We've long liked Troy Asset Management. Personal Assets Trust, which it manages, is in MoneyWeek's investment trust portfolio. We are great fans ofits long-term, value-orientated flagship Trojan Fund. We've also written at length about the strong performance of the Troy Income and Growth Trust and Trojan Income Fund.
Imagine, then, my horror when it was pointed out to me that while I have interviewed all sorts of people (some fabulous, some not so fabulous) on these pages, I have never interviewed Sebastian Lyon, the firm's chief executive and investment director. Something of an oversight.
I know Sebastian quite well and he tends to have the look of a busy man about him, so when I did finally get to his office last week, we dispensed with small talk and went straight into the effects of quantitative easing (QE).
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I asked him if he thinks it works. First time round, he says, it did. We were on the edge of a huge deflationary shock and QE offset that by keeping money in the system. To the extent that it was designed to keep asset prices up (as Ben Bernanke openly said in November 2010) and so maintain confidence, you could also say it worked.
But it is subject to the "law of diminishing returns". Now that central banks all over the world are printing money (America, Britain, Europe, Japan, Switzerland) "the race to debase" of competitive devaluation has begun in earnest. That means that no one country can count on their own QE causing the kind of currency devaluation they need to get growth going.
At the same time, while QE in most cases has done enough to prevent markets from falling, it is no longer pushing them up in the way it did a few years ago. It also isn't doing much to get cash into the economy.
Instead, in Britain at least, it is only just offsetting the credit contraction resulting from cuts in bank lending. As CLSA's Russell Napier likes to say, "for every pound Mervyn King creates in London, Stephen Hester burns one up in Edinburgh".
Does that mean he thinks that King should create even more money? It does not. QE doesn't work. Any faith central bankers have in it is "entirely misplaced" it is only the lack of alternatives that mean they find themselves stuck with it "loony sect" style.
But the truth is that in the wake of a credit bubble collapse, you get a period of pain and you get a choice do you want to take it over "two or three years or do you try and extend it over ten or 15"? Sebastian's preference clearly would for the former.
"If it hadn't been for QE, the equity markets would be considerably lower than they are; there would be much greater value for investors and therefore we would be much more fully invested."
Right now, due to the fact that there isn't much value around, the Trojan Fund is only 30%-45% invested in equities. That's the lowest it has been since close to 2000. Valuations are not at attractive levels and the investor fixation with yield is getting worrying.
Equities need to be thought of as a very long duration asset in that, unlike when you buy a bond, you have no idea when, or indeed if, you will get your money back. With a bond, your duration is maybe five to ten years. With an equity it is more like 50-plus. That means you are taking a hefty amount of capital risk which is something that large numbers of people, in their "myopic search for yield", simply aren't taking into account.
It makes sense, of course, to look around for a return of some kind when the return on cash is effectively zero, but not without checking on the true value of the underlying asset providing that yield.
Are we in bubble territory? "It's certainly pretty foamy out there." The problem is that this kind of "unsustainable" situation can last for a long time (those in doubt need only check any single past stockmarket bubble).
Perhaps, says Sebastian, but there is a difference between now and, say, the run-up to 2007. Post financial crises, economic cycles tend to be much shorter and more volatile than usual, which might suggest that the overvaluation might not drag on for quite so long either.
In America and Britain the nasty recessions that should have appeared post-Lehman were cut short by fiscal and monetary stimulus. But the underlying influences didn't go away they were just disguised with a new wave of credit.
But the effect of these waves of stimulus constantly diminishes, leaving us with "ever decreasing circles" of activity cycles of more like three to four years than the seven to eight we were used to pre-crisis.
Let's not forget that only at the beginning of 2012 there was a wave of optimism as America looked like it had bottomed out, Germany was growing fast and China was "still going gangbusters". But now, only a few months later, none of that is true anymore even China is looking like it is "very firmly rolling over".
Troy has never invested directly in China, but Sebastian is recently back from Hong Kong, having visited with a view to investing in the Far East for the first time. Did he come back the proud owner of any new stocks? No.
Troy looks for a variety of things in its holdings, but core to its demands are "strong corporate governance, good equity ownership, and a very good long-term track record of looking after shareholders". There "aren't many of those" and what there are don't come cheap enough for Troy. So they are waiting. There is a strong chance that China will disappoint its fans this year and give value investors a chance to buy in at the right price.
I wonder just how bearish Sebastian is on China. Not as bearish as some, it turns out. He sees the next 18 months or so as not being a time of collapse, but one of necessary transition as the country moves from an all-out focus on industrialisation and exporting to being "more of a consumer society". It will be a "bumpy process", but only a crisis if it slows enough to create a "deflationary shock".
This brings us to pretty much the only thing that really matters for investors: is the end game of our financial crisis inflation or deflation? The investments in Troy funds are chosen based on the idea that it is most likely to be high inflation.
With all government policy geared towards preventing deflation and QE now more or less open-ended everywhere it's hard to see any other outcome (note that while the $40bn a month of QE the Fed is now running might not sound like much, "it can easily be increased from 40 to 80 to 120"). But there's every chance of a deflationary shock before the inflation really kicks off.
The former is likely to cause the latter by prompting more money printing, then a rise in the velocity of money as well. It is with an eye to this pre-inflation deflation that Sebastian holds so few equities in a deflationary shock, "the last thing you want to be holding is risk assets". What do you want? Gold.
Gold, says Sebastian, is a "monetary instability asset" and hence something that insures you against inflation and deflation (regular readers may be beginning to see why we're keen on Troy). So the Trojan Fund holds about 13% of its assets in gold bullion (via Gold Bullion Securities and ETFS Physical Gold Swiss Gold) and 6%-7% in gold equities.
I'm all for this for our most recent thoughts on why you should be in gold mining stocksread Is the gold mining sector about to take off? but I want to talk a bit more about the rest of the stocks in the portfolio.
Troy tends to focus on holding good, dividend-paying, blue-chip stocks. That's a strategy that has worked brilliantly for some years now (as MoneyWeek readers who have followed our advice to do the same will know). But there's a problem.
A few years ago you could buy the likes of Nestl and Coke at ten to 20-year lows. No more. Today all these stocks are pretty expensive despite the fact that they aren't immune from slowing economies and that means they come with a nasty downside risk.
I wonder if it's time to sell them. Not entirely, says Sebastian. He has cut back on high-quality stocks (Nestl was 5% of the portfolio in 2009, now it's only 2%) and replaced them to a degree with slightly lesser names (Microsoft and Imperial Oil, for example), but it is the high-quality firms "that I want to own on a long-term basis". That means holding cash and waiting (again, you need patience for this kind of investing) for prices to come down.
The key to all this for Sebastian is that successful investing isn't just about stock selection, it's about asset allocation too. When you're in the market you need to be in the right stocks but you also need to remember that the great investors, the likes of Sir John Templeton, made their real money by moving into markets when they were cheap and out when they were expensive.
That's what Troy, in the search for excellent long-term returns, is also trying to do. Is it working? The FTSE is more or less where it was when the Trojan Fund was launched in May 2001. Take into account dividends, and the total return from the index is around 40%. The respective numbers for the Trojan Fund are 100% and 170%. So far so good.
Who is Sebastian Lyon?
A graduate from Southampton University in 1989, Sebastian Lyon's first job in the finance industry came with Singer & Friedlander Investment Management. That was followed by a spell as a director at Stanhope Investment Management the firm that looked after the GEC pension fund.
Lyon's conservative style drew the attention of then GEC boss, the late Lord Weinstock, who wanted Lyon to manage his personal wealth. So in 2000 Troy Asset Management, named after Weinstock's famous 1979 Epsom Derby winner, was set up.
It now runs four low-cost unit trusts on an absolute-return basis and two investment trusts. They have a conservative emphasis, with the main aim being to preserve capital.
The flagship Trojan Fund is up 170% since its 2001 inception, while the Trojan Income Fund, which was launched in 2004, is up 92%. The two later additions to the stable have also done well. The Trojan Capital Fund is up 56% since launching in 2006, while Spectrum, which has more of an international focus, has returned 38.5% since its 2008 start.
