22 October 2009
Dear Fellow Investor
I have been an admirer of Ian Rushbrook, manager and largest investor in the Personal Asset Trust, ever since I read about him in Jonathan Davis’s book Money Makers – Stock Market Secrets of Britain’s Top Professional Investment Managers.
Ian unfortunately passed away last year in October, a sad loss to the investment world. Shortly thereafter I stopped following the activities of the Personal Asset Trust also cancelling my subscription to their quarterly newsletter.
Earlier this month I came across a insightful blog post by Jonathan Davis, the author of the above book, where he wrote a questions and answer article with the new manager of the Personal Asset Trust. Even thought the interview took place at the end of July, the advice is still timely.
Jonathan graciously agreed for me to use the interview in the guest post below.
24 July 2009
Sebastian Lyon, the CEO of Troy Asset Management, is one of the coming talents in investment management. The firm he runs was recently given the mandate to run the Personal Assets Trust in Edinburgh, following the untimely death of Ian Rushbrook in October last year.
Troy Asset Management started life with the task of running the family money of the lateLord Weinstock and other senior managers at GEC, from whom he inherited his conservative investment style and a focus on capital preservation.
Troy, which is named after Lord Weinstock’s famous racehorse, now runs three low cost unit trusts on an absolute return basis. The funds are aimed at investors whose primary objective is to preserve capital.
This is something that the Trojan fund successfully achieved throughout the sharp bear markets of 2000-03 and 2007-09. Sebastian is one of a number of top-flight professional investors who offer me periodic snapshots on their view of the markets, and whose low cost funds I am happy to own and recommend.
Where are we now in the market cycle, in your view?
We have been in a secular bear market for equities since 2000. This is a long process of valuations being derated. That has been my view since the Trojan Fund was launched in 2001. The bear market is likely to last 10 to 14 years. Having had two down phases (2000-2003, the tech bust and 2007-2009, the credit bust), we are now well into the second half of that bear market, in my view.
Having been very cautious, we can begin to be a little more optimistic on equity markets. There is a clear correlation between starting valuations and 10-year equity market performance.
The UK stock market, for example, has derated from a PE of 24x in 2000 to a PE of around 10 today. Bear markets usually bottom on single figure PEs, so arguably there is one further derating to go before we can celebrate an enduring new bull market. Now that the S&P and the FTSE have bounced off the 2002/3 lows in 2009, markets may have bottomed in nominal terms, but not when inflation is taken into account.
In a bear market equity income is the key to equity returns as it is clear that PE multiple expansion is not likely. We have therefore concentrated on stocks that pay a high and sustainable income. This served us in good stead during the credit crisis when financials, cyclicals and highly leveraged businesses have all been forced to cut their dividends. Investors in these sectors suffered permanent capital loss and the added insult, in many cases, of huge dilution as balance sheets have had to be repaired.
What have you been buying recently and why?
Nestlé: Over the past five years dividend growth has been 14%. The valuation (11 x earnings) is the lowest I have seen it in my career, so what you get is a top quality consumer staple at a very attractive entry point. The firm is globally diversified, operates in 130 countries, and has a highly conservative balance sheet (interest cover of 16x).
The company is a proven innovator and has better top line growth than its peers over the past 10 years. Yet it is valued at no premium to them. Should inflation return, fast moving consumer goods companies will be in a good position to pass on rising input prices.
BATs. Over the past five years dividend growth has been 16%. The tobacco company offers material international diversification for a UK investor since its sterling earnings are minimal.
We believe the UK economy with struggle to grow for a number of years and quality defensive international exposure is underrated by investors. Such predictable cash generators are often ignored or seen as dull by the consensus.
Berkshire Hathaway. We have avoided financials stocks such as banks and life companies because of the opacity of their structure and exposure to bad debts/illiquid unmarketable securities. Berkshire Hathaway has not performed well this year.
Strong balance sheets are not in favour for now. Pricing power in insurance and reinsurance remains very strong however. Berkshire’s other direct corporate investments are valued conservatively at book value. It seems we are paying little if any premium for Mr Buffett’s investment abilities.
We know investors go through periods of according different degrees of goodwill to Berkshire. At present we have a good margin of safety, with some healthy upside on a two to three year view.
Gold: In a world of currency compromise gold will retain its real value and protect real wealth for private investors. Still viewed with skepticism by mainstream investors, gold has risen in value every year this decade.
Although we have a small exposure to gold miners, we prefer holding bullion as miners are notorious in failing to create long term value for investors. The volatility of mining stocks is also much higher. Gold is independent from the world financial system and supply is limited, not something that can be said about sterling and the dollar! I view our gold holdings as being in lieu of holding cash.
What are you avoiding and why?
We do not own cyclical recovery stocks and financials for the reasons given above. Banks will require more capital and the overhang created by the UK ‘nationalised’ banks (Royal Bank of Scotland, Lloyds Banking Group etc) has still to be unwound. A number of UK domestic sectors, such as pub stocks and airlines, have been recapitalized, but I believe they have not yet raised enough money. Debt levels are far too high.
I am wary of corporate bonds. There is a consensus rush into corporate paper which makes me nervous. We need to be in real assets – equities, index linked and gold. Bond spreads may look mouth- watering, but liquidity is very poor in the UK corporate bond market. My concern is that lessons have not been learned from the dash for yield that occurred in 2004-07. The truth is that were it not for quantitative easing (QE), government bond yields would be higher and corporate bond spreads consequently lower.
Any further thoughts on the markets?
Investors are more short term minded than they ever were. They are not, in my view thinking forward to the unintended consequences of fiscal and monetary policy. I think and hope that following the severe losses incurred in 2008, the obsession with relative performance in investment may now be seen for what it is – an absurd and imprudent way to manage private wealth.
What is suitable for pension funds is not suitable for irreplaceable capital, whether that capital has been earned or inherited. There may still be one final lesson to be learned before we can say goodbye to this problem.
About Independent Investor
I have been analysing investment markets for more than 30 years, initially as a journalist on The Times, The Economist and The Independent, more recently as a columnist, author and investment professional. I am Investment Director of Agrifirma Services Ltd and a Non-Executive Director of Hargreaves Lansdown plc. Any personal views expressed in the newsletter are entirely my own.
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From what I gathered in the interview the Personal Asset Trust investors are in good hands.
More of Sebastian’s insightful writings can be found in the Troy Asset Management – Investment Reports
I strongly share Sebastian’s view that investment performance measured against an index (relative performance) is complete rubbish.
I have worked hard to save the funds I invest and the only thing that matters is the year on year growth of my invested capital (absolute performance).
This is also the central view taken with all recommendations and portfolio management of our investment alert service.
As the market races ahead I am finding the investment opportunities few and far between. I have recently been thinking of ways of lowering the downside should the markets suddenly correct.
I am however very happy to continue holding the high dividend paying solid companies I have been recommending and buying recently.
I am in the process of selling a few small company positions in my portfolio and closely looking at my other positions for over valuation. But with 81% in cash and up about 6% for the year I am happy with my performance.
Tim du Toit
Disclosure: I do not have a position in any of the companies mentioned above