Terry Smith: Index Funds Are Not Actually Passive; They Are A Momentum Strategy

In a recent interview with EXPANSIÓN, Terry Smith, the co-founder and CEO of Fundsmith, offered a clear-eyed assessment of current market dynamics.

His investment philosophy, which has earned him the nickname “the English Warren Buffett,” is being tested by an environment he views with skepticism. Smith states plainly, “I think there’s probably a bubble.”

He points to “massive committed investments that don’t have a proven ability to generate income” and highlights a particular concern with tech, noting “the circularity issue” where companies finance each other’s purchases.

A central theme in the interview is the profound distortion created by passive investing. “More than 50% of assets are now invested through index funds, which are not actually passive; they are a momentum strategy,” Smith explains.

This leads to capital flowing based on size, not quality, causing prices to rise irrespective of valuation. “The effects are more extreme than in the dot-com bubble because in 2000 less than 10% of funds were index funds, and now it’s more than 50%,” he adds.

Despite this, Smith continues to find opportunities, adhering to his core tenets: “Buy good companies. Don’t overpay. Do nothing.”

He applies this to his holding in Spain’s Amadeus, which he describes as “a classic example of a highly integrated service with its customers and low transaction costs.” He believes it “is capable of increasing its revenue at an annual rate of 8%, and it seems cheap with a P/E ratio of 22.”

His strategy remains focused on ownership, not speculation. “What we really want is to own the businesses we invest in,” he counters regarding M&A rumors.

Reflecting on lessons from Buffett, Smith underscores long-term thinking. “Any form of short-termism is the enemy of a good investment strategy,” he says, arguing against quarterly reporting.

He values management that “act like owners,” prioritizing sound capital allocation over box-ticking governance. For Smith, the goal remains simple: “It’s better to own a great business at a fair price than an average business at a great price.”

You can find a transcript from the interview here:

Expansión Interview – Terry Smith: “There could be a stock market bubble more extreme than the one in 2000”