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Patient approach with the golden touch

INTERVIEW: Sebastian Lyon, manager of the Trojan Fund, talks to Moira O'Neill about achieving returns without excess risk - and why he still loves gold
Patient approach with the golden touch

Three years ago he was managing a modest £182 million in his Trojan fund. Since then the fund has grown to a massive £1.161 billion and his performance record at the fund's 10th anniversary at the end of May speaks for itself.

Troy Asset Management, of which Mr Lyon is chief executive, was set up to look after the family interests of the late Lord Weinstock, the revered former chief executive of GEC, with the objective of protecting wealth as much as growing it. With a total return over ten years of 143.5 per cent, compared to 55.4 per cent from the FTSE All-share index, the Trojan fund has consistently delivered top decile performance compared to its peers in the Investment Management Association's balanced managed sector, and is ranked 1st out of 55 in the sector since launch.

Incredibly Mr Lyon has managed to achieve this way above average performance by taking on below average risk. Over the period the fund has had an average monthly volatility of just 2 per cent compared with 4.5 per cent for the FTSE All Share. This is over a decade with huge stock market volatility with two 50 per cent falls. "Taking on risk to generate good returns is such a mistake," he says. "Back in 2001, I thought there was far more risk to capital than upside. It is important that you don't just hope for the upside but also think about downside risks."

So in 2001, having a "fairly good feeling" that it would be difficult to generate capital returns in the equity market over 10 years, he decided that income generating companies would do better in this environment. In May 2001 he was only 20-30 per cent invested in equities. He raised this to 50-60 per cent exposure in 2003 when he was "not aggressively bullish but thought stocks were fairly good value" and then in summer 2008 was very defensively positioned. At the end of 2008 he had gone from 40 to 75 per cent in equities. Since the market came off the top this year, "we have quietly and slowly battened down the hatches", reducing equity exposure to 40 per cent, mostly in higher dividend yield, lower risk stocks such as British American Tobacco and Nestle (see table for other top holdings). In an inflationary climate, he likes companies with genuine pricing power such as Coca-Cola and Unilever.

Sebastian Lyon CV

Sebastian graduated from Southampton University in 1989 and worked at Singer & Friedlander Investment Management. In 1995 he joined Stanhope Investment Management (the management company for the GEC Pension Fund) where he jointly managed the £2 billion equity portfolio and the Fund’s asset allocation. He was appointed Director in 1999.

In 2000 he left to establish Troy Asset Management, where he is chief executive and fund manager of the Trojan Fund and Trojan Capital Fund. He is also investment adviser to Personal Assets investment trust ().

The rest of his portfolio is in cash, index-linked bonds (linked to the Retail Prices Index) for inflation protection and gold, because he doesn't think today is a good starting point for investment in equities. "Ultimately, I anticipate we will get better opportunities to invest, even though we are not getting interest on the money."

Despite his inflationary expectations, he does hold cash - rather a lot, at 17 per cent of the portfolio. "You may be losing money because of inflation, but there are still times when cash is the right thing to hold on a two- to three-year view. With cash, you might lose real value but you don't lose nominal value." He thinks many of the alternatives are even more unattractive given the overvaluation of conventional bonds and most equities. Cash provides an ability to purchase stocks when they become cheap.

Although he does believe equity valuations are lower than ten years ago, he thinks that we are ten years into a 15-year investment cycle and the period when he will be very optimistic is yet to come. All he can say is that "it will be within 10 years and could be within 3-5 years". As he states in his April newsletter to fundholders, "patience is the friend of investors with a long-time horizon".

Sebastian Lyon

The tenth anniversary is important for Mr Lyon because he believes long-term goals are what should matter to investors. He accuses the fund management industry of being too short-termist, concentrating too much on monthly performance figures than longer term track records. "When we set up the Trojan fund there was no one leaning over my shoulder and the Weinstock family never interfered in the investment process. They never questioned the investments I made," he says. "Lots of managers don't have that freedom [for those that do read ]. There is often too much business risk involved to give the manager that latitude."

Investors have cottoned on to his winning formula, with the Trojan fund coming near the top of many fund sales charts from stockbrokers and fund platforms. The fund doubled in size in 2009 and again in 2010.

This led to the decision earlier this year to "soft close" the Trojan fund to new investors. Mr Lyon says he didn't want it to double in size again in 2011, a decision that he says is more about his time constraints (he is also investment adviser to and several charity and endowment mandates) than any 'too big to be nimble' worries. It may reopen again. But you can still buy the fund via platforms like Hargreaves Lansdown, Skandia, Alliance Trust Savings, Novia Financial, Axa, Standard Life, Ascentric, Transact and Nucleus Financial.

Table: top 15 holdings* excluding short-dated government bonds

Instrument% Fund at 31 May 2011Year of initial purchase
Gold Bullion Securities72005
ETFS Physical Gold5.32010
British American Tobacco4.12002
Newcrest Mining2.42009
Newmont Mining2.32002
Johnson & Johnson22007
Philip Morris1.92010
Reynolds American1.62004
Total top 1541.8 
21 other holdings37.1 
Cash & Equivalent21.1 

* as of 31 May 2011

The golden touch

Sebastian Lyon is a contrarian investor and his biggest contrarian position in the Trojan fund is the 12 per cent holding in gold. Gold is a big differentiator for the Trojan fund as other managers don't like it, but Mr Lyon has held gold in the Trojan fund's portfolio since 2005.

He acknowledges the old argument against gold - that it doesn't yield anything - but he has no truck with the idea that this makes the yellow metal impossible to value, and hence worthless.

"Gold has always had intrinsic value whereas paper currencies have come and gone, like blossom in the spring," he says. "Back in 1919, a £20 note could have been exchanged for 20 gold sovereigns. Now those sovereigns are worth £5,000. You would have been a lot better holding your money in gold than in £20 notes."

Mr Lyon believes that gold is a monetary asset and competes with paper currencies as a store of wealth, while the allure of the dollar, sterling, yen or euro diminishes with ongoing money printing and negative real interest rates. He doubled his gold holdings in summer 2009 when the central banks took desperate measures to avoid deflation and printed money. "I could see that a £20 note was not going to be worth that in 3-5 years' time. The governments didn't want the effects of deflation and as a result we have a 'phoney world' with zero interest rates, asset prices distorted and governments printing money."

Nor does he agree with increasingly and "idle talk of a bubble building."

"We are in one of those cycles where gold has gone up five-fold over the last ten years. It has been a gradual but steady bull market. Gold performs very well during negative real interest rates and we are in that in the UK. There is no sign of interest rates going up. It is a very good environment to own gold."

In his May newsletter, he points to a remarkable story in the Hackey Citizen, "Hackney hoard of gold coins fails to count as treasure, court rules". The article tells of the forward-thinking Martin Sulzbacher, a German Jewish banker, who hid a hoard of 80 gold coins in a garden and subsequently had a streak of bad luck, which included internment. He never found the coins but they were discovered by a local resident and have been returned to Mr Sulzbacher's son. "At a value of £100,000, no paper money could have preserved wealth better over the 70 years," says Mr Lyon.

"I was asked recently by an investor 'What is the difference between gold and tulips?'," says Mr Lyon, referring to the famous 'tulip mania' in the 17th century. "Mr Sulzbacher's relations can happily answer that question. With only 0.6 per cent of global financial assets invested in gold (compared to 3 per cent in 1980) and with the supply of paper money increasing at an exponential rate, we are way off bubble territory."

How does he hold gold?

As the Trojan fund is an open-ended investment company, under Financial Services Authority regulations it is unable to hold physical gold bullion. So he holds gold via gold exchange-traded commodities (ETCs). These are transferable securities that trade on the stock exchange just like an equity, while providing a return equivalent to movements in the gold price less the relevant management fees.

His first holding was Gold Bullion Securities (GBS), and in 2010 he bought ETFS Physical Gold (PHAU) []. Both ETCs are backed by physical allocated metal held by the custodian HSBC. Each individual security has an effective entitlement to gold, and that entitlement changes daily to reflect the accrual of the management fee (0.40 per cent in the case of GBS and 0.39 per cent for PHAU).

Although ETF Securities, the provider of both gold ETCs, backs the securities with physical bullion, there had been some tittle-tattle about whether the gold was there. In August 2010, Mr Lyon put this gossip to the test. He gave ETF Securities 10 days' notice to deliver £45 million dollars worth of gold bullion to his bank. They delivered it. "It was an acid test for them," says Mr Lyon. "They saw the logic from our point of view because there have been some issues around ETFs. The nice thing was I had confidence in PHAU, and have since increased my investment in gold."