Personal Assets sticks with gold after "annus horribilis"

"Last year we paid the price for being prudent," says Sebastian Lyon, manager of Personal Assets. "Since mid 2012 performance has been very lacklustre as markets have been very strong due to quantitative easing. Prudence can seem imprudent in bull markets."

He says the underperformance is down to two main reasons: his caution on equities; and his gold holdings.

But he defends the allocation, arguing that "an artificial world" where the bank rate has been the lowest for over 300 years leads to a mispricing of risk. "And we do live in a phony, artificial world where there is a dislocation with 0 per cent interest rates and quantitative easing," he adds.

He also argues that what is traditionally described as a balanced portfolio - eg, 50 per cent equity, 40 per cent bonds and 10 per cent in cash - results in a falling yield. "Reaching for yield leads to low returns and high volatility," he adds.

This is similar to the view of another IC Top 100 Fund manager of a wealth preservation trust, Ron Tabouche of RIT Capital Partners (RCP). He recently said that a balanced portfolio "can provide sub-optimal performance and this is especially the case at this point in the cycle, where it could offset some of an equity re-rating."

Read our interview with Ron Tabouche

"We thought we were in a long-term secular bear market for equities," continues Mr Lyon. "And today we still feel the risks are more to the downside after a rally. Valuations are being ignored, and 0 per cent interest rates are no panacea - look at Japan in the 1990s.

"Call us old fashioned but we like to buy low, sell high. We reduce equities as markets rise. We wouldn't want 100 per cent in cash but if equities continue to rise we expect to reduce our allocation to them further."

He cites the US stock market rally over 2012 to 2013 as an example. "This is not based on earnings growth. It needs earnings to come through but they are not, and stock markets will have to have a dose of reality. US equities' cyclically adjusted price-earnings ratio (PE), which has a long-term average of 16 times, is nearer the 1966 high of around 25 times than the 1982 low (of less than 10 times). This is not a buy-and-hold asset class."

He thinks the technology and biotechnology sectors are particularly stretched. "Being cautious and looking to preserve wealth, we will not invest where earnings are uncertain," he says. "However, we do hold some technology shares such as Microsoft which has re-rated a bit and Sage (SGE). We like software companies for reasons including their repeat revenues."

In the UK, he points to investment trust discounts which are historically tight.

Read our report on this

"Sentiment is very positive or complacency is high," he says. "Tight discounts indicate poor value and low future returns. It is not a time to be bullish but more cautious after a five-year equity rally."

In terms of the gold allocation, currently around 14 per cent, he argues that portfolio insurance is still required. "I think that since 2009 central banks have been conducting an unprecedented experiment which they won't be able to exit in a benign manner, and gold is long-term insurance rather than a short-term trade. I have long-term concerns on inflation and gold should provide us with some diversification and protection. Just because gold didn't work for one year doesn't mean we shouldn't have it. Inflation will come eventually."

Mr Lyon used particularly weak moments for gold in 2013 to increase the trust's exposure to the physical metal, although not to gold miners. "Our current level is enough but it is important to hold it for the time being," he says. "However, we do not expect to hold it for the long term: this is temporary. If we find more attractive opportunities we will use it to buy into assets such as equities."

See what Mr Lyon thought of gold two years ago

When the opportunity arises, he will also look to put the trust's "dry powder" - cash and equivalents - into equities. "Investors in general are giving companies the benefit of the doubt - a classic function of the stock market and how it works," he adds. "But it will reverse and give us an opportunity to increase our equity allocation."

His concerns on inflation also mean that index-linked bonds account for around 22 per cent of assets. "Linkers may not be such a bad investment if inflation is higher and could do better than equities in that environment, which is why we have held them for a while," explains Mr Lyon. "Over the next decade or two we will need real assets because there will be inflation. (Conventional) bonds are a licence to lose money."

He adds that during this period of weak performance investors "at least don't get a double whammy because the discount has gone out".

Personal Assets has a zero discount policy in place and the shares trade consistently around par.

Despite the trust's "annus horribilis" some analysts are keeping the faith.

Monica Tepes, investment companies analyst at Cantor Fitzgerald, suggested it as a contrarian bet for your Isa in last week's issue.

Winterflood says: "Given its approach, Personal Assets was always likely to underperform a bull market. However, to lose money in absolute terms is a disappointing result. But the investment rationale remains intact and this fund should outperform its equity orientated peers in difficult market conditions. In addition, its portfolio is well-placed to generate absolute returns over the longer term."

Source: Morningstar, *Personal Assets.

Performance

Morninstar as at 5 March 2014

Top Ten Equity Holdings as at 31 January 2014

Asset allocation