Lyon is one of the few genuinely bearish fund managers left, with rivals such as Iain Stewart and Hugh Hendry recently increasing their risk exposure in spite of their wariness of rising markets.
The Trojan manager (pictured) believes that by and large equity markets around the world are overvalued, but says one sector ticks all the right boxes. Lyon priorities capital preservation above all else, therefore favours quality companies with strong balance sheets, limited downside, realistic earnings expectations and preferably a strong dividend yield. “We’ve been trying to add new ideas to the portfolio but it’s been incredibly frustrating,” said Lyon in an exclusive interview with FE Trustnet. “The one area we’re relaxed about is the tobacco sector. Philip Morris, British American Tobacco and Reynolds American are all big positions in the fund.”
“We like the consumer staples industry because of the predictability of cash and the global diversification.”
“Looking at the areas within the sector, the dividends of tobacco companies are well covered and secure and they have excellent capital discipline. Earnings have been a bit dull but certainly not disastrous.”
“These companies are trading at 13, 14 times, and are yielding 5 per cent. BAT is yielding 5 per cent and from there I don’t think there is a lot of downside.”
Lyon also likes Imperial Tobacco, which is held by colleague Francis Brooke in his five crown-rated Trojan Income fund. However, Lyon says he recently swapped American company Philip Morris for the UK-listed stock, because he is wary of Imperial’s higher level of exposure to Europe.
Tobacco had a fantastic 2011, but has struggled more recently – particularly in 2013. FE data shows the FTSE 350 Tobacco index has returned 7.88 per cent over a two-year period, compared with 22.82 per cent from the FTSE 100. Both Imperial and BAT have returned even less.
Performance of stocks and indices over 2yrs
Source: FE Analytics
Lyon’s cautious stance has cost his fund dear recently. He has the flexibility to invest 100 per cent in equities, but exposure has hovered around the 30 to 40 per cent mark since 2011.
The manager’s high degree of exposure to gold and gold miners, which currently sits at 13 per cent, as well as cash and inflation linked bonds has compounded his underperformance over the past 24 months or so.
Performance of fund and sector over 2yrs
Source: FE Analytics
As well as being wary of valuations, Lyon believes a deflationary shock is a significant possibility once quantitative easing is taken off the table. Over the long-term, the manager’s base case is higher inflation, as he expects central banks to resort back to monetary easing.
Although he accepts markets could continue to perform strongly in the short-term, he says he has no interest in chasing returns. He highlights cyclical areas such as financials and technology as particularly susceptible to a de-rating.
“US earnings were up 4 per cent last year and the market was up 30 per cent. It’s just not sustainable,” he said. “Either earnings have to go up markedly or markets come down. Top-line growth is very hard to grow and I just can’t see the gap being closed.”
“Why has this happened? Because cash is burning a hole in people’s pockets who are desperate for a return.”
“Generally the vulnerability is in the cyclical businesses, which have benefited from the uptick in the economy. Something like Foxtons was all but bust four or five years ago, but since coming back to market it’s had a stellar run.”
“Earnings have gone up because of an improvement in the property market, but transactional alone isn’t sustainable. With a fixed cost base I think current valuations are at real risk.”
“The fund managers are at risk as well. Rising markets last year saw the likes of Aberdeen and Jupiter have a very good 12 months, with some up over 50 per cent in 2013.”
“Biotech is up 360 per cent over the last four years, which is just parabolic. If you’re getting into that market now, the risk/reward is not attractive for us. We’re about wealth preservation. We’ve had a bad year, but we don’t want to compound that by changing our process.”
“People are buying tech companies without earnings, which is a worrying sign. Last year there was a sudden feeling that the Fed was on people’s backs, and investors took on more risk as a result. When you see the valuations of some companies out there that aren’t generating profits – well, we know where that ends.”
Although Trojan has had a tough time, its long-term record is still very strong, in no small part thanks to its stellar performance during down markets.
Performance of fund, sector and index since launch
Source: FE Analytics
FE data shows that the Trojan fund is a top decile performer in its IMA Flexible Investment sector since launch, with returns of 161.28 per cent. It has been significantly less volatile over the period as well.
The Trojan fund has clean share class ongoing charges of 1.09 per cent and is available on Trustnet Direct.