The secrets of investing when inflation is high

TL;DR

To preserve capital when inflation and interest rates are high, Sebastian Lyon emphasizes patience, lower stock-specific risk, reliable businesses, liquidity, and diversifying assets. Personal Assets Trust reduced its exposure to Microsoft and Alphabet, spread its equity allocation across about 15 stocks, and bought UK gilts when yields approached 5%. Read on for its approach to valuations, company selection, gold, inflation-linked bonds, and duration risk.

Transcript

foreign ER interview Our Guest today is Sebastian Lyon manager of the personal assets trust Sebastian thank you for coming in Sarah it's a pleasure good to see you we're now in this new environment of high inflation and high interest rates you are a wealth preservation trust so how are you investing today and what have been your big recent changes ... Read More

Key Insights

• 🤭 The Personal Assets Trust has been relatively quiet in making changes to its portfolio, as it was well-positioned for the current market conditions.
• ✳️ The trust reduced exposure to U.S tech stocks due to risks in growth and valuation and focused on reducing stock-specific risk within the portfolio.
• ✳️ Lyon emphasizes the importance of managing risk by avoiding leverage risk, business risk, and valuation risk. Instead, he prefers companies with consistent revenues and solid growth.
• 🥳 The trust sees value in the UK and European markets, with a focus on avoiding highly cyclical sectors and seeking opportunities in the less exciting parts of the market.
• ✳️ Gold plays a role in the portfolio as a diversifier and protection against negative real interest rates, geopolitical risks, and sovereign risks.
• ✋ The trust finds index-linked bonds and U.S Treasury Inflation-Protected Securities (TIPS) attractive for their potential to generate high single-digit returns in a higher inflation environment.
• 😮 Short-dated government bonds provide liquidity and flexibility while avoiding excessive duration risk in a bond market with the potential for rising yields.
• 🔬 Sebastian Lyon personally invests in the Personal Assets Trust, aligning his interests with those of the trust's shareholders.

Questions & Answers

Q: How should investors preserve capital when inflation and interest rates are high?

Sebastian Lyon’s approach is to remain patient, wait for higher rates to produce lower equity valuations, and avoid risks that can cause large drawdowns. Personal Assets Trust also maintains liquidity and spreads its equity exposure more evenly rather than relying on a few large positions.

Q: What changes did Personal Assets Trust make before and during the high-inflation environment?

In late 2021 and early 2022, the trust materially reduced its equity exposure, particularly its large positions in Microsoft and Alphabet, because Lyon saw risks to growth and valuations. It also reduced stock-specific risk and used available liquidity to buy UK gilts when yields approached 5% after the mini-budget.

Q: How does Personal Assets Trust limit stock-specific risk?

The portfolio holds about 15 stocks, with many positions representing roughly 2% to 3% of the overall portfolio instead of 6% or 7%. Lyon says this made the portfolio more evenly distributed from a risk perspective and helped avoid large drawdowns.

Q: What types of companies does Sebastian Lyon favor for wealth preservation?

Lyon favors companies with consistent revenues, including contracted-revenue software businesses and companies selling essentials or little luxuries. He highlights staples such as Unilever, Nestle, and Procter & Gamble because these businesses have delivered solid long-term growth.

Q: What investment risks does Sebastian Lyon try to avoid?

He seeks to avoid leverage risk, weak or unpredictable businesses, cyclical risk, and valuation risk. The trust generally avoids highly leveraged property companies, volatile businesses such as airlines, profitless speculative companies, and stocks trading at astronomical multiples.

Q: Why does Sebastian Lyon invest with a long holding period?

Lyon waits for strong businesses to fall out of favor and adjusts position sizes when valuations become attractive rather than trading frequently. The trust has held Unilever since 2004, Diageo since 2006, and Microsoft since 2010.

Q: Why does Personal Assets Trust hold gold?

The trust uses gold as a portfolio diversifier and as protection against negative real interest rates, geopolitical risks, and sovereign risks. Its physical gold is held in an allocated account to provide low-cost protection.

Q: Why does the trust use inflation-linked and short-dated government bonds?

The trust views index-linked bonds and U.S. Treasury Inflation-Protected Securities as capable of generating high single-digit returns in a higher-inflation environment. Short-dated government bonds provide liquidity and flexibility while limiting duration risk if bond yields rise.

Summary & Key Takeaways

• Sebastian Lyon believes in patiently waiting for valuation situations to resolve themselves before making changes to his portfolio.

• Recent changes include reducing exposure to U.S tech stocks due to risks in growth and valuation, as well as reducing stock-specific risk within the portfolio.

• Lyon emphasizes the importance of managing risk by avoiding leverage risk, business risk, and valuation risk, and instead focuses on companies with consistent revenues and solid growth.