Sydney Futures Exchange

When I opened my account with Interactive Brokers I signed up to trade all electronically accessible US markets. But in fact one can trade many international markets too from the same account. I just added the Sydney Futures Exchange to my permissions as the data is free and I am curious about trading on it in case we end up moving back to Australia. IB charge $A5.00 per contract for trades (about $US4) which is good. The only stock index traded is the S&P/ASX 200 Index. The contract size is $A25*index. As the index is currently at 6213 the contract size is around $US128k which is bigger than the US mini contracts but smaller than the US full size stock index contracts. The minimum tick is one index point which is percentwise about the same as the NQ and ES tick. I am tracking it now in real time and around 50-150 contracts are trading per minute at the open, so there is plenty of liquidity. Initial margin is $A6250 which is in line with the margin for a couple of ES contracts of similar value.

I don't try to day-trade the Aussie stock market because I think commissions are too high and the information flow isn't as good as in US markets (some of the info is better though). IB don't offer Aussie stocks yet. The Australian market trades in the US evening opening at 8pm EDT in the northern summer and 6pm EST in the northern winter. US markets open at 11:30pm or 1:30am Sydney time. Even though I tend towards being a nightowl it would be hard for me to daytrade the US market from Aus I think. As I get older I also am waking up earlier in the morning. Of course, all the Asian markets would be open to me from a base in Australia but language issues might pose a barrier. For example, Yahoo's Hong Kong site is in Chinese but the Singapore site is in English. Hong Kong is a bigger financial market.

Accounting for the Effect of Australian Superannuation Taxes on My Rate of Return

The earnings of Australian retirement accounts, known as superannuation accounts, are taxed by the Australian government at 15%. Contributions are also taxed at 15%. This is in contrast to the US approach of either taxing the contributions at the regular income tax rate (e.g. Roth IRA) but not taxing the earnings or not taxing the contributions and deferring the regular income tax on the contributions and earnings till the money is withdrawn (e.g. 401k, 403b, traditional IRA). The superannuation earnings tax is deducted at source from managed funds and the amount is not reported to the account-holder/taxpayer. Up till now I have been using the after tax returns on these accounts in my performance calculations combined with pre-tax returns on all other accounts. The correct way to compare returns to a market index is, however, on a purely pre-tax basis. I've now added back in the superannuation tax paid to each month's returns:



Obviously the result boosts my rate of return and I now almost match the MSCI World Index over 10 years and beat the S&P 500 total return index on all time horizons. The change has the effect of increasing alpha very slightly but boosting beta by about 5 percentage points.

I've been fascinated by the concept of "portable alpha" or "alpha-beta separation". This concept is based on the idea that any mutual or hedge fund can be broken down into a market neutral fund and a market index fund. The former is the "alpha" and the latter the "beta". I did a decomposition of my total returns into the portion attributable to the market (estimated beta*MSCI total return) and the residual or market neutral portion:



The total return index is the product of the market neutral and market related indices. This is natural as current returns multiply the capital built up from past returns.

Paid Off Balance Transfer

I paid off my balance transfer on my Amazon.com Chase credit card. I've had a balance transfer for the last couple of years and have been rotating it around my cards. It's relatively cheap finance but I've decided I've had enough of messing around with it and I won't be doing any more balance transfers in the near future. It only amounted to about 1.5% of net worth at this point.

In other news, our lawyer phoned my brother to tell him our second property in eastern Germany sold and we should have our share of the money in the near future. Near future in legalspeak can be a near eternity :) When it's done it will finally close the lid on this saga that has been ongoing since 1995 and in the broader time scale a last vestige of our family's history in Germany. This property will be redeveloped, other buildings and family graves still stand, but we won't own anything in Germany anymore. In fact, we don't already except some money in a German government account.

I Did Make a Trade After All

Just before the close and going to my meeting of Graduate Porgram Directors I bought one Apple June $90 call. Looks like it worked out well. But if I'd been available at 4:30pm I might have bought 500 AAPL shares instead...

Money Arrives

The money arrived in my HSBC savings account today, even though 25 April is a public holiday in Australia (ANZAC Day). HSBC charge another $US25 fee. So I paid 1.4% in total for the transfer. I could get the percentage cost down for the next transfer if I borrowed some money on my Aussie margin loan to bring it up to the maximum $A10k allowed per transfer or waited longer for $A10k to accumulate in cash in my money market account (CMT in Aus-speak). I didn't trade today due to a bunch of awkwardly timed meetings, but it would've been a great trading day....

Token Arrives

The "token" arrived from Commonwealth Bank in a bright yellow box with real Australian stamps stuck to it. Inside is this tiny electronic device:



Very cute. I registered it and shifted money to my account from a money market account in Aus ready for the actual transfer to the US. Everyone seems convinced the USD is going down - including a colleague who teaches international economics that we went to dinner with together with a bunch of students from her class yesterday - so a contrarian move seems to be the right thing to do. Anyway, I'm only moving my dividends and distributions back to the US at this point. Not a huge amount of money. Snork Maiden was here to give a presentation in the class yesterday that was like a mini-preliminary-job-interview. But there isn't a position here for her at the moment. Today maybe we will hear if she got offered the job in Europe. In the meantime she got a phone interview lined up in Aus for a couple of weeks time.

Obsessions

The Money Diva tagged me to write about my obsessions, obsessive thoughts etc:

1. Obviously investing and especially trading. Even though I posted yesterday that I wasn't going to trade I made 6 roundtrip or still open trades in the 24 hours after making the post :)

2. Obviously, too economics but really economics is just a symptom of my underlying obsession with understanding the world. Which is why I studied geography and economics, became an academic researcher, have always been a news junkie - reading newspapers since age 10 or younger, obsessed with maps and now Google Earth etc.

3. Obviously I am currently obsessed with personal finance and trading blogs. It's just fascinating to read how all kinds of different people address the issues facing them and I hope to learn something practical from the more investing and trading oriented ones.

4. Rabbits. This is an inside joke with Snork Maiden.

5. Bears. I am more and more convinced that I was a big fuzzy bear in a past life.

OK, so I need to tag some people. How about Millionaire Artist and Ms MiniDucky.

Trading Update

In the last couple of days I've wanted to place trades but just can't do it. Partly due to being up and then back to zero for April - while the model is doing well - and partly because I am very busy and will be nervous if I can't monitor the trades more. So maybe I'll take a break from trading pretty much till the end of April and then after things quieten down a bit (I hope) get back into it. My investment portfolio has a relatively low beta and so shouldn't be hard hit if there is a market decline. The rise in the Australian Dollar means I'm up a lot in US Dollar terms at this point in the month. It is hard being a serious part time trader if you aren't in charge of scheduling your other activities.

P.S. 5:16PM

I did do a trade in the end. Trading Google after its earnings announcement. Held 100 shares for 3 minutes and made $878. So maybe this trading month will be a small positive after all.

IPO Update

I just placed a couple of bids in the IB IPO. Very simple. I bid to buy 200 shares if the IPO price is $27 and below and 100 shares if it is between $27 and $36. I can always alter these. So my maximum bid is for only 1.28% of my net worth roughly. Should I bid for more? I can bid for up to my account value ($14500) and it doesn't seem to have an effect on my buying power in the meantime.

Organizing

That's the theme of the moment.

1. Have everything I need to fax in the stuff to set up the transfers from my Australian account to my US accounts. But seems there is a need for a security calculator - two factor authentication. We'll have to see if they'll send that here to the US. The representative told me they will phone me after I fax them.

2. Almost have all the forms and info for the next stage in my green card application - getting police records from the 3 countries I've lived in apart from the US. Britain wants me to mail them original IDs with my date of birth and name! I think Aus looks easier now they finally sent me the forms. Israel wants me to come in person to the consulate in NYC - that will have to wait till next month.

3. Ameritrade e-mailed Snork Maiden yesterday and said that we didn't sign one of the forms for her Roth IRA. If she can get it faxed to them by today maybe we can get the 2006 contribution in. Though you only need the postmark on the letter with the check, apparently the account must be open before the deadline too to make a 2006 contribution. Hopefully, she can sort this out today, though it is a big hassle. I understand this. I have been procrastinating on these police records.

4. Looks like my brother is going to come visit us, so when that's fixed some travel planning.

5. Snork Maiden had a phone interview yesterday with a university in Europe. By next Tuesday we should know if they want to hire her.

I haven't been doing any trading the last couple of days, though I could have made some money yesterday if I did because I would have been long. Will wait till I feel comfortable. This is going to be a busy couple of weeks though as the semester nears it's end.

P.S. 1:55PM

We failed in the race to make a 2006 contribution to Snork Maiden's Roth IRA. Ameritrade are giving her a lot of trouble because she is still on a foreign student visa. We told them that she is now resident for US tax purposes but they want us to mail in a signed copy of the W8-BEN, fax the signed application form, and send a photocopy of bank statement! Anyway there was something they said couldn't be faxed. Anyway, we can now wait a while to see if a 2007 contribution is going to make sense.

P.P.S. 9:14PM

Commonwealth Bank e-mailed me to tell me I was approved for online international money transfers. Another one says they are sending me the "token" - a calculator used in two factor authentication. Let's see when it arrives.

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.

Moom vs The Model

More dumb trading moves today and back to pretty much zero for the month. The chart is a regression of my monthly trading rate of return against the model rate of return:



I've scaled up April's returns for the entire month.

The beta is 3.95 and alpha -23.8% per month. Ouch! This means that if the model returned zero for the month - something that hasn't happened - I would lose 23.8% of my account. It also means I am using 4 times leverage. I'd expect to have a negative alpha, which means that I'm not implementing the model correctly. But I'd like it to be much smaller! The R-Squared is 0.77.

Some months obviously are better than others. This is shown by the positive and negative residuals above and below the regression line. September 2006 was the worst month given how well the model did that month. Though October-December 2006 also all lost money the model was not doing as well in those months.

There are many trading blogs out there and a lot of the traders struggle to make money even if in the long-run they are making money. Making money trading is possible but obviously it is not at all an easy thing to achieve. It makes it clear that the ads telling you how easy it is to make money with the trading method they want to sell you are at best not telling the whole story and at worst scams.

Pay Raise

Today I received a letter from my Dean. The annual pay raise letter. This year's pay raise was 1.75% which is slightly better than last year but still less than the rate of inflation. The maximum possible raise was 2.5% though the Provost can in special cases award a little extra. This is $66.50 extra per month in take home pay, which is almost a 2% increase. Maybe you can see why I am so determined to become a consistently profitable trader. These below inflation pay increases are just demoralizing. A successful trader's income will rise at the rate at which he or she saves. So if you could save 20% of your income you'd get a 20% income increase in the next year, all things being equal, or as economists like to say, ceteris paribus. Up till about age 40 my rate of wage income increase was around 7.5% per annum.

Income does tend to rise fast until people reach about 40 years of age at which time the rate of increase slows until maximum income is typically reached in the mid-50s. After that it tends to decline. This is the US profile from Finn Kydland's Nobel Prize lecture:



Snork Maiden said: "Is that why people have mid-life crises?"

IPO

I have an opportunity to participate in an IPO, in this case the IPO of Interactive Brokers - one of my US stockbrokers. When I lived in Australia I participated in several IPOs some of which were very profitable and some of which were disastrous. I've learnt how to tell them apart upfront. My guess on this one, even before reading the prospectus is that it would be intermediate between the two extremes. Only 5% of the company is being IPOed. Owners don't do that if they expect the value to fall. They will sell the whole company then (see HIH). On the other hand they are going to use a Dutch auction to set the price and they are opening it to all the account-holders of the company. This encourages a full valuation of the company as it is an efficient auction mechanism. The indicative pricing ($23-27) gives a P/E of around 20. I haven't participated in a US IPO before. Maybe I'll do it just for fun. I'm thinking of bidding for 100 @ $27 and 100 @ $36. If the issue prices from $27-36 I'd end up with 100 shares and below $27 200 shares. What do you think?

P.S. 9:54PM

Another IPO - Platinum Asset Management - these guys are the manager of Platinum Capital (PMC.AX) , which is one of my passive alpha investments. They are selling 20% of the company valuing it at $A2.8 billion. They have $A22 billion under management. I can't participate in the IPO as I'm not resident in Australia. But this one is going onto my watchlist.

Can You Get at Your Money?

This is the kind of problem that people that move internationally have. A little while ago I began to receive most distributions and dividends from my Australian investments as cash payments rather than having them reinvested. Now I want to begin transferring them to the US. At the moment the distributions are accumulating in a money market account in Australia, so they are earning interest and the Australian Dollar so far continues to rise. My regular checking account in Australia allows online international wire transfers. Initially the limit for a transfer is set at zero and you need to phone the bank to raise the limit. Last night I phoned them and things were going well until the representative asked me for my Keycard number (this is an ATM card):

"Umm", I said, "I don't have one of those as they wouldn't send me a new one when the old one expired because I don't have an address in Australia."

The truth is that I didn't want to bother my friend there with having to send me a card which I wasn't really going to use at the time. I could have used his address. The representative then told me last night that I need to download a change of details form and send a fax including that, two copies of my signature and a photocopy from my passport. I couldn't find that form on the bank's website and so now e-mailed the bank to send me one electronically. Maybe I'll end up phoning again. But it looks like we can sort this out and begin transferring money bank to the US. I have done transfers from my bank here back to Australia. But to do them I needed to go into the branch, let them photocopy my passport etc. I even transferred money to China that way.

I'm just feeling a little worried this morning that if I move out of the US again I won't be able to get my hands on my money. This is an irrational fear because I will find a way. One option is HSBC's Premier Service. Seems you can set up accounts in multiple countries and then do online wire transfers between them. You need to have either $100k with HSBC or pay $50 a month. I doubt I'd have $100k with them any time soon as I like to have my money doing something more productive than sitting in bank deposits and savings accounts and I don't particularly want to set up a stockbroking/investment account with them. $600 a year is also quite a lot at this stage too for this service. At the moment I am likely to spend just $A88 a year with my Australian bank for transfers and $A60 to maintain the account and in the past I spent maybe $50-75 a year making transfers from here to Aus. But probably down the road I will eventually set up an international banking service of this sort to be sure I can get my money easily wherever I am.

Some people ask me why I maintain investments and accounts in Australia. There are three reasons:

1. I can't get the money out of my retirement accounts or transfer the accounts out of Australia until I am 60.

2. If I sell out my positions in regular accounts I'll owe capital gains tax.

3. From 2002 till now investing in Australia has been an extremely good move. The Australian Dollar has gone up and the Australian stock market has been very strong.

Tax Extension

Yes, I'm going to file an automatic extension. I just printed out the form. I think I am probably quite close to break even on my taxes. So not desperate to get a refund. And the interest/penalties on paying late are pretty small (as long as you pay before October 15) so I'm not in a rush to pay up either. I think people must be scared by that word "penalty" and think something awful will happen to them if they don't pay on time. But it ends up not being much worse than a credit card interest rate (7% p.a. + 1/2% per month = 13% p.a. and if 90% of your taxes are already paid by April 17th then the 1/2% per month penalty isn't added) on the amount that you owe in excess of withholding. In May I'll have plenty of time to sit down and work it all out correctly.

Beta

This part of my portfolio is where I hold traditional long-only mutual funds invested in stocks and bonds, I do modify my exposure to the stock market over the course of the four year stock market cycle. In retrospect I made a mistake though in getting too conservative in 2005 and switching into the CFS Conservative Fund (actually I switched into another fund first - the CFS Diversified Fund) and the CREF Bond Market Fund and out of stock only funds. The Conservative Fund is invested about 30% in stocks and 70% in fixed income and cash. Both stocks and bonds include Australian and global investments. The return has been reasonable - certainly better than switching into cash but I would have been better off to stay in the types of funds in the lower part of the table. Returns on those funds have all been very nice. I first invested in Future Leaders in 1997 and have held ever since. It was my first mutual fund investment in Australia. It's invested in mid-cap Australian firms. Developing Companies is invested in smaller listed Australian firms. I kept holdings in those funds because they are closed to new investors. Maintaining a holding means that I will be allowed to switch back into them at some point. I invested in the Global Resources Fund in 1999 when commodity prices seemed to be at a low. I had to go into my brokers office back then (to get the load rebated). I think she thought I was nuts. This fund is invested in resource stocks all over the world. It biggest holdings are in BHP, Rio Tinto, and CVRD - each composes about 10% of the fund.

At some point I am going to switch out of the more conservative funds to equity only funds. If the yield curve inversion ends , the stock market seems to be going up, and the economy speeding up, I'll drop the bonds. If there is a significant fall in the stock market and a bottom seems to be reached I'll do the same. Maybe I should have switched last summer. The inverted yield curve kept me in all these bonds. Bonds should do well in a recession and the yield curve has usually signalled a coming recession. However, the sample of recessions is too small to assign any statistical significance to the prediction power of the yield curve.

Industrial Stocks

As I've mentioned many times, my investment style doesn't depend on being able to pick individual stocks which aren't in fact companies making other financial investments. I think is is hard for an individual investor to do this. Few mutual fund managers are any good at it. Which is why you have to be very selective about the managers you invest in. I'd love to get comments from people who are good at stock picking if you can back it up with a track record.

I only have four of these industrial stocks. Croesus Mining has been an unmitigated disaster. I was trying to trade it when the stock was halted and then the company declared bankruptcy. I'm still waiting for the situation to be finally resolved. I originally invested a small amount when I read about how it was undervalued and the most likely Aussie gold company to be taken over. Apparently not undervalued in fact and only taken over once bankrupt :) OTOH Ansell and Powertel have been good investments and Symbion a poor but at least moneymaking investment.

Before Telecom NZ announced the acquisition of Powertel, this investment returned to me an annualized 132% I invested in May 2006 @ $A1.20 a share and the buy out price is $A2.30 a share. We are now just waiting for the buyout to proceed. Unfortunately we are going to get cash but I'll just squeak into the holding period for the long-term capital gains rate. If we received Telecom NZ shares then there would be no tax to pay. But who wants them? I bought into Powertel on the recommendation of an online acquaintance in Hong Kong. He sent me the research reports by Goldman Sachs etc. I was very impressed when I looked over the accounts and decided to give it a shot. The story was here was a small telecom owning an important infrastructure asset that was just about to break into profitability. If they didn't become profitable an acquisition was then likely.

I originally bought into the then Mayne-Nickless when it was announced that Peter Smedley who had managed Colonial very successfully - I owned Colonial from the IPO to its acquisition by the Commonwealth Bank - was coming in as CEO. Initially Mayne's stock price rose, but then it eventuated that his management style wasn't working in the healthcare parts of the business. The stock price then plummeted again. It's been a long story. Eventually the company was dismantled and Mayne Pharma was spun-off and then acquired by Hospira. Symbion is the remaining Australia based healthcare businesses. There is ongoing talk of consolidation in this sector and Symbion's price goes up and down with the news and speculation. I'm still holding on to see if something eventuates. It looks like in the long-term my rate of return has been 9.7% which is OK I guess.

My rate of return on Ansell has been 18.2% annualized. My current cost basis is -$2965. So I have pulled out my initial investment and almost $A3000 in profit. Another restructuring, turnaround story. I invested in the then Pacific Dunlop in September 2001. I can't remember what the exact rationale was, but clearly it was cheap. Today Ansell makes, surgical and industrial gloves and condoms. It is a global player headquartered in the US but still listed in Australia. In fact they have dropped their US listing. Rising rubber prices have negatively impacted the company recently but I'm still willing to trust management but with a reduced position in the stock.

In order to buy into another industrial stock I'm going to need a good business case, plus a low valuation. Sure I'll miss out on some growth stocks that would be great investments. But I find it hard to tell ahead of time. That's not where my edge is and I'm happy to leave it to the fund managers.

Moominhouse Fund

Snork Maiden sent in the paperwork for setting up her Roth IRA :) The plan is to use these Roth IRAs a few years down the road to maybe buy a house if we stay here in the US. So this is part II of the Moominhouse Fund:



On the other hand, we might end up leaving the US. Or maybe we still won't want to buy a house. But all the options are out there. Even with a 10% withdrawal penalty I hope the returns are going to be better than the money sitting where it currently is.

Real Estate Investments

Continuing in the "passive alpha" theme we get today to my real estate investments. These include the TIAA Real Estate Fund, Newcastle (NCT), Challenger Infrastructure Fund (CIF.AX), and Hudson City Bank Corp (HCBK). The TIAA fund, which TIAA-CREF call very confusingly a "variable annuity" - it can be automatically converted to a variable annuity when you retire as I understand it - is effectively an open-ended mutual fund directly invested in real estate. They own office, retail, industrial, and residential properties around the US (and one overseas investment). Currently I put 50% of my incoming 403b contributions into this fund. It has performed excellently since September 2002 when I first invested with an annualized 11.4% rate of return and a very low variance. It's had only two slightly negative months. As a result, its Sharpe Ratio is an almost unheard of 4.5! My annualized rate of return is 12.9% as I've changed my contribution rate over time. It also has only a 0.078 correlation with the returns of my overall portfolio. I'm thinking to roll over my 403b into a Roth IRA when I one day quit my current job, but it is certainly tempting to hold onto this fund!

I've held the other investments for shorter periods and they haven't been as good as this one. I bought into Challenger Infrastructure around the time of its IPO (I couldn't participate due to being non-resident in Australia) in August 2005. It's returned 9.7% annualized since then. CIF is a closed end fund that is invested in infrastructure assets in Britain - gas distribution networks and broadcasting towers etc. It is supposed to be a global fund but ended up only investing in the UK for some reason. It's accounts have been pretty impenetrable. I originally bought 3000 shares and when the fund was trading below NAV I bought 2000 more. Later I sold 3000 due to the factors I mentioned above. I like to understand how an investment makes money and be confident in management's strategy. I didn't sell all my shares as I believed the investment was still udnervalued but I sold some to reduce my risk. Maybe I should think about selling the rest? One thing I do like about this investment is that the management company is heavily invested in the fund itself.

NCT and HCBK have both lost me a little money so far. Newcastle is a mortgage REIT managed by the Fortress Investment Group (FIG). It is mainly invested in commercial mortgages. I figured that in a real estate slump this fund could gain by buying assets cheaply. The assets it already held were high quality. And it has begun buying up assets from distressed institutions. So I'm going to hold for now. It also has a very high dividend yield - 9.9%. HCBK's main assets are high end residential mortgages. It also has immense amounts of cash and stockholder equity for a bank. So it has been buying back shares and I figured it too could win in a real estate slump. Also I anticipated it being added to the S&P 500 index. This has now happened but was a non-event as far as the stock price went.

The only passive alpha investment left to discuss is Berkshire Hathaway... and I don't think I need to explain that one! :)

Long-Short Funds

I just saw an interesting post on levels of competence in investing. In this passive alpha section of my portfolio I am being an evaluator - the second level of competence. I think I am getting better at it. The third level applies to my trading. That is an ongoing struggle and I don't think I have proved yet that I am a consistent performer. But I have a good idea of what is needed there.

On to today's passive alpha investments. I have three long-short funds: Hussman Strategic Growth, TFS Market Neutral, and Platinum Capital (HSGFX, TFSMX, PMC.AX). Each of these has very different strategies and so they make sense as complementary investments. I've discussed the first two before, for example here and here. Hussman is long individual stocks and then hedges using derivatives based on his research on past market conditions. The fund does very well in bear markets and quite well in strong bull markets but seems to underperform in moderate bull markets as we have seen recently. Hussman is good at picking stocks. His stock picks have outperformed the index. I am concerned though that economic conditions may have changed and he may be too bearish. He argues that the share of profits in GDP must return to its historic levels. I am not so sure. It is possible there has been a permanent change in the economy. I don't know for sure. I wouldn't make a bet on this either way at this point.

The TFS Market Neutral Fund is much smaller and mainly invests in smaller cap stocks. It is always long and short stocks and doesn't alter its hedging in response to market conditions. Recent returns have been much better than at Hussman. But the track record is much shorter. Both these mutual funds are invested in US stock markets.

Platinum Capital is a closed-end fund that is invested in stock markets globally. They are also always short some stocks but have a long bias. They change the weighting they give to different countries based on their assessment of global macroeconomic conditions. They also actively hedge foreign currencies. But interestingly they don't just hedge foreign exposures back into Australian Dollars. They may hedge into Yen, or Euros or any other currency. So this fund is also a bet on currencies. As Platinum Capital is a listed fund its price relative to NAV varies. But unlike most closed-end funds it usually trades at a significant premium to NAV. I believe this is due to the fact that the fund has considerable undistributed profits, which under the Australian taxation system have attached "franking credits". In Australia closed-end funds pay taxes (unlike the in the U.S.). When they pay out dividends, those dividends have credits for those taxes paid. Platinum Capital reports the franking balance. I maintain a spreadsheet that regresses the share price on NAV and the franking balance and tells me when PMC is under or over-valued. I buy when the stock is undervalued and sell some when it is overvalued. This has significantly boosted my returns over a buy and hold strategy. BTW, trading closed end funds is one of TFS's strategies too. Because of all my trading in and out it's hard to come up with an accurate estimate of my rate of return. Also I invested in 2001-2 and then again in April 2004. In the recent period it's been about 20% annualized. Platinum Capital does charge a performance fee with a hurdle of beating the MSCI World Index. Like Hussman, they performed better in the past. The MSCI has returned 20% p.a. over the last two years. I matched it by trading PMC, the fund itself has not performed as well.

Clime

Another pair of fabulous twins today - Clime Capital (CAM.AX) and Clime Investment Management (CIW.AX). Clime Capital is the closed-end fund and Clime Investment Management the management company. CAM is a long-only stock fund. The manager, Roger Montgomery, worships Warren Buffett and has been achieving Buffettoid results. My annualized rate of return is 54% (in Australian Dollar terms). I met Roger Montgomery when he gave a presentation at the Securities Institute in Sydney. After that I followed what he did and found that he had floated this closed end fund. Initially, the fund was mainly in cash as he looked for good investment opportunities and I didn't buy shares till the fund was mostly invested in February 2006. I doubled my holding in September 2006 when there was a steep sell-off relative to net asset value as the infamous David Tweed tried to unload his holdings. I am looking to double my holding again when there is a good opportunity. This is one of the big advantages of investing in closed-end funds over open-ended mutual funds. Sometimes they are on sale at a steep discount. Montgomery's main strategy is similar to Buffett's and he is also not afraid to hold large positions in small companies. Some of the money though is also invested into the cheapest big cap Australian stocks on a systematic basis. Seems that he likes to play with various capital raising strategies, the latest being converting preference shares.

I first became aware of CIW.AX when they took a stake in Clime Asset Management which was the unlisted management company that managed CAM. At that point CIW was known as Loftus Capital Partners and was a closed end fund that took stakes in both listed and unlisted companies. Since then CIW has acquired the rest of Clime Asset Management and changed its name and strategy to become a broad based financial management company that will acquire other management companies (and it also has a substantial investment in CAM). Essentially, it is an embryonic Australian version of AMG. Its P/E is 17 and given the growth potential I think the shares are cheap. My annualized rate of return is 43%. All the founders including Montgomery now have large stakes in CIW as well as shares in CAM.

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.

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.

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.

March 2007 Report

All figures are in US Dollars unless otherwise stated.

Income and Expenditure



Expenditure was $2625 - 80% of take home pay ($3,299). Spending on travel boosted this month's level. 403b contributions totaled $1,792 and Roth contributions $333.33. Non-retirement investment returns were very strong again this month ($10,348). Retirement investment returns were also nicely positive ($4,315). The rise in the Australian Dollar again contributed significantly to returns.

Net Worth Performance
Net worth rose by $US16849 to $US406,544 and in Australian Dollars gained $A7812 to $A501,658. I am way ahead of my goals for this point in the year. Each month I think that I will suffer a loss and things instead keep turning out positively. The Australian Dollar again rose this month resulting in a relatively large gap between performance in the two currencies. Non-retirement accounts reached $US223,017. Retirement accounts also saw nice gains to $US183,527.

Investment Performance
Investment return in US Dollars was 3.76% vs. a 2.05% gain in the MSCI (Gross) World Index, which I use as my overall benchmark and a 1.12% gain in the S&P 500 total return index. Non-retirement accounts gained 4.87%. Returns in Australian Dollars terms were 1.04% and 2.11%. U.S. Dollar returns also beat the indices over the last 12 months:



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



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. This month, trading conditions were tough and I made some stupid mistakes. But I still eked out a positive result for QQQQ/NQ trading ($794). The biggest gain was from Everest Brown and Babcock - an Australian listed fund of hedge funds and hedge fund management company - and from a balanced mutual fund - the CFS Conservative Fund.

Progress on Trading Goal
Trading in my US accounts netted $1,021 a 3.3% return on trading capital. The model gained 6.7% while the NDX rose 0.6%. My goal for the year is to end up with at least as much in my three accounts - regular trading, Roth IRA, and IB - as I've put into them. The accounts in total gained a net $1,096 and I have now achieved $9,048 of the annual goal of about $19,000. Since the beginning of the year the trading capital gained 41.7%, the NDX has gained less than 1% and the theoretical model gained 28.4%.

Asset Allocation
At the end of the month the portfolio had a beta of 0.33. 40% of the portfolio was in stocks, 42% in bonds, 13% in cash, and loans totalled -7%. The remainder was in hedge fund type and real estate investments, futures value etc. Looking at asset allocation the way I prefer, 22% was in "passive alpha", 66% in "beta", 8% allocated to trading, 7% to industrial stocks, 4% to liquidity, and I was borrowing 7%.

Back to the Moominhouse

Back at the Moominhouse after a visit to Snork Maiden. I helped her open an Online Savings Account with HSBC. We got everything ready to set up a Roth IRA with Ameritrade. The jury's still out on whether she'll actually mail in a check (when I did it there was an electronic funding option - I don't know why this wasn't offered to us this time) with other relevant paperwork. And umm my collection of toy rabbits doubled in size (to 2). The TSA guy at the airport seemed to be looking long and hard at my bag in the machine. Maybe he was looking at this:



Or maybe it was my portable hard-drive :)