Target Portfolio

Following up on my previous post where I tested the performance of an idealized portfolio, here are some more ideas about an actual implementation. In total, 50% would be allocated to stocks, half of that Australian and half of that international. A fifth (maybe more) of the Australian category would be allocated to small cap stocks. Of the remaining 20% portfolio allocation half would go into unhedged funds/stocks and 10% into hedge fund type funds, probably mostly listed hedge funds, such as Cadence Capital (CDM.AX). Of the 25% in international stocks, half would go into hedge funds, primarily Platinum Capital (PMC.AX), which pays franked dividends. Then 25% is allocated to managed futures, probably mostly Winton Global Alpha Fund. This should mostly be held in a superannuation account for tax reasons – pay 15% tax on distributions instead of 47%. That means I am going to need a self-managed superannuation fund.

5% is allocated to gold. This would be held in a taxable account as it doesn't pay dividends. On the other hand, the long-term capital gains rate in superannuation accounts is 10% (and zero after going into pension mode) and my current long-term capital gains rate is 23.5%. If Labor get into power, which is likely, and implement their program, which is less likely, that will rise, though in retirement I expect my marginal tax rate will fall back into the 32.5% bracket but with Medicare tax and Labor's proposal, I would still be paying more than 25% for long-term capital gains. So it makes sense to get more money into superannuation, which is zero taxed in pension mode for the first $1.6 million for each partner. I plan to initially invest about $900k in the SMSF. This will come from rolling over my superannuation fund now at Colonial First State and adding $300k - you can invest 3 years of contributions at once - for each of Moominmama and myself.

The remaining 20% is allocated roughly equally to (mostly direct - i.e. not listed) real estate, bonds, private equity, and cash. Then the whole thing is levered up a bit, with the overall exposure adjusted for market conditions. I expect that debt will be roughly equal to the value of our house ($840k).

To summarize, this is the asset allocation (not including our house):

We are quite a long way from that - in particular very overweight long Australian shares and underweight hedge funds, managed futures, and gold.

Safe Withdrawal Rates

Interesting simulations of safe withdrawal rates over longer time horizons by ERN. The lowest withdrawal rate simulated is 3% p.a. Ed Thorp states that 2% is actually the safe capital preserving withdrawal rate. Our current spending is about 2.75% of estimated total net worth including the inherited money. But I expect our spending to continue to increase faster than inflation for a long time to come.

Art and Net Worth

On one of the many documents we've been sorting through my mother estimated her and my father's net worth in 1995. The number she came up with is equivalent to about USD 1 million today (£350k at the time). But she estimated that an inherited artwork* they owned was worth £20k (USD 56k today). The next year the artwork sold at auction for... £750k (USD 2.1 million). Another letter from my father to his brother in 1954 stated that the art had been valued at USD 880 or around USD 8500 today.

*The art consisted of panels like on this cabinet, but not the cabinet itself:

Sorting Things Out

We're sorting through everything in the apartment - first finding things specifically identified in the will to be given to various people. Mostly jewellery and silverware. But also a stamp collection, which I am supposed to get. We found most of them, but not all. Searching through boxes of documents - recycling a lot of routine financial statements and reserving others for further study. There are files and boxes of letters from the early 20th Century and even greeting cards from the 19th Century. Old books, some family books with names in, others that my mother saved from destruction. We are sorting books into ones we are interested in and others to probably give away. We decided to sell the apartment within a year - if we sell in less than 18 months our mother's previous tax status will apply and we won't need to pay capital gains tax. The apartment will need a lot of work to put it into saleable condition. But there is plenty of demand. My brother keeps getting asked if he is going to rent it out. But like me, he is not keen on owning physical assets directly....

My Mother

This weekend I am traveling to the other side of the world to visit the "home country", though it's not the country I grew up in.

Just over three weeks ago my mother died. She had dementia for several years. When I visited in December, things didn't look good, but she went through a few more cycles of getting a little better and then worse again. Still when the news came it was a shock, though it was so long expected. Maybe partly just finally hearing the bad news. I had decided beforehand not to rush to the other side of the world, right away. The custom there is to hold the funeral on the same day if possible. So, I would miss the funeral or hold everyone up. It seemed better to try to go on with life somewhat normally for a little while than inconvenience everyone here to sit on a plane and in airports on my own for two days each way. Now I am going for the ceremony when the gravestone is "set".

I am also going to work with my brother on sorting all the legal and financial stuff out. Things are actually quite well organized, especially as my brother and I managed all my mother's finance and care etc in the last few years, but there are still some uncertainties. My brother will have to handle most of the organizational details. The main  thing I have been involved with so far is paying the termination payment for the care worker who looked after my mother in the last 7 years. Her devoted work meant that my mother could continue to live at home and did not move to a nursing home or hospital. My brother and I shared in making the payment, which includes paying out her nominal superannuation savings - there aren't real accounts for foreign workers superannuation it seems. We transferred the money to her daughter in her home country. My mother's bank accounts are all frozen now until the probate is sorted out, so we have to take care of all these expenses. Luckily we have the means to handle this kind of thing - my share of this payment was equivalent to a few months salary for me - easily.

Out of IPE

I sold my 700,000 shares of IPE.AX on Friday and today at 13.5 cents each. This was after the company announced that due to a potential performance fee the net tangible assets of the fund were likely 13.8 cents a share. They will pay out next month a 7 cent per share distribution that is about half unfranked dividend and half capital return. If I had kept my shares I would have got a $A49k distribution with about $A11k of tax payable on it this year. By selling now and taking a capital gain, because I still have accumulated capital losses, the income tax is effectively deferred to a future year - by bringing forward the date I will have to pay capital gains taxes again. This probably doesn't make strict financial sense as I "threw away" about $2,000 to avoid paying $11,000 in tax this year rather than a year or two later, which implies a high discount rate. On the other hand, it's quite likely that the fund will have other expenses etc before we would get a final distribution from the fund.

On the other hand, Mercantile (MVT.AX) - Ron Brierley's firm - are still buying. They probably won't have the same tax consideration that I do and they must see some upside in the shares still. It will, therefore, be worth having another look at this stock again after the ex dividend day later this month.

Lifetime profits over the ten years I've been invested in IPE, starting with just 6,000 shares have been about $A31k with $A20k in gains since the beginning of this year.

I also recently sold out of Clime Capital (CAM.AX). Their performance has been subpar in recent years. Instead, I have increased my holding in Cadence Capital (CDM.AX).

Dividend Reinvestment Policy

If a company offers shares at a discount to the market price through a dividend reinvestment plan then I participate in the plan. Not participating seems like not getting part of the return on investment. We own shares in two companies that offer a discount – Platinum Capital (PMC.AX) and Cadence Capital (CDM.AX). But if a company or fund doesn't offer a discount, currently I'm not participating. We did this to help build up the money in our offset account, but it seems to make sense in the longer term to provide cash for rebalancing and new investments without paying fees to sell shares or increasing margin borrowing. There is one exception to this rule, which is the Winton Global Alpha Fund. But I am trying to increase the allocation to managed futures and so it doesn't make sense to withdraw money from the fund.

Optimal Portfolios

I have been doing some experimentation with designing optimal portfolios, something which I last looked at in 2011. I have the monthy rates of return on various asset classes going back to 1996. These include international shares (MSCI World Index, gross) both hedged into Australian Dollars and not. Australian shares (ASX 200 accumulation), Managed Futures (a mix of Man AHL and Winton), direct real estate (a particular US fund as a proxy), hedge funds (HFRI index), the bond market (again I'm using a fund as a proxy), Australian Dollar cash, and gold in Australian dollars. You can use the solver in Excel to find the allocation that monthly rebalanced gives the highest Sharpe Ratio. This optimal portfolio varies over time but generally it doesn't like hedge funds and allocates about 10-20% to gold, and 20-40% to managed futures. Because future performance won't necessarily be the same as past performance (particularly a worry for managed futures) and because managed futures, in particular, are not tax effective – they pay most income out subject to marginal tax rates – I wouldn't allocate according to a particular optimization. A target portfolio gets near the optimal performance while being more diversified and a bit more tax effective:

This graph shows the performance of various assets and a "target portfolio":

Here the target portfolio is 25% international shares (half hedged into Australian dollar and half not), 25% Australian shares, 25% managed futures, and then 5% in each of real estate, bonds, cash, gold, and hedge funds. Then the whole thing is geared up a bit with borrowing. It performs pretty nicely over various historical periods.

Here we have a close up of performance since the financial crisis:

I've managed to match the performance of the Australian index but have lagged behind the MSCI World Index. It matches the performance of the MSCI but has a smoother path. The next graph shows ten year rolling returns:

Here we see that such a portfolio clearly dominates in the long-run over regular stock indices or my own performance, which has not been good over a ten year period recently. The graph also shows how the performance of the Australian stock market has declined. It had very high ten year  returns prior to the crisis, but now has lower returns than international shares over the last ten years.

I have been moving in the direction of the optimal portfolio by diversifying out of Australian shares and buying managed futures, but it has been too slow so far. In the last few months I have been buying $A10k of managed futures each month. I also allocated more to international investments when I reinvested my CFS superannuation fund in their wholesale funds.

February 2018 Monthly Report

After eight months of gains comes a losing month. Here are our monthly accounts (in AUD):

"Current other income" which is mostly salaries (after tax) was $12.3k. Spending (not counting our mortgage) was a little on the high at $8.6k. But spending was elevated by $2.7k I paid for a plane ticket to "the other side of the world" - more about that soon. After deducting the mortgage payment of $4.1k (which includes implicit interest saving due to our offset account - the actual mortgage payment was $910 less than this), we dissaved $0.4k on the current account and added $2.2k in housing equity. Retirement contributions were $2.9k. Net saving was, therefore, $4.7k across the board.

The Australian Dollar fell from USD 0.7794. The MSCI World Index fell 4.16%, and the S&P 500 3.69%. But the ASX 200 gained 0.36%, the All these are total returns including dividends. We lost 0.43% in Australian Dollar terms and 3.92% in US Dollar terms. So, we underperformed the Australian market and outperformed international markets.

The best performing investment in dollar terms was CFS Geared Share Fund, which gained
$3.3k. The worst performer was the Winton Global Alpha Fund, down $4.5k. I am assuming that the market plunge was too sudden for them to change direction. The best performing asset class was hedge funds, up 0.44% and the worst commodities down 4.48%

As a result of all this, net worth fell AUD 3k to $2.156 million or USD 64k to USD 1.681 million.