Why Value Investing Is Struggling and Whether the Critics Are Right

Value investing is struggling against momentum and passive flows in a way that has now prompted one of its most prominent practitioners to reconsider his approach. Over the ten years to 31 July 2026, the MSCI World Value Index delivered an annualised return of 11.0%, against 13.3% for the MSCI World Index and 15.2% for the MSCI World Momentum Index. That gap has sharpened a long-running debate: is value investing broken, or is it simply being tested?

Fundsmith’s Difficult Year Puts the Question in Focus

The debate moved from abstract to pointed when Terry Smith, chief executive and chief investment officer of Fundsmith, acknowledged in July 2026 that he would start paying more attention to the momentum factor when selecting investments for the Fundsmith Equity Fund.

The backdrop was a bruising first half. According to Fundsmith’s semi-annual shareholder letter, the fund returned -2.9% in the first half of 2026 while its equity comparator returned +11.2% over the same period. From inception in November 2010 to the end of July 2026, the fund has returned 593.4%, comfortably ahead of the MSCI World Index’s 525.4% over the same period, per Fidelity citing the Fundsmith factsheet. The long-run record remains intact. The recent pattern is harder to defend.

Annual returns over the five years to 30 June 2026 (per Morningstar, excluding initial charge) show a fund that has oscillated rather than compounded steadily:

Smith’s response in H1 2026 was to rotate the portfolio at an unusually high rate. Trustnet reported that disposals included Unilever, Novo Nordisk, Atlas Copco, Coloplast, EssilorLuxottica, Intuit, LVMH, Mettler-Toledo, Otis and Wolters Kluwer, replaced by names in power infrastructure, payments and streaming. His rationale for selling was a mix of slowing growth, valuations he judged too high, and acquisition missteps at individual companies.

In the shareholder letter, Smith described buying quality companies after share-price setbacks as catching ‘the proverbial falling knife’, adding: ‘All we are getting is cut fingers as their downward share price spiral is exacerbated by the index momentum enhancement effect.’ The portfolio currently targets a 4.3% weighted average free cash flow yield and Smith estimates the underlying companies will grow their cash flow by around 14% per annum over the next three to five years.

Why Value Investing Is Struggling: Passive Flows and the Tech Premium

Two structural forces are behind value investing’s struggles, and they reinforce each other. The first is the rise of passive investing. According to Morningstar data cited in the original analysis, passive funds’ share of the total investment fund market rose from 12.4% in January 2008 to 46.4% in July 2026. Market-cap-weighted index funds concentrate capital in the largest companies regardless of valuation, which means inflows mechanically push the biggest names higher.

The second force is the technology sector’s dominance. Cloud computing, smartphone proliferation and the AI boom have concentrated market returns in a set of stocks that are structurally inaccessible to value investors. As of 21 August, Palantir Technologies traded at over 150 times its trailing earnings and 112 times its forecast earnings; Tesla at around 336 and 185 times respectively. The MSCI World Momentum Index factsheet for June 2026 shows Information Technology as the largest sector weight at 39.04%, with the United States accounting for 59.61% of the index.

Smith attributed Fundsmith’s underperformance directly to this combination, describing in his shareholder letter ‘a market which is dominated by so-called passive or index funds… and the boom surrounding AI which have combined to produce a market dominated by momentum rather than any fundamental factors like profitability, returns on capital and growth’.

The Counter-Argument: Distortion as Opportunity

Not everyone reads the same environment as a reason to adapt. Cedric Jacque, investment manager at Lloyd Capital, acknowledged the diagnosis but rejected the remedy. ‘We agree with [Smith] that a market driven by passive flows and momentum can become increasingly distorted, that momentum sits at levels last seen in 1999, and that this will end badly,’ Jacque said. ‘Where we part ways is on the remedy. We believe that becoming more of a crowd follower, and setting aside time-tested investment principles, is not a solution we can get behind.’

Jacque argued that passive flows are widening the pool of mispriced securities, which over a long enough horizon should benefit disciplined stock-pickers. ‘Passive investing and index flows should increasingly expand the pool and the magnitude of the mispricing and therefore lead investment opportunities for the patient long-term shareholders,’ he said.

That argument has been made before, including by Smith himself in earlier annual letters. The difference now is that one of the strategy’s most prominent advocates is modifying his own approach. Whether Smith’s pivot proves prescient or premature will be settled by returns, not by the argument. The next twelve months of index data will do more to resolve the question than any debate about first principles.