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Sebastian Lyon: Why defensive stocks will continue to outperform

01 December 2014

The manager of the Troy Trojan fund expects high inflation and further economic shocks in the medium-term and is positioning his portfolio accordingly.

By Anthony Luzio,

Production Editor, FE Trustnet

A weakening global economic environment combined with the UK Government’s reluctance to raise interest rates will mean defensive stocks will continue to outperform in 2015, according to Sebastian Lyon (pictured), manager of the Troy Trojan fund.

ALT_TAG The September pullback in markets has meant that more cautious fund managers such as Neil Woodford, Mark Barnett and Lyon’s colleague Francis Brooke have topped the performance tables so far this year, as FE Trustnet reported back in October.

However, despite the fact that defensive stocks have already been on a strong run and the oft-repeated contention that this area of the market looks overpriced, Lyon says a poor economic outlook means they should maintain their strong upward trajectory.

“Growth and inflation numbers from Europe, Asia and Japan have continued to be very weak,” he explained.

“According to ACM Shipping, freight rates from Asia to Europe have collapsed. Evidence is mounting, both from companies and economic data, of a global economic slowdown as we approach 2015.”

“Five years on [from the financial crisis], it remains a slow, grinding recovery with little prospect of escape velocity.”

“In a weaker economic environment, our more defensive stocks should perform better, as they have done so far in 2014.”

Lyon says equities as a whole look like investors’ best bet in the coming years, but adds this does not mean he is overly optimistic about the asset class – he believes that interest rates are now unlikely to rise for some time, meaning stocks are simply the best of a bad bunch.

“It is well over four years since rises in interest rates were first mooted and as little as five months ago, Mark Carney, governor of the Bank of England, was giving strong hints of a rate rise this month,” he said.

“In late October, Andrew Haldane, the Bank’s chief economist, was put into bat, saying: ‘Interest rates could remain lower for longer, certainly longer than I expected, without endangering the inflation target.’”

“Now long-suffering savers will have to wait even longer to get a return on cash, possibly to the first quarter of 2016 or beyond. David Cameron is likely to be the first prime minister since Clement Attlee in the late 1940s to have served a full parliamentary term without a single Bank of England base rate change.”

“We stick to our view that rates are unlikely to rise for the foreseeable future. This will no doubt continue to make equities look attractive, at least on a relative basis, even if valuations do not look particularly compelling.”

“The question investors need to ask themselves is: are they sufficiently compensated for the volatility they are likely to experience in the next few years?”

Lyon says the main driver of this volatility over the medium term will be high inflation, as the full impact of continued government intervention eventually begins to be felt by markets.

“Many investors ask us where the inflation will come from, particularly since, unlike in the 1970s, labour has little power to demand higher wages,” he continued.

“They forget the prospect of inflation by debasement of the currency. An ordered example followed the devaluation of sterling in 2008, which led to headline levels of inflation of 5.6 per cent by September 2011. A more egregious illustration has recently occurred in Russia, where the rouble has declined in value against sterling by 25 per cent this year.”

Although some analysts say the recent crash in the oil price is more likely to cause deflation than anything else, Lyon believes this will simply delay the inevitable and argues that it could even increase inflationary forces in the long term.

“We have long suspected that a deflationary shock was likely before higher levels of inflation take root,” he added.

“Policymakers will not tolerate a dose of deflation and the response, when it comes, is likely to be disproportionate. Hope that western consumers will respond to falling prices by spending more may not be well founded. Demographic changes, especially baby-boomers heading into retirement, may mean this surplus cash is saved rather than spent.”

“The recent temporary upsurge in the forces of deflation is making the debt burden on the world economy even heavier and in the absence of strong growth, only inflation can reduce it in the long run.”

According to FE Analytics, Lyon’s Troy Trojan fund has returned 119.07 per cent over the past decade, compared with a 115.59 per cent rise in its FTSE All Share benchmark and an 87.95 per cent gain from the IMA Flexible sector.

Performance of fund vs sector and index over 10yrs


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Source: FE Analytics

However, its high exposure to gold – which Lyon is using as a hedge against future inflation – and cash has caused it to fall behind over the past two years.

The fund has made just 3.79 per cent over this time compared with 26.83 per cent from the FTSE All Share and 23.19 per cent from its sector.

Performance of fund vs sector and index over 2yrs

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Source: FE Analytics

Troy Trojan requires a minimum investment of £1,000 and has an ongoing charges figure of 1.07 per cent.


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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.