Behind Trojan walls

As chief executive of Troy Asset Management, Sebastian Lyon's main concern is not to lose investors' money. He used to work for GEC as one of the team running its pension fund but in 2000 was asked by GEC managing director Lord Weinstock to set up an independent management company to look after £36m of the family fortune, with a brief to look after it conservatively.

Troy's three funds are open to investors who have £10,000 (or £7,200 in an individual savings account) to invest, and between them they have assets of £258m.

"It's not an easy time to be a fund manager," admits Mr Lyon, who manages the conservative Trojan Fund and co-manages the more aggressive Trojan Capital Fund. "We will probably continue to be in a bear market for the next year or so."

Bear markets are where absolute return funds such as Mr Lyon's should come into their own. The company was founded on the premise that many investors were disillusioned with the focus of the investment management industry on relative, rather than absolute, returns. Troy's funds are conservative portfolios for the long term - the ultimate goal is steady growth in all market conditions with minimum volatility.

Contrarian, but not stubborn

Although Troy aims for the holy grail of absolute returns, it's not a hedge fund manager. Mr Lyon adopts a long-term, long-only approach to equities and does not 'short' or sell equities that are not owned in portfolios.

"We try to be contrarian - but not in a Tony Dye stubborn way," he says. [Mr Dye earned the nickname 'Dr Doom' for his obstinately pessimistic stance on shares during the stock market boom of the 1990s; this led to his being ousted from his job at Phillips & Drew Funds Management - but he was eventually proved right.] "There are times to be contrarian and times to be sensible - now is a time to be sensible."

With his sensible hat on, Mr Lyon doesn't think much of current contrarian calls to buy banks and housebuilders. "The environment will still be difficult for them in 18 months time," he says.

Launched in 2001, the £182m Trojan Fund is a balanced fund that aims to protect investors' capital and increase its value year on year. The fund pursues an active asset allocation strategy in order to capture a wide range of performance and risk diversifying opportunities.

Mr Lyon is refreshingly critical of the fund management industry for its high charges. "Our fees are low compared with the industry. I think 1.5 per cent is excessive as an industry norm. So we have a 1 per cent flat fee on our Oeics."

The Trojan Fund is designed to be used by investors as the core of their lower-risk assets. "It's not a classic balanced fund holding 80 per cent equities and 20 per cent bonds," says Mr Lyon. "We're not frightened of holding cash and are below average risk compared with our peers." Over the year to 30 June, the Trojan fund was down 5.3 per cent, compared with the FTSE All Share's loss of 13 per cent.

Freedom to roam

Mr Lyon has the freedom to invest in equities, bonds, preference shares and commodities. His equity weighting can range from as little as 25 per cent when very cautious up to 75 per cent when he is more optimistic. Equity exposure is currently 45 per cent. The cash weighting is an active allocation decision and can range from 1 to 50 per cent - its currently 19 per cent.

Within the equity portfolio, the fund invests in 30-45 UK and selected overseas companies. "We pick stocks carefully on upside and downside risk. We're not sizeist but need companies with strong balance sheets," explains Mr Lyon. "This pushes the portfolio in the direction of large cap and liquidity."

He likes family-run businesses such as soft drinks manufacturer AG Barr (which produces Irn Bru), as they tend to be more conservatively financed. "We believe in family-run businesses. They want to leave something for the family to inherit."

Other typical Trojan Fund holdings include Tesco ("which should be viewed as a global rather than UK business - it has huge potential in the US"), BT which "has been disappointing" and Sage, "a growth situation".

"We like to hold things for the very long term," he says. "In the Trojan Fund, we've held British American Tobacco and National Grid for four to five years. We stick with things and keep costs down for investors. I've met a manager whose turnover was 120 per cent. Although his performance was very good, that's not our strategy."

In the Trojan Capital fund, which he co-manages, Mr Lyons has sold a number of holdings in consumer cyclical sectors, including motor dealer Inchcape, and Holidaybreak, the tour operator. "These businesses are very vulnerable to the consumer downturn beginning to take shape. High ticket items, like cars and holidays abroad, will be exposed to the inevitable reduction in spending."

However, at the opposite end of the scale are products bought every day. Mr Lyon recently acquired a new holding in Bic, the maker of razors, lighters and pens. "Bic has a strong brand, net cash on its balance sheet and is on a very low multiples to earning (11 times) and book value (1.3 times). This provides comfortable downside protection amid a challenging environment. The company may even benefit from trading down."

Gold and mining

So what about the remaining 60 per cent of the Trojan fund's portfolio? Gold is more than 5 per cent of the portfolio, held through the Lyxor Gold Bullion exchange-traded fund. Mr Lyon thinks gold is a critical part of a portfolio when currencies are being devalued as they are at the moment. "Gold is the ultimate financial currency," he says.

Apart from gold, the Trojan Fund doesn't hold commodities at present because "they're very volatile and we try to reduce volatility". Saying this, he has held the BlackRock World Mining Trust in the past, and "might get back in". For the moment, though, he says: "I'd rather play commodities with gold than mining stocks".

Although sterling seems to have stopped falling, for now, with monetary and fiscal policy in stasis, Mr Lyons thinks the currency appears likely to take the strain. In June, he therefore added to the Fund's Swiss franc exposure. He is also beginning to build his exposure to index-linked assets.

Mr Lyon's cautious approach stems from his belief that we are in the second phase of a bear market. Will the next rally be the end? It will be difficult to tell. "The key will be the central banks being aggressive against inflation. We're not there yet."

His stance on the credit crisis differs from other fund managers who see buying opportunities in banking stocks. "We've been very sceptical about banks and, although we hold some preference shares, we don't hold any equity," he says

Not banking on banks

"There won't be reversion to the old type of bank lending. The new need to lend to someone you trust has huge ramifications in equity markets. Even good stocks are being revalued. I think there's still a couple of years to go in banks raising capital so you need to be careful.

"It makes total sense for the savings ratio to rise in this environment. But with savers being squeezed in real terms it will be difficult. Economic growth will be slower."

He warns investors not to draw conclusions from the previous cycle. "People are looking back to 1991 but I think the current downturn will be more like the early 80s. If inflation takes hold, it will be more like the 70s."

His biggest tip is that "Financials distort what is happening in the market" and investors should look at the FTSE All-share ex Financials index for a true picture.

So where should investors seek comfort? "When we set up the Trojan fund, the PE ratio on the FTSE was 22, double what it is now. The derating of large caps is almost over. You should be in large liquid stocks such as Johnson & Johnson and Coca Cola."

In the Trojan War, the Greeks waited nine years to win their prize of the city of Troy and Mr Lyon is also prepared to wait for the right time for a buying spree. "Patience is necessary. Our whole industry lacks patience," he says.

"Sometime by the end of next year you will have the opportunity to buy equities at very attractive levels. On a PE ratio of less than 10 in the long run, you will make lots of money."

TROJAN FUND ASSET ALLOCATION (As as 30 June 2008)

TROJAN FUND PERFORMANCE (Source: Lipper Hindsight)