Interactive Investor

Personal Assets Trust: how to protect and grow wealth in turbulent times

5th May 2023 16:14

by Sam Benstead from interactive investor

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Personal Assets (LSE:PNL) Trust manager Sebastian Lyon sits down with interactive investor’s Sam Benstead to discuss how he invests to protect and grow capital in his ‘wealth preservation’ strategy.  

He covers the types of stocks and bonds he likes to buy and how high inflation and interest rates determine what investments to own, as well as the outlook for UK shares and the impact of banking failures globally. 

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Sebastian Lyon, manager of the Personal Assets Trust. Sebastian, thank you for coming in.

Sebastian Lyon, manager of Personal Assets Trust: Sam, it's a pleasure. Good to see you.

Sam Benstead: So, please tell me a little bit about the trust. It's a wealth preservation trust, is that accurate? And how do you invest to preserve wealth?

Sebastian Lyon: It is a wealth preservation trust. I think that is one of the better descriptions. We are trying to generate absolute returns over the long term, but importantly for investors who have earned their money and dont want to lose it, were not speculating, were not trying to make money aggressively. We are trying to protect the real value of peoples capital and grow it, and the first thing is protect first. If the opportunities are there to make good returns, we will take those opportunities. If, as at the moment, which Im sure we'll come on, its harder, then we will be more defensive. And I think weve proven over the long term that weve achieved that aim.

Sam Benstead: And how do you invest then, to achieve that aim?

Sebastian Lyon: Essentially, we have a very broad canvas to paint on, which is fortunate, so were not in any way handicapped. We dont have to invest along terms of index lines. We dont have to be fully invested in equities if we dont think equities is the right place to be. We have invested in various asset classes over the years, predominantly in equities, and thats where probably between 60% to 70% of our returns have come from. But we also hold fixed income. Weve owned credit, weve owned preference shares, we own gold and gold shares. Were not shy of holding cash and having liquidity through various amounts. So we pretty much can go anywhere. Where we tend not to go are those highly speculative areas. We tend not to invest in places like emerging markets. We want to be in well-recognised markets where the pricing is obvious and liquidity is good.

Sam Benstead: Last year was a very tough year for stock markets. How did your portfolio perform and what worked for you? What helped you protect investors?

Sebastian Lyon: Well, we were down between 3% to 4%, which was satisfactory, I would say. We don't like losing money. Clearly, it was the most difficult year, certainly since 2008. We actually made money in 2008, very modestly. I think in some respects it was harder than 2008. And the reason for that was that in 2008, there were places to hide. You could hold bonds and make some money, and diversify in a way, [then] last year bonds and equities fell. In fact, bonds fell pretty much the same as equities globally, so there wasn't that barbell relationship with bonds and equities that there has been hitherto, and we've been warning investors that that was the case, that when the bond markets eventually turned, that it was going to be very difficult to protect capital. But we were very defensively positioned going into 2022. We had reduced our equity exposure a great deal, down into the sort of low thirties to 20%, which is the lowest it's been for a very long time, certainly since around the financial crisis. So, we were very defensively positioned, which allowed us to effectively protect capital.

The other thing is that we had quite a meaningful exposure to the US dollar, which obviously went up in sterling terms, so that helped. Gold, which we hold, went up again, not in dollar terms but in sterling times, and we don't hedge our gold, so there were some pluses. Our stocks did reasonably well. We certainly outperformed the equity benchmarks. Companies such as Unilever (LSE:ULVR), for example, actually made a positive return in 2022, so while there were some negative returns in the equity part of the portfolio, it wasn't all negative by any stretch, but it was a very difficult year from the point of view of attempting to do our job, which is preserve capital.

Sam Benstead: Does your defensive approach mean that you sacrifice gains in bull markets and do you even mind that?

Sebastian Lyon: The downside is more important. This isn't about being greedy. This is about being relatively conservative and relatively cautious, particularly when we've been in such a long bull market. We inevitably became more cautious and reduced our equity exposure as we went through the bull market over the last decade. So if you look back to 2009, we had 70%-plus in equities. Before Covid, we had about 40% to 30% in equities, and then obviously we had the Covid blowout during 2020 and 2021, and through that. I would express it in terms of either leaning into risk or leaning back from risk. When prices fall and we are paid to take risk, we will lean in and take risk. So, for example, during Covid, during February and March of 2020, we leant in, took a little bit more risk. Obviously, markets fell very quickly and recovered very quickly, but we were recognising that we were near the end of the cycle anyway. When it came to 2021, we really did see that full blowout and a sort of a similar type of environment to the tech bubble. There were differences, but there were definitely similarities in terms of the retail participation, as an example.

Then we leant back from risk and took a lot of risk off the table throughout 2021. And, yes, that did mean that we probably missed that last sort of blow off, but the thing is, you can never time it. You never know when, there is no bell telling you when the top is. It certainly felt very febrile and quite a greedy market in the beginning of 2020, 2021 and through 2021. So we were permanently looking at the valuations of the portfolio, looking at the valuations of the overall market and thinking that we just want to take less risk. So when we came into 2022, really right from the beginning of 2022 onwards - we had Ukraine in February of last year, which really tipped the whole bear market over, really started the bear market in full force - then we were already positioned because if you weren't already positioned, it was really too late. So you have to be ready for these eventualities. You can't expect to be able to pivot [the] portfolio within a matter of days, notwithstanding the fact that we've got a relatively liquid portfolio.

Sam Benstead: We're now in this environment of higher interest rates, higher inflation. Do you think that's going to persist? And how do you invest to make money in this type of environment?

Sebastian Lyon: One of the things that we've been saying to investors is that it's going to get harder. And I think that people have got to be realistic about their assumptions. We have some clients, particularly charities, who don't necessarily give us an index benchmark, but they will give us an RPI+2%, or RPI+3 or RPI+4. Now, clearly last year with RPI at 10%, 11%, 12%, trying to generate RPI+2% or +3% is just not an objective. I think people have to recognise that returns are effectively going to be more modest. Certainly real returns are going to be more modest. But whereas in the past, the last decade, with inflation being 2% pretty much throughout that period between 1% and 2%, making real returns was a lot easier.

So, I think the key thing is initially to have realistic expectations. If you're going to expect RPI plus an amount, then I think you're going to have to take a lot of risk to achieve that. And that will inevitably be in an environment where interest rates are higher, so the cost of capital is higher. So that means, generally speaking, valuations become lower. And that's really what we saw in 2022. 2022 wasn't about a recession, it wasn't about earnings falling, it was about valuations falling. And that's why it was particularly painful. And I think that we are in an environment where we can expect valuations to continue to fall. We were in a period really from 2010 to 2020 of valuations getting higher and higher and higher, and effectively people were paying more for the same thing, people were paying a multiple of 15 times earnings 15 times profits in 2010 by 2020, certainly the end of 2020.

In 2021, people were paying 20 times, 25 times, 30 times for essentially exactly the same thing. What I expect is if inflation remains more sticky, which I expect it will over the next five or 10 years, then interest rates probably need to be higher than we've been used to in the past. And therefore those valuations are likely to come down. And that's why we're almost as defensively positioned as we are, because I would expect that inflation will remain sticky for all sorts of reasons. But the main reason is wages. Wages have not been rising for a long time and [they] make inflation sticky. In the past, we've seen inflation peak and trough and peak and trough. Before the financial crisis, when the oil price peaked at what is still an all-time high - I think it's [around] $140 - we saw inflation peak in 2008. Inflation came crashing down and then we saw sterling was very weak. And so we imported a lot of inflation in 2010. And that, again, dissipated. So there were short cycles of inflation that were never sustained. Whereas now I think with deglobalisation, with a lot of the forces that kept inflation very low now not necessarily in place any longer and geopolitics being far more important, I think for investors inflation is likely to remain sticky for longer.

Obviously there is the base effect, which I think we're seeing at the moment. We're seeing comparisons with this time last year with the oil price having spiked in February during the invasion of Ukraine. So there is that base effect. So we are seeing, as we saw yesterday, CPI in the US begin to fall. The UK's actually been stickier and more stubborn, which is quite characteristic of the UK, but we will see that base effect. The question is it's not so much what happens now because the base effect is obvious as we compare one year against another year, it's what happens next year and the year after, and how sticky that inflation is, and we're yet to see. But the key thing as an investor is we need to stay open-minded about that future inflation rather than think things are going to come back to exactly where they were prior to Covid. We're going to go back to a world where inflation remains at 2% and stays at 2%. I think central bankers sort of know that, which is why we're positioned in the way that we are and why interest rates are where they are as well.

Sam Benstead: And in this environment of high interest rates, which is putting pressure on economies, putting pressures on some parts of the stock market like the banking sector, what could be the next part of the market to be under pressure? And how do you invest in this environment? What do you avoid investing in?

Sebastian Lyon: It's really interesting what we're seeing at the moment, particularly during the first quarter with Silicon Valley Bank and the very sudden sort of surprise - surprising, I think, to most people - collapse of Credit Suisse [and the] sort-of forced merger of Credit Suisse. I think that the cracks are beginning to show a little bit, like where we were in 2006, 2007, and 2008, and that was a function of higher rates, higher rates tightening. Obviously, [where] the damage started was in the housing market. This time around it's been in the banks, and it has  been the banks, interestingly, not because bad debts are going up, but because depositors are starting to move their money. Depositors haven't had a return for 12 to 13 years. All of a sudden they can get a return from buying gilts or buying a US Treasury at 4% or 5%. So it's a huge change. I was looking at the Fed funds right before I came out, and six months ago in September we were still only at 2.5%.

So, in a way, it's surprising that the cracks are already showing's 5%. The Fed funds rate is 5% now. And the Bank of England's base rate is 4%. But only six months ago we were down in the twos. So my expectation is there will be quite a lot of monetary policy, [and] generally speaking, [it] works with a lag. And so we're not going to see the effects of the rates that we see today, the 4% to 5%, probably until the autumn or maybe even early next year. So you're right, the cracks are showing. And I would expect those cracks, [but] they're not going to come consistently,  they never do. That's the problem, they're very unpredictable. But I suspect we will see more as these deposit flight issues continue, which is something we haven't seen before, certainly not for a very long time.

To answer the question about how we invest, the answer is cautiously. I mean, the good news is we are now paid interest. We've got about 30% of our portfolio that's liquid at the moment, but it's in US treasuries and UK gilts yielding between 4% and 5%. So we are being paid to be cautious, which we haven't been for a long time. I think we have a portfolio which is very defensively positioned. We've got a lot of liquidity, we've got index linked, we've got gold. Equities are probably the most defensive that they've ever been and with the lowest allocation of equities. Obviously we don't hold banks, so that's a good start. And I must admit I've saved an awful lot of sleepless nights by not owning banks in the last 20 years, but not just banks.

I think you want to be very careful about cyclicality because we are heading towards some sort of harder landing [and] if interest rates go from 0% to 5% very quickly, then almost certainly we're going to see some sort of slowdown and banks are clearly holding back on lending due to that lower liquidity. So cyclicality you want to be very wary of and leverage you want to be very wary of too. One of the things that's happened over the last decade or so is that companies, and this is right across the spectrum, have taken on incremental amounts of debt. So we've gone from a situation where probably five to 10 years ago, a company that was comfortable having one times net debt to EBITDA, i.e. one times the annual profits in debt, probably now has double that amount. They probably have two times. And the ratings agencies say, well, that's fine because interest cover is still very healthy even with rates having gone up.

But the more aggressive companies - and certainly in the private equity space where numbers are more like four, five, six times and I've seen a number of US companies that have had debt because of deals that have been done at four times-plus - they're suddenly saying, 'Oh my goodness, our interest charge really is going up a lot. Are taxes going up a lot?' Suddenly, even if the top line is growing and the profits are growing, the earnings are not growing because their tax rates are going up and their interest charges are going up. So I think that's one of the dangers that has been under-represented within the market. I don't think that's the lag effect. You haven't really seen that pain. And I think that companies are just hoping that that's going to go away, hoping that their interest rate's going to come back down again. And we'll see, but I suspect interest rates are going to stay higher for longer. In which case that is where there could be some more action still to come.

Sam Benstead: Sebastian, thank you for coming to the studio.

Sebastian Lyon: Good to see you.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel, where you can like, comment, and subscribe. See you next time.

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