Wednesday, December 31, 2008

Career Progress Report

The academic job I applied for (there are 3-4 positions available) got more than 250 applicants from around the world. They are now narrowing these down to about 40 who will get an initial half hour interview (most at a big academic meeting). I just heard from the chairman that I made it into the 40. So I'll be having a short interview in a couple of weeks time when he gets back from the conference. After this round they'll likely select about 12 for a full on-campus interview which in the academic world last 1-2 days and includes a seminar presentation.

I'll have to think about how to prepare - Last time I did an interview was back in early 2002. And should I wear a suit and tie?

Tuesday, December 30, 2008

U.S. Cheque Funds Available

We were told that there would be a 21 day hold on the proceeds of the U.S. cheque we deposited. But today (the first time I checked) the Commonwealth Bank site says that all that money is included in our "Available Funds". So I transferred $A1000 to our CBA credit card. The site didn't object to the move. The other moves I have planned are to Commonwealth Bank subsidiaries too. In line with the savings policy I plan to transfer another $A1000 to my margin loan, $A1000 to Snork Maiden's Colonial First State account and $A1000 to my CFS account. I plan to invest her contribution in a bond fund for two reasons: 1) To allow some liquidity in the account in case we need to withdraw some money; 2) A bond fund will move the allocation in the account a bit nearer our planned overall target allocation. After this move the planned allocation in her account will be:

In other words: 60% in stocks with double the allocation to Australian stocks as to foreign stocks and the remaining 40% split between hedge funds, real estate, and bonds. This allocation will be achieved by the following allocation to funds:

You won't get the asset allocation by adding up the percentages in each fund as the first two funds are geared. Overall the account effectively borrows 20 cents for each dollar of equity. I'll submit a new regular savings plan on this basis too soon. The new plan will also increase the regular savings amount to $A500 per month following an increase in her salary.

I'll put my contribution in the CFS Geared Global Share Fund. This makes sense as though we are at target weighting in non-US foreign stocks we are underweight US stocks and we're very overweight large-cap Australian stocks.

Monday, December 22, 2008

Depositing a U.S. Check in Australia?

We received a check for just over $US3,000 for Snork Maiden's costs getting to and attending the conference in China in October. I'd like to turn it into Australian Dollars if possible. Tomorrow I'm going to see if Commonwealth Bank can do this at a reasonable cost and delay. Otherwise we'll have to mail it to her account in the U.S. But the only way to convert it to Australian Dollars is for her to then write me a US check which I would then mail to the US and then I'd do a transfer to one of my brokerage accounts and then finally I could do a wire transfer back to Australia. I don't think TD Banknorth HSBC would agree to do a wire transfer to Australia with us the account owners not present in the U.S. Or maybe they would? Anyway, let's see what CBA have to offer first.

Net Asset Values of Infrastructure Funds are not Exaggerated

Often I read in the media that the values of real estate and infrastructure assets owned by listed and superannuation funds are exaggerated. That really these funds couldn't realise as much as the carrying values of the assets if they sold them. Today, Challenger Infrastructure Fund sold a £100 million stake in Southern Water at carrying value. Given this, this fund is extremely undervalued. NAV was estimated at $3.75 per share in June but the shares were last trading at only $1.60. Given the fall in the Australian Dollar and this sale at carrying value, it is unlikely that the NAV has fallen from this last reported figure.

"22 December 2008, Sydney - Challenger Infrastructure Fund (CIF) today announced that it has sold £100 million of Southern Water (representing one-third of CIF’s stake). The stake will be managed by UBS Global Asset Management, the manager of the UBS International Infrastructure Fund, on behalf of a major institutional client. Financial close occurred on Saturday, 20 December 2008. The sale price of £100 million (approximately $221.4 million1) for CIF’s equity interest was completed at the 30 June 2008 Net Asset Valuation (NAV). Proceeds from the sale will be utilised to repay 50% (or £50.4 million) of the redeemable preference securities (RPS) on issue, fund an on-market buy-back of CIF securities and potentially fund future opportunities within CIF’s existing assets or fund further capital management initiatives. CIF also announced an estimated interim distribution of 12 cents per stapled security for the six months ending 31 December 2008. The interim distribution, which will be fully funded from operating cash flow, ensures a clear alignment of securityholder returns with the underlying performance of the fund’s assets. Chief Executive of CIF, Steve Bickerton said: “Over the course of 2008 CIF has undertaken a number of capital management initiatives designed to maximise securityholder value. The first example was the sale of three minority assets at a collective premium to NAV earlier this year, highlighting the embedded value in the portfolio and reducing CIF’s net proportional debt by over $1.1 billion. The sale of a third of our interest in Southern Water at NAV is another example of CIF’s capital management efforts, resulting in de-risking and de-leveraging of the fund and a further $560 million reduction of CIF’s proportional net debt. “The sale of a third of Southern Water at NAV is a pleasing outcome for CIF, particularly in current volatile equity and financial markets. The transaction has given CIF financial flexibility to undertake an on market buy-back, repay 50% of the RPS and furthermore arm CIF with the capacity to fund future opportunities from within our existing assets. CIF will continue to actively manage its capital position for the benefit of securityholders,” concluded Mr Bickerton."

Sunday, December 21, 2008

Markopolos and Madoff

The report which Harry Markopolos submitted to the SEC in 2005 with his suspicions about Madoff is pretty amazing. This is how the SEC responded. They addressed the most minor aspect of the issue.

Saturday, December 20, 2008

Australian vs. Foreign Shares

The chart shows the MSCI All Country World Index converted into Australian Dollars and EWA including dividends converted to AUD. From an Australian perspective, Australian shares have outperformed unhedged foreign shares over the last 12 years. But they have also been more volatile. I also show a couple of diversified portfolios with 33% and 50% foreign shares. The mix with the maximum Sharpe value is 100% Australian shares. Of course, the portfolio without an overweight to Australian shares on a global basis will be indistinguishable from the foreign share index.

These results show why, in addition to the tax benefits, Australian investors might rationally overweight Australian shares very dramatically in their portfolios.

Though hedged foreign shares follow a very different time path than unhedged ones, the Sharpe Ratio is still maximized by a 100% allocation to Australian shares if we consider this option as well.

Friday, December 19, 2008

Australian Managed Fund Distributions Fall Dramatically

This isn't a surprise at all but I just checked our distributions from Colonial First State which were paid on 14th December. Snork Maiden received $18.53 (distributions from Platinum International and BT Property) and I received $32.55 (from CFS Global Resources which was automatically reinvested). Her last distribution was $205.17 in June when she had far fewer units. I received $4,500 just from the Global Resources Fund back then. I'm not expecting much in the way of distributions any time soon due to all the capital losses the funds have received.

Thursday, December 18, 2008

Record Low Returns for U.S. Large Cap Stocks

According to this chart, at the end of September the ten year return on U.S. large cap stocks was as low as it had been only four times before:

And now the return is negative.

But I'm a bit puzzled - how could the 10 year average return in 1932 be so high?

Clearly the Dow was lower than in 1922 then and even with a 5% + dividend yield it's hard to see how the returns could have been as high as shown on the chart above? This chart from Jeremy Siegel also shows what appear to be positive returns in that period, though not as high maybe?

Perhaps the explanation is that by the end of 1932 stock prices had risen around 50% from the bottom which occurred in July (see Yahoo historical data which start in 1928 unfortunately) and Goetzmann's data are annual year end numbers? But at the end of 1922 the Dow was just below 100 and at the end of 1932 at 60. A negative 5% yield. Did dividend yields average more than 10% over this period? If we use annual averages for 1922 and 1932 (about 80 and 64 respectively) we might be getting close to Goetzmann's supposed numbers but the dividend yield still doesn't seem high enough:

Conclusion, the Dow could have shown positive 10 year returns in 1932 but probably not as high as shown in the first chart in this post.

Wednesday, December 17, 2008

Man Investments Exposure to Madoff

A lot of visitors to this blog have been searching for various combinations of Madoff and Man Investments and its products. It turns out there is a connection between the two. Man's RMF division had 1.5% of assets invested with Madoff. 40% of our investment in the Man OM-IP 3Eclipse Fund is invested in the RMF Dynamic Program. So we lost about $A50 in the Madoff debacle.

AS is typical of Australian PDS's (prospectuses), all that is stated in the document is that the fund invests in 40 hedge funds. There is a description of the types of funds but nowhere the names of the actual managers. Australian managed funds invested in shares never tell you what they are invested in either. Colonial First State does give the ten largest positions in its quarterly performance reports. But that's it. U.S. prospectuses and fund reports give very detailed information of this type.

Moominmama seems to have zero exposure, as she is invested in the Man-AHL program but not the RMF program. It doesn't look like her UBS hedge funds had any exposure either.

Everest Brown and Babcock have clarified that they have no exposure either.

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.

Tuesday, December 16, 2008

Blog Traffic

I'm getting a near record daily number of hits (and we're only halfway through 16th December at the moment) due to my first post about Madoff being picked up by Abnormal Returns and the beginning of traffic via the Wikinvest Wire, which you're now seeing at the bottoms of my posts. They've picked up my story about gold and the Australian Dollar. Articles from other blogs are linked to my posts and my posts appear in the same lists of further reading on other blogs.

The record visit level came on April 3rd, 2008 when I posted about Madame X's portfolio. Another notable peak occurred on May 13th when I posted about the U.S. and Australian Federal Budgets. Most of that traffic was sent by Madame X too!

Madoff vs. Equity Market Neutral Funds

The table shows the average monthly returns, standard deviation and Sharpe Ratio for the Fairfield Sentry fund that was "invested" with Madoff and Credit Suisse/Tremont's Equity Market Neutral hedge fund index for the last 12 years. Based on this, Fairfield returned the same as other market neutral funds with about 3/4 of the volatility.

But the big problem with this analysis is it seems that Madoff related funds, at least recently, constituted up to 40% of this index. So it seems that the average market neutral fund is a lot more volatile than the index has been showing. If we assume a constant 40% share for Madoff the market neutral index returned 0.81% per month with a 1.20% standard deviation for a Sharpe Ratio of 1.55. So Madoff's returns were twice as smooth as the adjusted index. Assuming imperfect correlation between those funds the typical fund would be more volatile than that 1.2% monthly standard deviation.

Fairfield Sentry has a beta of 0.09 and an annual alpha of 5.5% relative to the reconstructed index. If you invested directly with Madoff you'd have "made" about 3% a year more than this.

Here are the total return indices for the reconstructed index and Fairfield:

Effect of Madoff on the Credit Suisse/Tremont Hedge Fund Index

Credit Suisse/Tremont Equity Market Neutral Index loses 40.45% in November:

Up to the end of October the index was pretty much flat for the year. The attached commentary states that they wrote down all the Madoff related funds to zero for November. Does this mean that they constituted roughly 40% of the market neutral index?

Seems to me that it would make more sense to just remove them from all past periods too?

Monday, December 15, 2008


A lot of people in the blogosphere are talking about how they knew that Madoff's scheme was obviously a scam. I got the returns data from the Fairfield Sentry fund which was invested in Madoff from Nomura's 3x Leveraged Product factsheet:

Does this look obviously like a scam? The returns are nowhere near as smooth as many media reports claim. One interesting feature is a decline in returns over time which could be related to increased difficulty in paying distributions and redemptions but hedge funds in general have seen declining returns. There is also an apparent reduction in the variance of returns.

The average monthly return from October 1996 to the present was 0.749% with a monthly standard deviation of 0.622% and a Sharpe Ratio of 2.506. This is a slightly higher return and a slightly lower variance than the TIAA Real Estate Fund. The reason that the latter fund is so smooth is that it receives a constant stream of rent payments and only slowly revalues its properties. But for a strategy depending on the stock market this does seem suspiciously smooth. The Credit Suisse Tremont Hedge Fund Index returned 0.728% with standard deviation of 2.205% in the same period. CREF's Bond Market Fund returned 0.463% with s.d. of 1.073%. Man-AHL returned 1.631% with a standard deviation of 5.257%. So this fund gave similar returns to the average hedge fund with less than bond market levels of volatility or just under half the returns of a managed futures fund with about an eighth of the volatility. No wonder Nomura's investors wanted to leverage into it! The returns have correlations of 0.23 to the MSCI World Index, 0.12 to the Credit Suisse/Tremont index and zero to the bond market. With these kinds of stats a Markowitz style portfolio analysis would tell you to put all your money in the fund as some clients seem to have done.

This total return index chart looks more obviously scamlike:

Yet another lesson to not put too much money with any one manager of anything but simple asset class exposures (that are well audited).

Gold and the Australian Dollar

It's commonly believed that there is a strong relationship between the Australian Dollar and gold. But is this true? I computed the monthly returns on gold (percent change in the gold spot price) and the AUD (percent change in the exchange rate to the dollar plus the monthly interest at the Reserve Bank of Australia cash rate) for the period from October 1996 to the present:

The correlation is 0.3 (equivalent to an R2 of 0.09). This isn't that high. The correlation between the returns on the Australian Dollar and the MSCI World Index is around double this. You would get more diversification from investing in a mix of gold and Australian Dollars than in investing in shares and Australian Dollars! The total return indices look superficially correlated:

(R2 is 0.90) but it is a somewhat spurious relationship.

Friday, December 12, 2008

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.

Performance of Endowment Style Portfolios

In the final post of this series I look at the performance of an endowment type portfolio over the last 12 years. 10% is invested in the CREF Bond Fund and the remaining 90% split equally between the MSCI World Index, the Man-AHL Diversified Fund, the Credit Suisse/Tremont Hedge Fund Index, and the TIAA-Real Estate Fund. As is the case with all the portfolios I've posted here the portfolio is rebalanced monthly. This is the Balanced Portfolio. The Levered Portfolio borrows 45 cents for each dollar invested. In other words, the managed futures and stock portion of the portfolio are geared by 50% (one dollar borrowed for each dollar invested). The unlevered portfolio returns 0.83% per month (10.4% p.a.) with a monthly volatility of only 1.78%. The levered portfolio returns 1.08% per month (13.7% p.a.) with a monthly volatility of only 2.58%. This volatility is roughly half that of stocks or managed futures and the return is more than double what stocks returned in this period. Beta to the stock market is 0.35.

These results look better in the last couple of months than Ray Dalio's All Weather Portfolio, which is one of my inspirations. The reason is that while the AWP only includes "beta sources" the portfolio proposed in this post has 45% of assets allocated to "alpha sources" (i.e. they produce alpha relative to the MSCI benchmark).

Implementing a strategy like this in Australia is probably going to require a self managed superannuation fund (similar but much more bureaucratic than a US IRA) for someone like me with half or more of net worth in superannuation as I haven't found a regular superannuation provider with a managed futures option or for that matter a hedge funds option. Funds like PSS(AP) have some money invested in hedge funds of course, but you can't increase that proportion. You can decrease it by also investing in some of their single asset class funds.

Thursday, December 11, 2008

Hedge Funds vs. Managed Futures

In recent posts I have looked at the optimal allocation between stocks and managed futures and between stocks and a composite hedge fund index. The Sharpe Ratio maximizing choice of managed futures was between 55 and 75% of the portfolio depending on the sample of months used. When choosing between stocks and hedge funds though the Sharpe Ratio was maxmized when the whole portfolio was allocated to hedge funds. In fact it was even better to short stocks and go long hedge funds.

But what is the best choice between a generic hedge fund index and a managed futures fund? Using data on the Credit Suisse/Tremont Index and the Man-AHL Diversified Fund for October 1996 to October 2008 the Sharpe Ratio is maximized for an allocation of 30% to the managed futures fund and 70% to the Hedge Fund Index. This portfolio has only slightly higher volatility than the hedge fund index (2.31% vs. 2.14%) and a higher return (1.012% vs. 0.787% per month). By borrowing 72 cents for each dollar invested you could boost returns to the level of the managed futures fund - 1.54% per month with less volatility (3.97% vs. 5.16%) and a slightly lower volatility than stocks.

I've also run portfolio analyses including the MSCI, Man-AHL, Credit Suisse/Tremont, and the TIAA Real Estate Fund and CREF Bond Fund to represent two further asset classes. The maximum Sharpe Ratio was for a portfolio 100% in the real estate fund...

In the real world taking into account tax and other considerations, limitations on leverage (or safer forms of leverage), higher moment correlations, and likely higher future returns from stocks (than in this lost decade period) the best portfolio probably wouldn't be as extreme as these simple analyses indicate. But it would be very different from most people's portfolios and much more similar to the university endowment portfolios. I'll analyse some endowment type portfolios in my next post.

Wednesday, December 10, 2008

Savings Policy

From now on we'll split all savings 50:50 between paying off debt (margin loans and credit card) and making new investments (in Snork Maiden's and my own Colonial First State accounts). Just another form of diversification. We are due to receive a refund of a large part of the costs of the China trip and hopefully get the moneys from redeeming EBI.AX units. In total that is $A12,000 to be reinvested. All this is on top of our regular $A400 monthly contributions to Snork Maiden's account.

Australian Fund Updates

Allco Equity Partners (AEP.AX): The Liberman family got a margin call and now ANZ owns the 25% of the company that they used to own and which had hoped they could sell to the now bankrupt Allco Finance Group for net asset value (about three times the current share price). Steve Eckowitz at EBB also got a margin call a while back. These wealthy families don't seem to be any smarter than me :) In the meantime, the company was trying to terminate its management agreement with Allco and rebrand. The courts just ruled against it. They're looking to appeal of course. They have also hired UBS to look at ways of reducing the discount in the share price.

Platinum Capital (PMC.AX): The very bold attempt to raise more capital with a 1:1 rights issue only raised a small fraction of the planned amount. Only 13,436,583 of the possible 127,163,967 shares were taken up but some shareholders asked for additional allotments of 2,878,901 shares. So they raised 12% of what they hoped for. They also raised a bit more with dividend reinvestment and a "share purchase plan".

Everest Brown and Babcock Alternative Investment Trust (EBI.AX): The fund is embroiled in legal proceedings over the planned delisting and the postponed shareholder meeting. I'm still hoping to get my redemption money on 19th December (the period was extended from 12th December). The stock is trading at about 1/3 of NAV. The AFR reported that there are rumors that the fund that is bringing proceedings (Laxey Partners) is being forced to sell units in the market due to margin calls.

Everest Brown and Babcock (EBB.AX): Not a fund, but a fund manager. Babcock and Brown (BNB.AX, which is close to bankruptcy) sold a 20% holding in EBB.AX to the Wingate Group which apparently is backed by the Smorgon family of Melbourne. One wealthy investor who didn't get a margin call or go bankrupt apparently :) This is good news I think because the company's share price of 4-5 cents (Smorgon bought at 4 cents and have already made 25% on their investment notionally!) looked like the market thought they were heading for bankruptcy too. Given the apparent smarts of this investor that would appear to not be the case. But $A2 million is peanuts for them so who knows.

Alternative Hedge Fund Indices

I got access to HFRI's site. As the chart shows there isn't a lot of difference between the HFRI Weighted Composite Hedge Fund Index and the Credit Suisse/Tremont Hedge Fund Index. It probably doesn't matter which you use to evaluate or develop asset allocation strategies.

Optimal Allocation to Hedge Funds

I've recently posted about the optimal portfolio choice between a global stock index and a managed futures fund. For this post I downloaded monthly return data from October 1996 to October 2008 for the Credit Suisse/Tremont Hedge Fund Index, which is an aggregate of many different hedge fund strategies. You can't actually invest directly in either index. This is in contrast to the managed futures analysis where the fund returns were after all fees and so the results are pretty realistic if the stock exposure occurred through a low cost index fund.

The hedge fund index yields 2.5% a year more than the stock index. So you'd want a fund of funds to cost less than that. Typical fees are 1% + a 10% performance fee. But the monthly standard deviation of the hedge fund index is 2.14% vs. 4.22% for the stock index. So it is possible to get a slightly higher return for less than half the volatility by investing in hedge funds instead of stocks.

The correlation between the two indices is 0.61 in contrast to the negative correlation between the managed futures fund and the stock index. This relatively high correlation and the higher returns of the hedge funds means that the optimal allocation is to invest only in hedge funds. Actually the Sharpe Ratio maximizing portfolio shorts stocks! The optimal share of stocks is -20% with 120% in hedge funds. This is the composite portfolio in the chart above. Borrowing one dollar for every dollar of equity results in a volatility about the same as stocks but with a monthly return of 1.37% vs. 0.58% for stocks and 0.79% for unlevered hedge funds.

Restricting the analysis to the period up till July 2007 only reduces the short position to 10%.

Tuesday, December 09, 2008

Positive Correlation in Bull Markets and Negative in Bear Markets

The chart shows the correlation between the returns of the MSCI World All Country Index and the Man-AHL fund that I've been discussing recently over the twelve months to the dates given. As you can see the correlation tends to be positive in bull markets and low or negative in bear markets. The latter include the 1998 crisis, the 2000-2002 bear market and the current bear market. This of course makes this fund the ideal diversifier for an equity portfolio - reducing downside risk while not sigificantly limiting upside potential.

Monday, December 08, 2008

Future Fund Allocation

The Australian Government has a sovereign wealth fund known as the Future Fund. The Commonwealth Government has run budget surpluses for many years. Once they had paid down most of the national debt they started to accumulate surpluses which in 2006 were allocated to this fund and dedicated to funding previously unfunded defined benefit retirement payments to public servants. The Future Fund's website gives some information on their investment policies:

Equities: 35%
Tangible Assets: 30%
Debt: 20%
Alternative Assets: 15%
Cash: 0%

Based on the PSS(AP) superannuation fund we can guess that 7% is allocated to US equities and therefore 28% to non-US equities. We can then compare this portfolio to the others I already discussed.

Both the PSS(AP) portfolio and Moominmama are almost as close to this allocation as they are to the average US university endowment fund. Moom is slightly closer to this portfolio than to the average US endowment but quite far from both (39% and 43%). Compared to PSS(AP) - which of course is an Australian government defined contribution retirement fund - the Future fund has double the allocation to debt and to real assets and is much lighter in equities and cash.

Sunday, December 07, 2008

Varying the Allocation to Managed Futures

The chart (the y-axis is logarithmic) shows the effect of varying the allocation to managed futures from 10% to 90% (with the remainder of the portfolio in the MSCI World Index) for the period of the last eleven years. To avoid any drawdown during the 1998 crisis (which looks so insignificant now) you needed an allocation of 40% to managed futures. To avoid drawdown in the 2000-02 bear market about 50%, while in the current crisis a 70% allocation has been necessary (which is close to the maximum Sharpe ratio portfolio). As I noted in yesterday's post, there are good reasons not to allocate so much to managed futures. Still these kind of results might make you rethink allocating so much to stocks or at least index funds.

Enoughwealth commented on yesterday's post asking what would the optimal allocation be from the point of view of July 2007 - i.e. before the current financial crisis started. Using data from October 1996 to July 2007 the Sharpe ratio is maximized for a portfolio that is 45% in stocks and 55% in managed futures. Borrowing 32 cents per dollar of equity results in the same volatility as stocks and a 1.5% average monthly return (Sharpe = 1.03) vs. 0.79% for stocks (Sharpe = 0.44). BTW the unleveraged portfolio with the maximum Sharpe ratio is the optimal portfolio in the Markowitz portfolio allocation model. One can then mix that portfolio with a cash allocation or leverage it up depending on your risk preferences.


The optimal Sharpe-Markowitz allocation only takes into account the means, variances and covariances of the two return series. It doesn't take into account higher moment correlations, which are important for understanding the attraction of managed futures.

Saturday, December 06, 2008

Optimal Allocation to Managed Futures

This post follows up from my recent posts about managed futures including this one on their diversification benefits. The Ibbotson-Pimco study suggested allocating a very large share of a portfolio to managed futures. I ran a simple experiment in a spreadsheet to find the optimal allocation between the MSCI World All Country Gross Index and the Man-AHL Diversified Fund. I use monthly returns from October 2002 to November 2008:

The correlation between these series is -.12 and as you can see the correlation seems to get more negative when more extreme returns are experienced as was discussed in the Altevo Research study. Not all correlations go to one in a financial crisis... The allocation which maximizes the Sharpe Ratio is 34% in stocks and 66% in managed futures. This is designated the composite portfolio:

The returns of this portfolio have a 0.33 correlation to the MSCI but a 0.90 correlation to the Man-AHL fund. Stocks returned 0.60% per month over the period with 4.56% standard deviation (Sharpe = 0.237). The Man fund returned 1.25% per month with a 5.05% standard deviation (Sharpe = 0.663). The composite portfolio returns 1.03% per month with a standard deviation of 3.50%. We can then lever this portfolio to increase returns. Borrowing 30 cents per dollar of equity results in the same volatility as the stock portfolio and a return of 1.27% per month on average (Sharpe = 0.751).

What are the downsides of a portfolio of this type? First, you would be assuming enormous manager risk - even though you could diversify across a small number of managers, all the best managers have developed their techniques from a common origin. Second, the strategies involve short-term trading and may not be as tax efficient as stock mutual funds. But this will depend on the fund structure, your jurisdiction, and whether you are holding the investment in a retirement account or not.

At the moment I only have 1.67% of assets (2.7% of net worth) allocated to managed futures. Moominmama has 2.2% in the Man-AHL Diversified Fund. My long-term target is to allocate 12.5% of assets to managed futures. But even this gives relatively little diversification benefit.

Friday, December 05, 2008

November 2008 Report

November was another horrible month. The percentage decline was not as bad as in October in USD terms. In fact, only half as bad. But we lagged the market very badly due to forced margin liquidations and in Australian Dollar terms this was our second worst month ever (September 2002 was worse).

Income and Expenditure

Expenditure was $3,800 ($A5,807). This was elevated by a registration fee we had to pay for the China conference. Core expenditure still came in at $3,003 ($A4,588), which exceeded non-investment income of $2,635. Retirement contributions were $1,133 as Snork Maiden's employer began to catch up on some of the missing contributions. They are still behind by three contributions. Total investment losses were $38,789. Foreign currency had little impact this month as the Australian Dollar and Euro were steady though the Pound fell.

Net Worth

Net worth fell by $37,448 to $195,284 or in Australian Dollar terms by $A54,305 to $298.427. This takes us back to mid-2004 levels in US Dollars or late 2004 to early 2005 levels in Australian Dollars. If I can get a decent job in the next year and markets recover a bit we could fix this damage in about 3 years I think.

Investment Performance

USD returns were -16.67% vs. -6.51% or -7.18% for the MSCI and SPX respectively. In AUD terms we returned -15.98%.

Using my preferred time series method, portfolio beta to the MSCI index was 1.43 with an annual alpha of 1.8%. Other methods now give a negative alpha.

Asset Allocation

At the end of October the allocation was 47% in "passive alpha", 59% in "beta", 1% was allocated to trading, 0.5% to industrial stocks, 6.5% to liquidity, 4% to other assets, and we were borrowing 17%. Due to the use of leveraged funds, our actual exposure to stocks was 101% of net worth. Deleveraging continued. In October we were borrowing 28 cents for each dollar in equity; we are now borrowing 17 cents. When we take into borrowing by the leveraged funds we are invested in, borrowing per dollar of equity declined from 75 cents to 63 cents. Looking at asset classes:

Exposure to foreign stocks and private equity reduced as they declined in value against other assets or we were forced to sell. The shares of the stronger performing asset classes increased. As a result, we moved away from our long-term target (A distance of 25% vs. 23% in October). The picture at the position level now looks like this:

There were only three positive performers this month, namely Platinum Capital (PMC.AX), CREF Bond Fund, and the Man managed futures fund. Everything else lost money.

Thursday, December 04, 2008

Endowment Asset Allocations II

Following up on my recent post about endowment asset allocations I've updated Moom's and Moominmama's numbers for November and also added the allocation of the Public Sector Superannuation Scheme (Accumulation Plan) which is Snork Maiden's retirement account:

The PSS(AP) allocation is the "trustee choice" or default option. We are investing 90% in this and 10% in the "Sustainable Option" which is Australian shares with a green bias. That increases the equity percentage of her portfolio and brings it closer to our developing target allocation.*

The top panel in the table is the allocation of each of the portfolios to the different asset classes while the bottom panel is the Euclidean distance between the portfolios on the left and the those listed on the top line. Moom is closest to the PSS(AP) portfolio, which is not so surprising as they are both Australian based allocations. Moom is also nearer the average US endowment than to Moominmama. This diversification is probably a good thing. While Moominmama is nearest to the average US endowment she is also quite close to the PSS(AP) portfolio.

Moom's allocation moved further from the US endowments and from Moominmama's portfolio this month, mainly due to selling US equities.

* Snork Maiden's retirement portfolio is 17% from our target portfolio and 23% from our current overall portfolio.


The New York Times reports on the losses of the Harvard endowment. Their losses in July-October pretty much match the S&P 500's losses (23%) but are better than the MSCI World Index (33% loss). And they are far far better than Moom's performance (47% loss in USD terms).

P.P.S. 8th December

I just found more accurate information on the PSS(AP) superannuation fund's current allocation (rather than the targets in the prospectus):

Hedge funds 15%, Domestic Equity (US) 9%, Fixed Income 10%, Foreign Equity 33%, Private Equity 7%, Real Assets 15%, and Cash 11%.

Given this Moom's distance from this portfolio is 26% and Moominmama's 28%. So we are both closer to this portfolio than to any of the US endowments.

P.P.P.S. 10th December

Harvard's actual allocation to foreign equity is 22% not 2%!

Wednesday, December 03, 2008

Beginning of Stabilization?

Things maybe began to stabilize a little in November. Moominmama suffered a loss of "only" 4.76% vs. 13.06% in October. The MSCI was down 6.51% vs 24.02% in October. I haven't calculated my results yet but they are likely going to be worse than the MSCI due to having to sell most of my US stocks at the worst point in the market. And though the rate of loss slowed, Moominmama dipped under the $2 million mark and back to 2004 levels. The fall is due to both the fall in global stock and commodity markets and the rise in the US Dollar that reduces the value of non-US assets in USD terms.

One bright point is that my Australian margin account is out of the buffer zone this morning, due to the good performance of the Man fund we own in October - they take a month to update the values for some reason. In the long-term I definitely plan to add more managed futures.

Tuesday, November 25, 2008


So apparently the government department who provided my contact with a grant that was never used is willing to see a new proposal as to what to do with the money. So I have to come up with a proposal fast. I'm reading up about what issues are of interest to them and hoping I can dust up an old proposal, make it relevant to those issues and the Asia-Pacfic region and give it a shot. Let's see.

Monday, November 24, 2008

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.

Friday, November 21, 2008


US markets fell below the 2002 lows today. I don't know whether that is the legendary "capitulation" or not, but I capitulated more or less in my Ameritrade trading account today. I sold most of my remaining stocks and kept just 4 (BRK/B, MVC, CHN, LGDI) and now the margin loan is less than 50% of the value of the stocks. Of course, I should have done this many months ago. But I didn't and there's not much I can say. The most important lesson is not to use margin loans. Some people maybe can use them as a short-term source of funding or be disciplined to use them in extreme moderation. Mainly, I sold because I want to be able to sleep at night. But really there is only a 10th of the peak value of the account left and if the market kept falling I would soon be wiped out entirely. My main concern now is for my Australian margin account. I've continued to make adjustments to keep within the margin "buffer". It's been a slow bleed.

Some people were right about how severe this bear market would be. But many of those were very early in their forecast and others were very extreme in their predictions. The average investor should be diversified across assets and managers and only adjust their weightings moderately in response to economic news. When things finally stabilize, that's where we are going personally with our future savings. Luckily we are still not that old.

The pain in this bear market has had two main dimensions for me. One is realizing that I am not as smart as I thought and the other is losing money I worked to earn and sacrificed to save. It is also painful to lose Snork Maiden's and my Mom's money through my decisions. But there were no margin loans there and unless the economy is shifting to a permanently lower state the money should come back eventually.

Wednesday, November 19, 2008

Surveying the Wreckage

Our estimated net realised capital loss for the year so far is $A38k ($US24). At least I won't be paying any capital gains taxes for a while. In Australia you can't deduct any of the net loss against other income but you can carry it all forward to future years to offset future capital gains.

On the theme that a demolition prepares the ground to build something new I've completed the first draft of my job application for the local university job. Academic job applications are always long but in Australia all government jobs (and maybe some private sector ones too?) require you to address a list of explicit "selection criteria". So most applications are rather lengthy. Snork Maiden will help me improve this first draft and then I'll try to get some input from another friend before submitting.

Monday, November 17, 2008


This chart shows in Australian Dollars my/our cumulative saving over the last twelve years. It doesn't include retirement saving and it completely ignores all investment income or losses. So it is purely the accumulated difference between non-investment earnings and spending. Unfortunately we don't currently have all this money as cumulative non-retirement investment earnings are negative. Retirement earnings, however, remain positive.

The big difference between the last bear market and the current one is I was spending far in excess of what I was earning then as well as losing on my investments/trading. This time we are actually saving a little.

The little spike in 2007 is where I added in Snork Maiden's savings and then we spent a lot when we moved to Australia.

Friday, November 14, 2008


No, I'm not moving to Perth, but my former PhD student was just offered a lectureship job there on the last day of his interview process. This student is from the same city in China as Snork Maiden and has been doing a post-doc in the U.S. Back in 1996 I was offered a job in Australia during my interview here. If they like you here they move, screw the bureaucracy. This is great news. He wants to move to Australia in order to get married to his Australian girlfriend - she'll move from Melbourne to Perth. Co-location was the main reason Snork Maiden and I moved here too.

Of even more interest, is that the guy I set up a meeting with here was looking to try to hire this student of mine too. This might increase my chances of getting hired myself instead.

The huge rebound on Wall Street last night makes me a little less nervous and a little more hopeful of retaining some account value. Otherwise, I'm puzzling out how to set up my website. Not sure if everything is activated yet or not. Sent a message to the helpdesk.

Thursday, November 13, 2008

Darkest Before the Dawn?

Today, Paulson said that he's changed his mind and they aren't going to buy up mortgages using the TARP funds. Now the name of the program: "Troubled Assets Relief Program" is a real misnomer, but I guess they are still trying to give relief to institutions with troubled assets. When the TARP was first proposed, many commentators argued that buying stock in the troubled institutions would make more sense due to leverage that banks balance sheets could provide to turn that capital into a much larger amount of new loans. But now that the government has finally decided to mainly do that (of course they have been doing that in practice) the Dow falls another 400 points. I guess investors have no confidence in the government after all these twists and turns.

Of course this fall battered my poor accounts again and I am again in a margin call. There is a chance that another account may soon be totally wiped out unless things turn around fast.

On a more positive note, I have a meeting set up in about ten days with a guy who maybe can either hire me as a researcher or work with me on developing a proposal that could fund me. On the website, opinions seem pretty divided between .org and .com. I'm leaning to .com following my brother's advice and that maybe in the future I'd offer consulting services via the website.


I registered my domain (.com) and applied for webhosting and I'm working on editing my old webpages from my former university site to be ready for my new site. Also I've registered for an open day (2 days actually) in my disciplinary area at the local university. It'll be a chance to meet all the relevant people. I also just contacted a senior professor about some lectureship jobs (assistant professor in American) that are currently being advertised here. I was an external examiner for one of his PhD students. I'm also putting the finishing touches on an academic paper I co-wrote with Snork Maiden.

Wednesday, November 12, 2008

Professional Website

As part of my new career direction I want to set up a professional website which is not linked to this blog. Snork Maiden found a cheap and easy service for buying a domain name and hosting a website: It is so much cheaper than my ISP's offerings. It sounds great. Only question is what domain name to go for. Here are some options:

All these are available. Let me know what you think. I found that there are restrictions on .au domains. You can't get a or without an Australian Business Number. And you really have to be a non-profit organization to get a domain.

Career Explorations

I'm beginning to make contacts and explore career options. In the short-term I want to stay here in Canberra, which somewhat limits options. But it is a good location for my long-term career goals and there may be also online money-making opportunities in the meantime. One idea I'm exploring is editing academic papers for authors who are not native English speakers. I have plenty of experience with this - I've continued as the associate editor of an academic journal since leaving my former academic position in the U.S. - and would play the role of a subject expert more than a copy-editor. The other track is meeting people in my academic field and discussing the opportunities here to work in research and/or teaching. I should have a better idea of what I might be doing by the end of this month and whether I need to move onto something else, perhaps in the public service.

Monday, November 10, 2008

Zimbabwe Crisis

Good series of photos on the hyperinflation in Zimbabwe. Nothing like photos to illustrate the craziness of hyperinflation. My Dad remembered the hyperinflation in Weimar Germany though he was only seven years old at the time. That was just as crazy. Most hyperinflations haven't gotten that bad. I wrote my undergraduate thesis in economics on Turkish inflation policy. The rate only got a little above 100% per year and I experienced the hyperinflation in Israel directly living through rates of 100-400% per annum. But those were relatively manageable compared to Zimbabwe, Weimar, and other ultrainflations.

Endowment Asset Allocations

Interesting article in Barrons this week on the performance of U.S. college endowments. In recent years endowments have increased exposure to alternative investments in an attempt to emulate the star endowments of Yale and Harvard. Barrons' main argument is that while this strategy looked good up till this year recently alternatives have performed just as badly as traditional assets (stocks and bonds) and that maybe these funds should focus more on traditional assets in future:

(I don't know how they're coming up with a 50% loss in private equity since June 30 - I think this is just a wild guess based on assuming that private equity moves like public equity and as it is levered the losses will be worse. Private equity funds aren't reporting these kind of losses as is discussed in another Barrons' article on Blackstone). In contrast to the article and the headline on the table, the theory of rebalancing would argue for putting more money into the alternatives that have had recent poor performance. What do you think?

Having a lot in alternatives hasn't done Moom and Moominmama much good either. These are our allocations at the end of October:

Compared to the star endowments Moom has heaps of foreign equity (mainly Australian stocks) and low allocations to private equity and real assets. Moominmama has piles of bonds and cash and zero allocation to private equity and a low allocation to real assets. Of course, our low allocation to US stocks is because we are not US based. Moom had a 46% allocation to his domestic equity but Moominmama has a zero allocation to her domestic equity. The average between our two portfolios is not that far from the portfolio of the average educational endowment as estimated by Bloomberg. And despite Barrons' article that might not be a bad benchmark to aim for in the long-term.


Using the concept of Euclidian distance we can compute the similarities between the portfolios (I dropped Stanford from the sample). Moom is closest to the average endowment with a distance of 38% and furthest from Harvard with a distance of 56%. Moominmama is also closest to the average endowment (30%) and furthest from Princeton (41%). The distance between Moom and Moominmama is 49%.

Saturday, November 08, 2008

Position Level Allocation

After all the changes of the last couple of months, I'm posting my position level allocation as at the end of October. This is one the main spreadsheets I maintain to see where I'm at across the whole portfolio. The primary breakdowns are according to currency and investment mode or function. "Passive alpha" are investments that are usually expected to have low correlation with stock or bond markets (including all individual financial sector stocks) while "beta" investments are funds and ETFs which are either index funds or mutual funds that are close to closet indexers. Some of these are sector funds (e.g. XLF, PBW, Global Resources Fund), some country funds (e.g. IFN), some capitalization funds - small and large cap Australian stock funds, and asset class funds (CREF Bond Fund). I break out individual non-financial stocks as "industrial stocks". The point of this post is mainly just to show what I'm currently holding in what proportion.

Positions that have done relatively well have grown into rather large percentages of net worth. In particular, the TIAA Real Estate Fund is now more than 9% of net worth and regarded as a "passive alpha" investment. It provides the bulk of our real estate exposure. It is a "direct property investment" as it is a non-exchange-listed open ended fund that directly invests in property. Direct property investments behave very differently from exchange listed property investments. They have a lower correlation to the stock market. Our only other exposure to direct property is through Snork Maiden's retirement account (PSS(AP)), which currently is still a very small exposure. Our other "real estate investments" are NCT (mortgage REIT), CIF.AX (Infrastructure Fund), BT Property Investments (a REIT mutual fund), and 3% of the CFS Conservative Fund. I'm rather loathe to cut exposure to the TIAA Fund given how well it has performed and our limited other opportunities currently for real estate investment. We could increase the share of Snork Maiden's retirement account in direct property, but the total amount to play with there is still rather small. Our other accounts are rather "liquidity constrained" :) So despite the single fund manager risk, I'm going to keep the current allocation.

Friday, November 07, 2008

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.

Wednesday, November 05, 2008

October 2008 Report

In percentage terms October's results are the worst on record but they were heavily influenced by the decline in the Australian Dollar that took place in this period. This has the effect of reducing both our expenses and non-investment income in US Dollar terms and making investment returns in USD terms much worse than in Australian Dollar terms. In Australian Dollar terms the results were bad but no worse than September. Of course, September was horrible.

Income and Expenditure

Expenditure was $3,523 ($A5,340). This was elevated by heavy spending in China on everything from family banquets to hotelrooms. Non-investment income of $7,057 which was increased by a third salary payment this month and by money we received from Snork Maiden's parents. Retirement contributions were $668. Total investment losses were $96,753, which is a record loss. But $37,660 of this was due to the fall in the AUD. In AUD terms we lost $A52,637 - a little less than in September - with a positive $36,866 contributed by the rise in the USD.

Net Worth

Net worth fell by $90,408 to $234,430 or in Australian Dollar terms by $A43,074 to $355,305. This chart, in Australian Dollars, does look a bit less scary than the US Dollar chart posted on NetWorthIQ:

Medium term balance is just non-retirement accounts and superannuation is retirement accounts (including US ones as well as Australian ones).

Investment Performance

We are now trailing the MSCI All Country Gross Index across all of these time frames. Returns just fell off a cliff in September and October compared to any previous period:

Whatever way you look at it:

Using my preferred time series method portfolio beta to the MSCI index was 1.27 in October with an annual alpha of 3.1%. This alpha is hugely down on past estimates but still positive.

Asset Allocation

At the end of October the allocation was 52% in "passive alpha", 58% in "beta", 2% was allocated to trading, 6% to industrial stocks, 6% to liquidity, 4% to other assets, and we were borrowing 28%. Due to the use of leveraged funds, our actual exposure to stocks was 105% of net worth, which was down sharply this month due to "forced deleveraging". In September we were borrowing 29 cents for each dollar in equity; we are now borrowing 28 cents. The change is much bigger when we take into borrowing by the leveraged funds we are invested in. In total, borrowing per dollar of equity declined from 82 cents to 67 cents. Looking at asset classes:

Exposure to stocks reduced as they declined in value against other assets or we were forced to sell. At the end of September currency exposures were roughly 51% Australian Dollar, 27% US Dollar, and 21% Other and Global.

Dollar Cost Averaging in Action

Added another $1,000 to Snork Maiden's Colonial First State account. Since the end of September we've added between 29% and 89% units (shares) to each of the seven funds in her account. The differences between the funds is because I'm using the additional contributions to rebalance the account and also because our money is buying far more units in funds whose price fell a lot than it is buying in the better performing funds.


Allco went into administration i.e. bankruptcy today. Allco Equity Partners announced that they are terminating the management agreement with Allco and will in future themselves employ the Allco managers seconded to the company. A name change is coming up. The upside is that this cuts the links with the embattled Allco Finance Group which I think has contributed to the exceptionally depressed state of AEP's share price. The downside is that the Allco administrators can now sell AFG's shareholding in AEP which could keep the share price depressed in the near term.