At the risk of sounding like a broken record, we are still very much living with the fallout from the 2008 financial crisis. Central banks across the world have thrown almost everything they have at stimulating growth in the hope it will eventually lead to higher interest rates. However, with many countries now experiencing negative rates, it seems such tactics have, by and large, failed.
Indeed, after years of investors viewing central banks as omniscient they are now beginning to realise their limitations. This recognition could go some way to explaining the sharp fall in stock markets year to date.
Investors face a dilemma when choosing the most suitable asset class for their savings. One of the most overlooked elements for any portfolio is cash. Despite the low returns available, in low-inflation environments such as today, it retains its purchasing power well. However, other than for the very risk adverse, it is unwise to hold an entire portfolio in cash.
So what about the “investment” portion? Fund managers will do the legwork for you and I suggest selecting at least one that will focus on losing as little capital as possible in the bad times.
Take Troy’s Sebastian Lyon, who manages its flagship Trojan fund and Personal Assets trust. In the past 15 years global stock markets have experienced two significant setbacks and Lyon is currently preoccupied with whether a third fall is coming. While he cannot be certain, he feels it is the most likely scenario.
With this in mind, his portfolio is positioned for tougher times ahead. He holds 24 per cent of the fund in cash or UK gilts, 15 per cent in UK index-linked bonds and 9 per cent in US index-linked bonds. On top of this, he holds 10 per cent in physical gold and 1 per cent in gold shares. Equities account for the remaining 41 per cent of the portfolio, split 13 per cent in UK equities and 28 per cent in those listed overseas.
The defensive nature of the cash and bond holdings are likely to shelter the fund from falls in equity markets or rising interest rates. However, it is important to note this asset allocation is in light of the current environment. When equities become more attractively valued exposure to the asset class is likely rise and could account for as much as 75 per cent of the portfolio. The level of cash and the ease with which the bond positions can be liquidated means Lyon is well positioned to take advantage of this opportunity as it arises.
Fundamentally, he feels many companies have overreached themselves in order to satisfy investors’ demand for income. Some have chosen to pay out cash rather than invest in growth, whereas others have taken on debt. Lyon does not view this as sustainable and these practices are likely to have a negative impact on share prices over the next few years.
The fund’s equity exposure is therefore concentrated in defensive stocks, such as tobacco companies Philip Morris and British American Tobacco. He has taken profits from holdings such as Microsoft and Reynolds American.
Lyon’s reasoning behind the fund’s relatively high gold exposure is simple. Interest rates are still some way from normalisation and there is a risk of negative rates if central banks lose control. In this scenario, investors often seek to hold gold over cash, driving the price higher. In contrast, the fund’s index-linked bond exposure provides insurance against rising inflation.
Lyon sticks resolutely to his objective of making money during the good times while sheltering investors from market falls. Since the fund’s launch in May 2001, he has successfully outperformed two bear markets and I have faith in his ability to repeat this.
Mark Dampier is head of research at Hargreaves Lansdown