Pieter Slegers — Has Terry Smith lost his mind?! (Compounding Quality)

One-line take: a guest post by TJ Terwilliger and almost entirely about market structure rather than securities — but it is the strongest statement in this archive of why the quality drawdown described a week earlier is happening. The event: Terry Smith, "The English Warren Buffett," whose third principle is literally Do Nothing, turned over more than 50% of Fundsmith's portfolio in six months and told investors to expect more trading. His stated reason is not conviction but survival — "there will be little point being proved right about the dangers of passive or momentum investment after our Fund has closed… the market can remain illogical longer than we can remain in business." The structural argument underneath is the piece's real content: passive funds "manage more than 60% of all assets under management" yet, per Cboe, active managers' share of trades has fallen from 80% in the 1990s to just 10% — so price is now set overwhelmingly by money that "doesn't care about price," buying on inflow and selling on outflow. That produces two self-reinforcing loops (inflow → buying → higher prices → better performance → more inflow, and its mirror for active funds), which makes relative performance partly a function of flows rather than of skill. The verdict is blunt and pointed: "I think the move Fundsmith made is strange. They are switching from quality to momentum right now. They might be making the switch at exactly the wrong time."

1. Stocks & names mentioned

No listed securities are discussed — this is a market-structure piece. The only named entities are two fund managers, both private. Terry Smith, John Bogle and Warren Buffett are people, not rows; Cboe Global Markets appears only as the source of the trading-share statistic. Research legend: QT Qualtrim · SA Seeking Alpha · STK Stock Analysis. Written post with no timestamps — the At link opens the article.

Ticker	Name	Research	View	What he said	At
private	Vanguard	—	Neutral	Named as the firm John Bogle founded to popularise index investing, and as the source of the piece's key anomaly: "In the UK, for example, Vanguard's UK All Share tracker has made 66% over five years, trouncing the average UK equity fund's return of just 32%." The post treats that gap not as proof that active managers are bad but as evidence that flows, not skill, are setting relative performance. No stance on the firm.	read ↗
private	Fundsmith	—	Negative	The subject, and the only argued view in the post. Launched 2010, "manages £12 billion and has achieved an impressive 13.1% CAGR after fees since inception" — but "Terry Smith has underperformed every single year over the past 5 years," and in the first half of 2026 "he turned over more than 50% of his portfolio." The letter concedes the change is defensive rather than analytical: "you can and increasingly have been taking money out… a buy and hold strategy can only work if you are not subject to flows, and we are… You should therefore expect that we will be more active in the future." The verdict: "I think the move Fundsmith made is strange. They are switching from quality to momentum right now. They might be making the switch at exactly the wrong time."	read ↗

Guest-authored. The byline is TJ Terwilliger and the piece was originally written for Compounding Dividends; Pieter Slegers publishes and signs it, and the closing judgement on Fundsmith is presented as the house view. Read it as the structural companion to the 14 July style-drawdown letter — the same phenomenon, explained by flows rather than defended by history. Part II, on price swings and the US retirement system, had not been published when this was archived.

2. Talking points

The event: a "Do Nothing" manager doing a great deal

"Typically, he doesn't trade much. But in the first six months of 2026, he turned over more than 50% of his portfolio. He even announced a major shift in his investment strategy."
Smith's three principles are stated first so the size of the change is visible: Buy Good Companies (ROCE above 15-20%, pricing power, cash conversion), Don't Overpay, and Do Nothing — "minimizing trading keeps fees low and lets compounding do the work over time."
The revision keeps the first two and softens the third: "there will be a little less Doing Nothing going forward."

The record that forced it

"Fundsmith generated a CAGR of 13.1% after fees since 2010." And: "Terry Smith has underperformed every single year over the past 5 years."
Smith's own diagnosis is that "investors cared more about momentum than business fundamentals" — the same complaint Slegers made in his own letter a week earlier, from a manager five years further into the drawdown.

The unusually candid reason for the change

"It's not because he thinks it's the best investment decision. It's because if he didn't adapt, the fund would eventually go out of business."
In Smith's words: "We run open-ended funds, and you can and increasingly have been taking money out, we suspect mostly to join the exodus from active to passive… there will be little point being proved right about the dangers of passive or momentum investment after our Fund has closed… In a market in which share price moves of 33% per day for even large stocks are not uncommon a buy and hold strategy can only work if you are not subject to flows, and we are."
The closing line of the quote is the structural admission: "the market can remain illogical longer than we can remain in business."

Bogle's argument, and where it stopped holding

The original case: most active funds fail to beat the market and charge fees on top; an index fund removes the fee and takes the average.
The test: "if that argument holds true, then shouldn't the index and the average manager perform similarly? They used to, but that's started to change" — Vanguard's UK All Share tracker +66% over five years against +32% for the average UK equity fund.
A gap that large is not a fee gap, which is the opening for the flow explanation.

The two feedback loops

"Passive funds: More money comes in → they buy more stocks → prices rise → performance improves → even more money comes in."
"Active funds: Money flows out → they sell stocks → prices fall → performance gets worse → even more money flows out."
The consequence is a valuation wedge that is not about business quality at all: "the stocks passive funds own become more expensive, while the stocks active funds own become cheaper."
Evidence offered: the S&P 500 tracks hedge funds closely until roughly 2012-13 and pulls away afterwards — the same point at which active inflows peaked and began to reverse.

Why an auction with only price-insensitive bidders behaves differently

The primer is deliberate: bid, ask, spread, order book. "In the image, there are a lot of people willing to buy at $37.37. But the lowest price anyone is willing to sell is $37.38. As a result, no transaction will take place."
"For a stock price to move, either the buyer or the seller has to give in." Prices are set by whoever is impatient, not by whoever is right.
Index funds are structurally impatient in one direction: "Money comes in → Buy. Money goes out → Sell. Index funds and ETFs don't care about price."

The statistic the whole argument rests on

Smith, quoted: "whilst AUM in index funds is now more than 60%, in terms of volume of trades, active fund managers are an even smaller minority than this implies. According to Cboe Global Markets, having been 80% of trades in the 1990s, active funds share of trades is now down to just 10%."
The original Bogle assumption is named and marked as broken: "Index funds would stay small and benefit from the research done by professional stock pickers. At the time, active investors made up almost the entire market. But that's no longer true."
"Today, passive funds manage more than 60% of all assets under management. This has never happened before."

The unresolved question, held for Part II

"But what happens if that buying and selling hits a market with fewer buyers and sellers than people expect? In Part 2, we'll show how this is already creating bigger swings in stock prices. We'll also explain why it could become a serious problem for the U.S. retirement system."

The verdict

"I think the move Fundsmith made is strange. They are switching from quality to momentum right now. They might be making the switch at exactly the wrong time." The same timing warning Slegers gave his own readers a week earlier, now aimed at a manager rather than a subscriber.

3. In plain English

A jargon-free summary of the thesis behind each argued name. (Renders on each name's consolidated page.)

Fundsmith Negative

Fundsmith is the £12 billion fund run by Terry Smith, sometimes called the English Warren Buffett. Its entire method is three rules: buy excellent businesses, don't pay silly prices, and then do nothing — because trading costs money and interrupts compounding. Since 2010 that has produced 13.1% a year after fees.

The news is that Smith has abandoned the third rule. He turned over more than half the portfolio in six months and told investors to expect more trading, because he is now taking momentum into account. What makes it remarkable is his own explanation: he does not claim it is the better investment decision. He says that his investors have been withdrawing money to move into index funds, and that a buy-and-hold strategy only works if you are not being forced to sell to meet redemptions. In his words, there is no point being proved right after the fund has closed.

The judgement here is unsparing and it is about timing rather than character. Switching from quality to momentum after five years in which momentum has already won is, on this reading, selling the strategy at its low — "they might be making the switch at exactly the wrong time." It is also a warning about the structure of open-ended funds themselves: a manager whose capital can walk out at the worst moment does not fully control his own process, which is exactly the constraint a private investor does not have.

Vanguard Neutral

Vanguard is the firm John Bogle built to sell index funds — funds that do not try to pick winners, just hold everything in a market at very low cost. The original argument was straightforward: most professionals fail to beat the market, and their fees make it worse, so simply owning the average is better after costs.

It appears here as evidence of something Bogle did not anticipate. Vanguard's UK All Share tracker returned 66% over five years while the average UK fund managed 32% — a gap far too wide to be explained by fees. The piece's suggested explanation is that money flowing into index funds mechanically buys the shares those funds hold, pushing them up, while money leaving active funds mechanically sells the shares those funds hold, pushing them down. Each flow then improves or worsens the measured performance that drives the next flow.

No view is offered on Vanguard as a business. It is the illustration of a market in which, on the numbers quoted, index money now owns 60% of assets while doing only 10% of the trading — so the marginal price is increasingly set by buyers and sellers who never look at the price at all.

Summary derived from the archived Compounding Quality post (text in transcript.txt) for personal study. Not investment advice. © Compounding Quality / Pieter Slegers / TJ Terwilliger for source material.