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Archive for the ‘Troy Asset Management’ Category

Why quality stocks pay off

It is no accident that some of the best performing fund managers of the last few years have been those who have stuck to investing in powerful global equities with a consistent history of profitability and sustainable earnings and dividends. In the UK those who fall into this camp include Neil Woodford at Invesco Pereptual, Nick Train of Lindsell Train, Sebastian Lyon at Troy Asset Management (mentioned in my last post) and Terry Smith, whose equity funds solely buy and hold this kind of high return on equity stock. It is also of course at the root of Warren Buffett’s long success as an equity investor.

But why do so-called quality equities (defined as stocks which have low leverage, high returns on equity and consistent earnings) perform so well, yet are so regularly overlooked by the majority of investors in favour of more speculative growth stories? A recent research note from Jeremy Grantham’s team at GMO uses long run US data to highlight the persistently superior performance of quality stocks and their particular attractions in today’s binary (“risk on, risk off”) market conditions. The primary driver behind this superior performance is the ability of these companies to preserve and grow capital, not to lose or squander it as many do, either through incompetence or normal competitive pressures.

Here are a couple of short extracts from the GMO research paper:

True competitive equilibrium is a rarity in the global economy. Instead, we find persistent winners and persistent losers. The competitive paradigm says that highly profitable activities attract capital, and that capital flees those with low profits. This is the market mechanism behind mean reversion, which is supposed to close the profitability gap. In reality, certain companies earn persistently high returns on equity. Superior returns are delivered to investors in the form of dividends, stock buybacks, and accretive growth.

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Written by Jonathan Davis

August 18, 2012 at 12:17 PM

An invidious choice

I find it hard to disagree with these comments from Sebastian Lyon, the CEO of Troy Asset Management, writing in the annual report of Personal Assets, the investment trust to which he and his colleagues now act as Investment Adviser, following the death of Ian Rushbrook four years ago.

The secular bear market in UK and US equities is now in its thirteenth year. How much longer must we wait until we can again be fully invested (or even geared!) and reap the double-digit returns we long for? Ask the policy makers! Stocks would be considerably lower were central banks not keeping stock prices artificially high by means of zero interest rates and quantitative easing. Despite these interferences, stock markets have gone sideways during the past year. Savers have not been rewarded for taking risk and hence our cautious strategy has paid off, for now, although we are likely to lag short term rises in the market should further monetary interventions be forthcoming.

Politicians in Europe are confronted with the invidious choice between severe austerity, which is likely to lead to periodic recessions and declining tax revenues, or incautious borrowing in the hope of buying growth. Both approaches will eventually force governments to pay higher rates of interest on debts. The maths do not stack up. No wonder governments are looking to extricate themselves from an intractable problem by leaning on central bankers to pull their inflationary strings. But our greatest concern is that the European challenges that have dogged markets since early 2010 are merely the dress rehearsal for the main event – a US fiscal crisis. While the UK and Europe have at least tried to tame their budget deficits, the United States has pushed ever harder on the fiscal accelerator. Stock markets swooned last August when they got a shock preview of what might happen should the brakes be applied. Following the public disagreement in Washington over increasing the public debt ceiling, the Dow Jones Industrials Index fell 13% in seven trading days. Read the rest of this entry »

Written by Jonathan Davis

August 16, 2012 at 7:56 PM

New Year hopes

My suspicions back in the autumn that a market rally was on the way have, I am happy to say, been borne our by events. Not for the first time, the peak of rhetorical despair – this time about the dire outlook for the world economy should the Eurozone crisis not be resolved – has turned out to be the moment to turn bullish. The rally since the failure of the Cannes summit has been impressive.

The MSCI world index is up by more than 20 per cent since its October low and has risen for seven straight weeks in a row, something that has not happened since the spring of 2009, according to the equity strategists at Societe Generale. Equity markets have made an even stronger start in 2012, with January producing one of its best monthly returns for many years. Contrarian sentiment indicators, such as the venerable Investors Intelligence survey of investment advisors in the United States, once again proved invaluable in identifying a turning point back in the autumn.

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Patience the number one requirement

It is more than 15 years since I first trawled up to Edinburgh to meet Ian Rushbrook, the iconclastic onetime Ivory & Sime partner who took over the running of the near-dormant Personal Assets Trust in 1990 and soon turned it into one of the most successful capital preservation vehicles for private investors there is. Ian featured in my book Money Makers (first published in 1998, soon to be re-issued in a new edition).  A smart young fund manager called Sebastian Lyon was one of those who read my book and liking what he read, later made a pilgrimage to Ian’s den behind Charlotte Square to learn more about the business of managing money.

Now, several years on, as CEO of Troy Asset Management, a fund management business that originated as the guardian of  Weinstock family money, he also acts as Investment Adviser to Personal Assets, following Ian’s untimely death three years ago. The trust has since gone from strength to strength, delivering NAV growth of 51.7% in the three years to the end of November 2011, outperforming the FTSE All-Share by a useful margin as a result. With shareholders funds of more than £400 million, and a succesful no-discount policy in place, shares in the investment trust have now reached the giddy heights of being included in the FTSE 250 index. Read the rest of this entry »

Written by Jonathan Davis

December 20, 2011 at 4:18 PM

Taking The Helm

When a highly regarded and well trusted investment manager dies, it leaves the stewards of that fund with a delicate dilemma. Closing the fund, on the grounds that nobody can adequately replace the talent and commitment that has gone, is a wonderful posthumous tribute to the individual concerned. But it can also be a tricky business decision, involving as it does the painful duty of waving goodbye to fees and employment for those who remain responsible for the fund, and creating potential tax bills for the investors at a time which may not be to their liking or convenience.

On the other hand, recruiting a replacement for the departed investment manager by implication must inevitably take some of the lustre from the reputation of the man (or woman) who has to be replaced. If you have spent several years basing your fund’s marketing on so-and-so’s unique or exceptional talent, it is awkward to have to admit that they are now to be replaced by someone who, you now declare, is just as uniquely and exceptionally talented as the one who went before.

In fund history, I think it is fair to say, there are few examples where the first option is the one that has been adopted. Funds do close regularly after a star fund manager has retired or died (or simply lost the plot), but it is rarely for lack of effort by the fund’s sponsors to keep the entity alive. The urge to procreate almost invariably proves stronger than the desire to declare farewell or RIP. As the cult of the star fund manager is more often than not based on flimsy footings, this is hard-headed but not necessarily irresponsible.

In recent years, Fidelity has faced an acute version of this dilemma in the UK with the retirement from active fund management of Anthony Bolton, whose special situation funds had grown to represent a significant proportion of the firm’s funds under management. As his track record is one of the few that can genuinely be regarded as exceptional, whatever measure you care to choose, it is not surprising that his successors have struggled to make the same impact and the funds have duly shrunk in size and popularity compared to their heyday.

In Edinburgh, meanwhile, the board of Personal Assets has sensibly taken their time to choose a replacement for Ian Rushbrook, the idiosyncratic genius who saved an unloved investment trust from extinction when he took it over in 1990, but who sadly died last October at the age of 68.

As was noted in this space last year, he died ironically just as his unheeded warnings about the dire consequences of the credit and housing bubbles in the United Sates were finally coming to fruition. His analysis of the impending credit crisis remains unmatched for its clarity and foresight.

In his place the board have appointed as Investment Adviser the much younger CEO of Troy Asset Management, an investment management business that started life with a mandate to look after the money of the Weinstock family and other senior managers at GEC. It has since developed its own successful family of low cost unit trusts which share the same priority of preserving investors’ capital before looking to grow it. (The tragic demise of GEC provides an object lesson, incidentally, in how the difficulty of replacing great managers after their death is not confined to the investment business).

The odds of Personal Assets Trust surviving the loss of Mr Rushbrook without enduring damage look a lot more promising than most such succession plans. For a start, although his methods are different, the investment philosophy of the new adviser, Sebastian Lyon, is very similar to that of the man he is replacing. The board of the trust has always claimed an active role in arguing out its investment strategy.

It also helps that Mr Lyon and his family have had a chunk of their own money invested in the trust for several years. There have been minimal net redemptions of shares. All the shares that were bought in and held in treasury to minimize the discount have subsequently been reissued to new investors. The shares have continued to trade close to NAV, which is one of the trust’s unusual commitments to its investors.

Most importantly, perhaps, the new investment adviser talks conservative common sense, which is what the trust’s investors like. He remains wary of bank shares and corporate bonds, preferring to put his faith in the low ratings currently accorded to companies with strong franchises, cash flows and dividend growth (Nestle being a good example of a share that in his experience has never been cheaper).

He has added gold to the trust’s portfolio in lieu of the liquidity that Mr Rushbrook famously, and some felt excessively, preferred. Equities, discriminatingly chosen, in his view, remain the most attractive asset. That still looks to me like the right stance, and one that his predecessor too would almost certainly have echoed as we move into the post credit crisis world.

Written by Jonathan Davis

July 26, 2009 at 8:55 PM

Q and A: Sebastian Lyon

Sebastian Lyon, the CEO of Troy Asset Management, is one of the coming talents in investment management. The firm he runs was recently given the mandate to run the Personal Assets Trust in Edinburgh, following the untimely death of Ian Rushbrook in October last year. Troy Asset Management started life with the task of running the family money of the late Lord Weinstock and other senior managers at GEC, from whom he inherited his conservative investment style and a focus on capital preservation.

Troy, which is named after Lord Weinstock’s famous racehorse, now runs three low cost unit trusts on an absolute return basis. The funds are aimed at investors whose primary objective is to preserve capital. This is something that the Trojan fund successfully achieved throughout the sharp bear markets of 2000-03 and 2007-09. Sebastian is one of a number of top-flight professional investors who offer me periodic snapshots on their view of the markets, and whose low cost funds I am happy to own and recommend.

Where are we now in the market cycle, in your view?

We have been in a secular bear market for equities since 2000. This is a long process of valuations being derated. That has been my view since the Trojan Fund was launched in 2001.  The bear market is likely to last 10 to 14 years.  Having had two down phases (2000-2003, the tech bust and 2007-2009, the credit bust), we are now well into the second half of that bear market, in my view. Having been very cautious, we can begin to be a little more optimistic on equity markets. There is a clear correlation between starting valuations and 10-year equity market performance.

The UK stock market, for example, has derated from a PE of 24x in 2000 to a PE of around 10 today.  Bear markets usually bottom on single figure PEs, so arguably there is one further derating to go before we can celebrate an enduring new bull market.  Now that the S&P and the FTSE have bounced off the 2002/3 lows in 2009, markets may have bottomed in nominal terms, but not when inflation is taken into account.

In a bear market equity income is the key to equity returns as it is clear that PE multiple expansion is not likely.  We have therefore concentrated on stocks that pay a high and sustainable income.  This served us in good stead during the credit crisis when financials, cyclicals and highly leveraged businesses have all been forced to cut their dividends. Investors in these sectors suffered permanent capital loss and the added insult, in many cases, of huge dilution as balance sheets have had to be repaired.

What have you been buying recently and why?

Nestlé: Over the past five years dividend growth has been 14%. The valuation (11 x earnings) is the lowest I have seen it in my career, so what you get is a top quality consumer staple at a very attractive entry point. The firm is globally diversified, operates in 130 countries, and has a highly conservative balance sheet (interest cover of 16x). The company is a proven innovator and has better top line growth than its peers over the past 10 years. Yet it is valued at no premium to them.  Should inflation return, fast moving consumer goods companies will be in a good position to pass on rising input prices.

BATs. Over the past five years dividend growth has been 16%.  The tobacco company offers material international diversification for a UK investor since its sterling earnings are minimal.  We believe the UK economy with struggle to grow for a number of years and quality defensive international exposure is underrated by investors. Such predictable cash generators are often ignored or seen as dull by the consensus.

Berkshire Hathaway. We have avoided financials stocks such as banks and life companies because of the opacity of their structure and exposure to bad debts/illiquid unmarketable securities. Berkshire Hathaway has not performed well this year. Strong balance sheets are not in favour for now. Pricing power in insurance and reinsurance remains very strong however. Berkshire’s other direct corporate investments are valued conservatively at book value.  It seems we are paying little if any premium for Mr Buffett’s investment abilities. We know investors go through periods of according different degrees of goodwill to Berkshire. At present we have a good margin of safety, with some healthy upside on a two to three year view.

Gold: In a world of currency compromise gold will retain its real value and protect real wealth for private investors. Still viewed with skepticism by mainstream investors, gold has risen in value every year this decade.  Although we have a small exposure to gold miners, we prefer holding bullion as miners are notorious in failing to create long term value for investors. The volatility of mining stocks is also much higher.  Gold is independent from the world financial system and supply is limited, not something that can be said about sterling and the dollar!  I view our gold holdings as being in lieu of holding cash.

What are you avoiding and why?

We do not own cyclical recovery stocks and financials for the reasons given above.  Banks will require more capital and the overhang created by the UK ‘nationalised’ banks (Royal Bank of Scotland, Lloyds Banking Group etc) has still to be unwound.  A number of UK domestic sectors, such as pub stocks and airlines, have been recapitalized, but I believe they have not yet raised enough money. Debt levels are far too high.

I am wary of corporate bonds. There is a consensus rush into corporate paper which makes me nervous. We need to be in real assets – equities, index linked and gold.  Bond spreads may look mouth- watering, but liquidity is very poor in the UK corporate bond market.  My concern is that lessons have not been learned from the dash for yield that occurred in 2004-07.  The truth is that were it not for quantitative easing (QE), government bond yields would be higher and corporate bond spreads consequently lower.

Any further thoughts on the markets?

Investors are more short term minded than they ever were. They are not, in my view thinking forward to the unintended consequences of fiscal and monetary policy. I think and hope that following the severe losses incurred in 2008, the obsession with relative performance in investment may now be seen for what it is – an absurd and imprudent way to manage private wealth. What is suitable for pension funds is not suitable for irreplaceable capital, whether that capital has been earned or inherited. There may still be one final lesson to be learned before we can say goodbye to this problem.

Written by Jonathan Davis

July 24, 2009 at 3:31 PM