Sebastian Lyon’s Trojan fund and other portfolios run by the cautious Troy Asset Management could start to have a noticeably more bullish positioning in the coming years if a jump in volatility knocks some of the “ebullience and complacency” out of markets, the star manager says.
The £2.5bn Trojan fund is currently sitting in the IA Flexible Investment sector’s fourth quartile over three and five years after its very defensive positioning meant it missed out on much of the quantitative easing-fuelled market gains of the recent past.
Trojan – which is built around ‘four pillars’ of blue-chip equities, index-linked bonds, gold and cash – has made just 5.81 per cent over the past three years. Its average peer, meanwhile, is up 23.35 per cent while its FTSE All Share benchmark has risen 30.26 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
This cautious stance stems from the manager’s view that we are in a secular bear market which has been running since 2000, which is no place to be overly confident on equities. The rally of recent years has been supported by unorthodox monetary policy, but he does not expect this cyclical bull phase for stock markets to run forever.
Lyon’s opinion that markets are long overdue a correction seem prescient given the difficult run they have just been through. Between May and the end of August, the FTSE All Share fell by close to 13.5 per cent on the back of concerns such as the potential for higher interest rates in the US and a slowing Chinese economy.
Markets have been calmer since the end of September – when the Federal Reserve once again pushed back its decision to lift interest rates from their historic lows – but the manager thinks this is unlikely to last for too much longer.
“As we head towards 2016, the potential for further shocks and greater volatility should not be ruled out. The market’s twin props of cheap debt and stable corporate earnings look vulnerable,” he said.
The stock market rally following the financial crisis has been in part fuelled by low borrowing rates for companies, which has allowed them to repurchase their stock and fund M&A activity. However, corporate bond yields are starting to decouple from government bond yields (US corporate BAA bonds have seen their spread over government debt widen from 2.5 per cent to 3.3 per cent).
Lyon argues that this suggests “the invisible hand of the free market is beginning to make its presence felt” and says the market seems determined to raise rates even if the Federal Reserve won’t.
Meanwhile, corporate earnings in both the UK and the US are coming under pressure from a multitude of factors, such as falling levels of demand, the impact of excess supply on margins and the effect of currency movements.
Recent research by Canaccord Genuity made the same point. The following chart shows UK large-caps that have made earnings downgrades (defined as a cut to consensus earnings forecasts of 1 per cent or more over the last 3 months) or upgrades (a rise of 1 per cent or more) for this year and next.
UK large-cap earnings momentum by sector
Source: Canaccord Genuity Quest
But Lyon still thinks markets look expensive, even though valuations have fallen back from the record highs witnessed in April when the FTSE 100 passed the psychologically important 7,000 mark.
“Having fallen from their peaks, are markets offering value? Alas no. Stocks are yet to be compelling cheap,” he said. “With a few exceptions, quality assets remain fully valued while what looks myopically cheap is risky.”
While the current conditions might not be the best hunting grounds in Lyon’s view, he thinks the likelihood of a significant correction in the future will open up a much more attractive entry point.
“Should a material fall in markets occur, it is likely to call time on the end of the secular bear market that began 15 years ago,” he said.
“The best investments are made during apathy and despair – not ebullience and complacency. We are preparing for being far more invested than in the past decade or so. In 2008, many expressed reservations as we bought into a collapsing market but fundamental value was evident back then, even in great companies.”
“Those opportunities will come again. As we head into more challenging conditions, do not be surprised if we become bullish.”
During the crash year of 2008, Troy Trojan made a 1.11 per cent return – at a time when very large falls were seen by the average IA Flexible Investment fund and the FTSE All Share index.
Performance of fund vs sector and index in 2008
Source: FE Analytics
The fund did go on to lag in the strongly rising markets of the following two years but its 8.52 per cent rise in 2011, when markets were hurt by the eurozone debt crisis, meant that it was the best performing member of its peer group.
Since launch in May 2001, it has been the second best performing fund in its peer group with a 180.12 per cent total return; only CF Ruffer Equity & General has returned more with a 191.94 per cent gain. Its average peer has made 71.91 per cent and the FTSE All Share has risen 100.61 per cent.
Troy Trojan has a clean ongoing charges figure of 1.06 per cent.
