Lucerne’s Anthony Murphy gets defensive amid fears the market’s party is over

Amid warnings of an imminent market correction, Lucerne Investment Partners CEO Anthony Murphy doesn’t want to be the last one to leave the party.

Traders work on the floor at the New York Stock Exchange. Says Anthony Murphy: ‘The US sharemarket is now 2.1 times larger than the US economy. To put that in perspective, pre-GFC it was 1.3 times, and pre the dotcom crash it was 1.7 times.’ Picture: AFP

Amid warnings of an imminent market correction, Lucerne Investment Partners CEO Anthony Murphy is on the hunt for investments that offer downside protection. Like everyone else, he doesn’t want to be the last one to leave the party.

To hedge against the impact of a correction, Mr Murphy’s Lucerne Alternative Investments Fund, or LAIF, has been reducing its market correlation in the portfolio to record lows and taking positions that will generate returns even if the market turns.

“We are concerned about euphoric behaviour in the market which is generally the last stage of a bull market.

“So we’ve been allocating more capital to managers that over the long term have proven to deliver returns in large market dislocations. That can be done with long short equity funds, but another strategy that we‘re looking to deploy capital to at the moment is a volatility strategy.”

This strategy will see LAIF effectively pay a risk premium each month, just like insurance.

“If the market crashes, you get that payout. A number of our underlying managers delivered that last year, but now we’re looking at a specific volatility manager that can deliver returns of sort of 30 to 40 per cent, in a two-month window if the market does fall out of bed.”

Mr Murphy sees the potential for a correction before the year is out, as valuations, in the US in particular, reach extreme levels.

“The US sharemarket is now 2.1 times larger than the US economy. To put that in perspective, pre-GFC it was 1.3 times, and pre the dotcom crash it was 1.7 times.

“So it’s a pretty serious statistic and it tells you that the world is absolutely banking on, and hoping, that earnings catch up. If they don’t, I think there’s pretty stormy skies ahead,” Mr Murphy said.

The market could be 20 or 30 per cent lower by the end of the year if a correction hits, he warned.

“Every time the market corrects it corrects quite sharply: In the GFC the market fell 25 per cent in two months. Last year with the pandemic it fell 40 per cent in three weeks.

“The market will wake up some day, and say, ‘Well, this is overheated, it‘s ridiculous, we need to go back to mean reversion back to more appropriate long term PE ratios’.”

Anthony Murphy, CEO of Lucerne Investment Partners.

Mr Murphy has held the top job at Lucerne, a fund manager that invests in other funds, also known as a fund of funds, since 2015.

The alternative investments LAIF seeks out are designed to give investors equity-like returns without the equity-like risk. The fund returned 31 per cent last year and dropped just 5 per cent in March 2020, when the equity market crashed 30 per cent.

Despite investing in complex and opaque products, the fund is a retail product and provides a way for retail investors to access wholesale funds, Mr Murphy said.

Last year, the fund made the decision to dip its toe into crypto waters, handing over a sum to local crypto investment fund Apollo Capital. After scoring a 400 per cent return on its investment, LAIF took profits and reduced its investment.

“When you’ve got photos of dogs’ faces on coins that are worth $50bn, that’s when there’s euphoria in that space. When there’s local church parish insurance groups that are setting up crypto trading funds for their youth community, that’s when we hear alarm bells. We didn’t want to be the last at the party so we reduced significantly.”

Not wanting to abandon the crypto space completely, LAIF has again entrusted Apollo Capital with a portion of its funds, this time in Apollo’s new Opportunities Fund, which aims to take advantage of market neutral strategies in the crypto asset market.

The opportunities fund deals with crypto investing in a similar way to the margin lending space, Mr Murphy said.

“You can actually just lend out your holdings or provide them into a platform for others to buy.”

“You’re not going to have any significant drawdown with a product like that, and that really sits with LAIF’s mandate, that’s where the discipline comes in: We’ve done really well with crypto, let’s recognise that and now let’s own the asset, through a different strategy that can still provide a high double digit return, but without the risk of crypto.”

Apollo is providing a fixed target return of 30 per cent per annum on its opportunities fund.

Alongside crypto, LAIF’s other investments include convertibles, a space that Mr Murphy says is both under-appreciated and often misunderstood by investors.

The fund’s biggest weighting, at 15 per cent of the fund, is in one such investment manager that provides debt to ASX growth companies and then converts that debt to equity.

“That fund will go out to those businesses and provide debt at a coupon rate of say, eight to 12 per cent per annum. But then attached into that they‘ll have a call option or warrant for the equity.

“And so if the business actually does start performing and its share price appreciates, the fund will then convert that debt into equity at a premium to that conversion price, and sell out over time.”