EBB, EBI, and EAIT

Received the documentation and forms for the revised version of the planned EBI delisting today. I'm going to withdraw 6000 of my 8707 shares from EBI and apply for shares in the new unlisted EAIT. The number that I'll keep in EBI is exactly the number that I was going to withdraw from EBI in the previous delisting proposal. No redemption of EAIT units will be allowed till the end of this year. Keeping EBI shares allows for some liquidity and reduces my EAIT stake to 5% of net worth (at the NAV value). The plan is to gradually wind up EBI and distribute the proceeds. My impression is that a big chunk will be distributed this year and then the remainder over the next few years. There can still be some hitches in this process mainly concerning financing. Currently EBI holds $1.57 in assets for every $1 in equity. This is accomplished through a swap provided by Macquarie Bank. Macquarie still hasn't said whether this financing arrangement will be maintained for EBI once EAIT is delisted and Laxey Partners become the effective investment manager for EBI. Financing for EAIT is in place (subject to some conditions).

In the meantime, the share price of EBB the current manager of EBI has skyrocketed from a low of 3.5 cents on December 8th to 12 cents at today's close and an intraday maximum of 14 cents. In response to an ASX query EBB stated that there is no news that the market is unaware of and that they will be announcing a positive operating profit for the financial year that closed 31st December. Actual P&L will be a loss due to writing off of intangible assets. The real news is that the various companies controlled by Steve Eckowitz have been selling shares in EBB including sales by Harsit Holdings of 17.7 million shares on 17th December and 14.9 million shares on 31st December. In total they have sold a net 34.3 million shares of the 48.8 million that they held last December. Ecko Investments sold essentially all of its 3.8 million shares - most of them in December and Pointyen Pty sold all its 225 thousand shares on 31st December. This seems to be due to margin calls related to ANZ from what I can tell. I suppose that traders think that the (forced) selling must now be over. Wingate Group's purchase at 4 cents a share is now looking like a brilliant move. I hold 20,000 shares with 10,000 bought on 17th December for 6.1 cents.

EBI Management Ponder a Buyback

I'm not the only one who thinks this investment is a bargain:

7 August 2007

ASX RELEASE

Everest Babcock & Brown Alternative Investment Trust (EBI)

EBI applies to ASIC for relief to conduct buy-back

Following the announcement of an unaudited net tangible asset backing per unit (NTA) of $4.06 as at 31 July 2007, the responsible entity of EBI announces that it is considering conducting an on-market buy-back of EBI units. It has today applied to ASIC for the appropriate relief.

As at close of 6 August 2007 the market price of an EBI unit was $3.18 being a 22% discount to the July NTA and EBI believes that a buy-back would be an efficient use of capital which would generate unitholder value.

Any buy-back is subject to ASX consultation, ASIC relief and potentially (depending on size) unitholder approval. At the time ASIC relief is obtained, the responsible entity of EBI will review the discount between the EBI unit price and its NTA and will determine its next course of action.

************************************************************************************************

The current undervaluation started with the botched capital raising in April. The capital raising raised the desired funds but resulted in a loss of net asset value to those who did not participate. This included me - I wasn't allowed to participate because I was a foreign investor. The loss of value as a result of the capital raising was very unfair. The stock price plummeted even further. More recently as hedge funds have changed from being the investment du jour to being very out of favor the discount to net tangible assets (NAV) has widened considerably.

Passive Alpha

I promised a series on asset allocation, here is the next installment. I'll cover the investments I call passive alpha first. As I mentioned before, it's a bit of a misnomer. This category includes all actively managed funds that aren't broad bets on stocks or bonds or aren't strongly correlated with an underlying benchmark index as well as all other financial stocks. The individual investments are as follows:



There is a mix of Australian and US investments here. Though the Australian investments won't be of direct interest to most readers, the reasons why I invested in them may be. I hope to discuss that in more detail in future posts.

Real Estate TIAA Real Estate, Challenger Infrastructure, and Newcastle are three different sorts of real estate funds. Hudson City Bank Corp can also be thought of as a real estate fund. Both it and Newcastle have mortgages as their primary assets though Newcastle is a REIT and HCBK a bank.

Closed End Funds Clime Capital, EBB Investment Trust, and Platinum Capital are all exchange traded closed end funds but they are all rather different. Clime is a long-only stock fund, EBI is a fund of hedge funds, and Platinum Capital is a long-short hedge fund.

Hedge Funds TFS Market Neutral and Hussman Strategic Growth Fund are mutual funds that employ quite different hedging strategies. Platinum Capital and EBI are also of course hedge funds - and as they charge incentive fees they are more traditional ones. Challenger Infrastructure also charge a performance fee. Is it a hedge fund?

Management Companies Everest Brown Babcock is a hedge-fund-of-funds management company that among other things manages EBI.AX. Clime Wealth Management is also a fund management firm and included in its managed funds is Clime Capital.

Insurance Berkshire Hathaway is an insurance conglomerate. But clearly, people don't invest in it just to invest in insurance, or even the many unrelated subsidiary businesses BRK owns outright. Money management by Warren Buffett is a big part of the attraction.

As you can see it is a little tough to exactly classify all the entities in this category. But none of them is your traditional long only stock or bond mutual fund. And that is why I've placed them here.

P.S. 9:03pm

I just bought 4000 more shares of EBI.AX @ $A3.75 taking my holding up to 4.73% of net worth - financed by an increase in my margin loan. Today is the ex-date for a rights issue that is part of a capital raising. The price of shares under the rights issue is $A4.07 while institutional investors are paying $A4.29. The price today opened at $A4.1 and then plummeted as low as $A3.65. Now it is true that the rights offer also includes 1 EBB share (the management company) for free for every 4.5 EBI shares bought. But from my understanding the rights offer and placement doesn't reduce the net asset value of the fund per share at least not below $A4.07. The NAV at the end of February was $A4.29 at the end of February. So this seems irrational. Even if there is something I don't understand here I can't see that I am paying more than NAV. Therefore, the purchase this evening. I am not allowed to participate in the rights issue because I am not resident in Australia. This is one of the pitfalls of direct international investing.

P.P.S. 10:55pm

And then EBI was put into a trading halt when the price was at $A3.85 pending an announcement from the company. It can't be anything very bad as shares in the management company EBB are up 5.23% on the day at this point and not in a halt. I am guessing they want to either: Calm the market and say there is no grounds for the price drop, or one of the hedge funds they invest in (there are around 20 in the fund) blew up and therefore some fall in price was justified in fact. Those are my guesses of best and worst case scenarios. We'll have to wait and see. They did a trading halt last week to announce that the placement was oversubscribed. These things are common in Australia. But I still remember when Croesus Mining went into a halt so it makes me nervous. But there has to be a floor to the share price for a closed end fund of this sort.

EBI Proposes to Delist from the ASX

The Everest Brown and Babcock listed fund of hedge funds, EBI, proposed today to delist from the ASX. This is the same fund whose downgrading by CommSec triggered my margin call. BTW, the redemption of Colonial First State Funds seems to have gone through OK. Now you can see why I just didn't sell the downgraded stocks! The proposal is a little complicated and has some similarities to the recent delisting proposal of Ellerston GEMS:

Prior to delisting (expected to occur in December 2008): A “Withdrawal Offer” of 10% of units on issue at a fixed price equal to a 7.5% discount to EBI’s then stated NTA per Unit.

At 31 December 2009: A one–off redemption facility for 25% of remaining units on issue at a 7.5% discount to EBI’s then stated NTA per Unit.

From 31 December 2010: On-going semi-annual redemption facilities at EBI’s then stated NTA per Unit.

Large shareholders will be able to be paid their investment in specie into a separately managed account.

I'll probably look to decrease my holding on market or at the first "withdrawal offer" and then participating with 2-3% of net worth in the unlisted fund. Currently EBI is about 5% of my net worth and at the 7.5% discount to NTA would be about 6.5% of net worth.

Carrousel Capital and Babcock and Brown who are both major shareholders are supporting the proposal but Laxey Partners is calling for an EGM to wind up the trust. Shareholders are still squabbling over the Ellerston GEMS delisting.

EBI's Performance

As I've reported, Everest Brown and Babcock Alternative Investment Trust (EBI.AX) has been in a lot of strife with investors. The main issue has been the discount of the stock price to NAV. The company proposed to delist the fund as a solution to that problem. But some large investors wanted to appoint a new manager or wind up the fund instead. Just how bad is the underlying investment performance of the fund?

Using the U.S. risk free rate, the beta and annual alpha of EBI's NAV relative to the Credit Suisse Tremont Hedge Fund Index were 1.68 and -4.32% for the life of the fund. Results for the HFRI index are almost identical. Using the RBA's cash rate instead the statistics are 1.66 and -2.72%. The high beta is expected due to the fund being leveraged into a portfolio of hedge funds via a swap facility provided by Macquarie Bank. I think that the correct risk free rate to use is the U.S. risk free rate. This is as the underlying funds are denominated in US Dollars and I assume Macquarie's swap is in terms of USD. Assuming fees of 1% + a 2% annual performance fee (20% annual performance * the 10% incentive rate) over the first two years of the fund when gains were positive means an average fee of 2.33%. On the face of it this indicates about 1.5% a year of negative skill. I wouldn't call this a disastrous situation though it's clearly not good that they don't at least earn their fees.

A complication arises though because the fund is supposedly hedged into Australian Dollars so that the returns reported in Australian Dollars are the same (or close to the same numbers) as the underlying funds report in U.S. dollars. To do this we could short the US Dollar and go long the Australian Dollar which can be accomplished by buying Australian Dollar futures contracts (for example the contract traded on the CME). Apart from the change in the exchange rate this contract earns the difference between the Australian Dollar and U.S. Dollar risk free rate.* An average of 2.63% over the life of EBI. And then this needs to be mulitiplied by the leverage ratio which is roughly equal to the beta. Assuming a perfect hedge we would need to deduct this earning of 4.3% per annum from the estimate of alpha!

But looking at the annual report, EBI never had a full hedge (in forwards) and by December 2007 only had a very small hedge in place. So at this point I got really confused and thought up various scenarios none of which I'm clear about. Perhaps Macquarie is doing the hedge and pocketing the interest differential while charging Everest the Australian rate for the leverage in the swap. So Macquarie takes Everest's money adds a loan to it and invests it in US hedge funds then sets up a hedge to remove the currency risk, earns the interest differential on the hedge and pays back Everest the USD percent returns earned by the hedge funds but in Australian Dollars?

Maybe someone can help me out. I think the only real way to know is to see the agreement between Macquarie and Everest and that's not in the annual report. The annual report doesn't even say that the counterparty is Macquarie.

Here is how the fund's NAV stacks up against the index in USD:



* This is why the Australian Dollar contract normally has a price below the spot price and the two prices converge towards expiry.

Macquarie Capital Alliance Group to be Privatised

Another Macquarie private equity listed fund to be delisted. This bodes well for my various Australian listed funds that are trading at huge discounts to book value: EBI, AEP, IPE, CAM, and PMC. Though CAM and PMC are more traditional share funds. EBI continues to attract new hedge fund investors. The manager of the fund referenced in the EBI announcement, Andrew Weiss, was a professor of economics at my Alma Mater, Boston University. I remember once I went to look for him for some reason, but never did meet him. Some grad student was sitting in his office. EBI are going to introduce a buyback facility that will come into play whenever the fund trades 10% below book value. The problem with AEP is of course that it was an Allco sponsored fund, so no privatization likely there, though I expect another more serious takeover effort if it continues to trade so cheaply.

Ex-Rights Price Correction

That's the reason for the halt in trading in EBI.AX:

"Everest Babcock & Brown Alternative Investment Trust (EBI) requested a trading halt in relation to its units earlier today following an irregularity in the theoretical ex-rights price published this morning. The price published was $3.785. EBI confirms that the theoretical ex-rights price of EBI units is $4.165 based on the close of 3 April 2007 price of $4.26 and the entitlement issue price of $4.07."

So my bet was correct. I didn't see this theoretical price. But I thought the market price was too low. A nice $A1600 in profit as a result with very little downside risk. Seems trading has restarted and the price is still at $A3.85. Hmmm.

Everest Brown and Babcock

This is my first post on a specific investment in my asset allocation series. Well, actually two investments: Everest Brown and Babcock (EBB.AX) and Everest Brown and Babcock Investment Trust (EBI.AX). EBB is an alternative investment manager. Mainly they manage funds of hedge funds. EBI is a closed end fund of hedge funds that trades on the Australian Stock Exchange. You can learn all about the company and their funds here. I want to discuss why I bought this investment - most readers won't be able to buy into this specific investment and so the rationale is probably of much more interest than the specifics.

EBB originally floated on the ASX in early 2005 as a stapled security that included one share in a fund of hedge funds and one share in the investment management company. The idea was that the investment manager charges, like most hedge fund managers, a performance fee. By also investing in the investment manager you would get part of the fee rebated back to you. As you'll know by now, I like hedge funds and other alternative investments, and I especially liked the idea of getting some of the fee rebated. On top of that, when I invested in August 2005 the shares were trading at a discount to net asset value. That meant you were getting the management company practically for free! Also the managers were invested in the shares as well as in the management company (only part of the management company was floated in this transaction). I like to see this in the "passive alpha" investments I make. The founders also had the backing of Babcock and Brown - an upcoming global investment bank headquartered in Australia.

The shares continued to trade at a discount to NAV. In August 2006 it was decided to destaple the securities and let the management company and the investment trust trade separately. This was a brilliant move. The value of the management company shares has since soared. Looking at the two securities as a single investment my annualized rate of return has been about 54% since investing (pre-tax)! Total profit is now over $A13k. I originally invested $A9350 and in August 2006 invested an additional $3400 in the management company shares to double my holding. Yesterday I bought $A15,000 more of the investment trust to almost triple my holding of that stock.

EBB.AX now has a P/E of 52. Though I expect the firm to continue to grow, that does seem rather pricey and so I don't plan to add to my holdings. Anyway, I already have 3% of my net worth invested which is more than I really am comfortable to invest in a single stock that isn't a closed end fund. The only US listed hedge fund manager so far is Fortress Investment Group (FIG). Of course firms like Goldman Sachs are also in this business. FIG's pricey and I'm not looking to invest in it. But I'm not planning to sell EBB yet, either. The EBI.AX fund of hedge funds is undervalued at today's closing price. It in fact has had quite a high beta to the stockmarket. That might decline a little when the newly raised funds are deployed in other less correlated investments. There are no such investments listed on US stock exchanges yet, to the best of my knowledge.

Everest Babcock and Brown Alternative Investment Trust Changes Course Again

Everest Babcock and Brown Alternative Investment Trust (EBI.AX) changed course again, rendering my post from just a couple of days ago out of date. The fund has settled the legal dispute with Laxey Partners and will now follow two distinct tracks. Shareholders will be able to decide between swapping their units for units in an unlisted trust to be managed along the same lines as EBI by Everest Financial or to remain in the listed EBI which will be managed by a new manager and is likely to be wound up over time as hedge fund redemptions allow. All this is supposed to happen before the 30th of January. The main potential obstacle is Macquarie Group who are the provider of the swap that is used to leverage the underlying investments. NAV for November was also announced at $2.58 down 7.86% on the month. The stock currently trades for 80-90 cents.

As the 10% redemption offer has now been withdrawn, we will have $A7,000 less to pay off debt or make new investments.

Everest Babcock and Brown and Platinum Capital

Received the offer document for Platinum Capital's (PMC.AX) rights issue and Everest Babcock and Brown Investment Trust's (EBI.AX) withdrawal offer. Platinum granted shareholders the right to buy one new share for each share they own at a discounted price (well it was discounted at the time of the offer). I already sold my rights, which are essentially call options, on the stock market. Even if I had the money I wouldn't want to increase my position and currently the market price is equal to the exercise price.

EBI, which is planning to delist from the stock market is offering investors an opportunity to redeem some of their shares prior to delisting at a 7.5% discount to Net Asset Value. In total, up to 10% of all shares can be redeemed so if the offer is oversubscribed requests may be scaled back. I'm planning to redeem 31% of my shares. Despite the discount this price is much better than the current market price and it'll will be a year before another redemption is allowed. Still, I'll probably wait until October's NAV is published mid-month, before sending the form in.

EBI's management company is also in the news today with rumours of a takeover or some other transaction. The stock price of this firm has completely collapsed. It would be strange for the major stockholders to sell out at anywhere near this price - the P/E ratio is 1.6 based on last year's earnings and analyst's forecast a forward P/E of 3.8. But they probably need the money. A big one of course is Babcock and Brown.

I'd be happy with a price of 50 cents a share rather than the current 10 cents (or less). I'm ashamed to say that my net cost/breakeven point is 71 cents a share.

Margin Call

Things continue to get worse. I am now in margin call territory with CommSec because they reduced the lending ratio on EBI and EBB to 0% as these two stocks are supposedly are "Babcock Satelites". The main worry with EBI would be their total return swap with Macquarie Bank. Maybe some of the joint investments they did with Babcock, though these are a small part of the portfolio. I sold Qantas but it makes little difference. I'm going to have to sell more stuff if they don't revert this loan ratio back to something positive.

EBI Saga Finally Resolved

In the end 27% of shareholders (including 6000 of my own shares) opted to participate in the new unlisted hedge fund of funds EAIT. The remainder will stay in the listed EBI which will be managed by Laxey Partners - an Isle of Man based hedge fund. The plan is to wind up the fund and distribute the proceeds. Unless there is another complete collapse in global share markets this is a great investment - buy $2.38 worth of assets for just over a dollar and get the proceeds redistributed to you mostly in the next couple of years. I may in fact buy more units when I can. I'm bumping the value in my accounts of the unlisted fund to NAV. This will be the biggest positive contribution towards this month's results.

Borrowing

I still need to cover the trading, liquidity, and borrowing categories in my asset allocation series. Liquidity is pretty boring - I have checking and savings accounts in the US and overseas - and I have covered trading extensively. Borrowing on the other hand is worth covering as my borrowing arrangements are rather different to most pf bloggers and a lot of investment bloggers too. In particular, a lot of real estate bloggers seem to be unaware of the possibilities of borrowing against stocks.

My borrowing capacity is split between credit cards and margin accounts. I have a credit line of about $21,000 on the three credit cards I actually use. I have a zero percent balance of about $6500 on one of them and rotate it to wherever there is a good deal. My credit limits are low because my credit history is short as far as FICO is concerned. Anyway, I think that's the reason. I don't aggressively try to up the limits either. The balance transfer is very cheap financing and worth doing I think.

My main borrowing capacity is in my three margin enabled brokerage accounts. If you have a brokerage account I can't think of a reason not to ask for the ability to borrow on margin. Well, actually I pay some extra fees in Australia in my margin account. But that's not the case in my US accounts. Here's the current rundown on one of my US accounts (the other one just has about $15k in cash in it at the moment - so I can't actually withdraw more than the cash in the account without first buying some stocks):



I could immediately withdraw $19,982, $4,772 of which would be a loan secured by the stocks in the account. You don't need an emergency fund sitting in cash when you have a margin account. I could also spend that much on options or non-marginable stocks (e.g. stocks under $5 in price). But the interesting thing about margin is that if use a loan to buy stocks you can then borrow more money against the stocks you buy. So if I use my borrowing capacity to buy stocks I can borrow another $37,092. Intraday, I can borrow even more - this is so-called "day-trading buying power". The only problem is that my interest rate is currently 10.5%. Larger accounts pay lower rates. So I only borrow for short term trades on the long-side.

My Australian account is much bigger and so are my borrowing capacities:



All the figures are converted to US Dollars. My interest rate is 8.9% and I have an outstanding loan of $33k. I could withdraw or buy non-marginable securities of up to $62k. I really, really, don't need an emergency fund :) But if I buy marginable stocks I could buy more than $200k more of stocks. Recently I bought an extra 4000 shares of EBI.AX using my loan capacity. BTW, EBI.AX is already a levered product.

I often wonder if I should be more aggressive and borrow more. There are lots of potential sources of leverage which are cheaper than margin loans. So until I exhaust those options (no pun intended :)) my borrowing is likely to be very conservative.

Annual Report: Asset Allocation

The table shows our asset allocation at the account and security level at the end of 2007 (before my recent flurry of trades). The split by currency is not perfect - for example the CFS Conservative Fund has foreign (to Australia) investments while Platinum Capital is partially hedged into Australian Dollars. "Passive Alpha" investments obviously have plenty of correlation with the market (I call them "passive alpha" to distinguish them from my own active trading). I include in this category all financial stocks and funds whose performance would be expected to contain significant sources of return which aren't pure stockmarket beta. This includes a fund of hedge funds (EBI), hedgefund like funds (Hussman, TFS, Platinum Capital), real estate funds (Challenger, TIAA, Newcastle), and private equity (Allco). The Clime fund (CAM.AX) is a long-only closed end fund but deliberately does not track market benchmarks and is very focused. My rationale for counting a stock like Interactive Brokers (IBKR) as alpha is that the majority of their income comes from market-making. If this isn't a source of alpha in the financial markets, I don't know what is. There are also fund management companies (Clime and EBB), a bank (HCBK), and insurance companies (Berkshire and Safety). Beta investments are more traditional mutual funds, which can be pure stock plays or diversified or even bonds, which have less stock market beta. We only had one trading position at the end of 2007 - Beazer (a homebuilder) put options. It was doing OK. I only have two non-financial stocks listed under "industrial stocks" - Symbion and FTS. I don't believe that I have an edge in picking individual stocks so I don't do much of it. But investing in a bank stock, for example, is a way of indirectly getting exposure to a financial asset class (loans) that is hard to invest in otherwise. All the other categories of accounts either support our lifestyle or investing (margin loans). By using margin loans we are 98% invested in long-term investments as well as having 6% allocated to trading, while having liquidity for everyday life.

The table doesn't split things down by retirement and non-retirement accounts. 47% of the total is in retirement accounts.

In retrospect, I have been too conservative in my beta investments in the last couple of years, though now it is beginning to pay off to some degree. On the other hand, my passive alpha investments, which had been doing well, took a distinct turn for the worse from the August "quant crisis" onwards. I plan to get more aggressive in my beta investments once there are some clearer signs of a bottom in the stockmarket. I'll also be adding new passive alpha investments and aiming over time to reduce the percentage allocation to Australian Dollars.

U.S. Government Goes Insane

That's what it feels like. Bears won't be happy. UK stock market is up 9.3% at this moment.

In other news, I went to pick up my Mac laptop but when I got it home I found it hadn't actually been fixed at all. It's been lying in the storeroom at the Canberra City store for the last two weeks I think. In fact they didn't know where it was at first and phoned up all the other stores to see if it had accidentally been sent there. Outrageous.

I didn't hear anything on the outcome of my margin call. At least closing prices in Australia will have been a bit higher today. It's a shame that they decided to downgrade EBB and EBI and force me into selling something. I guess I should never be near the margin limit in case something of that sort happens in the future.

August 2008 Report

This month was OK, we lagged the MSCI index by about 1% resulting in a negative return and loss of net worth in US Dollar terms and gains in Australian Dollar terms, due to the 9% fall in the Australian Dollar over the month. The pound fell 8% and the Euro 6% against the USD.

As result, total returns (or accumulation index) in Australian Dollar terms have now caught up with total returns in US Dollar terms, which had been outperforming in the last few years, as measured from the 1996 inception point:



MSCI total returns are now also back in line with SPX total returns over the entire period though still outperforming over the last 5 years. It's depressing that we've made very little progress since the beginning of this decade, but neither have the major stock indices. The SPX has returned just 0.22% per year (this includes dividends) since 31st December 1999 while the MSCI has returned 1.98% per year. I've returned 4.66% per annum in USD terms and 2.10% in AUD terms. After taxes and inflation all of these are probably negative returns. In Australian Dollars the MSCI has returned -1.15%.

So there was again negative progress on our annual goals, which is reported on in the first part of this report. Other statistics appear towards the end of the report. All amounts are in U.S. Dollars unless otherwise stated.

1. Net Worth Goal: Reaching $500k In US Dollars we fell back $12,979 to $391,463, while in Australian Dollars we gained $A27,728 to reach $A457,209. Despite the increase in Australian Dollars, we are still way below the year's starting point at $A511,281.

2. Alpha Goal: Alpha of 8.5% The point of this goal is to earn at least an average wage from risk-adjusted excess returns. Using my preferred time-series method, our returns had a beta of 1.07 and an alpha of 6.0% with respect to the MSCI World index, which lags our annual goal and is worse than last month. The risk adjusted excess return for August based on this analysis was -0.8%. Multiplying this by net worth gives a loss of $3,124. For the year so far, the risk-adjusted excess return in dollar terms has been $3,982. Using the estimate of alpha, the smoothed annual income is $23,715. Most other performance metrics are equally poor in recent months. I "re-equitised" too soon and then didn't "de-equitise" enough at the May peak though I did do some rebalancing. I then increased leverage again too early in the down wave from the May high to the July low.

3. Increasing Non-Retirement Net Worth by More than the MSCI Index The point of this goal is to make sure that we only spend out of non-investment income and excess returns and don't use the normal market return on investments to fund spending. In other words, this makes sure we have positive saving. So far this year these accounts have declined by 5.11% more than the MSCI return so that we are dissaving, by this measure.

4. Achieving Break-Even on U.S. Taxable Accounts We made a $1,636 or 2.26% gain this month on US Taxable and Roth IRA accounts. My Interactive Brokers account gained 9.24%. The NDX gained 1.26% for the month. We are still more than $10,000 from breakeven after achieving breakeven in May.



5. Make at Least $10,000 from Trading Realised gains this month were $1,059 and so far this year $3,149. Even though I didn't do any active trading I closed positions in PSPT and NNDS and I mark to market my CFD position.

Background Statistics

Income and Expenditure



Expenditure was $3,598, which is what it typically is when there are no unusual expenditures and just day to day living costs. Non-investment income was also at baseline levels. Non-retirement accounts had $3,579 in underlying gains while retirement accounts did much better this month with $9,383 in gains. Foreign currency movements removed $25,348 from USD net worth.

Investment Performance

Investment return in US Dollars was -3.06% vs. a 2.11% loss in the MSCI (Gross) All Country World Index, which I use as my overall benchmark. Returns in Australian Dollars and currency neutral terms were 6.71% and 3.20% respectively. So far this year we have lost 14.05%, while the MSCI has lost 14.55%.

The contributions of the different investments and trades are as follows:



The big winner was Australian shares as represented by the CFS Geared Share Fund, Conservative Fund, Developing Companies Fund, and Future Leaders Funds as well as Clime Capital, the SPI CFD, and Qantas among others. Takeovers of NDS and PeopleSupport also generated nice returns. The worst performer was the EBI listed hedge fund of funds whose decline mostly represents an increase in the discount to net asset value. On the other hand, Allco Equity Partners saw a decline in its discount. Resource stocks also declined and the former Loftus Capital Partners continued its miserable share price performance. At least the company is buying back stock.

Asset Allocation

Allocation was 47% in "passive alpha", 73% in "beta", 2% was allocated to trading, 8% to industrial stocks, 3% to liquidity, 3% to other assets and we were borrowing 36%. Due to the use of leveraged funds, our actual exposure to stocks was 134% of net worth. Leverage declined and we increased exposure to private equity and reduced exposure to stocks:



The first two columns of percentages in the table indicate how much of net worth was allocated to investment in each asset class in July and August. The fourth column gives the percentage of total underlying assets in each asset class. In other words, rather than accounting for a levered share fund by how much we are investing in it, we are counting the shares that they own. In total we are borrowing an additional 85 cents explicitly or implicitly for each dollar of net worth. Due to using levered stock funds and derivatives the shares of the non-equity asset classes are lower than their shares in net worth. I didn't account for leverage in non-equity funds, but probably I should in future. I also broke out managed futures for the first time under "commodities". We have less than 1% exposure to this asset class.

Our currency exposures were roughly 54% Australian Dollar, 24% US Dollar, and 22% Other and Global.

Margin Call Resolution

After a lot of rushing around faxing and phoning (I don't have a fax machine at home) it looks like we have a resolution to my margin call caused by the downgrading of EBI and EBB by CommSec. I am selling units in CFS Conservative Fund (all my non-superannuation units) and half of my CFS Global Resources Funds. Both of these sales will actually be capital gains, though off their best prices of course. This will about halve the size of my margin loan with CommSec to about $50,000. The downside of selling these funds is that they are marginable and so I need to sell a large amount to get back inside my margin limits. I would have to sell only about a quarter as much of my non-marginable stocks. But I'm loathe to sell stuff that is trading way below book value or what I think is fair value, which is the case for most of my non-marginable stocks and my other marginable stocks in fact like Challenger Infrastructure Fund.

A tip - CommSec said they didn't get my fax yesterday because I faxed it to the "back office" - the number on the redemption form and on the website - and of course there is chaos there at the moment. So this morning I faxed it again to the "front office". And then I phoned up to check they really did have it. So it's worth checking where to fax required forms to in an emergency.

Annual Report 2006: Part IV

This is the final part of the annual report where I review my current investment allocation and strategy:



This is a screen shot of part of the allocation spreasheet I set up each month to keep tabs on my investment strategy. 2/3 of my net assets are in Australian Dollar related investments. Australian based international investments that aren't hedged into the Australian Dollar are listed in the "Other" column. Yes, over half my net worth is in the CFS Conservative Fund - this fund is 30% invested in equities with the remainder in bonds and cash. I've listed it under Australian Bonds even though it also includes foreign bonds and equities and Australian shares. I have 1-2% of net worth allocated to any individual stock investment. Larger shares can be allocated to closed end funds or trading positions (e.g. 15% allocated to a SPY trade). Unlike the majority of PF Bloggers I don't have any index funds as investments. I use ETFs as trading vehicles.

Here is a different view of the portfolio:



My strategy is to invest 100% of my net worth and borrow against this to fund trading. At the end of 2006 my net trading position was long. The beta exposure column shows how much each category adds to the portfolio's beta (which measures its sensitivity to the S&P 500 index). The investment portfolio contributes a beta of 0.45. My trading positions added a beta of 0.553. So currently I have a very conservative investment portfolio. The overall portfolio's beta can range from 0.9 when I have long trading positions to -0.1 when I have short trading positions. IMO this is a much better approach to market timing than trying to swing an entire portfolio for and against the market. I developed this philosophy from Soros' approach as described in "The Alchemy of Finance".

The overall investment portfolio is conservative at the moment because the yield curve is inverted and there is a strong risk of a recession. Bonds do well in economic slow downs and recessions when the Fed cuts interest rates. So I do adjust the investment portfolio but over the course of years, trying to only incur long-term capital gains taxes. When I am bullish on the economy the beta of the investment portfolio will be above 1.

Breaking down the investment portfolio I have the following kinds of investments:

Core Investments (22%): Loftus Capital, Clime, EBB, EBI, Challenger Infrastructure, Berkshire Hathaway, HCBK, TFS Market Neutral Fund, Hussman Strategic Growth Fund, TIAA Real Estate, Newcastle, Platinum Capital. I don't intend to change these investments with changes in the economy. The investments are a mix of hedge funds, real estate funds, and investment management companies. I would like to have more of this type of investment.

Market Related Mutual Funds (71%): The four Colonial First State Funds, and CREF Bond Market Fund. In fact I have never adjusted the CFS Global Resources Fund since I bought it many years ago, but often wonder if I should. So maybe that too is a core investment. I hold onto positions in the CFS Future Leaders and Developing Company Funds because they are closed to new investors. In order to expand my holdings in the future I need to remain in them. I used to hold a much higher percentage in these funds. My holdings in these funds will change dramatically when I get bullish on the economy.

Industrial Stocks (9%): Ansell, Croesus, Symbion, Powertel, Telecom NZ. Croesus is probably worth nothing in fact (but has not been delisted). I have subsequently sold Telecom NZ. Ansell and Symbion are in the health related field and so I think will not be affected much by recession. Powertel is a small Australian telecom that has done very well and recently reached profitability. I will sell these when I think future gains don't look promising. I may buy new single stock investments when I see opportunities.

August 2007 Report

All figures are in US Dollars unless otherwise stated. This month again saw negative investment performance in USD terms, though this was due to the sharp fall in the Australian Dollar and underlying performance was positive. Trading results were positive but volatile and spending was very high. At the end of the month I merged my finances with Snork Maiden for purposes of reporting net worth etc. The income and expenditure figures for this month are mine alone, but the final net worth figure is our joint figure. Net worth fell in US Dollar terms and rose in Australian Dollar terms post-merger. Both figures fell on a pre-merger basis.

Income and Expenditure



Expenditure was $7,959. More than half the figure was moving expenses and more than a quarter the cost of my new computer. Other expenses totalled only $1625. Yes, there is a retirement contribution ($901) there though I am no longer employed.

Non-retirement accounts lost $11,332 but would have lost only $2214 if it were not for the sharp decline in the Australian Dollar. Retirement accounts lost $4151 but would have gained $2693 if exchange rates had remained constant. Net worth declined by $23k on a pre-merger basis. At one point in the month it was down around $50k.

Net Worth Performance
Net worth fell by $US5755 to $US439,155 and in Australian Dollars gained $A20817 to $A538,576. Non-retirement accounts were at $US242k. Retirement accounts were close to $US197k.

Investment Performance
Investment return in US Dollars was -3.75% vs. a 0.23% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 1.29% gain in the S&P 500 index. Non-retirement accounts lost 5.13%. Returns in Australian Dollars terms were 1.36% and -0.02% respectively. YTD I'm up 12.9% vs the MSCI with 8.3% and the SPX with 5.1%. My non-retirement accounts are up 17.4%. So I'm not too concerned about this month's performance, especially as we gained in Australian Dollars!

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency losses appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. The biggest positive contribution came from the CFS Conservative Fund which has a 30/70 equity/fixed income mix. Interactive Brokers began to rebound this month. Voltality (of the right sort) should help the stock. The investment in Hudson City Bankcorp also began to pay off as it is seen as a solid bank in a shaky environment. Something similar could be said about Berkshire Hathaway. Trades in IYR, Lehman, Toll Brothers, Beazer, and the S&P 500 made nice contributions. All three of my earnings plays (AAPL, GOOG, DELL) did not work out and neither did NDX trading this month. The quant fund meltdown resulted in a huge loss in the hedge fund of funds management company Everest, Brown and Babcock and to a lesser degree in their fund of funds EBI.AX. The latter is very undervalued at the moment.

Progress on Trading Goal.

Asset Allocation
At the end of the month the portfolio had a beta of 0.50. Allocation was 35% in "passive alpha", 63% in "beta", 4% allocated to trading, 5% to industrial stocks, 10% to liquidity, and we were borrowing 17%. My Australian Dollar exposure fell to 59% partly due to the fall in the Aussie and partly due to the merger which brought in $US17k in US Dollars. The merger also increased "liquidity". We will keep this very high level of cash through the move to Australia. We'll spend quite a lot more in the process and then reallocate our cash when things have settled down in October.

Career Update

I met with the guy who might have some research funding and was trying to hire my student who got the job in Perth. He'll look at whether the funder would be interested in using the money for someone with my skills or whether they want their money back. We also discussed a bunch of topics he's interested in researching. They're all pretty fluffy as he admitted and I'm not sure how I can match them to my skills and come up with a proposal. We also talked about who else I should meet with. I went through a bunch of iterations of my job application with Snork Maiden and now I sent it out to our friend/colleague for some comments and also to one of my references, who I met this afternoon when I was on campus. Thursday is going to be my next chance to meet a bunch of relevant people at the open day I mentioned before.

On the investment front, Everest Babcock and Brown (EBB.AX) is proposing to change it's name to Everest Financial following the virtual collapse of Babcock and Brown. Also it will write off all it's intangible capital. At the still listed investment trust (EBI.AX) a major shareholder has decided to switch ranks and support removing EBB as manager. This might now delay the delisting and partial redemption of units in the trust. I was looking forward to getting some money out and reducing my margin loan. Maybe we'll have to wait longer for that. Platinum Capital (PMC.AX) only sold a small fraction of the shares it wanted to issue in a 1:1 rights issue. At least I sold my rights.