RRI), which measures a company’s current reputational risk exposure based on controversies over the last 24 months. At the end of December 2025, the weighted average RepRisk Index for our portfolio was 28.5, higher than the 27.3 at the start of the year and lower than the MSCI World’s weighted average of 34.5. This implies that, on average, our portfolio has a lower exposure to reputational risks relating to sustainability factors than the MSCI World. The portfolio’s RepRisk Index rose over the year, partly due to increases in the RRI at Marriott and IDEXX of 23 and 17, respectively. This was offset by the addition of Intuit, Wolters Kluwer, and EssilorLuxottica to the portfolio, all of which had lower RRIs than Mastercard, which was sold from the portfolio. Marriott’s RepRisk increased after a guest of its St.the

US. IDEXX’s increase is due to its inclusion in a PETA report on animal testing. IDEXX usually experiences very little negative news, which means the scale of the RRI increase is larger. IDEXX creates machines for vets to use to diagnose pets, so it shouldn’t be that surprising that they are involved in animal testing, given it’s their main business. At the end of 2025, the four companies with the highest RepRisk Index scores were: Stock RepRisk Alphabet 64 Microsoft 58 Marriott 52 Novo Nordisk 49 Source: RepRisk Alphabet and Microsoft are among the largest companies in the world, and their products and services are used by millions of people every day. As a result, both companies are subject to extensive media coverage. This inflates their RRI beyond what we would consider an accurate reflection of their negative impacts. Both companies faced continued antitrust scrutiny in the US and Europe in 2025, which contributed to their high RRIs. We expect the companies we invest in to manage this regulatory risk effectively and do not currently think that Microsoft or Alphabet are excessively abusing their market position. One reason Microsoft and Alphabet have such strong positions is their continued success in developing superior products and services compared to their competitors.

At the end of 2025, the four companies with the lowest RepRisk Index scores were: Stock RepRisk Waters 0 Mettler-Toledo 0 Wolters Kluwer 5 ADP 11 Source: RepRisk Waters and Mettler-Toledo remain on the list from 2024, and this year are joined by payroll company ADP and new holding Wolters Kluwer, which provides expert information and software to accountants, lawyers, doctors and other professionals. We use the RepRisk Index scores in two ways.investable

universe. Second, as a proxy for the absolute negative impacts a company has, particularly on society. While environmental impacts are relatively easy to measure (e.g., greenhouse gas emissions) and therefore assess, aggregate, and scrutinise both absolutely and relatively across companies, impacts on society are often qualitative and much more challenging to assess objectively. Hence, we use the RRI as a proxy for evaluating these negative impacts. However, it isn’t perfect as companies with larger public profiles, such as Alphabet and Microsoft, receive significantly more media coverage than many of the other names in the Fund’s investible universe, which inflates their RRI scores beyond what we would deem to be a fair reflection of their impact. Further, companies that are rarely subject to negative press experience excessively large RRI increases when news does appear. This ‘novelty’ factor makes sense for reputational risk but is imprecise for measuring the scale, both absolute and relative, of net negative impact, especially given that it doesn’t take account of any positive impacts of a company’s products and services. With this in mind, we have started using data from a Finnish company called the Upright Project (‘Upright’). It uses a science-based approach to calculate a business’s net impact by accounting for upstream and downstream impacts, based on the products and services it produces.

The company uses academic studies and proprietary modelling to quantify the net impact of over 150,000 products and services. Upright’s net impact model comprises two main parts: a macro model and a company model. The macro model uses a database of over 200m scientific articles and Upright’s own deep learning algorithm to calculate the negative, positive, and net impact of a product or service. The company model then aggregates the positive and negative impacts of all the products/services sold by a company, proportional to revenues, to calculate the net impact of the overall business. A company’s net impact ratio is expressed as a percentage, with a positive score indicating a net positive impact and a negative score indicating a net negative impact. A score of 10%, for example, would suggest that a company produces 10% more positive impacts from its products and services than negative impacts. The net impact of a product/service is measured across four dimensions: environment, health, society, and knowledge, which we think is a better reflection of the impact companies have.portfolio:

EssilorLuxottica Net Impact Breakdown Source: Data from Upright, as at 31st December 2025 This provides a much clearer breakdown of the company's impact across the different subcategories and greater transparency into what drives these scores. EssilorLuxottica makes the vast majority of prescription lenses worldwide, which is why it is rated as having a significant positive benefit on Physical Diseases. With 5.6 positive impacts and just -1.4 negative impacts it has an overall 75% net impact ratio (5.6-1.4)/5.6). We have been using data from the Upright Project for about a year to inform the net-negative impact assessment. We are also going to start using it in the annual sustainability summary and quarterly

Sustainability Factsheets instead of the RepRisk data, as we think it provides a more accurate proxy of a company’s impact on society and the environment. Overall, the Fundsmith Stewardship Fund performs similarly to the MSCI World in ‘Knowledge’ and ‘Environment’ but significantly outperforms in ‘Health’, mainly due to our higher exposure to healthcare companies. The Fund slightly underperforms the index in ‘Society’, largely due to underperformance in the societal infrastructure subcategory. The main topics considered in societal infrastructure are energy, transportation, water and sanitation, and industrial infrastructure, areas in which we do not invest. The result is that our companies’ positive contribution to these areas is lower than that of the MSCI World, not because the companies in which we invest have a higher negative impact. Overall, the Fundsmith Stewardship Fund has a net impact ratio of 23% compared to 10% for the S&P 500 and 7% for the MSCI World, with the scores split by category as below: Net Impact Ratio Source: Data from Upright, as at 31st December 2025 The companies held in the Fundsmith Stewardship Fund also continue to show their commitment to reducing their contribution to climate change. At the end of 2025, companies which are responsible for 94% of the Fund’s emissions had already set 1.

MSCI All Country World Index1 and 87% of the Fund’s emissions were covered by a company-wide target to reach net zero emissions by at least 2050. The third leg of our strategy is about valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of 2025 was 3.2% and ended the year at 3.6%. The year-end FCF yield of the S&P 500 was 2.8% and MSCI World was 3.1%. Our portfolio stocks have become a lot more lowly valued than the S&P as the free cash flow of many of the major stocks which now dominate the index has shrunk or disappeared in the face of massive capex spending on AI. Our portfolio consists of companies that are fundamentally a lot better than the average of those in the S&P 500, and in the past we have explained that it is no surprise if they are valued more highly than the average S&P 500 company. In itself this does not necessarily make the stocks expensive, any more than a lowly rating makes a stock cheap but they are now significantly cheaper than the S&P. But it also raises an obvious concern about what will happen to the market. Turning to the fourth leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 4.6% during the period. It is perhaps more helpful to know that we spent a total of just 0.

002% (a fifth of one basis point) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with subscriptions and redemptions as these are involuntary). We sold one company, purchased three and received a holding in Magnum Ice Cream which was spun out from Unilever. As last year this may seem like a lot of names for what is not a lot of turnover as in some cases the size of the holding sold or bought was small. We have held ten of the portfolio’s 27 companies since inception in 2017. Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2025 for the I Class Accumulation shares was 0.95%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. 1 https://www.msci-institute.com/wp-content/uploads/2025/11/MSCI-Transition- Finance-Tracker-Q3-2025-201125.pdf

When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the I Class Accumulation shares in 2025 the TCI was 0.98%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We are pleased that our TCI is just 0.03% (3 basis points) above our OCF when transaction costs are taken into account. However, we would again caution against becoming obsessed with charges to such an extent that you lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. We sold our stake in Mastercard and started purchasing stakes in EssilorLuxottica, Intuit and Wolters Kluwer during the year. We reduced the Fund’s exposure to payment processors by selling our stake in Mastercard ahead of the Trump administration proposals to cap rates on credit card lending. EssilorLuxottica arose from the merger of French and Italian companies which dominate the market for eyeglasses, both frames and lenses.

There is a tailwind for this business from people who do not yet have access to vision correction. In addition, it has some interesting innovations such as the Stellest lenses which help prevent deterioration for children with myopia and of course the Meta AI glasses. We previously sold a position we held in Intuit, the accounting and tax software company, after it acquired Mailchimp in 2021 because we felt that Mailchimp fell outside its circle of competence and they paid about three times the right price, something which they attempted to justify by pointing out that half the consideration paid was in Intuit shares. What this implied about their valuation seemed obvious to us. For a while after we sold the shares AI hype drove the price but latterly the poor performance of the Mailchimp acquisition has become evident and reflected in the share price. We have started to rebuild a stake in the hope that the management has learned from the debacle. Wolters Kluwer is the leader in technical publishing used by professionals in health, tax, accounting, risk & compliance and legal.but

this seems about as true as the now discredited view that Adobe and Intuit were AI beneficiaries. This view has driven the PE to <19x and it is still growing at c.5% p.a. with a ROIC of 18% and ROE of about 50%. We intend to continue holding a portfolio of good businesses in the hope and expectation that their strong fundamental returns will shine through into superior share price and fund performance over the long term and that in the interim our fund will prove relatively immune from any shocks which arise if or when the present extraordinary market conditions unwind. Finally, once more I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Stewardship Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its products. This document is a financial promotion and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority.

The views and opinions expressed herein are those of Fundsmith as of the date hereof and are subject to change based on prevailing market and economic conditions and will not be updated or supplemented. Sources: Fundsmith LLP, Bloomberg and FE Analytics unless otherwise stated. Data is as at 31st December 2025 unless otherwise stated. Portfolio turnover is a measure of the fund's trading activity and has been calculated by taking the total share purchases and sales less total creations and liquidations divided by the average net asset value of the fund. P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2025 unless otherwise stated. Percentage change is not calculated if the TTM period contains a net loss. The MSCI World Index is a developed world index of global equities across all sectors and, as such, is a fair comparison given the fund's investment objective and policy.

The Investment Association Global Sector in Sterling is representative of funds that invest at least 80% of their assets globally in equities. This facilitates a comparison against funds with broadly similar characteristics. The Bloomberg Series-E UK Govt 5-10 yr Bond Index shows what you might have earnt if you had invested in UK Government Debt. The £ Interest Rate shows what you might have earnt if you had invested in cash. MSCI World Index is the exclusive property of MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and ‘GICS®’ is a service mark of MSCI and Standard & Poor’s.

Fundsmith LLP is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales: OC354233. Regist ered office: 33 Cavendish Square, London, W1G 0PW. January 2025 Dear Fellow Investor, This is the fifteenth annual letter to owners of the Fundsmith Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 and various comparators. % Total Return 1st Jan to 31st Dec 2024 Inception to 31st Dec 2024 Sortino Ratio6 Cumulative Annualised Fundsmith Equity Fund1 +8.9 +607.3 +14.8 0.87 Equities2 +20.8 +403.4 +12.1 0.60 IA Global Sector3 +12.6 +254.0 +9.3 0.42 UK Bonds4 -2.3 +23.6 +1.5 n/a Cash5 +5.1 +18.5 +1.2 n/a The Fund is not managed with reference to any benchmark, the above comparators are provided for information purposes only. 1 T Class Accumulation shares, net of fees, priced at noon UK time, source: Bloomberg. 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg. 3 Source: Financial Express Analytics 4 Bloomberg Series-E UK Govt 5-10 yr Bond Index, source: Bloomberg. 5 £ Interest Rate, source: Bloomberg. 6 Sortino Ratio is since inception to 31.12.24, 3.5% risk free rate, source: Financial Express Analytics. The table shows the performance of the T Class Accumulation shares, the most commonly held share class and one in which I am invested, which rose by 8.9% in 2024. This compares with a rise of 20.

8% for the MSCI World Index (‘Index’) in sterling with dividends reinvested. The Fund therefore underperformed this comparator in 2024 but a longer-term perspective may be useful and is certainly more consistent with our investment aims and strategy. Since inception, the Fund has returned 2.7% p.a.Sortino

Ratio of 0.87 versus 0.60 for the Index. This simply means that the Fund has returned about 45%, ((0.87÷0.60)-1)x100, more than the Index for each unit of price volatility, of which more later. Our Fund is the second best performer since its inception in November 2010 in the Investment Association Global sector of 162 funds, with a return 353 percentage points above the sector average which has delivered just 254% over the same timeframe. Outperforming the market or even making a positive return is not something you should expect from our Fund in every year or reporting period, and outperforming the market was more than usually challenging once again in 2024. Just five stocks (the ‘Fab Five’?) Nvidia, Apple, Meta, Microsoft and Amazon provided 45% of the returns of the S&P 500 Index (‘S&P 500’) in 2024. This is similar to the concentration of returns provided by the so-called Magnificent Seven in 2023. Moreover, a single stock — Nvidia — produced over 20% of the S&P 500 returns in 2024. Nor is this concentration of returns in a few technology companies a purely US phenomenon. In Germany 41% of the return from the DAX Index came from a single stock — SAP, the software company whose share price rose by 69% so that it is now trading on a mere 97x earnings. Our Fund owns some but not all of these stocks and it was difficult to perform even in line with the Index unless you owned them at least in line with their index weighting.

I do not intend to give a narrative of why we do not own all of them, but I will give some more detail on this point later in this letter. In looking at individual stock contribution to performance I prefer to start with the problems. The bottom five detractors from the Fund’s performance in 2024 were: Stock Attribution L'Oréal -2.0% IDEXX -1.2% Nike -0.7% Brown-Forman -0.6% Novo Nordisk -0.6% Source: State Street L’Oréal was adversely affected by events in China where the economy is struggling under the weight of a moribund residential property sector and the associated credit problems. However, this does not alter our view that L’Oréal is fundamentally a very good business. This is not the first time that a major economy it operates in has mis-fired and we believe its management can cope.

IDEXX which makes veterinary diagnostic testing equipment and supplies is suffering from a slackening in the pace of vet visits after the scramble to adopt pets during the pandemic. As the industry leader in an area with real long-term growth prospects and a stock where we would probably struggle to buy back our position if we sold it, we intend to continue holding IDEXX and to try to smile through the pain of underperformance. Nike is a stock we bought after the share price fall during the pandemic when investors seemed convinced there would be many fewer buyers of trainers. In fact, Nike had made great strides in online marketing and fulfilment. What we hadn’t realised was that the then management would parlay this success into a problem by ignoring the traditional bricks & mortar retail channel, which has recovered as the pandemic passed, and in so doing open the door literally to competition. To be fair there have been other issues such as an increasing dependence on fashion and less on traditional exercise uses. However, the good news is that there has been a change of CEO this year. We see many commentators musing about the reasons why the US economy is so successful. Perhaps one reason is a quicker finger on the trigger when top executives do not deliver. In which context we note that Unilever’s shares were up 20% in 2024. We await developments from Nike’s new management who have after all inherited what is still the dominant market share in the sector.

Brown-Forman, one of the world’s top five drinks companies and the distiller of Jack Daniel’s Tennessee Whiskey has suffered from the fall in consumption from the pandemic highs and is probably seeing early signs of the adverse impact of weight loss drugs. We sold our Diageo stake during the year which I will cover later but retaining Brown-Forman keeps a foothold in what has long been a sector with good business characteristics and which has the potential benefits of family control, which can promote good long-term decision making, and a larger bias towards premium spirits than Diageo which may help obviate the impact of weight loss drugs (‘drink less but better quality’). It is a company which survived Prohibition so we hope there is literally something in the DNA to help with these adverse circumstances. Novo Nordisk was arguably our most surprising poor performer in 2024. It remains the market leader in weight loss drugs, which it pioneered, and the year was marked by a stream of news about other conditions which these drugs treat effectively and label expansion applications which drug regulators seem willing to approve. Yet not only did the share price fall 10% but it finished the year on a P/E ratio half that of its nearest competitor Eli Lilly.

In investment it is always better to travel hopefully than to arrive and there is certainly an arms race going on amongst drug companies to develop competitor drugs. Yet we are still dealing with a company in Novo which is the market leader and holds production and labelling advantages which should sustain that position, with revenues that are growing at 20% p.a. Moreover, we originally bought Novo because of its radical approach to drug discovery and would not rule out further developments. For the year, the top five contributors to the Fund’s performance were: Stock Attribution Meta Platforms +4.1% Microsoft +1.6% Philip Morris +1.5% Automatic Data Processing +1.3% Stryker +1.3% Source: State Street For Meta and Microsoft I am simply going to repeat my comment from last year’s letter albeit with the number of times updated: ‘Meta Platforms’ (formerly Facebook) performance makes me wonder whether I should have a fund which invests solely in the one stock in our portfolio each year for which we have received the most critical comments. Meta makes its fourth appearance in this list of top contributors while Microsoft appears for the ninth time having attracted strident criticism when we started buying at about $25 a share in 2011 (2023 year end price $376).’ 2024 year end price was $422.

Philip Morris makes its 4th appearance as it continues to show the benefits of its industry leading move into Reduced Risk Products (‘RRPs’) such as heat not burn tobacco products and its acquisition of Swedish Match with its nicotine pouch business. You can tell when some things are right by the people who oppose them. The governments and dysfunctional health organisations who have set their stance against these RRPs, which are proving to be an invaluable aid in reducing risk to smokers, is yet another indicator that Philip Morris is on the right track. ADP which makes its 2nd appearance continues its metronomic performance. It rarely shoots the lights out in terms of performance but then neither does it disappoint which makes it a good stock for our strategy.

Stryker, which is making its 5th appearance, is benefitting from work on the backlog of elective surgical procedures which built up during the pandemic. Given the number of repeat appearances in our top five contributors I am tempted to repeat one of our mantras which is that ‘You make money with old friends’. However, three of those old friends which have been repeat contributors were detractors this year, namely L’Oréal, IDEXX and Novo Nordisk. However, if anything I would regard this as a blip in their long-term record and we intend to (mostly) patiently await a return to form. In our view they are simply too good to sell and risk being uninvested when the tide turns. We continue to apply a simple three step investment strategy: • Buy good companies • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first and most important of these — whether we own good companies — by giving you the following table which shows what Fundsmith Equity Fund would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look- through’ basis, and compares this with the market, in this case the FTSE 100 and the S&P 500. This also shows you how the portfolio has evolved over time.

Year ended Fundsmith Equity Fund Portfolio S&P FTSE 2017 2018 2019 2020 2021 2022 2023 2024 2024 2024 ROCE 28% 29% 29% 25% 28% 32% 32% 32% 16% 17% Gross Margin 63% 65% 66% 65% 64% 64% 63% 64% 45% 42% Operating Margin 26% 28% 27% 23% 26% 28% 29% 30% 16% 15% Cash Conversion 102% 95% 97% 101% 95% 88% 91% 85% 85% 90% Interest Cover 17x 17x 16x 16x 23x 20x 20x 27x 9x 9x Source: Fundsmith LLP/Bloomberg. ROCE (Return on Capital Employed), Gross Margin, Operating Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. Interest Cover is median. 2017–2019 ratios are based on last reported fiscal year accounts as of 31st December and for 2020–24 are Trailing Twelve Months and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. In 2024 operating profit margins were higher in the portfolio companies than in the past. Gross margins and return on capital were steady.significantly

better than the companies in the main indices (which include our companies). Moreover, if you own shares in companies during a period of inflation it is better to own those with high returns and gross margins. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2024? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 14% in 2024. The only metric which continues to lag its historical performance is cash conversion — the degree to which profits are delivered in cash. Although this recovered slightly to 91% in 2023, this is still below its historical level of around 100% and it declined again in 2024 to 85%. This was due to a sharp rise in capital expenditure at a small group of companies: Alphabet, Microsoft, Meta and Novo Nordisk. Novo is racing to build production capacity to supply enough of its weight loss drug Wegovy and finished the year spending €10 billion purchasing three manufacturing sites. The tech companies are in a race to build capacity of Artificial Intelligence (‘AI’) in the form of GPU chips and data centres.

Whether this arms race produces adequate profits and returns for the amounts expended remains an open question to which I will return later. At least Novo is building capacity to produce a drug for which there is established demand and profitability and in which it currently has a competitive advantage. The average year of foundation of our portfolio companies at the year-end was 1920. Collectively they are over a century old. The second leg of our strategy is about valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of 2024 was 3.0% and ended the year at 3.1%. The year-end median FCF yield on the S&P 500 was 3.7%. Our portfolio consists of companies that are fundamentally a lot better than the average of those in the S&P 500, so it is no surprise that they are valued more highly than the average S&P 500 company. In itself this does not necessarily make the stocks expensive, any more than a lowly rating makes a stock cheap. However, we expect some of this disparity in valuation to be eradicated in 2025 if, as we expect, the cash conversion of our portfolio companies improves.our

objectives and this was again achieved with a portfolio turnover of 3.2% during the period. It is perhaps more helpful to know that we spent a total of just 0.002% (one fifth of a basis point) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with subscriptions and redemptions as these are involuntary). We sold three companies and purchased two. As last year this may seem like a lot of names for what is not a lot of turnover as in some cases the size of the holding sold or bought was small. We have held four of the portfolio companies since inception in 2010, nine for more than ten years and 15 for over five years. Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2024 for the T Class Accumulation shares was 1.04%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK.

This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2024 the TCI was 1.05%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We are pleased that our TCI is just 0.01% (1 basis point) above our OCF when transaction costs are taken into account. However, we would again caution against becoming obsessed with charges to such an extent that you lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. We sold our stakes in Diageo, McCormick and Apple during the year. Diageo, which we had owned since inception, has exhibited problems with its new management, shown by a lack of information about its Latin American business which produced results far worse than the sector in this area. Moreover, we suspect the entire drinks sector is in the early stages of being impacted negatively by weight loss drugs. Indeed, it seems likely that the drugs will eventually be used to treat alcoholism such is their effect on consumption.

We sold McCormick as we had been disappointed by the slow response which the company exhibited in its ability to pass on input cost inflation so compressing its margins, together with its exposure to own label competition which has stiffened as inflation has caused consumers to trade down. We began purchasing Apple two years ago at about $156 a share when its P/E was below the S&P 500 average and the growth in service revenues had somewhat convinced us that the much talked about ecosystem, tying its users to the products, might really exist. We correctly foresaw a number of reporting periods ahead when sales growth would be lacklustre and so bought a small stake hoping to add to it as the poor sales performance came to pass. We were right about the sales performance — its sales grew just 2% last year — but wrong about the share price which rose strongly, placing the shares on a rating about 50% higher than the S&P 500. We were not going to buy more stock against that background and it was occupying a place in our portfolio and so we sold our stake. We started purchasing stakes in Atlas Copco and Texas Instruments during the year.

Atlas Copco is a Swedish industrial company which makes compressors, vacuum equipment, electrical and pneumatic tools and which has three characteristics which we find attractive: • it outsources much of the manufacturing so making it capital light which enhances returns; • it is highly decentralised with over 600 operating entities which have considerable autonomy in addressing their local market; and • there is a controlling stake held by the Wallenberg family vehicle which should lead to good long-term decision-making since they have been in business for 151 years this year. Texas Instruments is a manufacturer of analogue and embedded microprocessors which go into a wide range of consumer and industrial devices, automobiles, and communications equipment. It is investing ahead of a probable upturn in the semiconductor cycle although it is now apparent that there is not one cycle. Demand for GPUs of the sort made by Nvidia far from being in a down cycle has been on a lunar trajectory, and there are clear differences between the cycle for regular automotive chips and chips for electric vehicles or chips for other appliances, as well as between regions. However, Texas Instruments has a long history of investing well ahead of upswings in demand and producing handsome returns from it.is

also a beneficiary of the onshoring of semiconductor manufacturing to avoid the geopolitical risks of Taiwan and China. Last year I spent some time in this letter discussing the rise of interest in AI, as one of the driving forces behind the rise of most of the Magnificent Seven stocks and especially Nvidia. This boom/hype (you choose) continued in 2024, but some of its characteristics changed. One is that it may have become more focused. It had been seen as a driver of share prices of companies which we had previously held such as Adobe and Intuit, both of which had blotted their copybook with us by engaging in over-priced and seemingly ill- conceived acquisitions or attempted acquisitions. Both of them significantly underperformed the market in 2024 as reality seemed to dawn on investors that AI may not be of immediate and/or universal benefit and could actually be detrimental. Conversely, this has had the effect of focusing investors’ attention on fewer real immediate beneficiaries of the AI boom such as Nvidia. During this period commentators have frequently asked whether the AI boom is the same as the Dotcom era and therefore will have a similar ending. In response I am tempted to quote Mark Twain, ‘History doesn’t repeat itself, but it rhymes.’ Undoubtedly some of the AI enthusiasm is hype, as was the Dotcom mania, but there are a couple of key differences: 1.

The leading company in the AI boom, Nvidia, is very profitable, albeit with a history of some downturns, whereas in the Dotcom boom a lot of the share price performance was driven by reference to clicks and eyeballs in the absence of any profits or even revenues. Even companies which were to rise Phoenix-like from the ashes after the Dotcom meltdown, such as Amazon, were not yet profitable; and 2. The rise of so-called passive or index funds. 1993 1996 1999 2002 2005 2008 2011 2014 2017 2021 2,000 6,000 8,000 12,000 US$ Billions 2023 4,000 10,000 14,000 16,000 Active Assets Passive Assets Source: Morningstar.Funds

In late 2023 passive investment via index funds exceeded the amount of assets held in active funds for the first time. They are now more than half of Assets Under Management (‘AUM’). However, during the Dotcom boom only about 10% of AUM was in passive funds. As ever we do not always aid understanding with the labels which we sometimes use in investment. Index funds are not truly a passive strategy. There may be no fund manager taking investment decisions, but such index investing is in fact a momentum strategy. The vast majority of index funds are market capitalisation weighted, like the indices on which they are based. The size of holdings in companies in the index fund is based upon their market value compared with the market value of the index. So when there are inflows to index funds the largest portion goes to the largest companies, and vice versa when there are outflows. The result is that as money flows out of active funds and into index funds, as it has been doing, it drives the performance of the largest companies which are companies whose shares have already performed well which is how they came to be the largest companies by market value. This is a self-reinforcing feedback loop which will operate until it doesn’t.

For example, were there to be an economic downturn which led to a reduction in tech spending, which is now so large a proportion of overall spending that it cannot be non-cyclical, one area of vulnerability might be spending on AI as it is not currently generating much revenue. Were the largest companies then to produce disappointing results, their share prices are likely to react badly which will drag down the index performance more than that of those active managers who are underweight in these stocks. But even if some scenario like this awaits us in the future, what exactly will cause this and when it may occur is difficult or impossible to predict. Which brings me back to the subject of volatility which was raised at the start of this letter. We don’t agree that true volatility is measured by ratios such as the Sharpe or Sortino ratio which look at the volatility of fund prices or share prices, but they are widely accepted as a measure. Moreover, whilst investors should rationally focus on volatility in the fundamental value of the businesses they invest in and accept higher price volatility if this leads to higher returns, it is easier said than done. One problem is that it is difficult to remain calm and focus on the fundamental characteristics when the price volatility is sharply negative. Take a stock like Nvidia, which has been a spectacular performer for the past two years. The Nvidia share price fell by over two thirds as recently as 2021–2022.

Meta demonstrates, but given how difficult they can be to own maybe one is enough for our portfolio at any one time. In 2021–2022 Meta’s stock price fell by 76%, but whilst we continued to own it despite this, to our current benefit, there are several key differences between the situation of Meta then and Nvidia now: • Meta serves some 3.3 billion consumers and several million advertisers. Nvidia’s demand is dominated by a literal handful of so-called hyperscalers building data centres to handle Large Language Models for AI. • People sometimes ask us whether it is dangerous to own consumer stocks in an economic downturn. To which we reply yes, but it is not as dangerous as not being close to the consumer in those circumstances. If you think the performance of consumer companies is a worry in a downturn wait until you see what happens to their suppliers, especially the suppliers of capital equipment like factory machinery. A 5-10% downturn in sales revenues at the consumer companies can translate into a cessation of orders for some suppliers. Nvidia supplies capital goods — its latest generation GPU server sells for about $3m each — and a significant downturn in demand from its clients who do service consumers would be interesting to watch from a safe distance. • Before its share price fall Meta was on a P/E of 28x whereas Nvidia is currently on a P/E of 54x.

All of which brings me to a reminder of what we are seeking to achieve with the Fundsmith Equity Fund and that is to produce a high likelihood of a satisfactory return rather than the chance of a spectacular return which could be spectacularly good or spectacularly bad. Finally, once more I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance.exchange

rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its products. This document is a financial promotion and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. The views and opinions expressed herein are those of Fundsmith as of the date hereof and are subject to change based on prevailing market and economic conditions and will not be updated or supplemented. Sources: Fundsmith LLP, Bloomberg and FE Analytics unless otherwise stated. Data is as at 31st December 2024 unless otherwise stated. Portfolio turnover is a measure of the fund's trading activity and has been calculated by taking the total share purchases and sales less total creations and liquidations divided by the average net asset value of the fund. P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2024 unless otherwise stated. Percentage change is not calculated if the TTM period contains a net loss. The MSCI World Index is a developed world index of global equities across all sectors and, as such, is a fair comparison given the fund's investment objective and policy. The Investment Association Global Sector in Sterling is representative of funds that invest at least 80% of their assets globally in equities. This facilitates a comparison against funds with broadly similar characteristics.

The Bloomberg Bond Indices UK Govt 5-10 yr shows what you might have earnt if you had invested in UK Government Debt. The £ Interest Rate shows what you might have earnt if you had invested in cash. MSCI World Index is the exclusive property of MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and ‘GICS®’ is a service mark of MSCI and Standard & Poor’s.

Fundsmith LLP is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales: OC354233. Registered office: 33 C avendish Square, London, W1G 0PW. January 2024 Dear Fellow Investor, This is the fourteenth annual letter to owners of Fundsmith Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 and various comparators. % Total Return 1st Jan to 31st Dec 2023 Inception to 31st Dec 2023 Sortino Ratio5 Cumulative Annualised Fundsmith Equity Fund1 +12.4 +549.7 +15.3 0.83 Equities2 +16.8 +316.7 +11.5 0.51 UK Bonds3 +5.6 +26.5 +1.8 n/a Cash4 +4.6 +12.8 +0.9 n/a The Fund is not managed with reference to any benchmark, the above comparators are provided for information purposes only. 1 T Class Accumulation shares, net of fees, priced at noon UK time, source: Bloomberg. 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg. 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 year, source: Bloomberg. 4 £ Interest Rate, source: Bloomberg. 5 Sortino ratio is since inception to 31.12.23, 3.5% risk free rate, source: Financial Express Analytics. The table shows the performance of the T Class Accumulation shares, the most commonly held share class and one in which I am invested, which rose by 12.4% in 2023. This compares with a rise of 16.8% for the MSCI World Index in sterling with dividends reinvested.longer-term

perspective may be useful and is certainly more consistent with our investment aims and strategy. Since inception, the Fund has returned nearly 4% p.a. more than the MSCI World Index and has done so with significantly less downside price volatility as shown by the Sortino Ratio of 0.83 versus 0.51 for the Index. This simply means that the Fund has returned about 63%, ((0.83÷0.51)-1)x100, more than the Index for each unit of price volatility. Our Fund is still the best performer since its inception in November 2010 in the Investment Association Global sector of 165 funds, with a return 335 percentage points above the sector average which has delivered just 215% over the same timeframe. Outperforming the market or even making a positive return is not something you should expect from our Fund in every year or reporting period, and outperforming the market was more than usually challenging in 2023. The performance of the Nasdaq Composite Index, which was up 43% in USD in 2023, was dominated by a few companies, the so-called Magnificent Seven — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla — which accounted for 68% of that Index’s gains. Nvidia, the designer of chips for use in AI applications, alone accounted for 11% of the 43% gain. We do not own all the Magnificent Seven and would probably not be willing to take the risk of doing so, even if all of them fitted our investment criteria.

In looking at individual stock contribution to performance I prefer to start with the problems. The bottom five detractors from the Fund’s performance in 2023 were: Stock Attribution Estée Lauder -1.8% McCormick -1.1% Diageo -0.6% Mettler-Toledo -0.6% Brown Forman -0.5% Source: State Street We sold our stake in Estée Lauder whose mishandling of the demand/supply situation in China following reopening post Covid and in the travel retail market revealed serious inadequacies in its supply chain. McCormick has yet to return the profit margins in its food service business to the level they were before the pandemic. Mettler-Toledo suffered from a downturn in demand for laboratory equipment post the pandemic, demand falling in China and a tighter funding market for biotech companies.no

concerns about their longer-term prospects and our holding in Mettler-Toledo, in particular, is small and we may be able to use share price weakness to acquire more. Brown-Forman and Diageo have suffered along with other drinks companies from softening in demand, especially in the Americas. Diageo’s CEO, Sir Ivan Menezes, died in June just before he was scheduled to retire. In our view he was one of the unsung heroes of the corporate world. For the year, the top five contributors to the Fund’s performance were: Stock Attribution Meta Platforms +4.5% Microsoft +3.9% Novo Nordisk +3.6% L’Oréal +2.1% IDEXX Laboratories +1.4% Source: State Street Meta Platforms’ (formerly Facebook) performance makes me wonder whether I should have a fund which invests solely in the one stock in our portfolio each year for which we have received the most critical comments. Meta makes its third appearance in this list of top contributors while Microsoft appears for the eighth time having attracted strident criticism when we started buying at about $25 a share in 2011 (2023 year end price $354). Novo Nordisk rose to prominence this year as a result of the wild success of its weight loss drug Wegovy (also known as Ozempic when sold for treating diabetes). However, we have owned the stock for seven years — attracted by its seemingly unusual approach to drug discovery and its ownership structure.

We are not aware of another drug company whose stated aim is the eradication of the ailment from which it derives most of its revenues. The controlling stake held by the Novo Nordisk Foundation seems to guarantee a genuine long-term approach to the business. Novo is making its fourth appearance in our top five contributors — this was a successful investment long before the words ‘weight loss’ were uttered in relation to Novo. L’Oréal is a long-term favourite whose handling of the China market contrasts sharply with that of Estée Lauder. IDEXX, the supplier of veterinary diagnostic equipment, makes its fifth appearance in our table of top five contributors despite concerns about a hangover following the upsurge in pet ownership during Covid.

We continue to apply a simple three step investment strategy: • Buy good companies • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first and most important of these — whether we own good companies — by giving you the following table which shows what Fundsmith Equity Fund would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look- through’ basis, and compares this with the market, in this case the FTSE 100 and the S&P 500 Index (S&P 500). This also shows you how the portfolio has evolved over time. Year ended Fundsmith Equity Fund Portfolio S&P FTSE 2016 2017 2018 2019 2020 2021 2022 2023 2023 2023 ROCE 27% 28% 29% 29% 25% 28% 32% 32% 18% 17% Gross Margin 62% 63% 65% 66% 65% 64% 64% 63% 45% 41% Operating Margin 26% 26% 28% 27% 23% 26% 28% 29% 16% 15% Cash Conversion 99% 102% 95% 97% 101% 95% 88% 91% 76% 85% Interest Cover 17x 17x 17x 16x 16x 23x 20x 20x 11x 10x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. Interest Cover is median.

2016–2019 ratios are based on last reported fiscal year accounts as of 31st December and for 2020–23 are Trailing Twelve Months and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. In 2023 returns on capital and operating profit margins were higher in the portfolio companies than in the past. Gross margins were steady. Importantly all of these metrics remain significantly better than the companies in the main indices (which include our companies). Moreover, if you own shares in companies during a period of inflation it is better to own those with high returns and gross margins. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2023? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 14% in 2023.

The only metric which continues to lag its historic performance is cash conversion — the degree to which profits are delivered in cash. Although this recovered slightly to 91% in 2023, this is still below its historic level of around 100% as a result of unusual events affecting a handful of our companies which we expect to largely unwind to their benefit in 2024. The average year of foundation of our portfolio companies at the year-end was 1916. Collectively they are over a century old. The second leg of our strategy is about valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of the year was 3.2% and ended it at 3.0%. The year-end median FCF yield on the S&P 500 was 3.7%. Our portfolio consists of companies that are fundamentally a lot better than the average of those in the S&P 500 so it is no surprise that they are valued more highly than the average S&P 500 company. In itself this does not necessarily make the stocks expensive, any more than a lowly rating makes a stock cheap. However, we expect some of this disparity in valuation to be eradicated in 2024 if, as we expect, the cash conversion of our portfolio companies improves. Turning to the third leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 11.

1% during the period, a little higher than usual. It is perhaps more helpful to know that we spent a total of just 0.008% (just under one basis point) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with subscriptions and redemptions as these are involuntary). We sold our stakes in Adobe, Amazon and Estée Lauder and purchased stakes in Procter & Gamble, Marriott and Fortinet. As last year this may seem a lot of names for what is not a lot of turnover as in some cases the size of the holding sold or bought was small. We have held ten of our companies for more than 10 years, five of which since inception in 2010. Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2023 for the T Class Accumulation shares was 1.04%.does

not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2023 the TCI was 1.05%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We are pleased that our TCI is just 0.01% (1 basis point) above our OCF when transaction costs are taken into account. However, we would again caution against becoming obsessed with charges to such an extent that you lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. Last year I spent quite a lot of this letter trying to explain the background to the period of low interest rates and Quantitative Easing and how the resurgence of inflation and interest rate rises had affected company valuations, and especially those which had above average valuations. As an illustration of this effect, consider the following.

If you had invested $100 in the Vanguard Long US Government Bond Index Fund (Ticker: VBLAX, ‘Bond Fund’) in June 2020, at the trough in yields on US Treasury bonds, your total income over the next 10 years would be a mere $7 i.e. you would receive 70 cents per annum in income. You would have had to invest a lot of dollars to get an income you could live on. Had you invested in October 2023, which may represent the high point in this economic cycle for bond yields, your total income over the life of the investment will be $47.50. Quite a change. This illustrates two points. One is that you would have lost a lot of money had you bought the Bond Fund in 2020 and had still been holding it in October 2023. The Bond Fund’s net asset value, at which it trades, declined from a peak of $17.71 in June 2020 to a low of $9.19 in October 2023, a fall of 48%. This puts the losses from investing in high quality equities over this period into perspective. Better to be in equities than long bonds when interest rates rise sharply. The other point it illustrates is that bonds have been offering an alluring alternative to equities for many investors.close

to risk free as you can get) of close to 5%, why take the risk of investing in equities? The short answer is because equities provide a better return. For the period 1928–2023 (the earliest for which I can get reliable data), the annualised return on 10 Year US Treasury Bonds was 4.6% whereas the S&P 500 compounded at 9.8% with dividends reinvested#. This of course includes the Great Depression and World War Two as well as other more recent and lesser incidents like the 1987 Crash, the Dotcom meltdown, the Great Financial Crisis of 2008–09 and the Covid pandemic. This is unsurprising. Equities benefit from a feature which no other asset class, including bonds, can provide: a portion of the profit or cash flow which belongs to the shareholders is reinvested each year by the company. This is the retained profit which is not paid out as dividends, and its investment is the source of compounding which underpins the returns of long-term investment. In my view this is the least discussed and appreciated aspect of equity investment versus all other asset classes. So, if equities outperform bonds why are investors so keen to hold bonds at the moment? The answer of course is that whilst equities may outperform bonds over long periods of time, there is no guarantee that equities will provide this superior return in any given period, and in fact they may lose value for periods of time, as they did in 2022.cartoon:

It requires not only a grasp of investment analysis but also an iron constitution to ignore the periodic shenanigans of the stock market and reap the rewards of long-term equity investment. I thought it would be amiss not to mention two events which marked 2023. The first event is the rise of Artificial Intelligence, or AI, as one of the driving forces behind the rise of most of the Magnificent Seven and especially Nvidia. What to make of it? I would offer a few observations. Firstly, AI is not quite as new as the rise in interest in AI in the stock market this year, driven by Microsoft’s investment in OpenAI and the adoption of its ChatGPT large language model (actually launched in November 2022). IBM launched an AI model called Watson which beat two human champions in the US quiz show Jeopardy! in 2011. Google (now Alphabet) acquired the AI developer DeepMind in 2014. Secondly, the stock market, in a fashion exemplified by the earlier cartoon, has decided at the outset that it can identify winners in AI in the form of Nvidia designing the chips on which the generative AI models will run and Microsoft as a provider of an AI model. If it can do so at this stage it would seem to me to be a break with tradition.

Think back to some of the major technology developments of the past half century or so and the early leaders: • Microchips: Intel • Internet Service Providers: AOL • Mobile Phones: Nokia • Search Engines: Yahoo • Smartphones: Research In Motion (Blackberry) • Social Media: Myspace Where are they now? Does this experience suggest that we can predict a winner in the area of AI at the outset? Moreover, maybe there won’t be a winner, either in the provision of large language models or their use. There are numerous large language models in development and deployment by the major tech companies: such as Alphabet’s Gemini, Meta’s Llama 2 (stands for Large Language Model) and Microsoft’s ChatGPT, as well as stock market excitement about the deployment of such models by Adobe, Intuit and Fortinet amongst just the companies that we follow. There is no shortage of contenders. The adoption of AI may lead to a situation where everyone has it, so no one has any advantage. The analogy I would offer (with acknowledgement to Warren Buffett) is a football stadium.the

game becomes exciting and the striker runs into the penalty area with the ball, the second row of spectators stands up to get a better view. This blocks the view of those in the third row who follow suit. Pretty soon all the spectators are standing but no one has a better view than before, but they are all less comfortable. So, I think we will suspend judgement of who, if anyone, will emerge as a winner in AI. The second event worthy of mention is the passing of Charlie Munger, Warren Buffett’s long time business partner, who passed away in December at the age of 99. Apart from offering a perspective on the perennial question about my retirement, Mr Munger’s demise has led to the inevitable repetition of quotations from him by commentators. However, none of the commentators has alighted upon the Charlie Munger quote which in my view encapsulates the current state of world affairs: “If you’re not a little confused about what’s going on, you don’t understand it.” Finally, once more I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance.

The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its products. This document is a financial promotion and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: Fundsmith LLP, Bloomberg and #NYU Stern School of Business, unless otherwise stated. Data is as at 31st December 2023 unless otherwise stated. Portfolio turnover is a measure of the fund's trading activity and has been calculated by taking the total share purchases and sales less total creations and liquidations divided by the average net asset value of the fund. P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2023 unless otherwise stated. Percentage change is not calculated if the TTM period contains a net loss. MSCI World Index is the exclusive property of MSCI Inc.respect

to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and ‘GICS®’ is a service mark of MSCI and Standard & Poor’s.

Fundsmith LLP is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales: OC354233. Regist ered office: 33 Cavendish Square, London, W1G 0PW. January 2023 Dear Fellow Investor, This is the thirteenth annual letter to owners of the Fundsmith Equity Fund (‘Fund’). Our Fund’s performance in 2022 will give credence to those who suffer from triskaidekaphobia. The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 and various comparators. % Total Return 1st Jan to 31st Dec 2022 Inception to 31st Dec 2022 Sortino Ratio Cumulative Annualised Fundsmith Equity Fund1 -13.8 +478.2 +15.5 0.84 Equities2 -7.8 +256.8 +11.0 0.36 UK Bonds3 -15.0 +19.8 +1.5 n/a Cash4 +1.4 +7.8 +0.6 n/a The Fund is not managed with reference to any benchmark, the above comparators are provided for information purposes only. 1 T Class Accumulation shares, net of fees, priced at noon UK time, source: Bloomberg. 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg. 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 year, source: Bloomberg. 4 £ Interest Rate, source: Bloomberg. 5 Sortino ratio is since inception to 31.12.22, 3.5% risk free rate, source: Financial Express Analytics. The table shows the performance of the T Class Accumulation shares, the most commonly held share class and one in which I am invested, which fell by 13.8% in 2022 and compares with a fall of 7.

The Fund therefore underperformed this comparator in 2022 but is still the best performer since its inception in November 2010 in the Investment Association Global sector with a return 299 percentage points above the sector average which has delivered just 179.1% over the same timeframe. Whilst a period of underperformance against the index is never welcome it is nonetheless inevitable. We have consistently warned that no investment strategy will outperform in every reporting period and every type of market condition. So, as much as we may not like it, we can expect some periods of underperformance. Underperforming the MSCI World Index is one issue, registering a fall in value is another. In 2022 unless you restricted your equity investments to the energy sector you were almost certain to have experienced a drop in value: Performance of S&P 500 Sectors in 2022 Energy +59% Utilities -1% Consumer Staples -3% Health Care -4% Industrials -7% Materials -14% Banks -22% Software & Services -27% Real Estate -28% Consumer Discretionary -38% Communication Services -40% Source: Bloomberg Why has this happened? We have exited a long period of ‘easy money’: a period of large fiscal deficits, where government spending significantly exceeds revenues, and low interest rates.

We can probably trace the era of low interest rates back to the so- called Greenspan Put which became evident in the 1990s as low interest rates were utilised as the palliative in periods of market volatility such as the Asian Crisis of 1997 and the Russian default and LTCM collapse in 1998. As the new millennium arrived so did new crises which seemed to warrant even easier money. It started with the Dotcom meltdown in 2000 and was followed by the Credit Crunch of 2008–09 which started in the US housing market and quickly became a full-blown international banking crisis.rates:

Quantitative Easing (‘QE’), so-called ‘printing money’ in which central banks created money to purchase assets, starting with government debt but eventually ranging into corporate debt and equities. As an aside, quite how it aided the economy of either Japan or Switzerland for their central banks to buy international equities is beyond my grasp. This was combined with low, no (Zero Interest Rate Policy — ZIRP) or even negative interest rates (NIRP). These measures I have collectively christened with the generic term ‘easy money’. Attempts to suppress volatility will only exacerbate it in the long term. If you count the current events, we have now had three economic and financial crises this century and it is still in its first quarter. This would seem to illustrate that attempts to expunge volatility from the financial system are actually producing the opposite of the desired effect. They breach the rule for what you should do if you find yourself in a hole. This is hardly surprising given that the central banks were aiming at the wrong targets. Central banks were attempting to maintain a benign level of consumer price inflation but ignored asset price inflation caused by their actions. Some also adopted employment targets that were not or should not be part of their remit. One of the problems of easy money is that it leads to bad capital allocation or investment decisions which are exposed as the tide goes out.

We saw this in Japan in the late 1980s in a bull market when the Emperor’s garden was valued more than the state of California and the Tokyo Stock Exchange was on a P/E of about 100. The aftermath has been prolonged and worsened by a penchant for not admitting failure. So-called zombie companies that should have been allowed to fail have been propped up with continued funding and allowed to survive. Sending good money after bad is never a recipe for success. However, before we leap to the conclusion that this is in any way a uniquely Japanese trait let us bear in mind that other than Lehman no other major company was allowed to go bust in 2008, despite it being the largest financial crisis for 75 years. Japan’s bubble was followed by the Dotcom era in which money could be raised for an idea. The resulting meltdown was painful and especially for investors who had bought a business plan rather than a business. It is worth bearing in mind that real businesses survived and prospered. Amazon’s stock declined by about 95% during the Dotcom bust. It has since risen about 600 fold to its peak.like

triple A credits when they were really triple Z. You can’t improve the quality or liquidity of an asset by putting it into a structure. The other problem with the policy of easy money was that it had to end eventually, but not before it had one last hurrah. There were half-hearted attempts to reverse QE in particular by lowering central banks’ bond purchases but when the stock market unsurprisingly reacted badly in the so-called ‘taper tantrum’ in 2013, these were abandoned. Then in 2020 came the pandemic and central banks reacted to this by enacting that good old saying ‘To a man with a hammer, everything looks like a nail’. They decided that they should double down with their new toy, QE, which seemed to work so well in the Credit Crisis without any nasty side effects, well none that had yet become apparent, and apply an almighty stimulus. This was applied when there was no problem with demand or the banking system. It was just that people were locked up in their homes and unable to spend on bricks & mortar shopping, travel and entertainment and the global supply chain was malfunctioning, leaving consumers with pent-up savings waiting to be spent. What happened next may be an example of Sod’s Corollary to Murphy’s Law: • Murphy’s Law: What can go wrong will go wrong. • Sod’s Corollary: Murphy was an optimist.

Sod’s Corollary gave us the February 2022 Russian invasion of Ukraine which affected the prices of oil, gas and other minerals, such as nickel, and cereals following the central banks’ stimulus. The net result of the further stimulus and this invasion has been an upsurge in inflation and as a consequence a rapid and painful end to easy money. This final round of easy money post the pandemic led to all the usual poor investments which people make when they are led to assume that money is endlessly available and costs zero to borrow or raise. We can see the unwinding of these unwise investments, for example, in the collapse of FTX, the cryptocurrency ‘exchange’ (sic) and the meltdown in the share prices of those tech companies with no profits, cash flows or even revenues.suffering

more in the downturn than lowly rated or so-called value stocks. This effect can be seen in the bottom five detractors from the Fund’s performance in 2022: Stock Attribution Meta Platforms -3.3% PayPal -2.5% Microsoft -1.8% IDEXX -1.7% Amazon -1.5% Source: State Street Four of the five stocks are in what might loosely be termed the Technology sector (although Meta is actually in the MSCI Communication Services sector and MSCI has Amazon as a Consumer Discretionary stock) and at least two — PayPal and IDEXX — started the period with valuations which were particularly vulnerable to the effect of rising rates. In some cases these share price falls have become more pronounced because of events surrounding the business. Meta has its well-publicised problems with the regulatory and competition authorities and has announced a large spend on developing the so- called metaverse which it changed its name from Facebook to reflect. PayPal seems intent on snatching defeat from the jaws of victory. It has taken a leading position in online payments and parlayed that into a lamentable share price performance. The elements in this would appear to be a disregard for engagement with the customers newly acquired during the pandemic and no obvious attention to or control of costs. This is hardly surprising given the attention devoted to pursuing some clearly over-priced acquisitions. That is what happens when management start to conclude that investments do not need to earn an adequate return.

We are not aware of any major fundamental problems with either IDEXX or Microsoft. Our highly valued and technology holdings did not fare as poorly as some of the companies which had significant market values but no profits, cash flows or in some cases even revenues.Research/Bloomberg

This may seem cold comfort and to quote an old adage, ‘When the police raid the bawdy house even the nice girls get arrested’. But looking back to the example of Amazon over the Dotcom meltdown and its aftermath, it is a lot more comforting to own businesses which are performing well fundamentally when the share price goes down than to be found playing Greater Fool Theory in the shares of a company with no cash flows, profits or even revenues. For the year the top five contributors to the Fund’s performance were: Stock Attribution Novo Nordisk +2.1% Philip Morris +1.1% PepsiCo +0.7% ADP +0.5% Mettler-Toledo +0.4% Source: State Street If one word had to be used to describe last year’s winners it would be ‘defensive’. Two of them are fast-moving consumer goods companies and one is a drug company. However, it is worth pointing out that ADP is actually in the MSCI Technology sector. Which brings me to another point. You may have read that the Fundsmith Equity Fund is becoming a ‘Tech fund’ based upon recent purchases: ‘Terry Smith tech-buying spree continues with Apple purchase’, Interactive Investor, November 2022. Here is the MSCI sector breakdown of the portfolio: As at 31st December 2022 % Consumer Staples 33.8 Health Care 26.0 Technology 20.7 Consumer Discretionary 9.4 Communication Services 4.5 Industrials 1.7 Cash 3.9 Source: Fundsmith Research/MSCI GICS® Categories 20.7% of the portfolio is defined as Technology by MSCI. This compares with 23.2% on 31.12.14.

I can’t see a ‘spree’. I am not that keen on relying upon sector classifications to define a business and you may note that 4.5% is in the Communication Services sector. As these are Alphabet (the former Google) and Meta, I regard them as technology stocks and Amazon is classified as a Consumer Discretionary stock, although how this fits Amazon Web Services is difficult to see.until

recently, in our portfolio are not in my view primarily technology companies but rather they use technology to deliver differing services, namely: • ADP — payroll, employee insurance and HR. • Amadeus — airline and hotel reservations and operations. • Intuit — tax and accounting services. • PayPal — payment processing. • Visa — payment processing. Moreover, commentators tend to take an all or nothing approach to reporting our holdings — as in the reference to Apple already noted — without any mention of the size of the holding, which is hardly surprising as this is only disclosed semi-annually. But to put this in context, our combined holdings of Alphabet, Amazon, Apple, Adobe and Meta amount to just 9.0% of the portfolio, compared to our holding in Microsoft of 7.6%. I would therefore suggest that the Fund’s exposure to technology is a lot more subtle and nuanced, as well as smaller and more widely spread than the headlines sometimes suggest. However, as well as the lower valuations caused by higher rates, technology stocks are facing some fundamental headwinds. A slowdown in the growth of tech spending is hardly surprising after the massive growth caused by digitalisation during the pandemic. Moreover, the cyclicality of tech spending and online advertising is probably about to become evident as the economy slows and maybe falls into recession.

It may be greater than in the past simply because tech spending has become a much larger proportion of overall corporate and personal spending. However, there may be a silver lining in this cloud (no pun intended) as this pressure on revenue growth may cause some of the tech companies we invest in to stop behaving as though money is free and halt some of the less promising projects outside their core business, such as: • Alphabet — Its hugely loss-making ‘Other Bets’. Lightning does not strike twice. It has a good core online search and advertising business. • Amazon — It has already withdrawn from food delivery and technical education in India (who knew?) It has a highly successful ecommerce and cloud computing business on which to focus. • Meta — Stopping or cutting spending on the metaverse?communications

and digital advertising business on a single-figure Price/Earnings ratio (P/E). We continue to apply a simple three step investment strategy: • Buy good companies • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first and most important of these — whether we own good companies — by giving you the following table which shows what Fundsmith Equity Fund would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look- through’ basis, and compares this with the market, in this case the FTSE 100 and the S&P 500. This shows you how the portfolio compares with the major indices and how it has evolved over time. Year ended Fundsmith Equity Fund Portfolio S&P FTSE 2015 2016 2017 2018 2019 2020 2021 2022 2022 2022 ROCE 26% 27% 28% 29% 29% 25% 28% 32% 18% 16% Gross Margin 61% 62% 63% 65% 66% 65% 64% 64% 45% 42% Operating Margin 25% 26% 26% 28% 27% 23% 26% 28% 18% 18% Cash Conversion 98% 99% 102% 95% 97% 101% 95% 88% 88% 66% Interest Cover 16x 17x 17x 17x 16x 16x 23x 20x 10x 11x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. Interest Cover is median.

2015–2019 ratios are based on last reported fiscal year accounts as of 31st December and for 2020–22 are Trailing Twelve Months and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. In 2022 returns on capital and profit margins were significantly higher in the portfolio companies than in 2020 and 2021. Gross margins were steady. Importantly all of these metrics remain significantly better than the companies in the main indices (which include our companies). Moreover, if you own shares in companies during a period of inflation it is better to own those with high returns and gross margins. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2022? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 1% in 2022.This

is the lowest growth rate we have recorded to date in our portfolio and probably says far more about the levelling off in demand in some sectors post the pandemic surge and macro-economic conditions than it does about the long-term growth potential of the businesses. You may recall that the free cash flow for our companies surged 20% in 2021, significantly above the more normal 9% growth in 2019 and 8% in 2020. Moreover, the free cash flow of the S&P 500 fell by 4% last year. Frankly we are pleasantly surprised that there was any growth at all in our portfolio companies, and if 1% growth worries you it may be wise not to read next year’s letter. Cash conversion remains depressed for our portfolio companies but is currently based upon some unusually volatile conditions caused by the pandemic’s disruption to supply chains leading to stockouts and subsequent hoarding of stocks by some companies. Cash flow is an acid test of a business but it is also a more volatile measure than profits which are based on accrual accounting and spread some cash flows between periods. We will have to wait a year or two before something approaching normality is restored and we can gauge how well our companies are doing on this measure. The average year of foundation of our portfolio companies at the year-end was 1922. They are just over a century old collectively. The second leg of our strategy is about valuation.

The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of the year was 2.7% and ended it at 3.2%. The year-end median FCF yield on the S&P 500 was 3.4%, roughly in line with our portfolio. This is one benefit of the fall in share prices over the period. Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index and are valued fractionally higher than the average S&P 500 company. Turning to the third leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 7.4% during the period, a little higher than usual. It is perhaps more helpful to know that we spent a total of just 0.003% (less than a third of a basis point) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with subscriptions and redemptions as these are involuntary). We sold our stakes in Johnson & Johnson, Starbucks, Kone, Intuit and PayPal and purchased stakes in Mettler-Toledo, Adobe, Otis and Apple.some

cases the size of the holding sold or bought was small. We have held five of our portfolio companies since inception in 2010. Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2022 for the T Class Accumulation shares was 1.04%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2022 this amounted to a TCI of 1.05%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We are pleased that our TCI is just 0.01% (1 basis point) above our OCF when transaction costs are taken into account.

However, we would again caution against becoming obsessed with charges to such an extent that you lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. In the past we have written about activism and our engagement with companies’ management, and this year I want to draw this together with a couple of examples. Last year I wrote about Unilever and attracted a virtual tsunami of comment for my remarks about Unilever, purpose and Hellmann’s mayonnaise. Events soon overtook this commentary insofar as Nelson Peltz’s Trian Partners announced that it had bought a stake in Unilever and he was invited to join the board. We are asked to suspend disbelief that this was in no way linked to the subsequent announcement that Alan Jope will be leaving the CEO role. This explanation sounds like it was lifted from the script of Miracle on 34th Street. As I have previously pointed out, our Fund has held Unilever shares since inception and was about the 12th largest shareholder when these events happened. Yet for the first eight years of our existence as a shareholder we did not hear from Unilever.headquarters

and listing to the Netherlands. As I remarked at the time, it is not a good way to manage relationships to ignore people until you need their support. Once contact had been established with Unilever we then tried to make some points about what we saw as problems with the performance of the business and the focus of the management, which were duly ignored. This is a business making a return on capital in the mid to low teens, below the market average, where you could measure annual growth if you could only count to three, and which missed every target it set out when it summarily rejected the Kraft Heinz bid approach. So it’s not like there weren’t some questions to answer. Then came the near-death experience with the abortive GSK Consumer bid. I don’t know how long Trian held its stake before Mr Peltz was invited to join the board or how big that stake was, but I would guess that they held it for far fewer months than we have held it in terms of years. We have no objection to Mr Peltz’s involvement. He at least seems to have the sense to become involved in good businesses which need some improvement, whereas some activists pick on poor businesses and all they can hope to achieve is a better-run bad business.

Where we have seen him involved in companies we have owned we have sometimes agreed with and admired his contribution — as in the operational improvements which accompanied his time at Procter & Gamble — and sometimes not — as when he promoted the idea of splitting PepsiCo into separate drinks and snacks businesses. What I find questionable is that companies mouth platitudes about wanting to attract long-term shareholders yet based on our experience, we tend to get ignored, whereas an activist who has held shares for fewer months than we have held in years gets invited to board meetings. One example may just represent an outlier. But what about PayPal? We had held PayPal shares since it was spun out from eBay in 2015. We tried to engage with PayPal as we identified, seemingly long before the management, that their lack of engagement with new customers was a problem as was cost control and that their acquisitions were value destroying. In particular, we pointed out that the value destroying acquisitions might be avoided if the management remuneration incentives included some measure of return on capital. A representative of the board kindly told us they would think about that. Whilst they were allegedly thinking about it Elliott Management bought a stake which led to them being given a board seat and an information sharing agreement.

Please don’t misunderstand the criticism I am levelling here. I am not envious. I do not want a seat on the board of Unilever, PayPal or any other listed company. Nor do I want an information sharing agreement. I think our research has been able to identify the problems of PayPal and Unilever better than the management and without any need for access to any unpublished information. In some cases you can determine more from what information is not disclosed. Take Unilever’s acquisition record as an example. Here’s a chart covering Unilever’s acquisitions in just its Beauty & Wellbeing division over the past eight years. Source: Fundsmith Research A few points are noteworthy: 1. Considering this is Unilever’s smallest division outside of ice cream they have been very active. Of course they might say that they are trying to build a wellbeing and beauty business by acquisition, but then all the more reason why we shareholders should know how they are performing. 2. Yet we were only told the cost in just three out of 27 acquisitions. Whilst I am sure Unilever complied with their disclosure obligations, is there some reason why we shareholders can’t know how much of our money they spent? (If anyone is thinking of responding ‘commercial sensitivity’ could you please have the courtesy to check that I don’t have

a mouthful of liquid before you say that?) We are aware from press speculation that Dollar Shave Club cost c.$1 billion and it has sunk without trace. 3. The coloured table shows which of these acquisitions were mentioned in subsequent annual reports. It is clearly a minority — only 10 out of 27 in 2021 and in some years like 2020, just two. We have not heard about the Carver Korea acquisition which cost €2.3bn since 2019 (spoiler alert: purchased from Bain Capital and Goldman Sachs). Now call me cynical if you want but I doubt that mention was omitted because they were all performing embarrassingly well. 4. You can find sources of information other than the company. This chart of Carver Korea’s sales revenue from Statista says it all: Source: Statista.com Shouldn’t we have some idea how Unilever and its management have performed before they are allowed to do any more acquisitions? Unilever’s low return on capital might be a clue. We do not need an information sharing agreement to reach an obvious conclusion. What I am complaining about is the bipolar response some companies have to long-standing shareholders versus newly arrived ‘activists’. As an investor you might reasonably query why if we had identified the problems at PayPal and Unilever we didn’t just sell the shares and avoid any underperformance.

One reason is that we try to be long-term shareholders and when we hold shares in what we consider to be a good business, which we think is underperforming its potential, we like to see if we can help to correct that.Won)

easier to change the management than to change the business. However, when we are continually ignored there is another even easier option to sell the shares which we turn to when all other remedies fail. Returning for a moment to Mayonnaisegate, amongst the outpouring of comments last year were a number of apologists for Unilever who were at pains to point out that the Hellmann’s brand has been growing revenues well and this was proof that ‘purpose’ works. Of course there is no control in that experiment; we don’t know how well it would have grown without the virtue signalling ‘purpose’. It also confuses correlation with cause and effect. There may be a positive correlation between stork sightings and births but that doesn’t prove that one causes the other. Maybe Hellmann’s would be growing as fast or even faster without its ‘purpose’. To further illustrate the point, this year we are moving on to soap. When I last checked it was for washing. However, apparently that is not the purpose of Lux, the Unilever brand, which apparently is all about ‘Inspiring women to rise above everyday sexist judgements and express their beauty and femininity unapologetically’. I am not making this up; you can read it here: https://www.unilever.com/brands/personal-care/lux/ I will leave you to draw your own conclusions about the utility of this.

One other topic which I want to cover this year is share-based compensation and especially its removal from non-GAAP (Generally Accepted Accounting Principles) profit figures. Share-based compensation has become an increasingly prominent part of some companies’ expenses in recent years, especially among companies in the Technology sector. If we take for example the 75 companies in the S&P Dow Jones Technology Select Sector Index, share-based compensation expense expressed as a percentage of revenue has gone from an average of 2.2% in 2011 to 4.1% in 2021. This may not seem like much of an increase, but keep in mind that during this period revenue for this set of companies had almost quintupled on average. There is nothing wrong per se with compensating employees with shares. In fact, there is a legitimate reason for doing so: it may help to align the interests of employees with those of shareholders. I want to focus on how share-based compensation is accounted for or, more accurately, how it is not accounted for in companies’ non-GAAP earnings figures.

Among the 75 companies in the Technology Select Sector Index mentioned above, 45 of them remove share-based compensation from non-GAAP versions of their earnings per share, operating income, or both — in plain English they remove the amount of the debit for share-based compensation which boosts their profits. That is about $26bn of expenses that have been adjusted out in reporting the 2021 profits in the non-GAAP results of these 45 companies. This amounts to about an average of $600m of share-based compensation for each company which is excluded or added back in reaching their non-GAAP earnings. You will find it as no surprise that all of the companies in the index whose share-based compensation represents greater than 5% of revenue remove share-based compensation from non-GAAP measures. What are the justifications for removing share-based compensation from measures of income and earnings? A common excuse that companies give for adjusting profits so that the debit for share-based compensation is removed is because it is a non-cash expense. This argument makes no sense. Plenty of income statement items are partially or entirely non-cash. Depreciation is non-cash, but it still reflects the very real cost associated with a company’s long-lived assets (although many of the same people who adjust out share- based compensation and many others try to get analysts to focus on EBITDA in order to ignore the inconvenient depreciation and amortisation cost).

Deferred income taxes are non-cash but are nevertheless recorded in the P&L account. Parts of revenue can be non-cash as well, but we certainly don’t see many companies removing them from their results. As long as accrual accounting is the standard, the ‘non-cash’ argument simply does not pass muster. If you want to review cash items, then look at the cash flow statement, not an adjusted P&L account. Other reasons given for excluding share-based compensation include the fact that the calculation of the expense may use valuation methodologies that depend on assumptions and that the values of the securities given to employees as compensation may fluctuate and are outside a company’s control. It is true that the expense associated with stock options provided as compensation is calculated using option pricing models, which rely on assumptions for the risk-free interest rate and share price volatility. But other items on a GAAP income statement make significant use of assumptions and estimates as well. Depreciation expense is calculated based on the estimated useful lives of assets, for example.a

company’s operations which can be in the income statement, such as commodity prices which may affect input costs and the value of hedges. The lack of control does not justify their removal from important financial metrics. Yet another reason proffered for excluding share-based compensation is that it results in double-counting because the shares paid to employees are reflected as both an expense item in the income statement and in the share count that is used as the denominator for per share measures such as EPS. First of all, it is important to note that this argument applies only to per share metrics such as earnings per share, and hence, it provides no excuse for excluding share-based compensation from measures of gross margin or operating income, which many companies do. Secondly, by their nature, financial statements have a degree of inter-relation. Many items on the income statement flow back into other parts of the income statement through the balance sheet. If you increase the cash expenses of a company, there will be less cash and/or more debt on the balance sheet. This will in turn affect the income statement by increasing interest expense and/or reducing interest income. Similarly, an increase in share-based compensation expenses will have a secondary impact on the balance sheet in the number of shares outstanding.

We now arrive at a fourth, and perhaps the most nefarious excuse given by companies for removing share-based compensation from their non-GAAP metrics: everybody else does it. This does not make it correct nor is it true. Indeed, it may very well be that the companies that do not adjust their profit numbers from GAAP are put at a disadvantage. Take the example of Microsoft and Intuit. Microsoft shares are currently being valued at a P/E ratio of 25.0 times the consensus EPS estimate for the fiscal year ending June 2023. Meanwhile, Intuit is being valued at 28.4 times the non-GAAP consensus estimate for the fiscal year ending July 2023. Many investors and analysts may accept that Intuit is trading at a higher multiple given expectations of greater growth potential. However, Intuit removes share-based compensation from their non-GAAP EPS whereas Microsoft does not. Given that Intuit’s GAAP EPS guidance for the year ending 31st July 2023 is $6.92–$7.22, its non-GAAP guidance is $13.59–$13.89, and the consensus estimate for 2023 EPS is at $13.69, it seems clear that most sell-side analysts are accepting the company’s non-GAAP adjustments, which includes the removal of some $1.8bn of share- based compensation, in their estimates.more

apples-to-apples comparison with Microsoft based upon GAAP EPS, Intuit’s 2023 EPS would be closer to $9, meaning that the shares would be trading at a multiple of about 43 times. I think investors and analysts may find a premium of 14% for Intuit over Microsoft (28.4 times versus 25.0 times) to be reasonable. I’m not so sure they are fully aware that Intuit shares are actually trading at a premium of 73% if share-based compensation is treated in the same manner between the two companies. Many investors and analysts, including us, look to cash flow metrics more than accrual profits. Unfortunately, share-based compensation may cause distortions in cash flow metrics as well, even when they follow GAAP. Under GAAP, share-based compensation is added back in the cash flow from operating activities, which in turn is used in the computation of free cash flow. Some researchers and commentators argue that share-based compensation should be reclassified from the operating activities section to the financing activities section of a cash flow statement for analytical purposes. We agree. After all, the decision to fund compensation to employees with shares rather than cash is a financing decision rather than one pertaining to the operations of a company. As such, a measure of cash flow from operating activities that does not benefit from adding back share-based compensation is likely more reflective of the ongoing cash generation of a company.

If we apply this concept to the case of Intuit, it would imply that the company is not in fact trading at a trailing twelve-month free cash flow yield of 3.5% as it seems. Removing $1.5bn of share-based compensation from the $4.1bn of operating cash flow reported in the cash flow statement would leave Intuit’s free cash flow yield much lower, at 2.2%. This example gives a sense of the magnitude of distortion that the accounting for share-based compensation could inflict on free cash flow yields. However, I suspect the most pernicious effect of adjusting profits to exclude the cost of share-based compensation occurs when the management start to believe their own shtick and mis-allocate capital based upon it. Too often management fail to mention expected returns on capital deployed when they make acquisitions and instead rely on statements about earnings dilution or accretion. We have just been living through an era where interest rates were close to zero. Statements about earnings dilution or accretion from an acquisition versus the alternative of interest income forgone on the cash do not reflect anything useful. In a period of such low rates the only acquisitions which could be dilutive are those where the money was literally shredded. Amazingly there are some of those too.

Once people start relying upon this spurious measure of whether an acquisition represents value based upon earnings dilution or accretion and combine this with using earnings adjusted by adding back the significant cost of share-based compensation, they can make some gross errors. We suspect this may be part of the reason for Intuit’s acquisition of the online marketing platform Mailchimp in 2021 for $12 billion, half of it in cash. This represented 12 times Mailchimp’s revenues (not its profits, its sales). As a result Intuit’s return on capital has fallen from 28% in 2020 to just 11% in 2022 but no doubt it is not dilutive to EPS adjusted by adding back share- based compensation. The Intuit CEO described the Mailchimp acquisition as ‘an absolute game changer’. Shareholders must hope he is right and in the way that he meant it. We have coined a phrase at Fundsmith for this practice of relying upon earnings adjusted to take out the cost of share-based compensation and other real and persistent expenses (such as restructuring costs that keep recurring). Instead of the usual phrase of ‘fully diluted earnings per share’ being earnings per share diluted by all the shares which a company has agreed to issue through options and so on, we refer to these heavily adjusted EPS measures as ‘fully deluded earnings per share’. Last year in this letter I said I thought we were probably in for an uncomfortably bumpy ride in terms of valuations.

We have no idea when the current period of inflation and central bank interest rate rises which caused this prediction to come true will end. It is sometimes said that central bank policy is always either too lax or too tight, it is never exactly right. We need not discuss whether it has been too lax in the past. Presumably at some point it will become too tight and quite probably tip the major economies into recession. This holds few fears for us. Our companies should demonstrate a relatively resilient fundamental performance in such circumstances, and the only type of market which ends in a recession is a bear market. What we are clear about is that we continue to own a portfolio of good companies. Where the end of the easy money era has exposed any doubts, and there are always doubts, we have acted upon them and/or aired them in this letter. Our companies are more lowly rated than they were a year ago, now being rated roughly in line with the market. This does not make them cheap and there is no guarantee that they will not become more lowly rated, but our focus is on their fundamental performance, as it should be, because in the long term that will determine the outcome for us as investors.

I will leave you this year with a quote from Winston Churchill: ‘If you are going through hell, keep going’. At Fundsmith we intend to. Finally, may I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its products. This document is a financial promotion and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: Fundsmith LLP & Bloomberg unless otherwise stated. Data is as at 31st December 2022 unless otherwise stated. Portfolio turnover is a measure of the fund's trading activity and has been calculated by taking the total share purchases and sales less total creations and liquidations divided by the average net asset value of the fund.

P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2022 unless otherwise stated. Percentage change is not calculated if the TTM period contains a net loss. MSCI World Index is the exclusive property of MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and ‘GICS®’ is a service mark of MSCI and Standard & Poor’s.

January 2021 Dear Fellow Investor, This is the third annual letter to owners of the Fundsmith Sustainable Equity Fund (‘FSEF’, ‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2017 and various comparators. % Total Return 1st Jan to Inception to 31st Dec 2020 Sharpe Sortino 31st Dec 2020 Cumulative Annualised ratio5 ratio5 Fundsmith Sustainable Equity Fund1 +18.0 +53.3 +14.4 0.92 0.78 Equities2 +12.3 +35.9 +10.2 0.53 0.49 UK Bonds3 +4.6 +11.0 +3.4 n/a n/a Cash4 +0.3 +1.9 +0.6 n/a n/a 1 I Class Acc shares, net of fees, priced at noon UK time, source: Fundsmith LLP 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 yr., source: Bloomberg 4 3 Month £ LIBOR Interest Rate, source: Bloomberg 5 Sharpe & Sortino ratios are since inception on 1.11.17 to 31.12.20, source: Financial Express Analytics The table shows the performance of the I Class Accumulation shares which rose by +18.0% in 2020 and compares with a rise of +12.3% for the MSCI World Index with dividends reinvested. However, I realise that many or indeed most of our investors do not use these as the natural comparator for their investments. Those of you who are based in the UK may look to the FTSE 100 Index (‘FTSE 100’) as the yardstick for measuring your investments and may hold funds which are benchmarked to this index and often hug it. The FTSE

100 delivered a total return of -11.5% in 2020 so our Fund outperformed this by a margin of 29.5 percentage points. For the year the top five contributors to the Fund’s performance were: PayPal +4.5% IDEXX +3.2% Microsoft +2.4% Starbucks +1.8% Intuit +1.8% Microsoft and Intuit are making their third consecutive appearance whilst IDEXX is putting in an appearance for the second time. Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either. Starbucks, which we discuss below, was purchased after sharp falls in March. The bottom five were: Marriott International -1.0% Sage -0.9% Amadeus -0.8% Intertek -0.4% Becton Dickinson -0.3% We hardly need to discuss the reasons for the poor performance of Amadeus and Marriott International. Airline and travel reservations and hotel management have not been happy places to be in the past year, although it is worth noting nowhere near as bad as investing in actual airlines or hotels. Amadeus’s share price fall of -13.5% in 2020 compares with a drop of -27.9% for the Bloomberg World Airlines Index. Marriott’s share price fall of -15.0% compares with a drop of - 35.1% for the Dow Jones US Hotel and Lodging REIT Index. This illustrates the virtues of Amadeus’s and Marriott’s business models in contrast to the industries they serve.

However, in both cases whilst they face a difficult situation, we are pleased that management has spent its time and effort managing liquidity and costs in an effort to ensure that they survive these events rather than pointlessly speculating about the likely timescale and course of recovery. In both cases we believe that they should not only survive but also strengthen their competitive position. We sold our stakes in Clorox and Reckitt Benckiser and one as yet undisclosed position and purchased stakes in Starbucks, Colgate, Zoetis, Procter & Gamble and an as yet undisclosed position.purchase

increased quantities of household cleaning products, personal cleaning products and OTC medicines. We felt that in both cases the ratings achieved did not reflect the pedestrian nature of these businesses in more normal circumstances or the issues they face which may come back into focus if or when the COVID related boost fades. Moreover, at the same time as these two stocks were enjoying an unusually good performance, Starbucks, which we admire, saw share price falls of over 40% at the height of the panic over COVID. They are probably familiar to you as the world’s leading coffee shop brand. Starbucks has high returns on capital and a good growth rate — two characteristics which we seek. Whilst it is easy to see the challenge to the lockdowns for Starbucks’s urban outlets which partly rely on seating and coffee collected on the way to the office, this is far from their only format. The sometimes spectacular queues and resulting traffic jams at Starbucks drive-through outlets both illustrate another format and testify to the continued loyalty to the brand as does the rise in loyalty club members in 2020. During this period Starbucks’s main competitor in its second largest market — Luckin Coffee in China — was exposed as a fraud in yet another illustration of the rule that it is only when the tide goes out that you find out who has been swimming naked. After the COVID lockdowns we also purchased a stake in Colgate- Palmolive, Procter & Gamble and Zoetis.

Colgate-Palmolive is the leader in oral care and liquid soap and has a speciality pet food business (Hills Scientific). Procter & Gamble is the world’s largest Fast Moving Consumer Goods (‘FMCG’) business with leading positons in laundry and cleaning products, baby and feminine care, beauty and grooming. Zoetis is the leading animal drug company which is also developing a business in diagnostic testing. We continue to apply a simple three step investment strategy: • Buy good companies • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first and most important of these — whether we own good companies — by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market, in this case the FTSE 100 and the S&P 500 Index (‘S&P 500’). This shows you how the portfolio compares with the major indices and how it has evolved over time.

Year ended Fundsmith Sustainable Equity Fund Portfolio S&P FTSE 2017 2018 2019 2020 2020 2020 ROCE 28% 29% 29% 23% 11% 10% Gross margin 63% 65% 65% 61% 44% 39% Operating margin 26% 28% 26% 21% 12% 9% Cash conversion 102% 95% 99% 102% 94% 95% Interest cover 17x 17x 17x 16x 6x 6x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Profit Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Sustainable Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Interest Cover number is median. 2017-2019 ratios are based on last reported fiscal year accounts as at 31st December and for 2020 are Trailing Twelve Months and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. Percentage change is not calculated if the TTM period contains a net loss. Returns on capital and profit margins were lower in the portfolio companies in 2020. This is hardly surprising in light of events in the economy, but the scale of the falls were hardly disastrous. When people have said to us, ‘You invest in non-cyclical businesses’ I always reply that I have never found one. It is the degree of cyclicality in our portfolio which we seek to control through our stock selection. As a group our stocks still have excellent returns, profit margins and cash generation even in poor economic conditions.

As you can see the same cannot be said for the major indices even though they have the benefit of including our good companies. The average year of foundation of our portfolio companies at the year- end was 1926. They are just under a century old collectively. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2020? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 9% in 2020. The second leg of our strategy is to employ both negative Environmental, Social and Governance (‘ESG’) screening (not investing in high ESG risk sectors such as aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account of not only the companies’ ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy and productivity of capital investment.each

company based on ESG factors and current “hot topics”. At the end of December 2020, the weighted average RepRisk indicator for our portfolio was 25.8, higher than it was at the start of the year but still well below the S&P 500 index score of 29.1. At the end of 2020, the four companies with the highest RepRisk Indicator scores were: Microsoft (54) Johnson & Johnson (53) Unilever (49) Visa (49) Microsoft’s and Johnson & Johnson have switched positions in this year’s ranking despite the RepRisk Indicator of both falling from 57 to 54 and from 58 to 53 respectively. Unilever has kept its position at third, although its score has increased from 46 to 49. Visa, replacing Marriott, is a new and somewhat questionable entrant into the list. It’s RepRisk increased by 15 in December after news it was suspending the use of its cards on Mindgeek’s site Pornhub, amid allegations of rape scenes, child abuse and private videos being shown on the website without participants’ consent. This is something that we would consider a positive impact, which reduces the investment risk of Visa. At the end of 2020, the four companies with the lowest RepRisk Indicator scores were: Kone (0) IDEXX (0) Waters (1) Undisclosed Position (4) Kone and IDEXX (which also appeared last year) are an elevator & escalator business and animal diagnostic testing business respectively, and therefore have unsurprisingly low scores.

Waters makes liquid chromatography and mass spectronomy and other equipment used for testing by the food and drug industry. We use the RepRisk Indicators as a proxy for the absolute negative impacts a company has on the environment and society. Environmental impacts are somewhat easy to measure and compare, assuming all companies report accurate statistics that are calculated using similar methodologies, which is an assumption that is becoming more true as each year goes by. With environmental impacts, one can calculate a number (e.g. GHG emissions) for a company and then compare how that has moved over time and with other similar companies. We can also aggregate data to assess the impacts of the entire portfolio.

Those of you who read the fund’s monthly ESG factsheet will have noted that we report environmental statistics per million pounds of FCF for the portfolio and S&P 500. For non-reporting companies we estimate their environmental statistics by applying the average statistics for the company’s respective subsector in proportion to their total assets. Over the past few months, we have been refining our estimation model to make it more accurate and expanding it so that it can produce comparable numbers for the MSCI World Index, which contains significantly more companies than the S&P 500. This has meant that for a few statistics which most companies produce – how much waste and greenhouse gases they produce and how much water and energy they use – we can compare the negative impact on the environment of FSEF to an easily investable index. These weighted average statistics are shown in the table below: Weighted average is weight of a company in fund multiplied by environmental stat of a company As you can see from the table above, owning units in FSEF has a significantly lower impact on the environment than owning the MSCI World. As the numbers by themselves can be fairly hard to imagine in real terms, I’ve converted the FSEF numbers into the number of average UK households it would take to emit this amount over a year, which is also shown in the table above.

Social impacts, however, are much more difficult to measure quantitatively because they are far more dependent on an individual company and what it is capable of doing, in either a positive or negative way, and can rarely be quantified. It is so dependent on the context of individual companies that it is almost impossible to compare them against one another. This is one of the reasons why the majority of reported social statistics focus on diversity statistics, as they can easily be measured and tracked over time. However, this ignores a lot of the nuance and detail of the good and bad impact companies have, Metric Unit FSEF MSCI World Equivalent no. of UK households Total waste produced Thousand metric tonnes 197 8,628 188k Hazardous waste produced Thousand metric tonnes 14.43k

which we will try to demonstrate through some of the positive impacts FSEF companies have had on society in response to the COVID-19 pandemic. Initially as the pandemic began, the companies in FSEF were quick to preserve cash by delaying dividends, cutting non-essential expenses and arranging additional debt facilities from banks. They were also quick to make their offices and factories safe for workers, while supporting those who were now working from home. Post the initial outbreak, numerous companies in FSEF contributed positively in the fight against COVID-19 in more ways that just donating money and equipment, although many also did that. There were numerous initiatives to support FSEF company employees, local communities and businesses. Other FSEF companies had the expertise and resources to directly help the fight with innovation or R&D. Overall, FSEF portfolio companies donated over $150m to support their local communities and employees through these difficult times. FSEF companies also provided support for local businesses, both big and small, which were affected by the crisis. Overall, FSEF portfolio companies offered over $900m in grants to small businesses. Some FSEF companies had the expertise and resources to directly support the fight against the COVID-19 pandemic. At Fundsmith, we find the idea that one could reduce the wide variety of positive impacts made by FSEF portfolio companies in response to the pandemic to a single rating number fallacious.

It overly simplifies something to the point that its meaning is lost. There is no way for anyone to quantify how much “better” it is for society for Johnson & Johnson to actually be producing a COVID vaccine compared to PayPal helping small businesses reopen faster. This is why we report the good and the bad which FSEF portfolio companies do each month in the commentary on our FSEF ESG factsheet so that you and we can assess particular instances. Over time we find that these tend to give us a clear picture of a company’s stance on sustainability, but it is one based upon informed judgment rather than box ticking or spurious precision. We also, rather than relying on external rating providers, perform our own analysis of both the positive and negative impacts our portfolio companies have in the widest possible sense, accepting that in many cases the impact isn’t going to be tangible. In contrast, the majority of the asset management industry rely on external rating providers to simplify their assessment of what they can and can’t invest in.

However, in doing so, a lot of the actual net impact companies have is lost. Further issues that arise from this need for simplified ratings is that it forces asset managers to look for things they can measure accurately (board and employee diversity) or whether a company has a policy towards social issues such as animal testing, human rights or modern slavery. These are, of course, good things to have and are signs of good transparent corporate governance, but just because a company has a policy toward something doesn’t mean they actually behave in that way, and conversely, if they don’t have a policy, it doesn’t mean that they don’t behave in a way that we would approve of. A policy does not equate to action, and reducing a company’s net impacts on society down to a single metric overly simplifies the issue and too many of the good impacts that companies have are ignored or lost in the process. This leads onto the question of valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) of the portfolio at the outset of the year was 3.3% and ended it at 2.9%, so they became more highly rated. Whilst this is a good thing from the viewpoint of the performance of their shares and the Fund, it makes us nervous as changes in valuation are finite and reversible, although it is hard to see the most likely source of such a reversal — a rise in interest rates — in the near future.

The year-end median FCF yield on the S&P 500 was 3.7%. The year- end median FCF yield on the FTSE 100 was 4.2%. More of our stocks are in the former index than the latter and I will not repeat the explanation which I gave in my 2017 annual letter on why I think the FTSE 100 is not an appropriate benchmark or investment proxy for our investors to use. Moreover, the valuation disparity with the FTSE 100 has been widened by the portfolio’s 30% outperformance of the FTSE 100 during the year. It’s hard to outperform by such a wide margin without becoming relatively more highly valued unless the portfolio’s cash flows have grown at a similar differential rate. What the market seems to be rewarding is consistency of performance which has been emphasised by economic conditions in 2020. Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index and are valued much more highly than the average FTSE 100 company and higher than the average S&P 500 company. It is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap.

Turning to the third leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with negative portfolio turnover of -2.6% during the period. It is perhaps more helpful to know that we spent a total of just 0.038% (3.8 basis points) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary). We have held 17 of our portfolio companies since inception in 2017. Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2020 for the I Class Accumulation shares was 0.97%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF.

We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2020 this amounted to a TCI of 1.01%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We are pleased that our TCI is just 0.04% (4 basis points) above our OCF when transaction costs are taken into account. However, we would again caution against becoming obsessed with charges to such an extent that you lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. Some commentators have attributed our recent outperformance to the performance of technology stocks accompanied by warnings that a ‘bubble’ is building in technology stocks rather like the Dotcom Bubble and that it may burst with similar ill effects. The technology heavy NASDAQ Index has provided a total return of +40.9% in 2020 and the MSCI World Information Technology Index delivered +40.2% so maybe they have a point.as

over-rated. However, it’s always good to start with the facts. Our Fund’s sectoral exposure was as follows at the year-end: Sector % Healthcare 29.6 Technology 28.0 Consumer Staples 27.4 Consumer Discretionary 9.2 Industrials 4.1 Cash 1.8 Technology is the second largest sectoral exposure, but smaller than consumer staples and in fact if you take all our consumer stocks — discretionary and staples — together, they far outweigh our technology exposure. Moreover, I am not sure that these sector labels are all that helpful in determining what we are really exposed to. For example, our Communication Services holding is in fact Facebook. Isn’t that a technology company? What do the following companies have in common? Amadeus, Automatic Data Processing, Intuit, Microsoft, PayPal, Sage and Visa? They are all owned by our Fund and they are all labelled as technology companies. Yet they span airline reservation systems; payroll processing; accounting and tax software; operating systems, distributed computing (the ‘cloud’), software development tools, business applications and video gaming; and payment processing. I would suggest that the secular drivers of these businesses have some distinct differences and that their prospects are not governed by a single factor — technology. This one size fits all label does not help much in evaluating them.

There are also issues with the relative valuation of some technology businesses which — like a number of businesses of the sort we seek to invest in — rely on intangibles. The main assets of the companies we seek to invest in are often intangible. Some examples of intangible assets are brands, copyrights, patents, know-how, installed bases of equipment which require servicing and maintenance and so produce customers who are locked-in to the supplier, software systems which are critical to a business or person and so-called network effects. They are distinct from tangible assets such as real estate, machinery and equipment, and vehicles. The return on intangible assets is higher as they mostly need to be funded with equity not debt and attract an appropriate return.tangible

collateral. Intangible assets can also last indefinitely if they are well maintained by advertising, marketing, innovation and product development and the duration of an asset is an important factor in figuring out its real returns. However, there are obvious problems in comparing businesses which rely on tangible assets with those that rely mostly on intangibles. Tangible assets appear on a company’s balance sheet. Cash is expended to purchase them or liabilities are assumed (debt or leases) and the assets are placed on the balance sheet. Only the depreciation charge, if any, enters the profit and loss account and there may be no impact on cash flow after the purchase. In contrast, intangible assets are mostly built through spending which goes through the profit and loss account and cash flow. Although some software development is capitalised, most is not and neither is brand development nor most research & development. Of course acquisitions skew this picture. The net result is that for any given level of investment in assets, the profitability of a company building an intangible asset is likely to be depressed versus a company building or buying a tangible asset. This makes a mockery of the comparison of their valuations which are done by some commentators and investors who simply compare their price- to-earnings ratios (‘PE’). In addition, the degree to which this needs to be taken into account in making such comparisons has been rising.in

tangible assets in the 1990s — not coincidentally as the internet age hit full pace. This not only makes comparisons between different types of company difficult, it also makes assertions about market valuations over time — such as the Cyclically Adjusted PE (or CAPE) difficult. A simple illustration of this is that in 1964 the average (median) tenure of a company that was in the S&P 500 was 33 years. By 2016 this had fallen to 24 years: Average Company Lifespan in S&P 500 Index Source: Innosight analysis based on public S&P 500 data sources. www.innosight.com. Years, rolling 7 year average They are not the same companies and at least in part not even the same sort of companies. I lived through the rise and fall of the Japanese equity market. When it reached its peak in 1989 with a PE of over 60 we were told that this was because Japanese company accounting was much more conservative than western companies. In fact, their shares were just expensive. So I am wary of explanations for why we should accept high valuations, especially if they are based upon theories about accounting. But whilst Sir John Templeton did say that the four most dangerous words in investment are ‘This time it’s different’ (which is actually five words before anyone points this out) sometimes it really is different and if you miss such inflection points it is to the detriment of your net worth.

It is impossible for me to report on 2020 without mentioning COVID. I hope you agree that our portfolio performed well, both in terms of the share price performance and the fundamental performance of the companies, which is just as important. It is also important to note that our operations were not impaired by the lockdowns and travel restrictions. Whilst the performance of the fund is important, it is also important that if you wish to contact us you can and are dealt with promptly and efficiently. You should be able to get any information you reasonably require which should be accurate and up to date. Perhaps most importantly, if you wish to deal — including redeeming your investment — we can execute for you. All of these vital functions continued seamlessly throughout the depths of the lockdowns. We have long been managing the dealing, operations, portfolio management and research across a number of widespread geographies, much to the amazement of some people who felt this could only be accomplished in a few London postcodes. So the need to Work From Home and an inability to travel were not major obstacles for us. One of the mantras which has been regularly trotted out by commentators is that the events of 2020 are unprecedented. Whilst that is literally true, as Mark Twain observed, history doesn’t repeat itself but it often rhymes.

It is certainly true that most of us have never experienced anything like it, yet it may not be strictly true that the events of 2020 are without precedent. There have been six identifiable pandemics over the past 130 years: Recent Pandemics Estimated Deaths Russian Flu (1889–90) 1m Third Plague (1894–1922) 12m Spanish Flu (1918–19) 50m Asian Flu (1957–58) 2–5m Hong Kong Flu (1968–69) 1–4m Swine Flu (2009–10) 0.5m We might be able to draw some parallels from these past pandemics as a guide for what may happen as a result of COVID. One of the conclusions that you might draw from the economic effects of pandemics is that they do not so much cause new trends but rather they accelerate some existing trends. The most obvious comparator — and one which people have most frequently alighted upon — is the Spanish Flu pandemic of 1918–19.mass

production. The assembly line was not invented as a result of the Spanish Flu pandemic — the Model T Ford was put on an assembly line in 1913 — but it accelerated its adoption. The increase in productivity this delivered helped to fuel an economic boom as the cost of production of items such as cars and household electrical appliances were reduced as the volume of production rose so that they became affordable by the middle classes for the first time. This helped to fuel the economic and stock market boom of the Roaring Twenties. Might something similar happen as a result of COVID? Obviously, I do not know, and fortunately my predictive capability is not the basis of our investment strategy. However, there are some clear signs that existing trends have been accelerated by COVID. For example: • E-commerce • Online working from remote locations using the cloud or distributed computing • Home cooking and food delivery • Online schooling and medicine • Social media and communications • Pets — which have become more important in isolation and when their owners are at home more • Automation and AI The result is that many people have become more productive. Salespeople can visit many more clients if video conferencing is acceptable and at virtually no incremental cost. We receive reports of factories which we are told are operating with 50% staffing due to social distancing rules but which have more or less maintained production. I wonder what conclusion that leads to.

Of course not all businesses benefit from these developments. The airline industry, hospitality, bricks & mortar retailing and office property may all have some very difficult problems to face, just as you wouldn’t have wanted to have been a saddler when Henry Ford and his competitors hit their stride. I became increasingly bemused listening to or reading various commentators predict that the economic recovery from the COVID lockdowns would be V shaped, or shaped like a U, an L, a W, a bathtub or like the Nike swoosh (I’m not making this up). But just when I was bored of this entire meaningless alphabet soup of predictions, I came across one that I thought might be correct and help to explain what may happen. It was that the recovery may be shaped like a K.economy

emerge from a downturn with sharply differing trajectories — like the arms of the Roman letter K. Imagine if you had been told this time last year that there would be a pandemic and that the measures taken to contain it would so affect the world economy that US GDP would fall by 9% in the second quarter of the year and the hospitality and travel sectors would be devastated by the measures as would large segments of traditional retail activity. Considering this would you have predicted that the MSCI World Index would deliver a return of 12.3%, slightly above its ten year average? Hopefully this illustrates the dangers of forecasting and market timing even when you know what major events will occur. I will leave you with this thought: What are the similarities between a forecaster and a one-eyed javelin thrower? Answer: Neither is likely to be very accurate but they are typically good at keeping the attention of the audience. Finally, may I wish you a happy New Year, a COVID free 2021 and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Sustainable Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance.

The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This document is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: Fundsmith LLP & Bloomberg unless otherwise stated. Portfolio turnover has been calculated in accordance with the methodology laid down by the FCA. This compares the total share purchases and sales less total creations and liquidations with the average net asset value of the fund. PE ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2020 unless otherwise stated. MSCI World Index is the exclusive property of MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein.a

basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and ‘GICS®’ is a service mark of MSCI and Standard & Poor’s.

February 2020 Dear Investor, This is the second annual letter to owners of the Fundsmith Sustainable Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2017 and various comparators. % Total Return 1st Jan to Inception to 31st Dec 2019 Sharpe Sortino 31st Dec 2019 Cumulative Annualised ratio5 ratio5 Fundsmith Sustainable Equity Fund1 +23.4 +29.9 +12.9 0.79 0.71 Equities2 +22.7 +21.0 +9.2 0.43 0.39 UK Bonds3 +3.8 +6.1 +2.8 n/a n/a Cash4 +0.8 +1.6 +0.7 n/a n/a 1 I Class Acc shares, net of fees, priced at noon UK time, source: Fundsmith LLP 2 MSCI World Index, £ net, priced at US market close, source: Bloomberg 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 yr., source: Bloomberg 4 3 Month £ LIBOR Interest Rate, source: Bloomberg 5 Sharpe & Sortino ratios are since inception on 1.11.17 to 31.12.19, source: Financial Express Analytics The table shows the performance of the I Class Accumulation shares which rose by +23.4% in 2019 and compares with a rise of +22.7% for the MSCI World Index in sterling with dividends reinvested. However, I realise that many or indeed most of our investors do not use these as the natural comparator for their investments. Those of you who are based in the UK may look to the FTSE 100 Index (‘FTSE 100’) as the yardstick for measuring your investments and may hold funds which are benchmarked to this index and often hug it.

The FTSE 100 delivered a total return of +17.3% in 2019 so our Fund outperformed this by a margin of 6.1 percentage points. For the year the top five contributors to the Fund’s performance were: Estée Lauder +2.2% Microsoft +2.2% Marriott Intl. +1.6% Intuit +1.6% Visa +1.5%

Microsoft and Visa both appeared in this list last year and have been consistently amongst the best performing stocks since inception of the strategy. Someone once said that no one ever got poor by taking profits. This may be true but I doubt they got very rich by this approach either. The bottom five were: Church & Dwight -0.7% 3M -0.3% Colgate-Palmolive 0.0% Clorox 0.0% Reckitt Benckiser +0.3% We switched the holding in Church & Dwight into another American consumer products company – Clorox – which produces a higher return on capital. We sold our stakes in 3M and Colgate Palmolive during the year. With 3M we were acting on growing doubts about the current management’s capital allocation decisions, and in the case of Colgate Palmolive we grew tired of waiting for an effective growth strategy to emerge. This year we have included the Sharpe and Sortino ratios for our Fund and the Index in the performance table on p.1. I realise that for those of you who are not investment professionals what I say next may well seem to be gobbledegook. However, whilst the returns which our Fund provides are very important so is the amount of risk assumed in producing those returns. These ratios attempt to measure that.

The Sharpe ratio takes the return on the Fund, subtracts a so-called risk-free return (basically the return on government bonds) to get the excess return over the risk-free rate, and divides the resulting number by the variation in that excess return (measured by its standard deviation — I warned you it was gobbledegook). The result tells you what unit of return you get for a unit of risk and our Fund has a Sharpe ratio of 0.79 since inception against 0.43 for the MSCI World Index — it is producing about twice the amount of return that the Index produces for each unit of risk. The Sortino ratio is an adaption of the Sharpe ratio, and in my view an improvement. Whereas the Sharpe ratio estimates risk by the variability of returns, the Sortino ratio takes into account only downside variability as it is not clear why we should be concerned about upside volatility (i.e. when our Fund goes up a lot) which mostly seems to be a cause for celebration. The result for our Fund since inception is a Sortino ratio of 0.71 but the MSCI World Index Sortino ratio is lower than its Sharpe ratio at 0.39.producing

almost twice the return that the Index produces for each unit of downside volatility. As you hopefully know by now, we have a simple four step investment strategy: • Buy good companies • ESG screen • Don’t overpay • Do nothing I will review how we are doing against each of those in turn. As usual we seek to give some insight into the first of those — whether we own good companies — by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market, in this case the FTSE 100 Index and the S&P 500 Index (‘S&P 500’). We not only show you how the portfolio compares with the major indices but also how it has evolved over time. Year ended Fundsmith Sustainable Equity Fund S&P 500 FTSE 100 2017 2018 2019 2019 2019 ROCE 28% 30% 29% 17% 17% Gross margin 63% 65% 65% 45% 39% Operating margin 26% 28% 26% 15% 17% Cash conversion 102% 95% 99% 84% 86% Leverage 37% 47% 22% 53% 41% Interest cover 17x 17x 17x 7x 10x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Profit Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Sustainable Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are both median.

All ratios are based on last reported fiscal year accounts as at 31st December and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share. As you can see, not much has changed, which is how we like it. Our portfolio companies remain superior to those in the main indices on any of the financial measures of returns, profitability, cash flow, or balance sheet strength. As we indicated last year, we are going to remove the leverage calculation from the table in future as it can be close to meaningless. As you can see, we are not planning to remove it just because it looks bad. On the contrary, this year it is at 22% for our Fund’s portfolio versus 53% for the S&P 500 and 41% for the FTSE 100.companies

that comprise the median number are 18% and 26%. Nor is a mean (average) number much better as seven stocks in the portfolio have net cash on their balance sheets. The average year of foundation of our portfolio companies at the year end was 1933. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2019? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 9% in 2019. The second leg of our strategy is to employ both negative Environmental Social and Governance (‘ESG’) screening (not investing in high ESG risk sectors such as aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account not only the companies handling of ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy and productivity of capital investment.

One of the key metrics we use to assess ESG risk is RepRisk data which provides a measure of the current reputational risk for each company based on ESG factors and current “hot topics”. At the end of December 2019, the weighted average RepRisk indicator for our portfolio was 21.9, slightly higher than it was at the start of the year but substantially below the S&P 500 index score of 29.3. At the end of 2019 the four companies with the highest RepRisk Indicator scores were: 1. Johnson & Johnson 58 2. Microsoft 57 3. Unilever 46 4. Marriott International 41 Marriott International dropped from 2nd to 4th following no further significant negative news after the data leak at Starwood in December 2018. Microsoft replaced PepsiCo in the list and its RepRisk indicator score rose due to issues surrounding tax planning by technology businesses and using its strong market position against smaller competitors, both negative impacts we don’t assign much weight to as these are part of what makes it a good investment.&

Johnson, which we talk about later, has still the highest score despite falling from 65 at the end of 2018 to 58 at the end of 2019. To some extent, reputational risk comes with the territory of medical equipment and pharmaceuticals, especially in the litigious US market but the only way of avoiding it altogether would be to hold no investment in this area, which strikes us as a counsel of despair given the major benefits which the sector can produce. In 2019, we also sold our position in 3M, which has faced numerous negligence lawsuits in recent years over whether it supressed information about the health risks associated with the chemicals (PFAS) used in its firefighting foam for military bases and manufacturing facilities. Reportedly, PFAs have contaminated drinking and groundwater for over 1.9m Americans, posing risks of cancers and immune system failure in children. At the end of 2019, the four companies with the lowest RepRisk indicator scores, which all have a score of zero, were: 1. ADP 0 2. IDEXX 0 3. Intuit 0 4. Sage 0 This looks similar to the list at the end of 2018, with ADP and Intuit replacing Intertek and Waters. Intertek and Waters’ RepRisk Indicator increased to 16 and 18 respectively.

Intertek’s score increased due to questionable criticism from the Clean Clothes Campaign for not promoting workers safety enough, while Waters’ increase was due to an article in Korea reporting that some scientific instrument sellers were fined for bid rigging in government contracts that Waters was mentioned in despite not receiving a fine. Both of these are good examples to show that the RepRisk Indicator, whilst generally a good proxy for negative impacts, can be misleading in some situations. As such, we didn’t give either of these score increases much weight in our investment view of the companies. Those of you with a keen attention for detail and who read our monthly ESG factsheet each month, will have noticed that we changed the Environmental statistics to means rather than medians from March this year. This places more weight on companies that have large negative impacts. The number of companies reporting basic environmental stats is still very poor. On average only 35% of S&P 500 companies report the amount of waste, water and energy they use or the amount of CO2 they emit compared to 68% for the Fundsmith Sustainable Equity Fund investable universe. We suspect this is because the companies we invest in tend to have a lower negative impact on the world and therefore are more likely to disclose environmental statistics.

For the companies in our investable universe that don’t report environmental stats, we have always estimated them by looking at the average per £m of assets for the company’s respective subsector for each environmental stat we report and then scaling that number up for the assets of the individual company. From March, we also started doing this for the S&P 500 environmental stats to give a more accurate comparison for our portfolio. Johnson & Johnson (J&J) has consistently had the highest RepRisk indicator (RRI) of any company in the portfolio since we launched the Fundsmith Sustainable Equity Fund. It started the year with an RRI of 66 and finished it with a slightly lower score of 58. The majority of that score comes from the risk associated with the safety of their products, whether J&J accurately represented those risks and publicity from US court cases and settlements. When a company has a high RRI it can be, but isn’t always, an indicator that the company has a large negative impact on the environment or society. However, it can also indicate there has been a lot of media coverage around a specific story where the headlines and the details tell different stories. J&J’s lawsuits, which are the main driver of its high RRI score, mainly relate to whether it misrepresented the safety of its products in its marketing.

The biggest of these in the past few years, in terms of number of news stories tracked by RepRisk, has been whether its talcum powder causes cancer and whether the company knew this. (The other lawsuits J&J has faced are around criticism it has received for its role in selling opioid painkillers and the safety of its mesh products). The Baby Powder talc lawsuits started in 2016, when J&J was ordered to pay $72m in damages by a court in Missouri to the family of Jacqueline Fox, a 62 year-old woman, who died from ovarian cancer in 2015. She had used the product for decades on her genitals and her family argued that J&J knew of the risks and failed to warn users. This was the first time damages were awarded by a US jury over talc claims. J&J appealed the verdict, which they later won, but it set a precedent for others to follow suit to claim damages against J&J for their ovarian cancer. The result of this trial would appear to show that J&J was responsible for miss-selling and irresponsibly sold a product that they knew contained asbestos and would cause the death of patients.41%

of articles about evil J&J valuing profits over patient safety. Looking closer at the scientific evidence and expert testimony that the jury based its verdict on shows that this conclusion, at the very least, is not entirely accurate. Mineral talc in its natural form contains asbestos, which is known to cause cancer. However, the talc used in J&J’s Baby Powder and other cosmetics has been asbestos-free since the 1970s, according to the company. At the time of Ms Fox’s trial, studies on whether asbestos- free talc caused cancer gave contradictory results. Some studies showed a link to cancer, but the research was dependent on people remembering how much talc they used years ago. Other studies argued that there is no link at all and claimed that there is no link between talc in contraceptives, such as diaphragms and condoms, which would be closer to the ovaries, and cancer. A 2003 meta- analysis, looking at 12k patients found that regular use of talc on the genitals increased the risk of getting ovarian cancer to 0.0161% from 0.0121%. I.e. a real increase of risk of 0.004%, which translates to four extra cases of ovarian cancer for every 1m people who use talc on their genitals, rather than the misleading 33% increase in risk most headlines focused on. The increase was so small that the researchers concluded that it is unlikely to be real, as their data did not show any dose response relationship. Exposure risks generally follow a dose-response curve.

The more years you smoke, the greater your increased risk of lung cancer. However, this relationship was not seen for genital talc use and ovarian cancer. Two more large-scale studies followed in 2013 and 2015, which relied on self-reported data and found no dose- response or any increase in risk of cancer. Ms Fox’s case was used as a precedent for others to come forward and sue the company. By March 2017, over 1,000 women in the United States had sued J&J for not warning customers about the possible cancer risks from using its Baby Powder. In July 2018, a St Louis jury awarded a record-setting $4.7bn in damages to 22 women after they claimed J&J talcum powder caused their ovarian cancer. In December 2018, Reuters publishing a story alleging that J&J knew since 1971 there were small amounts of asbestos in its Baby Powder and ignored it. The Reuters report suggested that it’s probably “impossible” to completely purify mined talc and definitely impossible to test for asbestos, which is a known carcinogen, thoroughly and conclusively in all commercial batches. Juries in New Jersey and California found that J&J was not to blame for two other women’s cancer and that, the company didn’t mislead consumers about the risk of talc-based products.

By the middle of 2019 J&J was in the midst of 11,000 lawsuits alleging that Baby Powder usage caused cancer, primarily ovarian and mesothelioma. This led the House Oversight Committee’s Subcommittee on Economic and Consumer Policy in the United States to focus its first meeting of the year on Baby Powder and whether it needed stricter federal regulation. J&J continued to insist that its products are safe and asbestos-free and that tests done by the US Food and Drug Administration (FDA) had not found any asbestos. In December, J&J commissioned 155 tests by two different third-party labs using four different testing methods on samples from the same bottle tested by an FDA contracted lab earlier in the year. This FDA contracted lab had found asbestos in the sample earlier in 2019 and this led to J&J voluntarily recalling the production lot of Baby Powder the sample came from. The tests conducted by J&J found that there was no asbestos in any of the samples, supporting the findings of a smaller number of independent tests done in October. In the last few weeks of the year, researchers from the National Institute of Environmental Health Sciences in North Carolina published a paper analysing data from 253,000 women (a much larger sample than the 2003 study) to assess whether using talcum powder on one’s genitals increases the risk of developing ovarian cancer. Of these women, 2,168 (0.9%) went on to develop ovarian cancer.

Researchers found that the rate of ovarian cancer was not significantly different between those who did and did not use talcum powder. The study concluded that the rate of ovarian cancer amongst those who used talcum powder was 61 cases per 100,000 people per year, compared to 55 cases for those who have never used it. Therefore, the current scientific evidence would imply that J&J did not falsely advertise the safety of its Baby Powder, as there is no evidence of asbestos in its talcum powder and talcum powder itself has not been found to cause cancer. An important lesson from this example is that negative impacts are never clear-cut and the devil is in the detail. This is especially true when assessing the extent of a company’s responsibility for a negative impact. The headlines can sometimes give the wrong impression of a company’s guilt or exaggerate the degree of control a company has. This is why we don’t automatically exclude any company that has a RepRisk Indicator score above a certain level and why any assessment of a company with a high RRI needs to look at the details. This example also raises the question that if talcum powder did cause cancer, as investors, what should our stance be toward corporate responsibility in the face of questionable scientific evidence? Clearly, corporations should follow regulations. They should do due diligence in ensuring their products are safe and effective.

nothing is risk free. At what point are risks so low that they are negligible? What is the responsibility of corporations to disclose possible, but not proven, tiny risks? If they do, this can lead to “alarm fatigue,” where consumers learn to ignore warnings because they are everywhere. These questions become especially relevant to medical device makers or personal care products, which don’t go through as much (or any) of the rigorous testing that the FDA requires for drug manufacturers. How much testing should or can be done on a product before it is released and at what point has a company done all it can to identify and assess these risks before they are no longer held responsible is an open question. RepRisk also doesn’t look at any positive impacts, which are particularly relevant for a company like J&J which has the large positive impacts that are too often ignored. We believe that when assessing the impacts a company has it should be done on a net basis, as a company will get a lot of publicity when things go wrong but significantly less for the good things it does every day. In 2018, J&J provided 39,000 people with access to tuberculosis treatment and 52,000 people access to HIV treatment, trained 105,000 health workers in 67 countries and invested $11bn in R&D to develop new treatments that help patients live better and longer lives.

Turning to the third step of our strategy, the weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) of the portfolio at the outset of the year was 3.9% and ended it at 3.3%, so they became more highly rated. Whilst this is a good thing from the viewpoint of the performance of their shares and the Fund, it makes us nervous as changes in valuation are finite and reversible, although it is hard to see the most likely source of such a reversal — a rise in interest rates — in the near future. The year-end median FCF yield on the S&P 500 was 4.2%. The year- end median FCF yield on the FTSE 100 was 5.5%. Our portfolio consists of companies that are valued more highly than the average FTSE 100 company and a bit higher than the average S&P 500 company but with significantly higher quality. It is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap. Turning to the fourth leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a negative portfolio turnover during the period.we

spent a total of just 0.01% (half a basis point or one two hundredth of one percent) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary). Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on, or in some cases obsess about, the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2019 for the I Class Accumulation shares was 1.05%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the I Class Accumulation shares in 2019 this amounted to a TCI of 1.09%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing.

The table below shows the TCI of the 14 largest equity and total return funds in the UK compared with FSEF and how their TCI differs from their OCF: OCF % Transaction Costs % TCI % % Additional Costs Fundsmith Sustainable Equity Fund 1.05 0.04 1.09 4 Invesco Global Targeted Returns 0.87 0.43 1.30 49 Baillie Gifford Diversified Growth 0.77 0.50 1.27 65 Lindsell Train UK Equity 0.65 0.09 0.74 14 Stewart Investors Asia Pacific Leaders 0.88 0.16 1.04 18 BNY Mellon Real Return 0.80 0.20 1.00 25 Invesco High Income 0.92 0.15 1.07 16 BNY Mellon Global Income 0.80 0.07 0.87 9 Liontrust Special Situations 0.89 0.18 1.07 20 Artemis Income 0.80 0.12 0.92 15 ASI Global Absolute Return Strategies 0.90 0.15 1.05 17 Jupiter European 1.02 0.06 1.08 6 LF Ruffer Absolute Return 1.22 0.35 1.57 29 Baillie Gifford Managed 0.42 0.05 0.47 12 Threadneedle UK Equity Income 0.82 0.05 0.87 6 Average 0.85 0.17 1.03 20 Source: Financial Express Analytics/Fundsmith as at 6.1.20, funds in descending order of size, primary share class. We are pleased that FSEF’s TCI is not only just 4% above our OCF when transaction costs are taken into account, but that this is the lowest increase in the group.you

lose focus on the performance of funds. It is worth pointing out that the performance of our Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. I think the above table speaks for itself in terms of the relative performance of our Fund so that you can look not just at the fees and costs but what you get in return — performance. The Fund’s performance for the year was adversely affected by a couple of poor months in September and October which cost the Fund about 6%. This was caused by two factors: 1) a rally in the sterling exchange rate from the recent lows which it had plumbed after the Brexit referendum result in 2016 and on subsequent hard Brexit fears; and 2) a ‘rotation’ from the high quality and relatively highly rated stocks of the sort which our Fund owns into lower quality and more lowly rated ‘value’ stocks. If you read the breathless commentary on this in much of the press without knowing the actual performance of our Fund you might be surprised to find that, notwithstanding these events, it ended the year up by 23.4% which was our best year since inception and outperformed the MSCI World Index by 0.7%. Taking each of these factors in turn, currency movements clearly have some effect on our portfolio. Over 58% of our portfolio is invested in companies listed in the United States. The actual exposure to the US dollar and therefore the pound/dollar exchange rate is better gauged by the c.

40% of our portfolio companies’ revenues which are in the USA. However, currency movements are not something we believe we can predict — they seem to have about the same predictability as a game of Snakes & Ladders — or hedge. I would suggest looking at the matter this way: imagine we were in a discussion with some of the companies which have produced great returns for us over the last nine years, or which might do so over the next nine, and we asked them to name the top three factors in their success. What do you think the chances are that they would say ‘currency exposure and exchange rates’? I would suggest they might name product innovation and R&D, strong brands, control of distribution, market share, customer relationships, installed bases of equipment or software, management, successful capital expenditure and acquisitions as far more important. So, we think it’s best to ignore the Snakes & Ladders of currency movements. Turning to the second point — the so-called rotation into value stocks, I am not much of a gardener but I believe this is becoming what gardeners term a hardy perennial as it crops up every year.in

abundance that shows that from a relative perspective quality stocks may today be considered expensive.’ The interesting point about that assertion is that it was published on 13th August 2012. A lot of superior returns have been had from those allegedly expensive stocks in the subsequent seven years. The argument might be encapsulated thus: stocks of the sort which our Fund owns have had a good run of outperformance as has the Fund but this is all about to end, or even has already ended, and so- called ‘value investing’ — buying stocks mainly based upon their supposed under valuation by the market — is making a comeback and funds which pursue that strategy are about to outperform us. Value investing has its flaws as a strategy. Markets are not perfect but they are not totally inefficient either and most of the stocks which have valuations which attract value investors have them for good reason — they are not good businesses. This means that the value investor who buys one of these companies which are indeed lowly rated but which rarely or never make an adequate return on capital is facing a headwind. The intrinsic value of the company does not grow (except for any new capital that its hapless investors allow it to retain or subscribe for in some form of share issue), or even erodes over time, whilst the value investor is waiting for the lowly valuation to be recognised and the share price to rise to reflect this.

Moreover, even when the value investor gets it right and this happens, they then need to sell the stock which has achieved this and find another undervalued stock and start again. This activity obviously incurs dealing costs but value investing is not something which can be pursued with a ‘buy and hold’ strategy. In investment you ‘become what you eat’ insofar as over the long term the returns on any portfolio which has such an approach will tend to gravitate to the returns generated by the companies themselves, which are low for most value stocks. As Charlie Munger, Warren Buffett’s business partner, said: ‘Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return — even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.’ Our emphasis added. Mr Munger is not offering a theory or an opinion — what he is saying is a mathematical certainty. The only uncertainty concerns our ability to forecast returns far ahead, which is why we prefer to invest in relatively predictable businesses.

The biggest flaw in value investing is that is does not seek to take advantage of a unique characteristic of equities. Equities are the only asset in which a portion of your return is automatically reinvested for you. The retained earnings (or free cash flow if you prefer that measure, as we do) after payment of the dividend are reinvested in the business. This does not happen with real estate — you receive rent not a further investment in buildings, or with bonds — you get paid interest but no more bonds. This retention of earnings which are reinvested in the business can be a powerful mechanism for compounding gains. Some 80% of the gains in the S&P 500 over the 20th century came not from changes in valuation but from the companies’ earnings and reinvestment of retained capital. If you were a great (and long-lived) value investor who bought the S&P 500 at its low in valuation terms, which was in 1917 when America entered world war one and it was on a P/E of 5.3x, and sold it at its high in valuation terms in 1999 when it was on a P/E of 34x, your annual return during that period would have been 11.6% with dividends reinvested, but only 2.3% p.a. came from the massive increase in P/E and 9.3% (80% of 11.6%) came from the companies’ earnings and reinvesting their retained earnings. The S&P example is for 500 average large companies.

This proportion of your return from the companies’ reinvestment activities is even more extreme when you invest in a good company with a high return on retained capital than in an average company. All of this was much more succinctly encapsulated by Warren Buffett when he said: ‘It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.’ He made the transition from being a traditional value investor based upon studying under Benjamin Graham (author of “The Intelligent Investor” and “Security Analysis”) into a quality investor looking for companies which could compound in value based upon the teachings of Philip Fisher (author of Common Stocks and Uncommon Profits) and the influence of Charlie Munger. Here’s how Buffett explained this change in his 1989 letter to Berkshire Hathaway shareholders: ‘The original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces — never is there just one cockroach in the kitchen. [Plus], any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return.investment

will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.’ The problems of waiting for value investment to pay off can be seen in the performance of the MSCI World Value Index (USD) which hit 6570 at the end of October 2007 and was lower than this at the end of February 2016. At 31st December 2019 it stood at 9812, just 49% higher than its 2007 peak value. Compare and contrast the S&P 500 (USD) which peaked on 9th October 2007 but had regained its 2007 high by 2013 and at 31st December 2019 stood 189% higher. Ah, but I can hear the siren song of the value investors who will take this data as confirmation that the resurgence of value investment which they have long predicted is about to commence. As an old saying goes ‘To a man with a hammer, everything looks like a nail’. The longer the strategy underperforms the market and the more money it costs investors the louder the siren song becomes. And sooner or later they will be right. But a) they have no idea when that will be (note the reference above to Investment Adviser’s comment in 2012); b) if you had followed their advice to date it would require a gargantuan reversal of performance to make up the gains forgone; and c) that may continue to be the case for some time to come.

Lastly, there are some commentators who say that one way to address this is to have a portion of your portfolio invested in both strategies — some in quality growth and some in value. I think the assertion that there is no harm in this diversification approach has been disproved rather comprehensively by Warren Buffett, but what does he know? Perhaps we should look at the value investment versus quality and growth strategy debate this way: would you rather side with a) a large section of the UK financial press and rent-a-quote investment advisers; or b) Warren Buffett, Charlie Munger (Berkshire Hathaway), Bill Gates (Microsoft), the Bettencourt family (L’Oréal), the Brown family (Brown-Forman), the Walton family (Walmart) and Bernard Arnault (LVMH)? The latter all seem to have become extraordinarily rich by concentrating their investment in a single high quality business and not trading regardless of valuation. So much for it not doing any harm to diversify across strategies. It seems impossible to comment upon developments in equity investing in the UK in 2019 without mentioning the word Woodford. The demise of Woodford Investment Management following the ‘gating’ of its main LF Woodford Equity Income Fund was undoubtedly the main news in the industry last year.

We have no desire to engage in a general commentary on this matter or to engage in an unseemly exercise in schadenfreude. We had long identified the problems which were brewing at Woodford but we kept our own counsel on the matter. The only comments you will find from us mentioning Woodford were in answer to direct questions concerning Woodford from our investors at our Annual Meeting. We regard it as a lack of professional courtesy to comment upon our competitors except when we are asked to do so by our investors. We only wish others in the industry would maintain the same stance. However, we now feel freer to comment on Woodford since it is hard to see how it can now exacerbate the situation, and I feel that we need to as the Woodford debacle has raised important questions about the industry, some of which have been directed at us and I feel that our investors should know our response. The most obvious problem at Woodford was the lethal combination of a daily-dealing open-ended fund with significant holdings in unquoted companies and large percentage stakes in small quoted companies which had very limited liquidity. Whilst this was clearly a very bad idea, Woodford is not the only fund to have encountered this problem. A large swathe of UK property funds was gated after the Brexit Referendum for the same reason, and more recently so was the M&G Property Fund. An open-ended daily-dealing fund is clearly not an appropriate vehicle through which to hold such assets.

The daily- dealing and open-ended structure give investors the illusion of liquidity but when a large number of them try to exercise it at once the effect is similar to shouting ‘Fire!’ in a crowded theatre. Amongst the causes which commentators seem to have failed to realise is the effect which the rise of investment platforms has had on this, and indeed other areas of the fund management industry. It is now the case that no one can expect to effectively market an open- ended fund on any of the major investment platforms which retail investors and wealth managers use to manage their investments unless it is a daily-dealing fund. As none of these platforms will admit an open-ended fund, unless it allows daily-dealing, that is what fund managers will use even for strategies for which this structure is wholly inappropriate. Where does the Fundsmith Sustainable Equity Fund stand on this? We have always regarded liquidity as an important issue. As evidence of this, we have published a liquidity measure on our Fund factsheet since inception. Equally we only invest in large companies. At 31st December 2019 the average market capitalisation of the companies in our Fund was £107bn and we estimate we could liquidate 100% of the Fund in seven days.

The reality is that the only type of fund which can guarantee 100% liquidity on demand is a cash fund, and I presume that is not what you wish us to invest in. But I suspect you will find it hard to find more liquid equity funds than ours. It tells you much about its liquidity that some of the least liquid stocks we hold are the FTSE 100 companies, Intertek and Sage. Another question which arises from the Woodford incident is the question mark over so-called ‘star’ fund managers, a label the press seems obsessed by. I can’t say I like the term, it strikes me as equally inappropriate as the term ‘beauty parade’ which is used when selecting professional advisers, many of whom do not seem to me to have obvious photogenic qualities. I think this concern is focused on the wrong issue. I think it makes no more sense to avoid funds run by ‘star’ fund managers any more than it does to avoid supporting sporting teams because they have star players. The trouble arises not because teams have star players but if the star tries to play a different game to the one which delivered their stellar performance. Would Juventus do as well if Cristiano Ronaldo played as goalkeeper? How is Usain Bolt’s second career as a soccer player going? Neil Woodford made his name as a fund manager at Invesco Perpetual with his successful Income Fund. In the course of this he took two high profile negative positions on sectors.

In the run up to the dotcom bust in 2000 he seems to have seen what was coming and avoided investments in technology, media and telecommunications stocks which was a major success. He also paired this with taking positions in some of the old economy neglected stocks which had become de-rated during the dotcom mania. Similarly, in the run up to the Credit Crisis he decided not to hold bank stocks. However, when he opened his own fund management business he took positions in a wide range of companies — AA, AstraZeneca, Capita, Imperial Brands, Provident Financial and Stobart are some examples. There is no common theme that I can detect to those companies, other than the fact that they all subsequently fared badly. This was supplemented by a raft of unquoted investments in start-ups and biotech. My suggestion is that what went wrong is that Neil Woodford changed his investment strategy. In the technical jargon of the industry, he engaged in ‘style drift’. The problem wasn’t that he was regarded as a star but that he changed his game. This style drift actually started when he was still at Invesco Perpetual in that his Income Fund began to accumulate large stakes in small illiquid companies and unquoteds, but this was taken further once he had his own firm.

Is there any chance of style drift or a similar change of strategy at Fundsmith? I think not. We published an Owner’s Manual for Fundsmith Equity Fund at the outset which describes our investment strategy, write to you in these annual letters analysing how we are faring in implementing our strategy and are the only mutual fund in the UK which holds an annual meeting at which our investors can question us and see their questions answered publicly. So, it would be extraordinary if we were able to effect a change in our investment strategy without you noticing. Moreover, we have no desire to change our strategy. We are convinced that it can deliver superior returns over the long term. I would pose a different question which links the discussion of the Woodford affair with the earlier discussion of the ‘rotation’ from quality stocks into value stocks. If you expect such a ‘rotation’ to occur at some point and for value stocks to enjoy a period in the sun would you rather we tried to anticipate that and switched into a value investment approach of buying stocks based mainly or solely on the basis of their valuation or would you rather we stuck to our existing approach of buying and holding high quality businesses? I would suggest the latter approach might be better, and it is what we are doing. There will be no style drift at Fundsmith. Finally, I wish you a happy New Year and thank you for your continued support for our Fund.

Yours sincerely, Terry Smith, CEO, Fundsmith LLP Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Sustainable Equity Fund are available via the Fundsmith website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This document is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: Fundsmith LLP & Bloomberg unless otherwise stated. Portfolio turnover has been calculated in accordance with the methodology laid down by the FCA. This compares the total share purchases and sales less total creations and liquidations with the average net asset value of the fund. P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2019 unless otherwise stated. Fund liquidity is based on 30% of average trailing 20 day volume.

MSCI World Index is the exclusive property of MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or final products. This report is not approved, reviewed or produced by MSCI. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s and “GICS®” is a service mark of MSCI and Standard & Poor’s.

January 2019 Dear Fellow Investor, This is the first annual letter to owners of the Fundsmith Sustainable Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2017 compared with various benchmarks. % Total Return 1st Jan to Inception to 31st Dec 2018 31st Dec 2018 Cumulative Annualised Fundsmith Sustainable Equity Fund1 +4.5 +5.3 +4.5 Equities2 -3.0 -1.4 -1.2 UK Bonds3 +1.2 +2.2 +1.9 Cash4 +0.7 +0.8 +0.7 1 I Class Acc shares, net of fees, priced at noon UK time. 4 3 Month £ LIBOR Interest Rate. 2 MSCI World Index, £ net, priced at US market close. Source: Bloomberg. 3 Bloomberg/Barclays Bond Indices UK Gov. 5–10 yr. The table shows the performance of the I Class Accumulation shares, the most commonly held Class, which rose by +4.5% in 2018 and compares with a fall of -3.0% for the MSCI World Index in sterling with dividends reinvested. The Fund therefore beat this benchmark in 2018, and our Fund is the third best performer since its inception out of 133 onshore and offshore ethical funds available in the UK listed in the Ethical Sector by Financial Express Analytics.

However, I realise that many or indeed most of our investors do not use the MSCI World Index as the natural benchmark for their investments. Those of you who are based in the UK may look to the FTSE 100 Index (‘FTSE’ or ‘FTSE 100’) as the yardstick for measuring your investments and may hold funds which are benchmarked to this index and often hug it. The FTSE delivered a total return of -8.7% in 2018 so our Fund outperformed this by a margin of 13.2 percentage points. It would not be surprising if some of you are worried about the returns in 2018, however I would suggest that the background needs to be taken into account and not just how the market indices performed but also other active funds. There are 2,592 mutual funds in the Investment Association (‘IA’) universe in the UK. In 2018, 2,377 or 92% of these produced a negative return. 13 posted a return of exactly 0%. Just 202 had a positive return. Our Fund was in the 2nd percentile — only 1% of funds performed better. 2018 was a year in which we saw considerable anxiety from some market participants due to:  The threat of a trade war between the USA and China  Brexit  The rise in US interest rates  The US mid-term elections  The Italian budget squabble (Italy is the third largest government bond market in the world)  The US government shutdown The response to this was a series of market jitters. The MSCI World Index (£ net) fell by 5.4% in October and after a rally this was followed by a fall of 7.4% in December.

Despite the hysterical headlines this, in my opinion, falls well short of turmoil — a word frequently used to describe these events. October has been a notoriously bad month for stock markets in recent decades and an example of what might reasonably be described as market turmoil was so-called Black Monday 19th October 1987 when the Dow Jones Industrial Average Index (‘Dow Jones’ or ‘Dow’) fell 22.6% in a single day. That felt dramatic. I should know as I was in work that day on the trading floor of the investment bank BZW and when I went home I received a slew of sell orders from a large US client who rang me.had

not been restored from the hurricane, which struck on the previous Friday, adding to the dramatic effect. I can only imagine with some amusement how some of the commentators, ‘investors’ and market participants who are reeling from the events of this October and December would have performed in October 1987. A December 2018 Financial Times headline referred to ‘Wild market swings’ and whilst the author might like to blame the headline writers for hyperbole — they are trying to sell papers/pixels after all — the article described a recent one day fall in the Dow of 3.1% as ‘eye-popping’. The fall of seven times that scale in 1987 would surely have led to them to exhaust the lexicon of hyperbole. Who knows what might have popped then? Tumultuous, turmoiled or turbulent Black Monday may have been, but did it really matter? Take a look at the chart below of the Dow Jones and see if you can spot Black Monday. You will need good eyesight or reading glasses to do so. In the long term, it did not matter. However, this does not stop advisers and commentators predicting crashes and bear markets and suggesting you take preventative action which ranges from reducing your equity holdings, buying or ‘rotating’ into lowly rated so-called ‘value’ stocks, through to selling everything and holding cash to safeguard the value of your assets or buying Bitcoin (down 80% in 2018).

My guiding principles for dealing with such events and predictions are as follows: 1. No one can predict market downturns with any useful level of reliability. Forecasts of what may happen in the market are about as reliable as Michael Fish’s infamous denial that there would be a hurricane in the BBC weather forecast on 15th October 1987. 2. However, when one of the repeated warnings proves to be accurate the forecasters will ignore the fact that if you had followed their advice you would have forgone gains which far outweigh your losses in the downturn. I can now trace back six years of market commentary that has warned that shares of the sort we invest in and our strategy would underperform. During that time the Fundsmith Equity Fund has risen in value by over 185%. The fact that you would have forgone this gain if you had followed their advice will, of course, be forgotten by them if, or when, their predictions pay off for a period. I suggest you don’t forget it. 3. Bull markets do not die of old age so ignore warnings which are based on a phrase such as ‘This bull market has gone on for a long time.’ They usually die from some event, often but not always rising interest rates. 4. Bull markets climb a wall of worry. The troubling events you can readily see unfolding are rarely the cause of a bear market. Alan Greenspan had already described the market as irrationally exuberant in 1996, so we were in a worryingly well- developed bull market.

This was followed by the Asian crisis of 1997, Russian default and Long Term Capital Management collapse in 1998 which all looked scary, but ironically they made the Federal Reserve hesitate to raise rates which gave the bull market a new leg which lasted until 2000. Maybe the possible trade war with China and market jitters will have a similar effect. 5. Bull markets do not broaden as they age — they narrow. The current bull market started in 2009 when shares rose indiscriminately. Then amongst developed markets, the US took the lead. Then the technology sector in the US. Then just the ‘FAANGs’ (Facebook, Amazon, Apple, Netflix and Google). The idea that in the late stages of a bull market investors can make gains by switching into the stocks which have lagged the market flies in the face of experience.

6. As for buying so-called value stocks, if you wish to pursue this strategy it is best done after the bear market has struck, not before. If you approached any of the famous value investors and suggested they buy some of the assorted value stocks in the FTSE 100 Index as a value play, I think they would just laugh at you. A ‘value’ stock like Imperial Brands (formerly Imperial Tobacco) was on an historic P/E of 8.1x at the end of 2000 in a bear market. It is now on an historic P/E of 16.5x. An aim for a value investor might be to buy ‘value’ stocks in a downturn when their yield is higher than the P/E. 7. A bear market will occur at some point. We may indeed already be in one. The best stance is to ignore it since you can’t predict it or position yourself effectively to avoid it without impoverishing yourself by forgoing gains. But you have to possess the emotional and financial stability to stick to this stance when it strikes. Returning to the events of 2018, the MSCI World Index (£ net) fell by -3.0%. So it was a poor performance but it still seems well short of justifying hysteria or a wholesale change of investment strategy. I say this notwithstanding the fact that on the bad days in the stock market there were clear signs of the sort of ‘rotation’ into ‘value’ stocks, which I touch upon in point 6 above. I often use the term ‘value’ in inverted commas for a number of reasons:  What some people mean by value is lowly rated.

A stock may be lowly rated but not good value if the (lack of) quality of its business and/or its prospects mean that its intrinsic or fundamental value is still below its lowly valuation.  The distinction which many commentators make between growth or quality investing and value investing is in my view a somewhat superficial one. To quote Warren Buffett: ‘Most analysts feel they must choose between two approaches customarily thought to be in opposition: "value" and "growth”. Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing. We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago).variable

whose importance can range from negligible to enormous and whose impact can be negative as well as positive.’ Most investment strategies require some regard for the valuation of the stocks purchased or held — even strategies like ours which focus on high quality companies. The rate of growth of a company is a critical component of its valuation.  As pointed out in point 6 above, most stocks are not currently at valuations which would attract classic value investors. True value investing involves buying stocks when they are trading significantly below your estimate of their intrinsic or fundamental value and then waiting for some event(s) to lift the share price up to or above the intrinsic value — usually a management change, takeover, demerger, a change in the economic or market cycle, or simply when they come back into fashion amongst investors. When this occurs the value investor seeks to realise his or her gains and move on to find another value stock on which to repeat this performance. Value investing has been out of fashion in recent years as persistently low interest rates have driven the value of almost all stocks beyond the reach of true value investors. Nonetheless value investing has its merits and will surely have its day when stocks of the sort which attract value investors perform well. However, it is not a strategy which we will be pursuing even if we could foresee it coming back into fashion, which it will at some point.

The sort of stocks which trade on low enough valuations to attract value investors are unlikely to be those which we seek – businesses which can somewhat predictably produce a high return on capital employed, in cash, and can invest at least part of that cash back into the business to fund their growth and so compound in value. Unlike our strategy which is to seek such stocks and hold onto them, letting the returns which the company generates from this reinvestment produce good share price performance, value investing suffers from two handicaps. One is that whilst the value investor waits for the event(s) which will crystallise a rise in the share price to the intrinsic value that has been identified, the company is unlikely to be compounding in value in the same way as the stocks we seek. In fact, it is quite likely to be destroying value. Moreover, it is a much more active strategy.this

is far from easy. Moreover, this activity has a transaction cost. Our strategy has the merit that inactivity is a benefit. If we have correctly identified the good companies whose stock can compound in value, we can hope to hold them indefinitely and still derive good investment performance from them with lower transaction costs. There are a couple of indices which tell you how value stocks perform. One is the MSCI Europe Value Index (GBP Net). In the 2007-09 financial crisis its maximum fall was 52%, which is 16 percentage points worse than the performance of the MSCI World Index (GBP Net) over that period. So much for the theory that value stocks protect you in a downturn. As you hopefully know by now, we have a simple four step investment strategy: • Buy good companies • ESG screen • Don’t overpay • Do nothing I will review how we are doing against each of these in turn. As usual we seek to give some insight into the first of those — whether we own good companies — by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market, in this case the FTSE 100 Index and the S&P 500 Index (‘S&P 500’). We not only show you how the portfolio compares with the major indices but also how it has evolved over time.

Year End FSEF S&P 500 FTSE 100 2017 2018 2018 2018 ROCE 28% 30% 16% 17% Gross margin 66% 64% 45% 39% Operating margin 26% 26% 15% 16% Cash conversion 104% 97% 84% 96% Leverage 29% 44% 46% 39% Interest cover 19x 18x 7x 9x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Profit Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Equity Fund and mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are both median. All ratios are based on last reported fiscal year accounts as at 31st December and as defined by Bloomberg. Cash Conversion compares Free Cash Flow per Share with Net Income per Share.

As you can see, not much has changed. I would suggest ignoring the increase in Leverage — the amount of debt the portfolio companies have as a proportion of their capital. The arithmetic average of our portfolio companies would not be very meaningful as it would average a wide range between eight of our stocks which have net cash and two which have leverage of over 1,000% (as they have reduced their capital through share buybacks). Even the median which we use is not much better — the median is the 13th stock in order of leverage but those either side have leverage of 27% and 49% respectively. For those of you who glaze over at statistical explanations — the figure tells you virtually nothing about the actual financial characteristics of the businesses. You might therefore wonder why we include it, and latterly so do I, but I don’t like taking figures out of tables we have provided in the past as it can cause suspicion about the reasons why (figures are rarely omitted when everything appears to be going well). The interest cover — which remains stable at about 18x and twice the level of the index companies — is a much better guide to the financial stability of our portfolio companies. What is more interesting is that the companies in our portfolio continue to have significantly higher returns on capital and better profit margins than the average for the indices.

They convert more of their profits into cash and achieve this with at least no more leverage than the average company. The average year of foundation of our portfolio companies at the year end was 1928. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2018? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 10% in 2018. We regard this as a very good result given the generally subdued and patchy growth which the world continues to experience and the fact that the previous year the portfolio companies achieved growth of a remarkable 15%, so the starting base for comparison in 2018 was a tough one.electric

utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account not only the companies handling of ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy of capital investment. Both these types of screening benefitted the fund in 2018. Whilst we have never identified an investable company in the majority of the excluded sectors there may be relatively good companies to be found in the brewers, distillers and vintners and tobacco sectors. However the Fund benefitted from not holding any of these companies in 2018 as they underperformed the MSCI World Index (£ net) by 11% in aggregate. Facebook, which also meets our criteria for a good company from a financial standpoint was excluded from the outset because our proxy for negative impact — the RepRisk indicator — was significantly higher than other companies (63 vs. portfolio average 20). Facebook had also done very little to reduce its negative impact score. Hardly that surprising for a company whose motto until 2014 was ‘Move Fast and Break Things’. The decision to exclude Facebook was made before the Cambridge Analytica scandal broke in March, where Facebook was accused of allowing external firms to harvest personal data from users through its site.

This was done using an app called “This is Your Digital Life”, which not only collected data of the person who agreed to take the survey, but also the personal information of all the people in those users’ Facebook social network. Since the scandal broke, Facebook has had to reassure users how it uses and profits off their personal data, while also increasing its transparency and the range of tools it offers to control the use of your data. Facebook still has more to do to meet our sustainability criteria. During 2018, the weighted average RepRisk indicator for the portfolio fell from 23.7 to 20.1, which means that the portfolio now has less reputational risk from ESG factors than it started the year with.44

The list looks very similar to that of 2017 with the highest scorer from last year, Nestlé, being replaced this year in the list by Marriott. Nestlé was sold from the FSEF portfolio during 2018, while Marriott’s RepRisk indicator increased by 28 in December after the data leak from its Starwood brand. Johnson & Johnson’s RepRisk indicator has increased from 53 to 65 as its medical subsidiary, Ethicon, has been widely criticised for the risks involved in transvaginal mesh implants, which caused chronic and excruciating pain for thousands of woman and has also been subject to extensive litigation and punitive damages awarded to patients who developed mesothelioma, a deadly form of cancer caused by exposure to asbestos-contaminated talcum powder between 1972 and 2003. At the end of 2018 the four companies with the lowest RepRisk scores were: IDEXX 0 Intertek 0 Sage 0 Waters 0 This list also looks very similar to end 2017, with the only change being CR Bard, which was taken over by Becton Dickinson, being replaced by Sage. A noticeable trend over 2018 has been the increasing number of companies commenting on their efforts to improve the recyclability of packaging and in particular plastics — especially since Sir David Attenborough highlighted the impact plastic waste can have on the oceans at the end of the television series Blue Planet II.

Out of the food and personal care companies owned in the Fundsmith Sustainable Equity Fund in 2018, PepsiCo, Nestlé, Colgate and Unilever have committed to 100% of their packaging being some combination of recyclable, compostable, biodegradable or reusable by 2025. This commitment could have a large impact on plastic waste as for example, only 25% of Colgate and Unilever’s plastic packaging is currently recyclable, while Unilever alone produces the equivalent weight of the entire global population in plastic. PepsiCo committed to 50% of the plastic it uses coming from recycled plastic (vs. 13% currently), while Colgate wants to use 25%. However, in order to reduce the amount of waste in the environment, there needs to be an increase in recycling capabilities around the world, as just because packaging can be recycled, doesn’t mean it necessarily is.recycling

infrastructures and capabilities. Unilever recently collected 450 tonnes of single-use plastic sachets in Indonesia, which would have otherwise ended up in the ocean. The sachets will be re-used in other Unilever products. To avoid the dependency on the need for better recycling infrastructure, Unilever announced that they signed an agreement with Bio-On, an Italian biodegradable plastic specialist, to develop new packaging. A further concern for the FMCG companies in the portfolio is how they source palm oil, which was brought to national attention in Iceland’s (the supermarket not the country) recently “banned” viral Christmas advert that highlighted the environmental impact of the palm oil industry. The advert was used as part of a campaign highlighting how it has removed palm oil from all of its private label products. For a bit of context, palm oil is the most widely used vegetable oil in the world because it’s one of the few fats that is semi solid at room temperature, has excellent cooking properties (smooth and creamy texture, lack of scent, natural preservative properties) and can be grown very efficiently, which means it can be produced cheaply. The average western consumer eats almost 2kg of palm oil a year and it is used in everything from personal products and cosmetics to pastries and baked goods. Currently 85% of palm oil production is in Malaysia and Indonesia where the industry employs 4.5m people and for many is their only way out of poverty.

However, the industry often results in what was once virgin rainforest being converted into biologically uniform palm oil plantations. The complexity of the issues surrounding the industry was shown when 2,000 palm oil plantation workers gathered in Malaysia’s capital, Kuala Lumpur, to protest against the EU’s plan to remove palm oil from its list of designated renewable fuels because of the impact it has on deforestation and the draining of wetlands. The farmers in Malaysia argued this wasn’t the case and that the only motive was to put Malaysian small holders back into poverty. The problem for FMCG companies is that substituting palm oil in their products will have a larger negative impact on the environment than continuing to use it. This is because palm oil yields around 5 tonnes of oil per hectare per year, which is almost 5x as much as rapeseed oil, the next best alternative with similar characteristics. Palm oil production also requires less fertilizer and fewer pesticides.at

least 5x more land — therefore contributing to more deforestation — but also, those products would need to be reformulated, which could have a major impact on sales and profits. Therefore, in the Fundsmith Sustainable Equity Fund we look for companies that are aware of the negative impacts of using palm oil and are looking to source more of it in sustainable ways. In 2018, Nestlé and Unilever were the most vocal about their efforts to improve the sustainability of their palm oil supply chains. Nestlé was reinstated by the Roundtable on Sustainable Palm Oil after it submitted a plan to only use sustainable palm oil by 2023. While Unilever also committed to using 100% sustainable palm oil, compared to 50% in 2017, but will do so by the end of 2019. We continue to monitor as many statistics as the portfolio companies produce in a consistent way to assess the overall sustainability of the portfolio, which are shown in the tables below and report every month in our sustainability factsheet. The sustainability of the companies in the FSEF portfolio on these measures continues to be markedly better than the main index for which we can get comparable data — the S&P 500 Index — on every count with the sole exception of the percentage of independent directors, which was 82% versus 89% for the Index largely because some of the investee companies have board members representing controlling founder family shareholders. The third step in our strategy is to not overpay.

The weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) of the portfolio at the outset of the year was 3.8% and ended it at 3.9%, so they became cheaper or more lowly rated. Whilst this is not a good thing from the viewpoint of the performance of their shares or the Fund, it is inevitable that sooner or later the cash flows generated by our companies will grow faster than their share prices, rather than vice versa. This is far from an unhealthy development especially if we are investing more in the Fund through the Accumulation shares. The year-end median FCF yield on the S&P 500 was 4.7%. The year-end median FCF yield on the FTSE 100 was 5.2%. More of our stocks are in the former index than the latter and I will not repeat the explanation which I gave last year on why I think the FTSE 100 is not an appropriate benchmark or investment proxy for investors to use. Our portfolio consists of companies that are fundamentally a lot better than those in either index and are valued more highly than the average FTSE 100 company and a bit higher than the average S&P 500 company but with a significantly higher quality.

For the year the top five contributors to the Fund’s performance were: IDEXX +1.4% Intuit +1.3% Microsoft +1.2% Visa +1.0% Coloplast +0.9% The bottom five were: Sage -1.0% Marriott -0.8% Colgate Palmolive -0.7% Reckitt Benckiser -0.7% Nestlé -0.5% Sage, the accounting software provider, was the subject of an unplanned change of CEO during the year, of which more later. Turning to the third leg of our strategy, which we succinctly describe as ‘Do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of - 12.2% during the period. Negative turnover occurs because the method of calculating turnover excludes flows into or out of the Fund, otherwise a newly established fund would automatically have 100% or more turnover. However, it is not very helpful in judging our activities. It is perhaps more helpful to know that we spent a total of just 0.031% (3.1 basis points or hundredths of a percent) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary). Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor.

Too often investors, commentators and advisers focus on or in some cases obsess about the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2018 for the I Class Accumulation shares was 1.05%. The trouble is that the OCF does not include an important element of costs — the costs of dealing. When a fund manager deals by buying or selling, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund, yet it is not included in the OCF.

We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2018 this amounted to a TCI of 1.16%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We did undertake some activity in 2018. In particular we sold our holdings in Dr Pepper Snapple, InterContinental Hotels and Nestlé during the year. We purchased holdings in Estée Lauder, the US based cosmetics business and Coloplast, the Danish medical devices company which specialises in the production of catheters, wound and skin care and a new position in a consumer staples business whose name will be revealed when we have accumulated our desired weighting across funds. Dr Pepper Snapple was a stock we have held since inception. We found the strategic rationale for the acquisition by Keurig Green Mountain difficult to comprehend and so took our leave of the situation. Commentators seem to forget that a similar combination was tried between Coca-Cola and Keurig which was unsuccessful and quietly abandoned. Last year we wrote in the Fundsmith Equity Fund Annual Letter about the attention which Nestlé, amongst other portfolio companies, had attracted from activist investors.

In Nestlé’s case this was followed by the announcement of new margin and share buyback targets and then a deal to purchase Starbucks supermarket coffee products, excluding the ‘Ready to Drink’ ones, for $7.15bn. In other words, bags of coffee. Presumably we can also look forward to being able to purchase Starbucks Nespresso pods. Virtually no mention was made of the royalty which Nestlé will continue to pay to Starbucks on sales of these products. We rely on the management of our companies to allocate capital in ways which create value for us as investors, and this deal did not seem to meet those criteria, although it certainly seemed to fit the activist imperative to do something and looked like a good deal for Starbucks. This year I thought I would use the opportunity afforded by this letter to talk about our engagement with companies. We are often asked by investors whether we meet company management and how we engage with them. The answer is that we meet them a lot. We visit companies we wish to research and meet them physically or virtually at results meetings and industry conferences.all

resolutions and proxy statements at general meetings. We do not employ any outside agency for this. However, meeting management is not our primary test of whether a business is of sufficient quality for us to invest. We think good businesses are identifiable from the numbers they produce. Nor do we meet management to give them our views on how to run the business. If they don’t know how to do so we are in serious trouble. There were two examples in 2018 of the closer engagement which we undertake when necessary. One was with Sage, the accounting software company and the UK’s largest quoted IT company. Sage like many software providers is in the midst of a switch from provision of perpetual software licenses for its products — historically in the form of a disc — to the provision of Software as a Service (or ‘SaaS’ as it is known in the jargon) in which the product is provided online as a subscription service. This has many advantages — knowing who the customer is, the ability to provide upgrades and sell adjacent products (like payroll and HR services) and repeat revenues. But it is not an automatic win — legacy customers can be reluctant to switch and the move to SaaS can provide an opportunity for disruptive competitors. Sage has had a couple of disappointing quarters of results in 2018 when the revenue growth which was expected to be 8% p.a. looked like it might come in closer to 6% p.a.

Whilst this was not ideal it was not as worrying as the possibility that the product development might not be fit for purpose and/or that in trying to reach for short term targets essential product development might be neglected. We therefore engaged with the Chairman to ensure that our concerns were understood. In this respect we felt we could draw upon our experience as shareholders in Intuit which competes with Sage and has made a so far successful transition to becoming a SaaS company. We did not however call for any change in management. The board nonetheless subsequently took the decision to part company with the CEO. We engaged with the Chairman to try to ensure that a suitable choice was made, drawing on our experience as a shareholder in Microsoft during the transition from Steve Ballmer as CEO to Satya Nadella, which has gone very well, and finally we met with the new CEO when he was appointed permanently to discuss the way forward for the business.announced

£60m of additional expenditure, two thirds of which is on product development. The other main corporate engagement outside the run of the mill AGM proxies and remuneration consultations in 2018 concerned Unilever, which announced a plan to unify its Anglo Dutch dual share structure and centre the headquarters and listing in the Netherlands. This was to be subject to a shareholder vote in the UK PLC which never occurred, presumably because the board could see it was about to be defeated. Unlike some investors, the switch of listing would not have affected our ability to continue as shareholders. Our engagement with the Chairman centred around the motivation for the move which was portrayed as a desirable simplification that would make it easier for Unilever to engage in acquisitions involving share issues, particularly in the United States. We were rather sceptical about the stated reasons for the change. The previous year Unilever had a near death experience with a takeover approach from Kraft Heinz. Add to this the episode in which the US chemical company PPG Industries had bid for the Dutch paint maker Akzo Nobel and a subsequent freedom of information request had revealed collusive activity between Akzo Nobel’s management and Dutch politicians to thwart the bid and you did not need to be the fictional Dutch detective Van der Valk to figure out that there might be some other motivations for the proposed move.

As you will be able to tell if you read our annual letter last year, we are far from enthusiastic about most shareholder activism nor are we shareholders in or fans of the Kraft Heinz business model. But we thought that Unilever’s management had a case to answer and we think that the ability to mount a hostile takeover is an important discipline in ensuring that our assets are properly managed. When the Chairman told us that he was never in favour of such actions, though he concurred that some companies were poorly managed, we were at best a bit confused about what mechanism he thought might be applied if such a change became necessary. Harsh language maybe? We did not take part in any public commentary about our voting intentions had the Unilever changes come to a vote and please note that we have not revealed that here, we have merely commented on the process. In our view achieving good stewardship of a business is not always a process best conducted through the media.

I would like to end by addressing the question of what will happen next in equity markets, which may surprise you given that I always respond to questions about this by saying I haven’t got a clue, and neither has anyone else. Imagine a fund manager approached you with an offer for you to invest in a portfolio of high quality companies. You may quite like the strategy but you are worried about whether or not this is a good time to invest in the stock market. Take a look at the chart below which shows the world’s largest index by market capitalisation, the S&P 500, and which includes more quality companies than any other index. Source: Bloomberg The chart looks like a roller coaster that has just passed the peak of the ride. Surely you would be stupid if you invested now no matter how good the strategy is. Better to wait until the market has had a proper fall. You may notice that there are no dates on this chart of the S&P 500. That’s because I wanted you to assume I was referring to the current market and our own fund, Fundsmith. In fact, the chart above shows the 37 years up to 1965 — the year in which Warren Buffett took control of Berkshire Hathaway. If you had made the decision to time the market and hold back from investing then you would probably have missed out on the 20.9% compound growth in the market value per share of Berkshire since 1965 as a result.

‘Ah but that’s not how market timing works’, I can foresee someone saying. ‘Just because I didn’t buy into it in June 1965 doesn’t mean that I wouldn’t have bought into Berkshire later after the market had fallen.’ Seems fair except that the market didn’t fall in the remainder of 1965. In fact, the S&P 500 went up by a further 13% in the second half of 1965. What would you have done then? Panicked and bought Berkshire or held off? If you had the nerve to do the latter, you might have felt vindicated in 1966 when the S&P 500 fell by 22% at one point. There are several problems with this though. Berkshire Hathaway is not the S&P 500. Its shares rose 49.5% in 1965 and only fell by 3.4% in 1966. So, your hesitancy would not have paid off. Moreover, by 1967 the market had recovered to a new peak. Are you really smart enough to not only a) predict a market fall but also; b) figure out how this translates into individual stock movements; c) get your timing sufficiently correct that you do not either forgo gains which far outweigh any losses you protect against or suffer some of the downturn; d) have sufficient mental agility and nerve to start buying when your prediction of a market fall has become reality; and e) get the timing roughly right on that side of the trade so that you don’t end up catching the proverbial falling knife or missing some or all of the recovery? If so, I doubt you will be reading this letter on your private island. But above all, I doubt you exist.

To be fair, there have been plenty of big falls in both the market and Berkshire Hathaway’s stock in the intervening 50 odd years since 1965. Berkshire’s shares fell by over 50% in 1973–75 and 2008–09, and by nearly 50% in 1998–2000, plus a mere 37% in 1987. The point about this is not simply that getting the timing of markets right is impossible it is also that in even attempting to do so you might have missed out on investing in Warren Buffett’s Berkshire Hathaway, the results of which far outweigh any market timing gains. So where are we now?date:

Source: Bloomberg Looks familiar doesn’t it? And it makes people reluctant to invest. ‘Ah’ but I can hear someone say, ‘Things are different — the valuation was much lower in 1965 than it is now.’ In mid-1965 the S&P 500 was on a P/E of 18.6x. Now it is on a 2019 forecast P/E of 17.1x. There is no significant difference, although it is actually more lowly rated now. But surely only an idiot would invest in a portfolio of high quality company stocks when the market chart looks like that... As Mark Twain said, ‘History doesn’t repeat itself, but it often rhymes.’ Finally, I wish you a happy New Year and thank you for your continued support for our Fund. Yours sincerely, Terry Smith CEO Fundsmith LLP

Disclaimer: A Key Investor Information Document and an English language prospectus for the Fundsmith Sustainable Equity Fund are available via the Fundsmith Sustainable Equity Fund website or on request and investors should consult these documents before purchasing shares in the fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This document is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: Fundsmith LLP & Bloomberg unless otherwise stated. Portfolio turnover has been calculated in accordance with the methodology laid down by the FCA. This compares the total share purchases and sales less total creations and liquidations with the average net asset value of the fund. P/E ratios and Free Cash Flow Yields are based on trailing twelve month data and as at 31st December 2018 unless otherwise stated.

January 2018 Dear Fellow Investor, This is the eighth annual letter to owners of the Fundsmith Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 compared with various benchmarks. % Total Return 1st Jan to Inception to 31st Dec 2017 31st Dec 2017 Cumulative Annualised Fundsmith Equity Fund1 +22.0 +261.7 +19.7 Equities2 +11.8 +135.5 +12.7 UK Bonds3 +1.4 +34.2 +4.2 Cash4 +0.4 +4.4 +0.6 1T Class Acc shares, net of fees, priced at noon UK time. 2MSCI World Index, £ net, priced at close of business US time. 3Bloomberg/Barclays Bond Indices UK Gov. 5–10 yr. 43 Month £ LIBOR Interest Rate. 1,3,4Source: Bloomberg. 2Source: www.msci.com. The table shows the performance of the T Class Accumulation shares, the most commonly held class and one in which I am invested, which rose by +22.0% in 2017 and compares with +11.8% for the MSCI World Index in sterling with dividends reinvested. The Fund therefore beat this benchmark in 2017, and our Fund remains the No.1 performer since its inception in the Investment Association Global sector by a cumulative margin of 40 percentage points over the second best fund and 160 percentage points above the average for the sector which delivered +101.2%. However, I realise that many or indeed most of our investors do not use the MSCI World Index as the natural benchmark for their investments.

Those of you who are based in the UK may look to the FTSE 100 Index (‘FTSE’ or ‘FTSE 100’) as the yardstick for measuring your investments and may hold funds which are benchmarked to this index and often hug it. The FTSE delivered a total return of +12.0% in 2017 so our Fund outperformed this by a margin of 10.0%. I will come back to the subject of the FTSE 100 Index later.

Last year in order to describe our Fund’s performance for the year I quoted the commentator’s cliché that football is a game of two halves, because in 2016 a strong first half performance by our Fund contrasted with a weaker second half of the year. In 2017 we experienced what stock market commentators often describe as a sector ‘rotation’ in which the sectors in which we are invested mostly fell out of favour and share prices of those companies underperformed, whilst other sectors which we do not own performed well—in particular the bank sector. This ‘rotation’ seems to have occurred as a result of expectations about a pick-up in economic growth leading to a potential recovery in the performance of cyclical stocks, especially after the election of Donald Trump as US President in early November with predictions that his economic policies would stimulate more rapid growth in the US economy. The commentator’s quote I wish to use to describe this year’s performance is from Yogi Berra, the American baseball player, manager and coach, who had some deceptively simplistic or seemingly illogical aphorisms. One of my favourites is ‘You can observe a lot by watching’ which I think some people would do well to consider. However, the one which I think expresses the performance of the Fund and market in 2017 is ‘It’s déjà vu all over again’. What have we experienced in December?

A fall in technology sector shares and a rise in bank shares in anticipation of the next rise in interest rates by the Federal Reserve Bank (being a stickler for at least attempting to use language correctly, I refuse to use the popular term ‘hike’ to describe the Fed’s actions as the dictionary definition of this in context is a sharp increase. I am fairly confident that is not what we are getting. My concern about correct usage may not be to everybody’s liking but in my view we should use language more carefully than many modern commentators do as it is after all our main means of communication). When judging these events, the fact that we seem to have seen this movie before might lead us to conclude that we know how it will end. I can now trace back five years of market commentary that has warned that shares of the sort we invest in, our strategy and our Fund would underperform. During that time the Fund has risen in value by over 175%. The fact that you would have foregone this gain if you had followed their advice will of course be forgotten by them if or when their predictions that our strategy will underperform the ‘value’ strategy of buying cyclicals, financials and assorted junk pays off for a period.

You or they might well counter by saying that this past outperformance is all very well but it does not help you in making a decision on whether to own our Fund from today, which must surely be determined by its future performance or as the legalese goes ‘Past performance is not necessarily a guide to future performance’. I think the key word in that sentence is ‘necessarily’. Let me offer a couple of thoughts on that. The first problem is of course that the commentators upon whom you might rely may simply be wrong.that:

• The UK would vote for ‘Remain’ in the Brexit referendum • The UK would enter a recession immediately if it voted to ‘Leave’ the EU • Donald Trump would not become President • Narendra Modi would not become Prime Minister of India • Narendra Modi’s economic reforms would fail • Theresa May would have such a resounding victory in the 2017 election that Labour would disintegrate • Angela Merkel would sweep to victory in the German elections • President Trump’s tax reform bill would not be passed by the US legislature In some cases, they have a ‘Full House’ having made all these predictions. The fact that they have been shown to be comprehensively wrong does not seem to stop them from giving us the dubious benefit of further predictions. In this regard they remind me of the broker who was always wrong and who is mentioned in the book ‘Hedgehogging’ by Barton Biggs, the strategist and hedge fund manager. Biggs found him useful to talk to because once the broker had given his views on what would happen or what to do, Biggs knew that the opposite was bound to be correct. For what it’s worth, my diagnosis of the problem for these commentators who seem to emulate this broker is that they are experiencing role confusion. They seem to have forgotten that their role is to report events accurately and have decided that instead they need to influence the outcome to one they desire.

They also seem to have missed the point that voicing your views in an echo chamber is not likely to lead to a challenging debate in which to test your opinions. Thankfully, I spend little or no time trying to apply predictions about macro events in order to manage our portfolio. However, that does not mean that I do not think about them. As I have maintained for most of the decade since the Financial Crisis, looking back to the Great Depression for an analogy that would enable us to understand these events and form a view of how they may unfold is probably a mistake. A better analogy may be the Long Depression of 1873–96 when a new industrial power came on stream and caused a wave of deflation as it could manufacture goods cheaper than in the Old World. That industrial power was America after the Civil War. The Long Depression was also preceded by a collapse of part of the banking system. Sound familiar? The wave of deflation we have been experiencing has been caused by a number of factors. These include the rise of China as the world’s greatest industrial power, other cheap manufacturers (South Korea, Thailand, Vietnam, India and Malaysia for example) and the offshoring of manufacturing to cheap manufacturers under free trade agreements, such as Mexico under NAFTA, which so exorcises President Trump.Depression

insofar as then there was virtually no international competition in services whereas now in our connected world there is in software (India) and call centres (the Philippines), for example. Plus there is the rise of the so-called gig economy in which the internet, casual employment and the sharing of assets have made price comparisons easier, and have driven down prices and returns in retail (Amazon), transport (Uber) and lodging (Airbnb), for example. If the closest analogy for the events which we have experienced since the Financial Crisis is the Long Depression, we may be barely half way through it simply on the basis of elapsed time. In which case, the period of sluggish economic growth and low interest rates which we have experienced over the past decade may persist for some considerable time. I think this is likely for the simplest of reasons: little or nothing has been done to correct the problems which led to the Financial Crisis. The unsupportable expansion of credit that sparked the crisis has not been resolved. There is in fact more debt in existence now than there was in 2007. Admittedly, some of it is in different hands—China has more debt now and much of the debt in the developed world has been ‘socialised’ and assumed by governments. However, governments are just us collectively, contrary to the fevered imaginings of the ‘magic money tree’ devotees.

What seems to have happened over the past decade is a prolonged experiment in borrowing your way out of a debt problem. Maybe it will work, although I am amongst those who would bet against it, but it certainly is not the sort of circumstance which would suggest that a ‘normal’ economic recovery or a rapid rise or ‘hike’ in interest rates is likely. As an aside, I would suggest that the headlong expansion of credit in much of the western world which preceded the Financial Crisis was an attempt to compensate for the effects of deflation. Instead of accepting that the loss of manufacturing and service jobs to the developing world meant we had to accept lower pay and lower standards of living to compete we opted for an expansion of the state, the mushrooming of non- productive jobs and borrowing to maintain our spending patterns. Secondly, if you nonetheless take the view that our Fund’s strategy has indeed delivered a good performance but that valuations (which I will come to later) for stocks of the sort it owns are high and that this will limit their share price performance at least in the near term, the obvious problem this poses is what you or we might invest in as an alternative. This presents several problems. One is that the valuation of the Fund’s stocks are not all that much higher than the market, especially when their relative quality is taken into account.

Of course, all this may prove is that everything is expensive or at least highly rated, and there are plenty of pundits and fund managers who have indeed suggested that we are in a so-called ‘bubble’ which will end badly with everything falling a long way. So far, they have only managed to demonstrate the difficulty in making predictions and implementing actions based upon them. Even if they are eventually proven right, why will a basket of cyclical stocks and financials prove to perform better in these circumstances than a group of companies which are high quality and defensive in terms of supplying everyday consumables and necessities? The events of 2007–09 suggest that the opposite is true.

There is also the fact that the alternative of investing in cyclicals, financials and so- called ‘value’ stocks involves investing in companies, which over time do not create shareholder value by generating returns on capital above their cost of capital and growing by deploying more capital at such favourable returns. We seek to invest in companies which accomplish this. Quoting Warren Buffett, the ‘Sage of Omaha’ and arguably the best investor over the past fifty or so years has in my view become somewhat passé. It is frequently done by acolytes or imitators many of whom seem to have done only the most cursory study of what he actually does, if anything at all. So instead I am going to quote his business partner and Berkshire Hathaway’s Vice Chairman, Charlie Munger: ‘Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return— even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result’ (emphasis added). I have no idea why Mr. Munger chose those particular rates of return but what I do know is that he is not voicing an opinion. What he is describing is a mathematical certainty.

If you invest for the long term in companies which can deliver high returns on capital, and which invest at least a significant portion of the cash flows they generate to earn similarly high returns, over time that has far more impact on the performance of the shares than the price you pay for them. Yet I have been asked far more frequently whether a share, a strategy or a fund is cheap or expensive than I am asked about what returns the companies involved deliver and whether they are good companies which create value or not. Even though Mr. Munger is right it requires a long-term investment perspective to capture that compounding by high return companies, and finding those companies is not easy especially as you need to assess their ability to grow and ward off competition. But the most difficult part of applying the investment strategy suggested by Mr. Munger’s quote, and which we seek to apply, is us. Our inability to take a really long-term view, particularly through the periods when our chosen strategy and companies are not performing as well as less good companies, which are enjoying their period in the sun, is our greatest enemy. I will leave this subject with a sporting analogy. We are often told that life is a marathon not a sprint. So is investing. Most of us will be investors for the majority of our lives. If we start investing in our 30’s with current average life expectancy most of us will be investing for over half a century. It makes Mr.

Munger’s 40 year example seem a bit short. So why we should think about what happens over shorter time periods, like quarters or even years is a bit of a puzzle. However, some people behave as though the best way to win this marathon is to engage the services of one hundred and five 400-metre runners (26 miles 385 yards or 42.195 kilometres divided by 0.4=105.5) who could surely run the distance faster than a single marathon runner.whatever

change you expect in market conditions. The problem is this; if you choose the one hundred and five 400-metre runner route I presume that to make the contest against the marathon runner realistic you have to carry a baton that you hand over to the next runner. This is the equivalent of you making the decision to sell all your high quality stocks and switch into somewhat cheaper (although maybe not cheap) cyclicals and value stocks. However, I seem to recall that very often that baton gets dropped, or the changeover is not made within the allowed zone and the team is disqualified. I suppose the investment version of this is that you get the timing of your switch wrong or you sell one strategy but remain in cash. The problem in trying to apply this sprint strategy in the real world of investment is even worse. In a relay race the runners for each stage are selected in advance. Whereas in an attempt to apply this technique in investment you would need to select whom you wish to receive the baton as you enter the changeover area each time. After all do you know in advance whether you want to go from high quality consumer staples to financials, commodity stocks or industrials, emerging markets, bonds or some combination of these? The scope for fumbled handovers is endless. And you have to do it many times to succeed with this approach. Moving on to review the outcome for 2017 in terms of our Fund’s strategy.

As you hopefully know by now, we have a simple three step investment strategy: • Buy good companies • Don’t overpay • Do nothing I intend to review how we are doing against each of these in turn. As usual, we seek to give some insight into the first of those—whether we own good companies—by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market, in this case the FTSE 100 Index and the S&P 500 Index (‘S&P 500’). This year we not only show you how the portfolio compares with the major indices but also how it has evolved over time. Year ended Fundsmith Equity Fund Portfolio S&P FTSE 2010 2011 2012 2013 2014 2015 2016 2017 2017 2017 ROCE 29% 28% 29% 31% 29% 26% 27% 28% 15% 14% Gross margin 54% 58% 58% 63% 60% 61% 62% 63% 44% 41% Operating margin 20% 22% 23% 24% 25% 25% 26% 26% 13% 13% Cash conversion 117% 103% 101% 108% 102% 98% 99% 102% 97% 96% Leverage 63% 15% 44% 40% 28% 29% 38% 37% 52% 46% Interest cover 15x 27x 18x 16x 15x 16x 17x 17x 7x 8x Source: Fundsmith LLP/Bloomberg. ROCE, Gross Margin, Operating Profit Margin and Cash Conversion are the weighted mean of the underlying companies invested in by the Fundsmith Equity Fund and the mean for the FTSE 100 and S&P 500 Indices. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are both median.

The companies in our portfolio have consistently had significantly higher returns on capital and better profit margins than the average for the indices. They convert more of their profits into cash and achieve this with a much lower level of borrowing than the average company. Moreover, their average level of borrowing is significantly lower than it was when we started the Fund. The world at large may not have de-geared much but the companies in our portfolio have. Nor is this a one off—they have been achieving these superior results for many years. The average year of foundation of our portfolio companies at the year end was 1916. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth—high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2017? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 13% in 2017. We regard this as a very good result given the generally lackluster growth which the world continues to experience. This leads onto the question of valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) on the portfolio at the outset of the year was 4.4% and ended it at 3.7% so they did become more highly rated.

However, it is important to bear in mind that this is not a like-for-like comparison as our portfolio did not remain static over the year. In fact the two shares we sold—Imperial Brands and J M Smucker—had by far the highest FCF yields in the portfolio and much higher than the FCF yields of the one we purchased— Intuit. If we had not made these changes the portfolio FCF yield would have remained at 4.0% (although it is worth noting that the growth rate would have been significantly lower—the FCF of both companies fell in 2017) so some of the fall in yield was a result of our action rather than any rise in market valuations. The year end mean FCF yield on the S&P 500 was 3.9% and the median 4.1%. The year end mean FCF yield on the FTSE 100 was 5.6% and the median 4.9%. More of our stocks are in the former index than the latter. To try to cut through all these means and medians, our portfolio consists of companies that are fundamentally a lot better than those in the index and are valued more highly than the average FTSE 100 company and slightly higher than the average S&P 500 company. In the case of the FTSE 100 Index this is because the valuation of the index is dominated by what I would regard as uninvestable companies like Anglo American and Centrica which traded on FCF yields of around 15% as at 31st December 2017. They may be lowly rated but that does not mean that they are necessarily cheap given their poor quality.

The past may not be a perfect guide but their return on capital has averaged 3% and 6% respectively since 2011 and they have achieved a total shareholder return of -35.3% and -40.7% respectively from 1st November 2010 to 31st December 2017, when our Fund (T Class Accumulation shares) has returned 261.7%. Maybe all this is about to change. It had better if you are thinking of owning them or the FTSE 100 Index.to

enable them to ‘invest in the UK’. Firstly, I have to question why you would want to restrict your investments to the UK. You may live in the UK as most of our investors do, but to quote Arthur Daley ‘The world’s your lobster’. You can invest outside it and it is unlikely that all or even many of the good companies in the world that you might benefit by investing in are headquartered or listed in a country which constitutes about 3% of world GDP. There is also the question of how representative the FTSE 100 Index is of the UK economy. As at 31st December 2017, of the 10 largest market cap (non-financial) companies in the FTSE 100, only three report in sterling. Only numbers 6, 8, 9 and 10 gave any UK numbers in their last reported accounts: • For No. 6, Rio Tinto, the UK is 1% of sales. Australia is bigger. • For No. 8, GSK, the UK is 3.8% of sales. The US is bigger. • For No. 9, AstraZeneca, the UK is 8% of sales. Japan is bigger. • For No. 10, Vodafone, the UK is 14.5% of sales. Germany is bigger. Which is all a clue that investing in the FTSE 100 Index is not investing in the UK. So if you are doing so you have already, perhaps inadvertently, made the decision to invest internationally. If so, you may as well do it properly and look at companies listed abroad. Finally, what sort of companies are in the FTSE 100? An insight into this is provided by the fact that as at 31st December 2017 just 1.8% of the FTSE is in Information Technology. This compares with 23.

9% in the S&P 500 Index, not the technology centric Nasdaq Composite Index. I am not suggesting that Information Technology is the only sector to invest in to capture future growth nor is it immune from becoming over-valued and delivering poor returns to investors from time to time. But if you were to ask which two sets of stocks were more likely to capture the benefit of future growth, one with 1.8% in Information Technology or one with 23.9%, I think the answer would be pretty obvious. So for all those reasons I do not really regard the FTSE 100 as a genuine benchmark for our Fund and neither am I at all concerned about the Fund’s valuation relative to it. However, that should not be taken to mean that we are entirely comfortable with the seemingly ever higher rating which the shares in our portfolio are achieving. It is clearly a finite and reversible source of performance. However, the growth in the free cash flows of the portfolio are providing a greater portion of the performance which is how we would prefer it and what Mr. Munger might have predicted. One aspect of our performance which we have often been asked about in the past is the degree to which it has benefited from the strength of the US dollar as the majority of the stocks we own are listed in the United States. This is a complex subject as currency exposure is driven by where a company derives its revenues rather than where it is headquartered or listed.

However, this year there has been a noticeable absence of such questions. Could this perhaps be because in 2017 the best estimate we have is that the weakness of the US dollar cost our Fund some -5.9%. The performance in 2017 was attained despite this headwind.

For the year the top five contributors to the Fund’s performance were: Paypal +2.9% Amadeus +2.3% CR Bard +1.8% Novo Nordisk +1.5% Waters Corp +1.4% CR Bard is making an appearance for the second year running, at least partly because it was bid for by Becton Dickinson, another of our portfolio companies. The bottom five were: JM Smucker - 0.3% Imperial Brands - 0.2% Dr Pepper Snapple 0.0% Colgate Palmolive +0.1% Reckitt Benckiser +0.1% We sold our holdings in JM Smucker and Imperial Brands during the year. JM Smucker was a disappointment. One half of the business is in ambient packaged food in which it is a struggle to generate growth—Folgers coffee, Jif peanut butter and Smucker’s jams (jellies if you are American). However, what attracted our interest was when JM Smucker acquired the Big Heart Pet Brands pet food business from private equity. We are keen on businesses which sell to pet owners, such as IDEXX, albeit indirectly, and we had made a very good return on the Big Heart business when it was owned by Del Monte before it was acquired by private equity. However, the outcome in terms of the margins and returns achieved on the business by JM Smucker proved to be disappointing and we were concerned by the management’s reaction to this especially as JM Smucker is a family controlled company. Imperial Brands is the former Imperial Tobacco that we had held since the inception of the Fund.

We had become increasingly concerned about the company’s positioning in terms of its lack of exposure to the developing world and to the next generation reduced risk products such as heat not burn devices, all of which has led to volumes falling at a rate that it is difficult to cope with. We were even more concerned by the management reaction which we literally could not understand. Colgate makes the table of our five worst performers for the second year running even though it is our smallest position. It has been facing a tough time with its largest market being Brazil. Turning to the third leg of our strategy which we succinctly describe as ‘do nothing’, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 5.4%^ during the period. It is perhaps more helpful to know that we have held 13 of our portfolio companies since inception and we spent a total of £1.3m or just 0.011% (1.1 basis points) of the Fund’s average value over the year on voluntary dealing (which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary).

Why is this important? It helps to minimise costs, and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on or in some cases obsess about the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2017 for the T Class Accumulation shares was 1.05%. The trouble is that the OCF does not include an important element of costs—the costs of dealing. When a fund manager deals by buying or selling investments for a fund, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, transaction taxes such as stamp duty in the UK. This can add significantly to the costs of a fund yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2017 this amounted to a TCI of 1.08%, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We think that figure will prove to be low if or when other funds produce comparable numbers. However, we would caution against becoming obsessed with charges to such an extent that you lose focus on the performance of a fund.

It is worth pointing out that the performance of the Fund tabled at the beginning of this letter is after charging all fees which should surely be the main focus. This year I thought I would use the opportunity afforded by this letter to talk about so- called activism and takeovers since we have seen a lot of events in these areas in the past year which have affected the companies we own and follow. Investment is a world in which words get used in confusing ways. Take the words active and activism. Active investors are the opposite of passive investors who simply seek to replicate the performance of an index. At Fundsmith we are active investors— our Fund will only own a maximum of 30 shares (it owned 27 as at 31st December 2017) and we limit it to a few sectors which have the characteristics we seek: consumer staples, some consumer discretionary products, healthcare and technology being the main sectors. So we are far removed from a passive investor. However, we change our portfolio positions very infrequently which I suppose makes us an inactive active investor. You can see why people are often confused. Activists are a different animal. They seek to benefit by causing change in corporations they invest in. Activists are usually active managers but some of them are passive (I’m not making this up) as they seek to improve the returns on their index fund by agitating for change where they feel it is necessary. So I suppose they could be described as passive activists.

Still with me? On the whole we are not fans of activism. Too often it seems to follow a playbook that has the following steps: 1. The activist ‘buys’ a stake in a company. I have put ‘buys’ in inverted commas because often much or all of the stake is held through derivative products which means that the activist can announce a seemingly large position in the company’s stock whilst risking and committing relatively little actual cash.This

methodology also gives some clue as to the activist’s time horizon which may not coincide with ours, as derivatives have an expiry date whereas stocks don’t. 2. Engage in a public row with the target company and seek board representation, a spin-off of part of the business, a merger with or sale to a competitor, raise debt to execute a share buyback (the activist can helpfully tender stock to assist with this) etc. 3. If the company responds by following the activist’s demands they then sell their stake. 4. We and other long term shareholders are left with a company that has incurred fees and diverted time from running the business to respond to the activist and execute the changes, which is now potentially more fragmented, more highly leveraged and has had to install new management. 5. Rinse and repeat with another victim investment. We have many possible objections to this process. In our experience a dialogue in which you seek to change someone’s behavior is best at least started in private. Seeking a public spat at the outset seems to us to be more closely aligned with a desire to seek a certain public profile rather than to effect corporate change. Often the proposals hinge on a misconception or two.

We have often been told that if a company has two divisions and one is in a slow growing segment and one is faster growing (like PepsiCo with soft drinks and snacks) then if the two are separated (as Nelson Peltz suggested to PepsiCo) the faster growing one will attain a higher stock market rating once on its own. This is probably true, but won’t that be compensated by a lower rating on the slower growth division? Of course not for the activist who intends to sell out as soon as possible. Thankfully in our view, on this occasion Mr. Peltz was unsuccessful and PepsiCo remains a drinks and snack business, which is not to say that we think everything is fine with PepsiCo’s management or that Mr. Peltz is always wrong, of which more later. Leveraging up the balance sheet to buy back stock is a frequent demand of activists and is invariably described as ‘returning cash to shareholders’ and not only when it is suggested by activists. The correct description for this action should be ‘returning cash to exiting shareholders’ as we remaining shareholders don’t receive any of it and this perhaps best encapsulates the problem we identify with this practice. Those of us who actually seek to own the company and remain shareholders see debt raised to take out shareholders who wish to exit. It is beyond us why we would want that to happen unless the shares purchased are demonstrably cheap.

However, whilst we question the motivation and methods of activists, and how companies respond to them, we do not always disagree with them. For example, we agreed with Carl Icahn’s view that separation of the two businesses which were part of eBay (the eBay marketplaces business and PayPal the payment service provider) would set PayPal free to grow more rapidly, and as you can see PayPal is the largest contributor to our Fund’s performance over the past year.

Quite a lot happened to affect our portfolio companies and we have seen some takeover activity in the past year. In addition to the bid for CR Bard and the bid approach from Kraft Heinz for Unilever, activists became involved in ADP and Nestlé, which we own, and P&G, which we had already sold, but which remains in our Investable Universe of stocks we would own given certain conditions. I thought it might therefore be helpful to investors if I described our reaction to each of these in turn, since we may not be very active in the sense of changing portfolio positions but we are often engaged in thinking about situations such as these. Automatic Data Processing (‘ADP’) / Pershing Square Payroll and HR services company ADP was approached by activist fund Pershing Square, led by Bill Ackman, who had ‘bought’ an 8.3% stake. The inverted commas are because this stake involved 36.8m shares, 28.0m of which were in fact call options and not actual shares. This did not amount to true ownership in our view since Pershing Square had no right to vote the shares covered by those call options and neither had they expended the cash to purchase the shares. Pershing Square’s approach to ADP became a public row and proxy contest with Pershing Square delivering a 168 page presentation, several letters suggesting ways to improve operating efficiency, which might be summarized as ‘cut costs quickly’, and demanding three board seats. The reaction of the ADP management was interesting.

They did not do what so many managements do when faced with an activist by issuing new guidance showing an increase in forecast profits or margins, increasing the dividend and/or share buybacks. Instead they challenged the analysis and assumptions underlying the Pershing Square proposals. We found this direct and refreshingly honest. The stock had significantly outperformed the S&P 500 Index over the past five years even before Pershing Square became involved. Maybe it could have done even better if Mr. Ackman is right, but during this period the management has also had to oversee a transition of the business from one which was mainly paper based to one where its products are delivered by a variety of electronic means, and it is not as though Pershing Square’s suggestions were without risk. We therefore decided to give the ADP management something rather old-fashioned, called the benefit of the doubt, and so voted with them and against Pershing Square’s proposals. We suspect there are far worthier targets for Mr. Ackman to attack even within our portfolio. Nestlé / Third Point Hedge fund Third Point, run by Dan Loeb, purchased a $3.5bn stake in Nestlé and in his June letter to investors Mr. Loeb talked of Nestlé’s ‘unrealized potential for margin improvement and innovation in its core businesses, an un-optimized balance sheet, a number of non-core assets’.

Third Point’s approach to Nestlé strikes us as close to the activist playbook which I described earlier in that it calls for ‘improving productivity’; ‘returning capital to shareholders’; ‘re-shaping the portfolio’; and ‘monetizing its L’Oréal stake’.

In respect of productivity, Mr. Loeb said Nestlé should ‘adopt a formal margin target’. He went on to specify the margin level he believes Nestlé should formally target as ‘18–20%’ by 2020. There is more to attaining an improvement in profitability than committing to a target. The approach reminds me of the G20 meeting in 2014 at which the countries committed to attaining GDP growth of more than 2%. If it’s that simple, why not commit 3% or even 4%? Some people seem to believe that GDP growth or profit margins can be conjured up by a commitment. Sadly it may take rather more than that. In respect of returning capital, Mr. Loeb says that ‘capital return in conjunction with a formal leverage target makes sense as well’. He goes on to say that raised leverage would provide share buyback capacity, which would probably be a better use of cash than acquisitions given high valuations (remember that bit please). Mr. Loeb mentions ‘Re-shaping the portfolio’ and invokes the fact that the company has over 2,000 brands, some of which he believes could fetch ‘above-market multiples’ given ‘large synergies to potential acquirers’. He also thinks Nestlé should consider ‘accretive, bolt-on acquisitions in high growth and advantaged categories’ (presumably despite the ‘high multiples in Nestlé’s sector’ he already mentioned).

His proposal for ‘Monetizing the L’Oréal stake’ is based on his belief that the stake is ‘not strategic and shareholders should be free to choose whether they want to invest in Nestlé or some combination of Nestlé and L’Oréal’. He ended by saying that divestiture ‘via an exchange offer for Nestlé shares…would accelerate efforts to optimize its capital return policies, immediately enhance the company’s return on equity (‘ROE’) and meaningfully increase its share value in the long run as earnings improve over a reduced share count’. Fairly obviously the enhancement of ROE from disposal of a stake which is equity accounted is purely cosmetic but then again some people are impressed by cosmetic changes. We are not amongst them and if I had managed to acquire a 23% stake in the world’s leading cosmetic company, as Nestlé has, I would need some more compelling arguments to persuade me to dispose of it. Nestlé’s first response to Third Point came only two days after Mr. Loeb’s letter. This talked about ‘value creation’. However it did include one specific, namely the announcement of a CHF 20bn share buyback program. A more detailed response came when Nestlé CEO Mark Schneider and other executives presented at the Nestlé investor day on 26th September. The company set a new formal margin target—up 150–250bps from the underlying 16% in 2016 to 17.5–18.5% by 2020; and said that it would accelerate share buyback activity.

It also said that as well as the already announced decision to ‘explore strategic options’ for the US confectionery business, it was ‘actively adjusting its product portfolio...as shown by the recent investments in Blue Bottle Coffee, Sweet Earth and Freshly’. However the company defended the L’Oréal stake. On the whole we are not impressed when a company announces new margin targets, share buybacks and acquisitions and/or disposals in response to activists or takeover approaches. The question which always springs to our mind is ‘If these things are possible and desirable, why weren’t you already doing them?Nestlé,

however, the CEO Mark Schneider should probably not be criticised for this as he is new in the role so he can’t be blamed for any past dilatoriness. To date Third Point’s approach to Nestlé has not lead to anything we are required to vote on which may be just as well. Procter & Gamble (‘P&G’) / Trian Trian is a fund run by Nelson Peltz whom I have already mentioned in the context of PepsiCo. Although we don’t directly have a dog in this particular fight, as we do not have any P&G in our portfolio, it still resides in our Investable Universe and so an investment is still regularly considered by us, and as we sold our stake because of concerns about P&G’s strategy we are interested in what Mr. Peltz had to say. Trian’s plan for P&G was detailed on 6th September. It called for ‘organizing P&G in a way that promotes accountability, faster decisions and responsiveness to local preferences’; ‘ensuring management’s $12–13bn productivity plan actually delivers’; ‘fixing the innovation machine’; ‘improving development of small, mid-size and local brands, both organically and through M&A’; ‘winning in digital’; ‘addressing P&G’s insular culture’; ‘improving corporate governance, including aligning management compensation with market share gains’. The page after these proposals—i.e. very much to the fore of the piece—details what Trian is ‘NOT’ (they wrote the word in capital letters) recommending.

Among the things which they are not recommending—a break-up of the company, a new CEO, replacement of any directors, taking on excessive leverage, pension benefits cuts, slashing of R&D, marketing or capital expenditure budgets, cost cuts which might impact product quality, moving out of Cincinnati. We like this approach. The next page reminded us that all Trian was seeking was that ‘Nelson become 1 of 11 (or 12)’ directors of P&G and that it is ridiculous to suggest that as one person out of 11 or 12, he would ‘derail’ P&G. The Trian presentation is 93 pages long and is all centred around P&G having a poor organizational structure—‘suffocating bureaucracy and complexity’—which means that no one is accountable, decisions take forever and so forth. When we sold our P&G stake the fact that the company is the overwhelming market leader with Gillette but was ranked no. 50 in online shave clubs struck as illustrating the sort of point Mr. Peltz was making. David Taylor, P&G CEO, went on Jim Cramer’s CNBC programme at one point calling some of Peltz’s proposals ‘very dangerous’. They strike me as more dangerous to Mr. Taylor than to P&G’s shareholders. Mr. Peltz succeeded in his bid to win a board seat even though P&G is said to have spent more than $100m of shareholders’ money to prevent it. We wish him well with his endeavours. His presence makes P&G more interesting to us.

Unilever / Kraft Heinz On 17th February, the story broke that Unilever had received a bid approach from Kraft Heinz, the listed food products company controlled by 3G, the Brazilian entrepreneurs who also control AB InBev, the world’s largest brewer, and Burger King, together with Warren Buffett’s Berkshire Hathaway. On 22nd February, Unilever put out two releases by way of immediate response. The first was entitled, ‘Unilever guidance update’ which said that Unilever ‘now expects core operating margin improvement for 2017 to be at the upper end of its 40–80bps guidance’. The second release said, ‘Unilever is conducting a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders. The events of the last week have highlighted the need to capture more quickly the value we see in Unilever. We expect the review to be completed by early April, after which we will communicate further.’ On 6th April, Unilever announced the results of this review.

The company said it was: • ‘Accelerating its ‘Connected 4 Growth’ programme and targeting a 20% underlying operating margin, before restructuring, by 2020’ • Combining the foods and refreshment units into one unit, ‘unlocking future growth and faster margin progression’ • Establishing a net debt/EBITDA target of 2x • Launching a €5bn share buyback program • Raising the dividend by 12%—about double the recent rate of increase This approach clearly falls foul of our scepticism when management produces rabbits from a hat when an activist or takeover comes into view. We think we should already have seen the rabbits or at least been told about their existence. To hopefully be clear, we are not fans of Kraft Heinz. We have never owned any shares in Kraft Heinz or its constituent parts. Although 3G has managed to operate the business with efficiency as they have AB InBev, to produce great cost savings leading to operating profit margins of 23% in 2016 and strong gains for owners, well certainly for 3G and Berkshire Hathaway, we have never found a business which can cut its way to growth. Although the Kraft Heinz management are certainly handicapped in this regard by the nature of the company’s brands, which are mostly not in growing areas of the market, the sort of people and approaches you need to grow businesses tend not to flourish in cultures in which the emphasis is on cost cutting.

However, the contrast between their approach and that of Unilever does raise some questions for Unilever’s management which remain unanswered. To give you a simple illustration of this, in 2016 Unilever had €52.7bn of revenues and an average of 169,000 employees, thus revenue per employee of about €312,000. Kraft Heinz had €23.8bn of sales and an average of 41,500 employees, and so revenue per employee of about €574,000. Kraft Heinz has slightly less than half the sales of Unilever but manages to achieve this with less than a quarter of the number of the employees. You don’t have to be a fan of brutal cost cutting to see that Unilever has a case to answer here.

Unfortunately we never got to hear Unilever justify its rather interesting sales/employee ratios because Kraft Heinz withdrew as soon as it became evident that Unilever was hostile to the approach. Warren Buffett is notoriously opposed to hostile takeovers. I hope that has given you all some insight into how we think about and interact with the companies in our portfolio and those we are interested in, and other shareholders, activists and bidders. Finally, I wish you a happy New Year and thank you for your continued support for our Fund. My colleagues and I look forward to seeing many of you at our Annual Shareholders’ Meeting on 27th February 2018 and to trying to answer any questions you may have. Please see the enclosed invitation for details. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: An English language prospectus for the Fundsmith Equity Fund is available on request and via the Fundsmith website and investors should consult this document before purchasing shares in the Fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product.

This financial promotion is intended for UK residents only and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. Sources: All data sourced from Fundsmith research and where appropriate using Bloomberg. ^The PTR (Portfolio Turnover Ratio) has been calculated in accordance with the methodology laid down by the FCA. This compares the total share purchases and sales less total creations and liquidations with the average net asset value of the fund.

January 2017 Dear Fellow Investor, This is the seventh annual letter to owners of the Fundsmith Equity Fund (“Fund”). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 compared with various benchmarks. % Total Return 1st Jan to Inception to 31st Dec 2016 31st Dec 2016 Cumulative Annualised Fundsmith Equity Fund1 +28.2 +196.6 +19.3 Equities2 +28.2 +110.6 +12.8 UK Bonds3 +6.5 +32.4 +4.7 Cash4 +0.6 +4.0 +0.6 1T Class Acc shares, net of fees, priced at noon UK time. 2MSCI World Index, £ net, priced at close of business US time. 3Bloomberg/EFFAS Bond Indices UK Govt 5-10 yr. 43 Month £ LIBOR Interest Rate. 1,3,4Source: Bloomberg 2Source: www.msci.com The table shows the performance of the T Class Accumulation shares, the most commonly held Class and one in which I am invested, which rose by +28.2% in 2016 and compares with +28.2% for the MSCI World Index in Sterling with dividends reinvested. The Fund therefore equaled the performance of this benchmark in 2016, and our Fund is still currently the No.1 performer since its inception in the Investment Association Global sector by a cumulative margin of 15% over the second best fund and 127% above the average. However, we realise that many or indeed most of our investors do not use the MSCI World Index as the natural benchmark for their investments.

Those of you who are based in the UK and look to the FTSE 100 Index as the natural yardstick for measuring your investments and/or who hold funds which are benchmarked to the FTSE 100 Index and often hug it will have had a much worse experience than the performance of the MSCI World Index. The FTSE 100 Index was up +14.4% in 2016 and the total return including dividends reinvested was +19.2%. The Fund outperformed this by +9%.

It is a commentator’s cliché that football is a game of two halves, and that was certainly true of our relative performance in 2016. At half time on 30th June our Fund (T Class Accumulation shares) was up +16.4% versus +11.0% for the MSCI World Index, aided by the sharp fall in the Pound after the Brexit result in the referendum of 23rd June as the majority of the shares in our portfolio are listed in the United States. Even though this is not an accurate reflection of the Fund’s currency exposure, which really depends upon where the companies generate their revenues and profits, the fact is that the US Dollar is still the largest currency exposure we have. So what happened in the second half of the year? We experienced what stock market commentators often describe as a sector “rotation” in which the sectors in which we are invested mostly fell out of favour and share prices of those companies underperformed, whilst other sectors which we do not own performed well, and in particular the bank sector. This “rotation” seems to have occurred as a result of expectations about a pick-up in economic growth which focused attention on a potential recovery in the performance of cyclical stocks.

This became more intense after the election (it is common to qualify this with the word “surprise” - “surprising to some” might be a better descriptor as indeed it might for Brexit) of Donald Trump as US President in early November as a result of predictions that his economic policies would stimulate more rapid growth in the US economy. I have no way of knowing whether this “rotation” will continue but then again neither do any of the analysts or commentators who are involved in opining on the matter. When judging this situation I think it is worth bearing in mind a number of points: I can trace back four years of market commentary which warned that shares of the sort we invest in, our strategy and our Fund would underperform. During that time the Fund has risen in value by about 100%. The fact that you would have foregone this gain if you had followed their advice will of course be forgotten by them at the very least. Much of the commentary is simplistic, for example, concentrating on the Consumer Staples sector as an easily identifiable set of stocks of the sort we invest in, as in a recent note by Deutsche Bank which said “the party’s over” in Consumer Staples. Even if this is true, these represent only about a third of our portfolio.

The predictions of underperformance also focus on so-called “bond proxies” - stocks of companies with relatively predictable returns - which investors have supposedly turned to as a substitute for bonds as bond yields have declined to and even below zero. We are told that these bond proxies will do badly when rates rise and that they are starting to do so. As I write the US Federal Reserve has raised the Fed Funds rate by a total of 0.5% from its record low in a whole year (the first 0.25% rise was on 17th December 2015 - how time flies!) As I pointed out last year, this glacial rate of increase does not seem to justify the popular term ‘hike’ described in the dictionary as a sharp or unexpected increase - a description which clearly does not apply to the Fed’s decision. Of course I have no idea when or by how much the Fed or any other central bank will subsequently increase interest rates. Neither I suspect do any of the commentators or analysts judging by their track record thus far, but that will not stop them making predictions and suggesting that you should make investment decisions based upon them.

There is also the question of what we might invest in as an alternative if we chose to sell the Fund’s holdings in defensive so-called bond proxy stocks or if you chose to redeem your shares in our Fund. The obvious suggestion, and it is one which would have worked well in the second half of 2016, is that you should switch into cyclical stocks such as banks. Buying cyclical stocks in anticipation of a rise in interest rates does pose a fairly obvious problem - won’t they perform worse than defensive stocks if the rise in rates causes an economic slowdown? There is also the fact that these stocks are in companies which over time do not create shareholder value by generating returns on capital above their cost of capital and growing by deploying more capital at such favorable returns, which is what the companies we seek to invest in accomplish. If you choose to invest in such companies then I would suggest it is not because you want to hold their shares indefinitely and allow them to compound in value but because you think you perceive an opportunity for a trade in which you buy them and then sell them for a higher price. If so I hope you have better luck with your timing in this game of Greater Fool Theory (in which you hope to buy from a seller who is less competent than you at spotting this opportunity and when the time comes you need to sell to a buyer who is similarly ill informed) than most people seem to have.

As we do not profess to possess this skill, our Fund will not be attempting it. I remain amazed (I could stop this sentence there) by the number of commentators, analysts, fund managers and investors who seem to be obsessed with trying to predict macro events on which to base their investment decisions. The fact that they are seemingly unable to predict events does not seem to stop them trying. During 2016 we had the spectacle of all the major polling organisations and the mainstream media failing to predict the outcome of the EU referendum in the UK or the US presidential election. Yet many of the same people are now busy telling us what the effect of Mr Trump’s economic policies will be and how they will affect our investments. I spend little time worrying about the macro trends and even less time trying to apply predictions about them in order to manage our portfolios. Here’s a short list of possible macro factors which may affect companies and markets in the near future: • Brexit • China • “Demonetisation” in India • French presidential elections • German elections • Interest rates • Korea • President Trump • Quantitative Easing by the European Central Bank • Syria • The oil price Even if you could correctly predict how these matters would develop, and the timing of that, this would not enable you to use this as a basis of investment decisions.

Markets are a so-called second-order system - to usefully employ your predictions you would not only have to make mostly correct predictions but you would also need to gauge what the markets expected to occur in order to predict how they would react. Good luck with that.deploy

most of my time and effort on things I can control. Two of those are whether we own good companies and what valuation we pay to own their shares. As usual, we seek to give some insight into the first of those - whether we own good companies - by giving you the following table which shows what Fundsmith would be like if instead of being a fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis, and compares this with the market (in this case the FTSE 100 Index and the S&P 500 Index). As at 31.12.16 Fundsmith FTSE 100 S&P 500 Equity Fund* Index+ Index+ ROCE 26.7% 13.5% 14.7% Gross Margin 61.9% 40.0% 43.2% Operating Profit Margin 25.5% 12.9% 13.9% Cash Conversion 99.4% 81.4% 83.6% Leverage 37.7% 48.9% 52.1% Interest Cover 17.0x 7.9x 7.9x Note: ROCE, Gross Margin, Operating Margin and Cash Conversion are the weighted average for the Fundsmith Equity Fund and averages for the FTSE 100 Index and S&P 500 Index. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are medians. All data as last reported. *Source: Fundsmith LLP +Source: Bloomberg The companies in our portfolio have significantly higher returns on capital and better profit margins than the average for the indices. They convert more of their profits into cash and achieve this with a much lower level of borrowing than the average company. Nor is this a one off - they have been achieving these superior results for many years.

The average year of foundation of our portfolio companies at the year end was 1912. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth - high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2016? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by just over 11%* in 2016. We regard this as a rather good result given the generally lackluster growth which the world is experiencing and which led to earnings falling on the FTSE 100 and S&P 500 companies in the past year. This leads onto the question of valuation. The Free Cash Flow (“FCF”) yield (the free cash flow generated by the companies divided by their market value) on the portfolio at the outset of the year was 4.3%* and ended it at 4.4%* so they did not become any more highly rated. The mean FCF yield on the FTSE 100 is 4.7%+ and the median is 4.6%+. The mean FCF yield on the S&P 500 is 4.3%+ and the median 4.8%+. To try to cut through all these means and medians, our portfolio consists of companies which are fundamentally a lot better than those in the index and are valued a little more highly than the average FTSE 100 company and about the same as the average S&P 500 company, and they grew more rapidly in the past year.

For the year, the top five contributors to the Fund’s performance were: IDEXX Laboratories +3.10% Stryker +2.54% CR Bard +2.06% InterContinental Hotels +1.71% Johnson & Johnson +1.68% The bottom five were: Estée Lauder - 0.06% Procter & Gamble - 0.02% Novo Nordisk +0.07% Colgate Palmolive +0.23% Imperial Brands +0.37% The largest contributor, IDEXX, is a company which we began buying in 2015. It is the world’s largest maker of veterinary testing equipment. In contrast, we have held stakes in Stryker, InterContinental Hotels and Johnson & Johnson since inception. Of the bottom five performers we sold our stake in Procter & Gamble in January 2016. You may note that out of the five worst contributors to our performance last year, four were consumer stocks and at least three are regularly cited as “bond proxies”. It seems strange to be accused of having benefitted from the popularity of these stocks when in fact they have underperformed. We only recently began buying stakes in Estée Lauder, the US cosmetics business and even more recently in Novo Nordisk, a Danish company, which is the world’s leading supplier of insulins. Turning to the third leg of our strategy which we succinctly describe as “do nothing”, minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of -15.6%* during the period.

It is perhaps more helpful to know that we have held 14 of our portfolio companies since inception and we spent a total of £181,025 or just 0.003% (0.3 of a single basis point) of the Fund on voluntary dealing which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary. Why is this important? It helps to minimise costs, and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on the Annual Management Charge (“AMC”) or the Ongoing Charges Figure (“OCF”), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2016 for the T Class Accumulation shares was 1.06%*. The trouble is that the OCF does not include an important element of costs - the costs of dealing. When a fund manager deals by buying or selling investments for a fund, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, Stamp Duty. This can add significantly to the costs of a fund yet it is not included in the OCF. We provide our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (“TCI”). For the T Class Accumulation shares in 2016 this amounted to a TCI of 1.11%*, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing.if

or when other funds produce comparable numbers. However, we would caution against becoming obsessed with charges to such an extent that you lose focus on the performance of a fund. It is worth pointing out that the performance of the Fund at the beginning of this letter is after charging all fees. As a cautionary tale about the merits of doing nothing, you may recall that in 2015 we sold our holding in Domino’s Pizza since it had reached a valuation which we felt was only justifiable if its rapid rate of growth was sustainable, which we doubted was likely. In my annual letter last year I said that I “sold it with some regret and trepidation. Regret since it is undoubtedly a fine business and had been our best performing share since the inception of our Fund. Trepidation since selling shares in good companies is something we are justifiably reluctant to do.” Domino’s managed to prove these fears right in the most painful way as the share price rose by +45%+ in 2016. Apart from demonstrating that I am, could we agree on “fallible” as a descriptor, I hope this illustrates why I am reluctant to agree with the commentators who suggest that you or I should sell our portfolio of great companies and invest in a portfolio of assorted junk in the hope that it will go up, the great companies share prices will go down and we can then profitably reverse the trade. Finally, I wish you a Happy New Year and thank you for your continued support for our Fund.

My colleagues and I look forward to seeing many of you at our Annual Shareholders’ Meeting on 20th March and to trying to answer your questions. Yours sincerely, Terry Smith CEO Fundsmith LLP P.S. As part of the Financial Conduct Authority’s (FCA) review of investor communications (Policy Statement 16/23 - Smarter Consumer Communications: Removing ineffective disclosure requirements in our Handbook) they have consulted and concluded that the half-yearly Short Form Report that we send you in March and September, for the periods ending 31st December and 30th June respectively, does not fulfill its purpose. I agree in that the format and complexity of this document was difficult to understand and I welcome the FCA’s decision that we are no longer required to send you one. Not only will this save the fund the costs of physically producing and sending it to you but it will also reduce the already excess amount of paperwork that you are required to receive and that I know many of you find frustrating. For those of you that remain interested in the detail, we will continue to produce the report and post it on our website. I believe that our annual letter to shareholders, our Annual Shareholders’ Meeting, the monthly factsheets on our website and the semi-annual Investment Statements, that coincide with the tax year end, are all more effective in evaluating how your investment has performed and we continually seek to improve the levels of these communications.document

before purchasing shares in the Fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This financial promotion is intended for UK residents only and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. *Source: Fundsmith LLP +Source: Bloomberg

January 2016 Dear Fellow Investor, This is the sixth annual letter to owners of the Fundsmith Equity Fund (‘Fund’). The table below shows performance figures for the last calendar year and the cumulative and annualised performance since inception on 1st November 2010 compared with various benchmarks. % Total Return 1st Jan to Inception to 31st Dec 2015 31st Dec 2015 Cumulative Annualised Fundsmith Equity Fund1 +15.7 +131.4 +17.6 Equities2 +4.9 +64.3 +10.1 UK Bonds3 +1.0 +24.3 +4.3 Cash4 +0.0 +3.5 +0.7 1T Class Acc shares, net of fees, priced at noon UK time. 2MSCI World Index, £ net, priced at close of business US time. 3Bloomberg/EFFAS Bond Indices UK Govt 5-10 yr. 43 Month £ LIBOR Interest Rate. 1,3,4Source: Bloomberg 2Source: www.msci.com The table shows the performance of the T Class Accumulation shares which rose by 15.7% in 2015 and compares that with 4.9% for the MSCI World Index in Sterling with dividends reinvested. The Fund therefore outperformed the market in 2015 by 10.8%, its fifth consecutive year of outperformance, which is ironic given that outperforming the market in any given reporting period is not what we are seeking to achieve. However, we realise that many or indeed most of our investors do not use the MSCI World Index as the natural benchmark for their investments.

Those of you who are based in the UK and look to the FTSE 100 Index as the natural yardstick for measuring your investments and/or who hold funds which are benchmarked to the FTSE 100 Index and often hug it will have had a much worse experience than the performance of the MSCI World Index. The FTSE 100 Index was down -4.9% in 2015 and the total return including dividends reinvested was still negative at -1.0%. Similarly, for US dollar investors, the S&P 500 finished the year down -0.7% and only delivered a return of +1.4% with dividends reinvested.

2015 was also the fifth anniversary for our Fund and so maybe a good moment to pause and reflect on the longer term performance. As well as outperforming the market with a compound return of +17.6% against +10.1% for the MSCI World Index, our Fund was the third best performing fund out of 203 in the Investment Association’s Global Sector. Why only third, you might ask? The two funds which performed better than ours are specialist healthcare funds which have benefited from the extraordinary boom in takeovers within the biotech sector in recent years. That won’t last indefinitely, at which point anyone who has benefited from investment in those companies and funds needs to find the next hot sector if that is their investment strategy. This is a game we profess no skill at and therefore will not be playing. This skill also seems to elude most other investors but that does not seem to stop them trying. 2015 was not a particularly bullish year for equity markets which were held back by the slowdown in China, setbacks in other Emerging Markets and the move on from the end of quantitative easing in America to the first rise in interest rates by the Federal Reserve (‘the Fed’) in nearly ten years. After all that the S&P 500 Index was down by -0.7% for the year. Trillions of pixels have been expended on the likely impact of this increase in interest rates and I do not intend to add much, if anything, to the debate. However, one aspect may be worth commenting upon.

For at least the past three years we have been reading comments which suggested that investors in our Fund faced at least one problem: the shares we own are highly rated and have become more highly rated in recent years. This has often been linked with the observation that these stocks are ‘bond proxies’ - that the relative certainty of their returns and dividends compared with most equities makes them a substitute for bonds, which many investors now seek to avoid, and so they may fare badly along with bonds as and when interest rates rise. There are several points to consider in response to this. One is that during the period that these commentators have been sounding this warning, these stocks and our Fund have continued to outperform the market significantly. So if, like the proverbial stopped clock which is right twice a day, the scenario which they paint eventually comes to pass, it will be worth remembering what you would have missed out on if you had followed their advice when they gave it. They will certainly forget to mention it when they proclaim the brilliance of their foresight and the accuracy of their predictions. There are also reasons to doubt both their predictions and the efficacy of their proposed solutions. Firstly, the assumption that all US interest rates are set by the Federal Reserve (‘Fed’) is too simplistic. The target federal funds rate is a short term rate and was increased from 0- 0.25% to 0.25-0.50% on 17th December 2015.

Longer term rates are set by the US Treasury bond market and the swap market in which banks, companies, people with mortgages and investors can switch between fixed and floating interest rates. The current 30 year US Treasury bond has a yield just under 3% which does not look quite so low.limited

scope for subsequent increases and the lack of effect on long term rates. In which case worries about the effect on so-called bond proxies may prove to be overdone. Secondly, what would these commentators have you do about this possible adverse impact on so-called ‘bond proxies’? Presumably they recommend selling them in view of this predicted disaster and investing your money elsewhere. Leaving aside the commentator who suggested that the answer was to invest in a fund which is ‘more immune to future market performance’ (seems like an overly modest target - why not just find one that only ever goes up?), the most common suggestion, it seems, is that you should consider switching into more cyclical stocks because they are more lowly rated and their returns are too volatile to be considered as bond proxies. Switching into cyclical stocks in anticipation of a rise in interest rates, what could possibly go wrong? As ever, spotting potential problems with our or any other investment strategy is not that difficult. In all my years in business I have never found that identifying a problem is quite as difficult as solving it. Likewise, suggesting what it is you should switch into that is immune from problems which may result from an interest rate rise is a bit more difficult. However, it seems likely that sooner or later the ‘stopped clock’ commentators will prove to be right and our Fund will experience a period of underperformance. What to do about that?

You could try some so-called market timing and redeem your shares in the Fund in advance of this event and maybe re-invest later when you think the time is right for it to begin outperforming again. If you do so I hope you have better luck and/or skill than I have because I know that I can’t accomplish that successfully. If you intend to remain invested in the Fund, as I do, including through any periods of underperformance, you might also, like me, take comfort in the fact that our investment strategy is based first and foremost on buying shares in good companies. We cannot promise you much about our Fund. But one thing we are clear about is that we seek to own shares in good companies and at least most of the time we succeed in that objective. Repeating an approach we took last year to demonstrate this, the table below shows what Fundsmith would be like if instead of being a mutual fund it was a company and accounted for the stakes which it owns in the portfolio on a ‘look through’ basis and compares this with the market (in this case the FTSE 100 Index and the S&P 500 Index). Fundsmith FTSE 100 S&P 500 Equity Fund* Index+ Index+ ROCE 26.0% 14.8% 17.5% Gross Margin 61.1% 40.2% 43.7% Operating Profit Margin 25.0% 14.3% 15.3% Cash Conversion 98.4% 69.8% 70.9% Leverage 29.3% 38.5% 52.5% Interest Cover 16.1x 8.2x 8.

7x Note: ROCE, Gross Margin, Operating Margin and Cash Conversion are the weighted average for the Fundsmith Equity Fund and averages for the FTSE 100 Index and S&P 500 Index. The FTSE 100 and S&P 500 numbers exclude financial stocks. The Leverage and Interest Cover numbers are medians. *Source: Fundsmith LLP +Source: Bloomberg What does this table demonstrate? In short, that our companies have much better financial performance than the market as a whole and are more conservatively funded.

The companies in our portfolio are certainly not immune to periodic downturns in business and/or management errors, and their share prices are subject to the usual factors which affect the stock market, but we can at least be reasonably sure that they are adding to their intrinsic value over time by continuing to invest at wonderful rates of return. If I gave you an exhaustive list of all the subjects in investment and the ways in which investors and commentators behave that perplex me then this annual letter would be considerably longer. However, one of these subjects is the obsession with share prices. Ultimately, of course, a focus on share price movements must be correct. It is no use owning shares in good companies if the strength of their business is never reflected in the share price, but a continuous focus on share price movements to the exclusion of the underlying fundamental economics of the companies is neither healthy nor useful. In the long term one will follow the other, and it is not the fundamentals which will follow the share price. Returning to the subject of valuation, what are the facts as opposed to commentators’ views? The weighted average Free Cash Flow (‘FCF’) yield of the portfolio (the free cash flow generated by the companies divided by their market value) started the year at 4.5%* and ended it at 4.3%* so the overall portfolio saw little increase in valuation in 2015. Our companies on average grew their free cash flow per share by 9.

7%* during the year which was a much more significant contribution to performance. This 4.3% FCF yield compares with a median FCF yield for the non-financial stocks in the S&P 500 Index of 4.4%+ and a mean of 2.7%+ or a median for the non-financial stocks in the FTSE 100 Index of 3.8%+ and a mean of 3.9%+. Our stocks do not look bad value in comparison to the market especially when their relatively high quality is taken into account. Although of course, both may be expensive, but then both may continue to be so or even become more expensive. For the year, the top five contributors to the Fund’s performance were: Dr Pepper Snapple + 1.94% Imperial Tobacco + 1.79% Microsoft + 1.69% Sage + 1.36% Reckitt Benckiser + 1.05% The bottom five were: Procter & Gamble - 0.22% PayPal - 0.15% 3M - 0.02% Kone + 0.02% Colgate Palmolive + 0.05% Of the bottom five performers, the only one which gives us significant cause for concern is Procter & Gamble which is on its third internally sourced CEO in as many years. We sold our holding in Domino’s Pizza during the year since it had reached a valuation which we felt was only justifiable if the current rapid rate of growth is sustainable, which we would doubt. However, we sold it with some regret and trepidation.is

undoubtedly a fine business and had been our best performing share since the inception of our Fund. Trepidation since selling shares in good companies is something we are justifiably reluctant to do. Still we believe that you ‘make money with old friends’ which is to say that we would be keen to own Domino’s again if the opportunity arises at a valuation which we regard as at least reasonable. We also sold our holding in Choice Hotels in 2015 as we did not like the risk/reward potential from the company’s investment in developing a third party reservations system called SkyTouch. As we do not do much trading to reallocate the Fund’s capital between our holdings we are reliant on the management of our investee companies to make decisions to reinvest part of their companies’ cash flows for us. When they do things which are different, exciting and outside their core area of competence we become worried. Hence our sale of Choice Hotels. We also sold the holding in eBay which we obtained when eBay split the eponymous online marketplace business and PayPal, the online payments processor, which we have retained. During the year we built a holding in Waters Corporation, a US based manufacturer of mass spectrometry, liquid chromatography and thermal imaging equipment, which makes much of its returns from the sales of consumables, service, spares and software to the operators who have installed its equipment.

It should have a clear source of growth from the seemingly inexorable trend for more testing and certification of products. We also began building a stake in another testing company with a similar source of growth and a new consumer staples company, both of which will be revealed in due course. Minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 2%* during the period. It is perhaps more helpful to know that we spent a total of £496,507 or just 0.014% (1.4 basis points) of the Fund on voluntary dealing which excludes dealing costs associated with fund subscriptions and redemptions as these are involuntary. Why is this important? It helps to minimise costs, and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor. Too often investors, commentators and advisers focus on the Annual Management Charge (‘AMC’) or the Ongoing Charges Figure (‘OCF’), which includes some costs over and above the AMC, which are charged to the Fund. The OCF for 2015 for the T Class Accumulation shares was 1.07%*. The trouble is that the OCF does not include an important element of costs - the costs of dealing. When a fund manager deals by buying or selling investments for a fund, the fund typically incurs the cost of commission paid to a broker, the bid-offer spread on the stocks dealt in and, in some cases, Stamp Duty.

This can add significantly to the costs of a fund yet it is not included in the OCF. We have published our own version of this total cost including dealing costs, which we have termed the Total Cost of Investment (‘TCI’). For the T Class Accumulation shares in 2015 this amounted to a TCI of 1.13%*, including all costs of dealing for flows into and out of the Fund, not just our voluntary dealing. We think that figure will prove to be low if or when other funds produce comparable numbers, although we are not holding our breath whilst we await this.the

performance of a fund. It is worth pointing out that the performance of the Fund at the beginning of this letter is after charging all fees, or as someone expressed it more elegantly “You get what you pay for”, or at least you should aim to. Finally, I wish you a Happy New Year and thank you for your continued support for our Fund. I and my colleagues look forward to seeing many of you at our Annual Shareholders’ Meeting on 1st March and to trying to answer your questions. Yours sincerely, Terry Smith CEO Fundsmith LLP An English language prospectus for the Fundsmith Equity Fund is available on request and via the Fundsmith website and investors should consult this document before purchasing shares in the Fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This letter is intended for owners of the Fundsmith Equity Fund only and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Conduct Authority. *Source: Fundsmith LLP +Source: Bloomberg

January 2013 Dear Fellow Investor, This is the third annual letter to owners of The Fundsmith Equity Fund. We have presented three periods of performance figures this year - the performance since inception, the annualised returns and the last calendar year. T Accumulation Shares, Total Return 2012 Since Inception Annualised % to 31.12.12 % % Fundsmith Equity Fund £ 12.5 29.4 12.6 MSCI World Index £ 11.4 14.8 6.6 We remain critical of attempts to measure investment performance over short periods of time. Even a calendar year is too short for this purpose. It is the time it takes the Earth to go around the Sun and has no natural link to the investment or business cycle other than for agricultural businesses. However this proviso notwithstanding, how did we do in 2012? The Fund rose by 12.5% in 2012 and modestly outperformed the market (which we take as the Morgan Stanley Capital International World Index - or MSCI World - in sterling with dividends reinvested) by 1.1%. I’m rather surprised that we managed to outperform the market at all in this reporting period. 2012 was a year in which so-called risk assets performed well. This is unsurprising in a year in which the major central banks in the developed world supplied increasing amounts of liquidity through their Quantitative Easing programmes in increasingly desperate attempts to keep some modest amount of economic growth.

All that liquidity has to go somewhere and indeed the supply of liquidity by central banks’ purchases of bonds helps to push investors towards the purchase of riskier assets, as does the regime of record low interest rates, of which more anon. This is not an environment in which I would expect our Fund to perform well relative to the market as the rising tide of liquidity floats all ships, many of which we would not consider owning. Moreover, the year was characterised by what is in my opinion is a naïve view that the words spoken or (more rarely) actions taken have somehow helped to resolve the financial crisis which we have been living with since 2007. I cannot see how the supply of liquidity can solve a crisis caused by over leverage and insolvency. These events were exemplified for me when the Financial Times declared Mario Draghi, the President of the European Central Bank as its Man of the Year.upon

the fact that in July Mr Draghi pledged to do ‘whatever it takes’ to save the Euro, which was followed by him doing precisely nothing and yet the borrowing costs of the major European problem countries, and most notably Spain, dropped and the Eurozone crisis went into remission. Depending upon your point of view, this is either an example of the perfect action by a central banker - the mere threat of action producing the desired result; or another episode in kicking for touch without any attempt to solve the underlying problems. No prizes for guessing which camp I am in, but in any event positive reactions to such events are far more likely to buoy the share prices of financial stocks, cyclical companies, those who might otherwise be bust or at least in difficulty and indeed a whole series of assets which we will never own in our Fund. For example, the MSCI World Bank Index in sterling with dividends reinvested was up 22.3% in 2012. We do not own any banks stocks and will never do so. The Financial Times also reported that a number of hedge funds doubled their money by investing in Greek bonds in 2012. Clearly such a double or quits trade is not ever going to attract us, and it is hard to see how a fund manager can hope to repeat such trades consistently enough to warrant the risk, which is presumably one of the reasons why HSBC reported that 88% of hedge funds underperformed their relevant benchmarks in 2012.

With assets such as this performing well I hope you can see why I am surprised that our Fund outperformed the market. It is also worth bearing in mind that we do not seek to outperform in every reporting period or in all market conditions, rather we seek to outperform the market and other funds over longer periods of time. The analogy I use for this is the Tour de France, which topically was won by a British rider - the now ‘Sir’ Bradley Wiggins - for the first time in 2012. The Tour is the greatest of cycling Grand Tours, with 21 stages run over 23 days. In the 100 years since the Tour was first run, no rider has ever succeeded in winning every stage of a Tour. Nor in my view will anyone ever achieve this. This is because the Tour encompasses three distinct types of stage: • the stages in which the riders form a peloton and riders can gain vital aerodynamic assistance by slipstreaming (or getting “a wheel”) from the rider(s) in front of them. A team can carry a sprinter (like Mark Cavendish) in the peloton and release him close to the line for the final sprint in an effort to win the stage; • time trials in which the riders are released individually and so cannot gain any assistance from each other. In order to maximise their own aerodynamic efficiency, the riders use tri handlebars, wear skin suits and aerodynamic helmets and often have solid rear wheels and wide rims on the front wheel.

This is a test of individual riding ability over the whole stage; and • mountain stages which are run as a team but involve significant climbs unlike the main peloton stages which are much flatter. A rider needs a very different physique to win as a sprinter to a time trialist or a mountain climber - compare Bradley Wiggins with Mark Cavendish - which is why no one can win all stages. The rider who wins the Tour is likely to be one who excels at one discipline - Wiggins is a time trialist, the discipline in which he also won a Gold medal at the 2012 Olympics - and is not too bad at, and obtains help from his team with, the other stages. Indeed on two occasions, the Tour has been won by riders who did not win a single stage.

In my view there is a moral here for investors. What we are trying to achieve with Fundsmith is to win the investment equivalent of the Tour de France for you-to outperform over a long period of time. However, we do not expect to outperform all the time or in all markets conditions. Rather our expectation is that we will perform relatively well in bear market conditions, and may struggle to keep pace in more bullish conditions, which is why I am surprised that we outperformed the market albeit modestly in 2012. It is important that our investors recognise that this is what we are aiming for. Too often investors seek to find fund managers who can outperform all the time and in all market conditions. The trouble is that no such person exists. But the attempt to find this mythical creature leads to some investors moving their assets between managers, incurring costs and most frequently ditching a manager who’s investment style is out of step with the current market in favour of one with recent good performance just as they are about to switch positions. Having said all that, how are we doing at winning the Tour? Since inception our Fund has managed an annualised return in Sterling of 12.6% p.a. versus a return of 6.6% p.a. for the MSCI. This seems like a satisfactory start on our investment Tour campaign. Our Fund remains the best performing fund in the IMA Global Sector since inception to the end of December 2012.

The main positive contributors to that performance in 2012 were: Intercontinental Hotels, L’Oreal, Reckitt Benckiser, Kone and Diageo. The main detractors from the Fund’s performance were: Procter & Gamble, McDonald’s, Imperial Tobacco, Becton Dickinson, and a Consumer Company which we are in the course of buying a position in and so would prefer not to name at this point. McDonald’s is a small position as it has only recently come within valuation range for us after reporting a number of periods with poor sales performance. We believe it is a business of the quality which we seek and therefore are willing to use this as an opportunity to buy stock. It might be worth thinking about the implications when a business which sells some meals for one dollar is struggling to grow sales. Clearly this is not because consumers are feeling flush and trading up. Portfolio turnover in the Fund in 2012 was 0.48%. This figure is flattered by the inflow of funds over the period which is not included in the calculation otherwise a new fund would have 100% turnover from investing cash inflows, but even so it is exceptionally low. Our only outright sale during the year was of SGS, the Swiss testing company. We remain convinced that it and the sector are good quality businesses, but the shares had reached the point at which they were one of the most highly rated within our Investable Universe and so we thought that there was better value to be found elsewhere.

We finished the year with 28 holdings up from 24 holdings at the end of 2011, which is towards the top end of our range but we are in the course of selling a holding which will reduce this number. Our outright purchases for the year were Choice Hotels, Domino’s Pizza, McDonald’s, Visa and the aforementioned Consumer Company. Our purchase of Domino’s is perhaps the one which requires most explanation since we sold it the year before.had

been postponed. We took this as a bad sign in a banking market which is exemplified by a cartoon which shows a man sitting in front of a bank manager (you can tell this because there’s a sign on the desk saying “Bank Manager”) who says “I’d like to borrow some money” to which the Bank Manager replies “What a coincidence, so would we.” There is clearly nothing wrong with Domino’s but plenty wrong with the banking industry on which it was reliant for its refinancing. In the event, Domino’s proved us comprehensively wrong. Not only did it manage to refinance but they did so on terms which enabled it to pay a $3 per share special dividend. So I did what you should always do, but we so rarely manage to do, when we get it wrong a) admit this - most importantly to yourself; and b) reverse the decision. So Domino’s was repurchased Fortunately there was a period of share price weakness after the refinancing which enabled us to do this on reasonable terms but frankly that does not matter as much as whether the shares were still good value when we repurchased them, which we believe they were. It is always a mistaken strategy to wait for the shares to get below the point at which you sold them before repurchasing, or the even more common trait of waiting for a loss-making share purchase to get back to break even before selling.

As I am fond of saying, the shares are unlikely to follow this desired pattern since they do not know whether you own them or not or at what price you bought or sold. There are several morals to the Domino’s trades but the main one is that almost every time we sell a position in a quality company we get to regret it in terms of subsequent share price performance. The good news is that we don’t do it very often. This brings me onto the wider subject of the expenses borne by the Fund. The Ongoing Charges Figure (or “OCF” as it is now called) for the year is likely to be 16bps or 0.16% in addition to the Annual Management Charge. This is a 4bp reduction compared to 2011 figure. These expenses are often ignored both by investors and other fund managers. But, like all charges, they detract from the performance of the Fund, deserve proper attention and should be minimised. The Fund can only perform as well as the performance of the shares it owns and to the extent that performance is absorbed by expenses, the returns for investors will suffer. The majority of the costs borne by the Fund are the costs of running and maintaining the share register. These costs are driven by numbers of shareholders and transactions. We continue to focus on reducing these charges, ensuring the Fund benefits from economies of scale as it grows and does not overpay for services simply because of the increase in its size.

If the Fund remains at its current size, we would expect the Ongoing Charges Figure to fall by another 3bps in 2013. Perhaps surprisingly, the Ongoing Charges Figure does not include all charges the Fund has paid in the year. The commission paid on share purchases and sales are not included and neither is Stamp Duty or the bid/offer spread which is incurred in dealing. During the year, the Fund paid £231,000 in commission-less than 4bp on the value of the total trades. The vast majority of those trades were due to inflows into the Fund. Stripping out the commission on trades caused by the inflow, the amount of commission paid on trades executed voluntarily was under 1bp of the average funds under management. This compares with estimated charges incurred by the average UK mutual fund manager of about 1% pa excluding Stamp Duty.

Turning to the characteristics of our portfolio, probably the question I am asked most frequently is whether the strong performance of most shares in the Fund to date means that they are now over-valued. The weighted average free cash flow (“FCF”) yield, which is our primary valuation yardstick, of the companies in the portfolio started the year at about 5.8% and finished it at about 5.7%. This 5.7% FCF yield compares with a median yield on the non-financial stocks in the S&P 500 of about 6.1% and an average of 5.4%; or a median for the non-financial stocks in the FTSE 100 of 4.6% and an average of 4.9%. The valuation of our stocks on this basis therefore looks about the same or a bit better (cheaper) than the average. The yield is also significantly higher than the yield on government bonds which was previously known as the risk free rate before investors started to relearn that governments default. This is significant. The coupon on those bonds cannot grow over time whereas the free cash flow from our companies can. So if we can buy them with a higher FCF yield than the bond yield then we have probably created value. We should perhaps compare the FCF yield of the portfolio not with the yield on major government bonds but what we think that bond yield should be since government bond yields across the developed world are distorted by Quantitative Easing in which the central banks, controlled by the government, are the main or even the sole buyer of bonds.

We work on the assumption that government bonds would need to yield at least 1% over the expected rate of inflation to attract rational investors, and so we seek to invest in companies only when their FCF yield is the same as or more than that required bond yield. The return on capital of the companies in our portfolio averaged about 32% p.a. This compares to an average of about 20% p.a. for the non-financial stocks in both the S&P 500 and the FTSE 100. Bearing in mind the longevity and resilience of our portfolio companies I think we can remain confident that we own stocks with a superior fundamental performance to the average which is not fully reflected in their valuation relative to bonds or other equities. It may seem surprising that we can buy shares in quality companies at reasonable or even cheap valuations and thereby expect to generate superior investment performance. I have written a short research note in an effort to explain this entitled “Return Free Risk” which can be downloaded from our website at www.fundsmith.co.uk/research. The title is not a mis-type, rather it’s a pun. As investors we are taught that to obtain higher returns you must assume higher risk, but much of the evidence contradicts this assumption. The fact is that for much of the time you get better returns from investing in predictable high quality companies than in smaller, riskier, more obscure company shares.

But there appears to be a human desire to indulge in excitement and back the 100-1 shot rather than the favourite, and to engage in complicated bets such as the Yankee defined as “four selections and consisting of 11 separate bets: 6 doubles, 4 trebles and a fourfold accumulator”. Can you accurately calculate whether the odds on such a bet are fair, in your favour or the bookmakers favour? If you can’t, then the bookmaker has the advantage. For bookmaker, read “market”. The principle is the same. At Fundsmith we obtain excitement not from the delusion that we have discovered an investment that no other investors have found or from a long shot winning, but from delivering predictable, superior investment returns.

The marginal fall in free cash flow yield of our portfolio is a result of the rise in the share prices of the companies in the portfolio nearly offset by a 9.6% increase in the free cash flows per share produced by our companies. On the whole, we would prefer that the share price performance of our stocks tracked the underlying free cash flow performance of the companies since performance from increasing valuations is a finite game which also tends to even out over long periods of time, and we intend to run this portfolio for a long period of time. Similarly, we would prefer that the increase in free cash flow from our portfolio companies was derived from top line volume growth, albeit from companies which are able to maintain good prices and high margins on their sales. However, in the low growth environment which we occupy, free cash flow growth is increasingly a result of cost cutting and/or share buybacks. These are also finite sources of growth even when share buybacks are executed in a way which creates value for remaining shareholders, which is not always the case. But it is better to be invested in companies which can maintain growth in free cash flow per share by these means in these circumstances than in companies which can’t. The historical dividend yield of the portfolio is 2.3% and we forecast the prospective yield is 2.5%. Dividend cover remains 2.6 times. Yield is an important element of investment return.

Over the long run, it has contributed a higher percentage of equity performance than share price appreciation. But I would caution against a blind search for higher yields. The current record low interest rates and bond yields have produced a desperate search by investors for yield. The investment industry stands ready to supply products to satisfy any craving by investors, not always to their advantage. Investment flows have started to gravitate to higher risk bonds such as junk bonds and emerging market debt as government bond yields in the supposed safe haven countries have shrunk towards zero. The yield on US high yield or junk bonds sank to 6% at the beginning of 2013, the lowest ever recorded. New issuance has boomed in high yielding real estate investment trusts, and so-called master limited partnerships in energy stocks and pipeline companies (I wonder how many investors can explain how they work). Even Collateralised Loan Obligations (“CLO”s), part of the toxic alphabet soup of instruments which helped start the Credit Crisis have been making a comeback with issuance trebling in 2012. How soon we forget. Equity investors are far from immune from this trend. For many investors the search for yield is satisfied by investing in an income fund which invests in high yielding equities. This can be a mistake.

At certain levels of yield all that is happening is that the investor is being paid back some of the capital value of his or her investment as income, and taxed upon it. All bar one of the income funds in the IMA Global Equity Income sector apply their charges not to income but to capital in order to maximise their stated yield. This has some obvious disadvantages, not the least of which is that it maximizes the investor’s tax bill as Income Tax is higher than Capital Gains Tax and much more difficult to avoid or defer. It also exaggerates the true yield, which has obvious marketing advantages for the funds. We think that investors should not focus solely upon yield but rather on the total return they derive from a share or a portfolio, and should not take the dividend yield as an exact indicator of what they can afford to remove from the fund periodically and spend.regular

income from your investment in the Fund without reference to the dividend yield. I am convinced that this, rather than buying high yielding shares which may have poor overall returns and managing them in a fund which overstates the yield by applying charges to capital, is the right way to address this need. It seems like an odd innovation for a fund manager to devise a way to make it easier for investors to withdraw money, so I doubt this will catch on with other managers. The average company in the portfolio was founded in 1902 – this time last year it was 1894. Clearly some of our purchases have shortened the average age of our companies which has produced a worrying leap on average into the twentieth century. Looking forward to 2013, one reasonably likely outcome is that we might experience “Groundhog Year” in which there are more EU summits, further commitments to do “whatever it takes” whilst actually doing nothing, another “rescue” deal for Greece, wrangling over the US debt ceiling to follow the Fiscal Cliff, and more QE to keep an otherwise stagnant economy across the developed world alive on life support. However, it seems likely that one thing is changing: the mandate of central banks in the developed world. The Fed recently doubled its monthly QE programme to $85bn and said it would maintain this programme at least (emphasis added) until unemployment falls below 6.5%.

Shinzo Abe became Prime Minister of Japan for the second time with the stated intention of making the Bank of Japan target an increase in inflation. Mark Carney, the much heralded new Governor of the Bank of England, got off to an unusual start by announcing seven months before he starts work that he thinks there should be a debate about whether central bankers should currently be targeting nominal GDP growth i.e. ignoring inflation. Now depending upon your point of view this is either good news because it means yet more stimulus will be applied or bad news because you do not think that the additional stimulus will do much to achieve economic growth or increased employment but it will risk side effects which can be as bad or worse than the ailment they are seeking to treat. I am in the latter camp. I think that central bankers should be independent of government and should be concerned with the soundness of the currency, and if they have the regulatory authority, the soundness of the banking system. Allowing them to stray outside that is dangerous as it will lead to confusion of fiscal and monetary policy, or in plain English, governments will be able to fund their profligate spending programmes by getting the central bankers to print more money and buy their bonds until the employment or nominal growth targets are achieved, or even beyond (note the term ‘at least’ used by the Fed). At some point, the inevitable consequence of this is inflation and currency depreciation.

The newer generation of central bankers such as Mr Carney have yet to experience that. When they do, they may discover that when inflation takes hold it does not conveniently stop at some predetermined target rate. They may also find that the only device they have to control inflation is the blunt instrument of interest rates, and a significant rise in rates would have some interesting effects on the affordability of government debt, private debt and the economy in its current condition. You might legitimately point out that depreciation of the major currencies is a bit tricky as they are all trying to depreciate against each other in order to achieve some competitive advantage. But maybe they will all depreciate against hard assets, or to put it more simply-inflation.

Still whilst we wait to see if or when this scenario comes to pass, the good news is that macro views and developments have no bearing on our strategy; increasingly desperate attempts to stimulate the economy are far more likely to stimulate the valuation of our portfolio (not that we like to make money that way); and our stocks are likely to be a relatively good hedge against a resurrection of inflation. Happy New Year. Yours sincerely, Terry Smith CEO Fundsmith LLP Important information: An English language prospectus for the Fundsmith Equity Fund is available on request and via the Fundsmith website and investors should consult this document before purchasing shares in the fund. Past performance is not necessarily a guide to future performance. The value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates, and you may not get back the amount of your original investment. Fundsmith LLP does not offer investment advice or make any recommendations regarding the suitability of its product. This financial promotion is intended for UK residents only and is communicated by Fundsmith LLP which is authorised and regulated by the Financial Services Authority.

Wednesday 11th January 2012 Dear Fellow Investor, This is the second annual letter to owners of The Fundsmith Equity Fund. Fundsmith opened for business on 1st November 2010, and so completed its first year on 31st October 2011. We have presented two sets of performance figures this year- the performance since inception and the last calendar year. We remain critical of attempts to measure investment performance over short periods of time. Even a calendar year is too short for this purpose-it is the time it takes the Earth to go around the Sun and has no natural link to the investment or business cycle. However this proviso notwithstanding, The Fundsmith Equity Fund rose by 8.4% net of fees for the year. This compares with some relevant benchmarks as follows: Since Inception 2011 Fundsmith Equity Fund 15.0% 8.4% MSCI World £ 3.2% -­‐4.5% MSCI EAFE £ -­‐6.1% -­‐11.2% FTSE 100 2.8% -­‐1.5% FTSE Actuarial Gilt Index 14.7% 15.6% The Fund outperformed the MSCI World Index, which we regard as the most relevant comparator, by 12.9% for the year. This strikes us as a good performance. It was achieved against the background of a year in which it gradually dawned on many people that the financial crisis of 2008-09 had not been solved but had rather been transformed into a sovereign debt crisis: if 2008 was the year in which governments saved banks, 2011 was the year in which the main question which emerged was who would save the governments.

Against this backdrop it is hardly surprising that equity markets performed poorly and so has the average fund. Only six other funds in the IMA Global Growth sector (into which the Fund is classified) achieved a positive return in 2011. This performance for the year took the Fund to third place in the Morningstar performance rankings for global equity funds. The main positive contributors to that performance were: Domino’s Pizza, Philip Morris, Imperial Tobacco, Colgate Palmolive and Unilever.

The main detractors from the Fund’s performance were: Serco, Stryker, Kone, Becton Dickinson and Intercontinental Hotels. Turnover in the Fund in 2011 was 15%. This was higher than we would ideally like although still significantly lower than most funds. Part of this turnover was really involuntary. We sold Del Monte Foods prior to the closing of the cash bid from KKR, and sold our holding in Clorox after a bid approach from Carl Icahn which we correctly judged would not result in an actual takeover but which drove the share price to a valuation which we regarded as offering poor value. Excluding dealing in Del Monte and Clorox, the turnover was 4% which is much closer to the level we seek (zero ideally). The only voluntary turnover during the year were sales of our holdings in Kimberly- Clark Corporation and Domino’s Pizza, Inc. Kimberly-Clark began to show adverse results from our regular calculation of the incremental return on capital. We sold the shares at a small profit. They have subsequently performed poorly in terms of fundamental performance although the share price has ironically been quite firm. We prefer to judge our investments by what is happening in their financial statements than by the share price. Domino’s shares rose in price by 113% during the year and had reached a point at which they no longer represented good value. Domino’s also has a re-financing of debt due by 2014.

There is nothing in the performance of Domino’s which causes us the slightest concern about this but there is plenty wrong with the banking system which will be required to provide the refinancing. As a result we hope to have the opportunity to become investors in Domino’s again. The net result this was that the Total Expense Ratio of the Fund was 1.2%. We hope to reduce that in future. The historic dividend yield on the Fund at year end was 2.4%. This dividend was covered 2.6 times by earnings. There is only one stock in the Fund that does not currently pay a dividend. This is significant: it is becoming clear that dividends are likely to provide a more significant portion of the total return on equities in the future than they did in the equity bull markets of 1982-2000 and 2003-07. The current yield on the Fund may not fully reflect its dividend paying capabilities as some of the companies also utilise share buybacks. During the course of the year we published some research on share buybacks (“Share Buybacks-Friend or Foe?” April 2011-available on the Fundsmith website) in which we concluded that buybacks were rarely accompanied by any reasoned justification; that they had become almost universally regarded as a good thing and contributing to shareholder value irrespective of the price paid or the valuation implied, which simply cannot be true; and in many cases their timing was poor.

During the year we wrote to the management of those companies within our portfolio which have engaged in share buybacks to ask for some insight into their rationale. The responses ranged from prompt, personalized (by the CEO) and well reasoned to being completely ignored. We regard the greatest risk for our investors after the obvious potential for us to buy the wrong shares or pay too much for shares in the right companies, as being reinvestment risk: we seek to buy companies which deliver high returns on capital in cash. What the management then does with these cash returns is one of the major factors affecting future returns on the portfolio. Management faces three main options for deploying these cash returns: return cash to shareholders, invest to grow the business organically or make acquisitions.for

choosing between these options are important. So are the ways in which they operate each option. So, for example, having determined to return a portion of earnings to shareholders, how does a management decide between a dividend and a buyback? In many cases we do not know as the management does not give any detailed rationale and we suspect that the answer is with the “benefit” of advice from their investment bankers who get fees, commissions, bid-offer spreads and maybe proprietary trading profits for advising companies to pursue buybacks but get nothing when a dividend is used. No prizes for guessing which way the advice is slanted. At the end of 2011 we held a portfolio of 24 stocks. On average companies in our portfolio were founded in 1894. We continue to invest in businesses which have shown great resilience over a long period of time-in most cases surviving two world wars and the Great Depression. The trailing free cash flow (“FCF”) yield at the start of the year was about 7% and about 5.8% at the end. The fall in the FCF yield was caused by a combination of the rise of share prices in the portfolio, changes in the portfolio and higher capital expenditure and working capital invested by the portfolio companies. This FCF yield compares with a median FCF yield on the S&P 500 of 6.1%. We have used the median by the way as the average is distorted by inclusion, for example, of a free cash flow yield of 76% on shares in Bank of America (“B of A”).

Before you rush to buy B of A shares however you might like to know that cash flows at banks are not the same as they are at non banking businesses. So, for example, in the calculation of B of A’s cash flow the computation adds back the provisions for bad debts and impaired assets which is a deduction from profits. This is strictly true-a provision is a non cash item-but it means that comparisons of banks with other company’s cash flow in this manner is truly a case of comparing apples and ugli fruit (I chose a fruit which was more alphabetically remote from A for Apples than the commonly used P for Pears and which exemplifies our view of banks). Our portfolio has a FCF yield about the same as the average for the market. Yet it is inconceivable in our view that it is not of higher than average quality in terms of longevity, resilience, predictability, gross margins, operating margins, return on operating capital and the conversion of profits into cash. Put simply this means that we own shares in businesses which are higher quality than the market on a valuation about the same as the average for the market. Last year I started a policy of allowing myself one rant per letter about a subject relevant to investment. I thought I would provide an update on how that went. Last year I sounded a warning about the perils of Exchange Traded Funds (“ETFs”).

What happened next even surprised me and I thought I had lost the capacity for such an emotion in the face of the shenanigans of the financial services industry. Practitioners within the ETF sector reacted with a fury which can only be generated by two factors: 1) the criticism was accurate and/or hit a nerve; and 2) it was in danger of derailing a large gravy train. Some ETF practitioners suggested that I was criticizing ETFs because of concerns about the impact the growth of ETFs would have on the active fund management sector in general and Fundsmith in particular. This response is not just wrong it is preposterous for two reasons: 1) Fundsmith’s market share of the active fund management sector is so small that I do not possess a calculator capable of getting enough zeroes to the right of the decimal point to calculate it.could

continue growing to the point where they had replaced most active funds and still leave Fundsmith with an insignificant share of the remaining sector, so they are unlikely to affect us; and 2) I have long and publically maintained that the best equity investment for most investors most of the time is an index fund because of its low cost and outperformance of most active fund managers. In an effort to be clear, my criticisms of ETFs are: 1. ETFs are almost certainly being mis-sold. My straw poll of investment professionals suggests that many investors think that ETFs are simply index funds. Many are not. Synthetic ETFs do not hold underlying securities of the sector or market they are supposed to replicate. Inverse ETFs can lose money even when the market sector they track has gone down, and leveraged long ETFs can lose money when their market or sector has gone up. None of these is consistent with the performance of a simple index fund. 2. Synthetic ETFs are of particular concern. If a fund which is described by the words synthetic, derivative, swap and counterparty does not cause you obvious concerns, I suggest you may need to study the events of the credit crisis of the past four years more carefully. 3. Because ETFs are tradable on markets unlike mutual funds, traders can sell them short.

Relying upon the assumed ability to create more shares in the ETF in order to close these short sales, it is not unknown for the short interest in certain ETFs to reach ten times the size of the underlying ETF’s assets. In these circumstances, the average ETF holder may be unaware that only some 10% of their holding in the ETF is represented by assets of the type they expect-the other 90% is a promise to deliver units from the short sellers. All will be well unless the short sellers find it difficult or impossible to buy enough of the underlying securities to deliver the required ETF shares which in some illiquid index or sector ETFs is entirely possible. My own warnings on ETFs were followed by warnings from amongst others, the Bank of England, the Financial Services Authority, the International Monetary Fund and the U.S. Securities and Exchange Commission in a rare example of closing the door on a stable which may still contain a horse. Since regulators have come in for so much criticism of their loose handling of the financial sector prior to the credit crisis it would be churlish to criticize them for these warnings, and foolish to ignore them. One more problem with ETFs became apparent to me in the course of this debate. ETFs are represented as low cost investments. Yet research published during the year demonstrated that ETFs were amongst the largest profit generators for some banks.

This seems counter intuitive: how does a low cost product become a major profit contributor? The answer of course is that synthetic ETFs in particular provide banks with innumerable ways to “clip the ticket” of the ETF. The fees paid by the ETF investor are a very small portion of the total revenues which operating the ETF provides. They also deal for the ETF, provide the swap agreements by which it holds its synthetic positions (I wonder who works out whether the bank is providing them a fair price?), and maybe earn leverage, prime brokerage, custodian and registrar fees. The banks also deal for the hedge funds and traders who want to trade the ETF. At about this point, I began to realise why my critique of ETFs had caused so much fury. My advice on this matter is simple. A broadly-based index fund is often the best investment you can make in the equity markets.buy

precisely that, an index fund, not an ETF. The only difference between a physical ETF (which frankly is the only sort you should contemplate unless you like the risk of synthetic derivative swaps with counterparty risk) and an index fund is that the ETF is traded on the market as the term “Exchange Traded” implies. Every piece of research I have encountered and all my experience shows that frequent dealing is the enemy of a good investment performance. So why buy an ETF rather than an index fund? You can deal daily in most index funds. The only people who want to deal more frequently than daily are hedge funds, high frequency traders, algorithmic traders and idiots (these terms are not mutually exclusive). Why join them? If you don’t want active management, and mostly you shouldn’t, buy an index fund. During 2010 Fundsmith also launched a SICAV and a US LLP. Neither of these affects your investment in The Fundsmith Equity Fund but I feel that you should be informed about this and it affords me an opportunity to raise another subject-currencies. The SICAV is denominated in Euros and based in Luxembourg. It is a so-called “feeder” fund-the only assets it holds are units in The Fundsmith Equity Fund. The US LLP is a Delaware partnership denominated in US dollars which is invested with exactly the same strategy as The Fundsmith Equity Fund but it cannot be run as a feeder fund. We launched these two funds in response to investor demand.

US based investors face a massive tax disadvantage in investing in a UK fund as it cannot issue a Form K1 for IRS reporting, and offshore investors wanted a non UK vehicle for investment. But in neither case does the denomination of the fund in a currency other than sterling affect the investments currency exposure. We are often asked by investors whether we hedge currencies. The answer is a firm ‘No’. How would we do so? Should we base it on the currency of the country in which the companies are listed? This obviously would not work. There may be no connection between the country in which a company is listed and its area of operations. The same is true of its country of incorporation or headquarters. Nestle is an example we often cite in this respect. Although it is headquartered in Switzerland, has its main listing there and reports in Swiss francs, it has only about 2% of its revenues in Switzerland, so hedging our holding by selling Swiss francs forward against sterling would surely not be a hedge at all. It is also far from unknown for companies to report in a different currency to that of the country in which they are headquartered or listed. Perhaps we should hedge currencies based upon the country in which each of our investee companies has its revenues? The problem with this approach is twofold. Firstly, most of the companies supply low value items and so manufacture and sell locally or at least regionally.

No one exports significant amounts of bulky low value items such as detergent. So the exposure, if there is any, relates only to the profit margin. Secondly, the corporate treasurer may already have taken out a currency hedge for the translation and/or transmission of those profits so that any currency hedge by us would in fact be creating an exposure. A lot of nonsense is talked about currency exposure and hedging. Our new funds denominated in Euros and US Dollars do not change the currency risks of those funds which are driven by the underlying investments. For those who don’t believe this, we are prepared to launch a new class of our Fund which will change its currency denomination each year to the worst performing currency. In 2011 it would have even denominated in Turkish Lira and would have risen by 32%.any

wealthier as a result. If you think you would be, let us know and we will set up the Money Illusion class of the Fund. We view the year ahead with some trepidation. It seems that it has yet to dawn on many of the key participants in the financial crisis that you cannot borrow and spend your way out of a crisis caused by over leverage, and that there is no higher authority than the governments who’s credit is now in doubt which can extend further funds to provide a painless “solution” or maybe even a temporary respite. The dawning of this reality is sure to have some very painful consequences. However, in contrast the Credit Default Swaps of Nestle have been less expensive than the cost of insuring against default on the debt of European governments and the US Treasury for some time. We are far from believers that the market is always right, but this does suggest that holding shares in major, conservatively financed companies which make their profits from a large number of small, everyday, predictable events is a relatively safe place to be if you have the patience, fortitude and liquidity to ride out the share price volatility which is likely to occur in such circumstances. And that’s exactly where and how our Fund is invested. Yours sincerely, Terry Smith CEO Fundsmith LLP

Mr Forename Surname Company Name Address line one Address line two Address line three Address line four Monday 10th January 2011 Dear Fellow Investor, This is the first annual letter to owners of The Fundsmith Equity Fund. Fundsmith opened for business on 1st November 2010, and we are critical of attempts to measure investment performance over short periods of time. Two months is not a short period, it is a ludicrously short period to do so. However, I thought that this letter is a good opportunity to give you a flavour of the reporting which is likely to occur in years to come. From 1st November to 31st December 2010, The Fundsmith Equity Fund rose by 6.14% net of fees. This compares with some common benchmarks as follows: Fundsmith Equity Fund 6.14% MSCI 7.99% MSCI EAFE 5.76% FTSE100 4.40% Long Bond (10 year UK Treasury) -2.57% Benchmarks are useful for measuring performance, provided a long enough time scale is used. Problems arise when fund managers start to use them for portfolio construction. At Fundsmith we do not endeavour to track any index or to minimise our “tracking error” versus any index (even the use of the expression tracking “error” tells you that an active fund manager has the wrong mindset). The Fund underperformed the MSCI and outperformed the MSCI EAFE-the difference being in the performance of US stocks which are included in the former but not the latter. It outperformed the FTSE100 and long bonds.

The main positive contributors to that performance were: 1. Del Monte Foods 2. Becton Dickinson 3. Domino’s Pizza Inc 4. Nestle 5. Stryker Corp The main contributor was Del Monte Foods. Del Monte could almost be a case study in how investment opportunities arise. We were attracted to Del Monte by its main product- pet food. Pet food is typical of the sort of product we seek to invest in. It is a small ticket, consumer, non-durable. As a small ticket purchase, no credit is required to buy it. The consumer has no opportunity to bargain on price - the price the supermarket or pet store displays is the price you pay. Consumers are typically brand loyal, and once it has been consumed there must be a replenishment purchase-there is no opportunity to defer this by prolonging the life or ownership of the product as there is with a consumer durable, like a car. Moreover, research clearly shows that if times are hard, consumers will reduce their spending on food for themselves or their children rather than cut back on their pets’ food. However, the fact that pet food is Del Monte’s main product line seemed to be lost on most investors, many of whom were assessing it on the basis of their folk memory of its main historic product range in canned fruit and veg. This is what produced the opportunity to buy Del Monte stock on a free cash flow yield which was generous for its likely financial performance.

On one occasion this misunderstanding was compounded when Bloomberg managed to publish an article from the Galveston County Daily News about a strike at Fresh Del Monte Produce Inc - an entirely different company which sells fresh produce - against Del Monte Foods. Such events can create opportunities to buy great companies at good prices. Eighteen days after the Fund opened and we purchased our initial holding in Del Monte it was bid for by private equity firm KKR at a significant premium to the price we had paid. Whilst it would be churlish to suggest that we do not like receiving a premium for our investments in cash, such events are not without their downside as we have to find an equivalent investment for our cash. The fact is we really want to own our stakes in the companies in our portfolio and benefit from the good cash returns on capital which they generate. We are not simply hoping to on-sell the investment at a higher price. This changes perspectives on events such as takeovers. Just as we counsel you not to become overly enthusiastic about share price rises, even those which relate to cash bids for our holdings at a premium which represents a good return on our investment, we hope that you will understand when we are explaining that price falls within the portfolio will often represent an opportunity for investment on even more rewarding ratings rather than an opportunity for soul searching and recriminations. Often but not always.

In no case do we believe that the fall in the price alters our view of the investment (other than the obvious point that we wish we had made it at the lower price) nor do we believe it reflects an adverse change in the intrinsic worth of the business. The historic dividend yield on the Fund at year end was 2.47%. This dividend was covered over 2.5 times by earnings. Only one stock in the fund does not currently pay a dividend. This is significant: dividends have historically provided a significant portion of the total return on equities. The current yield on the Fund may not fully reflect its dividend paying capabilities as some of the companies also utilise share buybacks. These can contribute to shareholder value creation when they are used correctly (to purchase shares which are under-valued when no better investment opportunity presents itself). At the end of 2010 we held a portfolio of 22 stocks including Del Monte. The average company in our portfolio was founded in 1883. We are investing in businesses which have shown great resilience over a long period of time-in most cases surviving two world wars and the Great Depression. The trailing free cash flow (“FCF”) yield was about 7%. This free cash flow was either distributed as dividends, used for share buybacks, or invested by the companies in order to generate further returns.

As our portfolio had an average return on operating assets of 50% this reinvestment of cash flows should produce compounding of value for us as shareholders. This FCF yield compares with a FCF yield on the S&P 500 of a bit less than 7%. The median (250thranked) FCF yield in the S&P is 6.6%. What we can say with a high degree of certainty is that our portfolio has a FCF yield higher than the average for the market. Yet it is inconceivable in our view that it is not of higher than average quality in terms of longevity, resilience, predictability, profit margins, return on operating capital and the conversion of profits into cash. Put simply this means that we own shares in businesses which are higher quality than the market on a valuation lower than the average for the market. Whilst that is not a total solution to successful investing, it strikes us as at least a good start. We regard an equity holding as a claim on a share of the cash flow produced by a business. In the Fund we seek to own companies which produce high cash returns on capital and distribute part of those returns as dividends and re-invest the remainder at similar rates of return. And we want to own those companies shares at prices which at best under-value their returns and at worst value them fairly.

We do not regard equity investment as a sophisticated game of pass the parcel in which we buy shares in companies that we don’t understand, which may be poorly performing businesses and/or which are over-valued, hoping to sell them to a greater fool when they have become even more expensive as a result of some fad or share price ramp. Such games are best left to video consoles unless your hobby is losing money whilst investing, which I rather suspect it is for some people. I aim to restrict myself to one rant per letter about a subject relevant to investment. Frankly given the behaviour of much of the wealth/asset management industry, I regard this as a model of self restraint given the target rich environment.

This year’s rant is a warning about the misunderstanding and misuse of Exchange Traded Funds (“ETFs”). I think this is relevant as The Fundsmith Equity Fund launch was somewhat against the tide of events as we launched an active equity fund at the end of a decade in which a) equities have performed badly; and b) the average active fund manager has again underperformed the index and so made a bad performance by the asset class worse. Faced with this failure of active management, it is hardly surprising that investors have turned their backs on active management and headed for lower cost, passive alternatives. As a result, the rise of ETFs has been a major feature of the investment landscape in recent years. By the third quarter of 2010, there were 2,379 ETFs with 5,204 listings on 45 exchanges managing $1,181.3bn of assets. So what’s the problem? I suspect that the average investor regards all ETFs as just another form of index fund, and indeed many of them are. But many aren’t and therein lies the potential for misunderstanding. Or worse. Some ETFs do indeed replicate the performance of an index by purchasing a weighted package of all or most of its constituent securities. But many so-called synthetic ETFs do not do so and instead use so-called swap agreements with counterparties who agree to provide a monetary return which matches the underlying asset class or the index the ETF is seeking to track.

Anyone who has studied the events of the Credit Crisis should be able to spot a potential problem here: what if the counterparty supplying the swaps defaults? This risk may once have been considered theoretical, but after the collapse of Lehman and the need to rescue AIG in order to prevent the contagion from a default it surely no longer is. True the ETF should be holding collateral against such a failure, but collateral is an imperfect science even where it is held which is not in all cases. Moreover, in some cases the sole counterparty Moreover, synthetic ETFs are often used at access markets which are not directly accessible to retail investors such as the Chinese A-share market or where liquidity in the underlying investments is poor such as equities in some emerging markets. The opportunity for the performance of the ETF to diverge from the performance of the underlying assets and therefore from the investors’ expectations in these cases seems obvious. The idea that a counterparty will provide you with a contract which matches the returns from underlying illiquid assets which you cannot directly own should give pause for thought-not least about how the counterparty will fulfil those obligations, for example in the case of extreme market movement and a liquidity crisis-a not unlikely combination. Of course not all ETFs are used to simply match the performance of an index.

There are leveraged ETFs which multiply index performance, inverse ETFs which replicate a short position in an index and of course, leveraged inverse ETFs. The issue with these ETFs is that their returns are compounded daily.tables;

Day 1 Day 2 Day 3 Day 4 Index 100 125 90 103 Daily Change 25% -28% 14% Cumulative Change 25% -10% 3% Leveraged ETF (+2X) 100 150 66 85 Daily Change 50% -56% 29% Cumulative Change 50% -34% -15% The first table shows the movement in an index in a highly volatile period in which it rises sharply then falls to finish just 3% up over the period. The second table shows the performance of a 2x leveraged ETF over the same period. With daily compounding the leveraged ETF produces a cumulative loss of 15% of value over the period versus a 3% rise in the index. How about an inverse ETF? Index % Movement Short Position ETF (Short) Day 1 100 100 100 Day 2 80 -20.0% 120 120 Day 3 60 -25.0% 140 150 Day 4 55 -8.3% 145 162.5 Day 5 100 81.8% 100 29.5 In a week where the index was volatile on the downside but got back to par by the end of the week an inverse ETF with daily compounding would turn in a 70.5% loss. You can imagine what a leveraged inverse ETF would do! I would bet that a large proportion of ETF investors do not realise that leveraged and inverse ETFs can produce these apparently perverse results. The moral of this is that these sort of ETFs are really day trading tools. If they are held for more than one day, they will begin to diverge from the performance of the underlying index or asset class. However, it would not be surprising if in many cases they were being used inappropriately as if they are index funds.

Finally, returning to our own active fund, we look forward to the year ahead. This is not because we have any faith in a sustained recovery in major economies and/or that we regard equities in general as cheap or equity markets as a whole as good value or well placed to track improvements in corporate profitability which in any event may not be forthcoming. It is firstly because we believe our Fund contains a portfolio of shareholdings in great businesses which we have purchased at reasonable prices or better and which we intend to hold onto in order for them to deliver the benefits of such investments. Secondly, it is because we enjoy running The Fundsmith Equity Fund. Robson Walton, the Chairman of Wal-Mart and son of its founder Sam Walton said, “My dad did not set out to make Walmart the world’s largest retailer. His goal was simply to make Walmart better every day, and he thought constantly about how to do just that.” Please be assured we are doing the same with Fundsmith. Yours sincerely, Terry Smith CEO Fundsmith LLP Disclaimer: Fundsmith does not offer investment advice or make any recommendations regarding the suitability of its product and no information contained within this document should be construed as advice. Should you feel you need advice please contact a financial adviser. Past performance is not necessarily a guide to future performance.