Volatility ahead: How to stay afloat in choppy waters
For most, it is almost irresistible to stay out of markets when they continue to rise against all odds. But Anthony Murphy, CEO of Lucerne Investment Partners believes the number one priority for investors right now should be capital preservation.
With many companies now trading at all-time highs, it appears investors are very bullish, expecting a V-shaped recovery. Murphy thinks many Aussie investors are 'all in' on markets. In his view, the year ahead is likely to be met with volatility, which is why he's reducing equity exposure.
In this interview, Murphy outlines how he believes investors should be positioning their portfolio, his three C's for identifying a successful fund and his outlook for the year ahead.
You are known for investing in high-quality funds early on. How does that approach improve your performance?
In investing, a lot of performance can be created by a first-mover advantage. Being early on to something that amounts to a great idea or strategy can generate significant returns. As the quality of a company or fund begins to be proven, its value will increase drastically. Take Afterpay for example, no one was really talking about it when it hovered around $3 - $4 a few years ago. Those who saw the opportunity back then really reaped the benefit of getting in early.
The same goes for managed funds. Those groups just cutting their teeth in the field often have finite pools of cash - meaning they can be more agile. Larger funds almost face this diseconomy of scale, where they become more sluggish the larger they become. Larger funds need to invest significant amounts of capital to move the needle on their investments. If you're managing $100 billion in a strategy, a 1% position will be $1 billion. There aren't many ASX companies that you can move in and out of without affecting the liquidity. Smaller funds are able to avoid these issues. We like this unhindered approach to funds management.
What are your 'three C's' for identifying successful managers early?
So the first is co-investment and this is non-negotiable for us. This is where the managers have their own capital invested in the fund. Too often in the funds management industry, funds are concerned with growing as large as they can since they charge fees over funds under management. If a fund manager is co-invested their interests become directly aligned with the shareholders.
Secondly, we consider the capacity of the fund very important. This relates to how much the fund will manage and whether there is a limit on this amount. Most managers today will have a cap set from day one and we want to make sure the funds stay true to that. As discussed above, the size of the fund is essential to determining how agile the managers can be and as they become less flexible, performance tends to drop away.
Thirdly, capital preservation is the final 'C' we consider before investing. However, the approach to capital preservation should differ between strategies. For a small-cap manager, we would like to see that they are able to take very large cash positions if necessary. Dealing with a great deal of risk in this asset class, the ability to turn positions to cash quickly is very important. For another strategy, such as private debt, managers are able to preserve capital through security over assets at an appropriate amount for the risk they're taking. Preserving capital through strategies like these is important to generating good quality returns.
What is the one thing most investors could do to improve their performance today?
Investors should do their best to avoid chasing performance. We've seen a strong recovery post-Covid, in the month of November alone the market was up circa 10%. The issue is that this performance has already happened. We have all tried it, but chasing that performance won't result in much.
Instead, I think investors should focus on capital preservation.
Warren Buffet's first rule of investing is "don't lose money". His second rule, "see the first rule".
As the index reaches highs of 6800 points their priority should be avoiding any future drawdowns of their investment capital. That is a bedrock of compounding returns over time.
At the moment, one way we're doing that by looking at other assets such as private debt. Due to the dislocation seen in equity markets, we see a lot of opportunities here as it allows fund managers and investors to write their own terms, take security over assets and generate very high-quality risk-adjusted returns, without waking up every morning and wondering what the stock market did the night before.
What does a typical portfolio look like for the average Australian investor and how do you think it should look?
As Australians, we are very patriotic and we enjoy holding the big Aussie names like Woolworths or BHP. While some investors will have an allocation to international equities they often remain underweight on these assets. We think investors should hold more international equities than they do Australian equities in order to better diversify their holdings.
Many hold a blend of fixed income products, including bank hybrids. Hybrids have become quite popular for Australian investors but that is something we like to steer clear of.
Finally, many investors are low on their allocation of cash and hold quite passive portfolios. We think in times like now, investors want to have large cash reserves and actively be monitoring their positions. This puts you in the best position to take advantage of the upcoming volatility and generate returns when the markets fall.
What are you expecting from markets over the next few years?
At the moment, many companies are hesitant to give earnings guidance given the volatility of markets. Despite this, many companies are now trading at their all-time highs. This tells us that investors are very bullish, expecting a V-shaped recovery.
The unpredictable path of COVID-19 will continue to drive markets for some time. We don't think the dispersion of a vaccine will result in an immediate recovery and stable markets.
The bottom line is that no one can provide a market outlook with any conviction today. So, rather than attempt to predict the unpredictable, we believe the best approach is a truly diversified portfolio containing a number of different strategies with a low correlation to equity markets.
A different type of wealth management
Lucerne Investment Partners is Australia’s pre-eminent independent Investment Group, providing high net worth investors access to a family office-style service. We allocate to any investment that meets your objectives and we invest alongside you. Click ‘CONTACT’ to get in touch.
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Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
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