Tuesday, December 25, 2018

What's Your Forecast for the Stock Market?

My brother asked me what my forecast for the stock market was. Here is what I wrote to him:

"Well, I’ve been surprised how weak it has been recently, particularly in December, which you may have heard is so far the worst December in US stock markets since 1931. December is a seasonally strong month as is January. The US economy has been strong though house prices have been falling in many places, presumably due to the Fed raising interest rates and this seems to have been the main reason why the market is down. House prices have been falling in Sydney and Melbourne without any increase in interest rates here. Some indicators though show that the global economy could already be in recession, but I don’t know how reliable that is. The reason I was a bit surprised was it has been very predictable that before recessions the yield curve would invert (short term interest rates higher than long term). This hasn’t happened yet in the US. However, the Fed is signalling that they are going to raise interest rates by another 0.5% in 2019 which would reach an inversion probably. Stock markets tend to be leading indicators and so looks like this time it is more leading than usual. The US economic expansion is the 2nd longest in history and so presumably would come to an end some time soon (Australia hasn’t had a recession since the early 90s though…). Now we can say that the bull market ended as stocks have fallen 20%. If we look at the last two recessions and stock market crashes in the US, the stock market bottomed near the end or after the actual recession – in March 2003 and 2009. At that point the Fed will have slashed interest rates dramatically and unemployment will be high. OTOH in the 1990s the US market bottomed in October 1990, which was when the recession was only just getting underway. The Gulf War turned that around.

I did reduce my exposure to the stock market in early October, but not by enough. So, I’d probably use rallies in the market to reduce exposure more at this point. I was planning to use trading as a hedge, but I stopped trading soon after that as backtests weren’t good and I got ill and didn’t have time to work on it.

Of course, I could be completely wrong about all of this. In the last cycle I got out too early and got back in too early. Probably this time I’ll be late :)

I’m not planning on buying Australian Dollars in a hurry either, even though the current price is quite good. I’ll buy them gradually."

Friday, December 21, 2018

No Interest on More Than $2 Million Deposit?

My brother and I have between us more than USD 2 million in cash in an account at UBS – most of the money we inherited – that we have been jumping through hoops to get out of there. In the meantime the bank seems to be paying no interest on the money and in the last two weeks it actually the account went down by USD 800 for no clear reason – online I can't find any info on fees the bank has charged. How is that possible?

Looks like we have everything in place now to close the account but have been told it'll take about 2 weeks still given the coming holidays etc. However, the client manager told my brother that she could transfer the majority of the money to us right away, while keeping some for unspecified fees and sending us the remainder not spent on fees later. My brother told her that he was happy to wait to get the money in one lump when they close the account. I was shocked and told him to accept her offer. It's hard for me to imagine that the extra fees for a second transfer could be more than the interest we could potentially earn on the money in two weeks (c. USD 2,000 if investing in US Treasury bills).

Update: We missed the client manager leaving for the Christmas break, so likely won't be till mid-January that we'll get the money out...
Another update: Actually, we now got about 90% of the money transferred to us. Why they need to hang on to a 1/4 million dollars, I don't know...

Monday, December 17, 2018

Will Listed Investment Companies Restructure if Labor Eliminates Refundability of Franking Credits?

As you probably know if you live in Australia, Labor plans to abolish the refundability of franking credits - the tax credits attached to dividends for company tax already paid. This will affect taxpayers with low marginal tax rates including self managed superfunds that are paying out a pension, which is tax free if they have less than AUD 1.6 million in assets for that member. This could significantly cut the retirement income of self-funded retirees who have a lot of Australian shares. OTOH, this was the policy prior to 2000 and most other offsets, like foreign tax credits, aren't refundable either.

I already plan to have relatively small amounts of Australian shares when I start an SMSF - this makes sense as I have lots of investments outside super and so it makes sense to put the least tax efficient investments like managed futures into super.

Listed investment companies (LICs) are closed-end funds that pay tax on their earnings and then distribute franked dividends to shareholders. I own shares in several of these like Platinum Capital, Cadence Capital, Hearts and Minds, and Tribeca Global Resources. Both Geoff Wilson and Cadence Capital's Karl Siegling have suggested that they will reorganize their funds if this happens. There are a couple of ways this could happen. One I had thought about, is to delist and turn the fund into a unlisted managed fund (mutual fund). For funds that trade at a premium to NAV, like several of Wilson's funds, this would cause investors to lose a lot of money as now their holdings would only be worth the NAV. For funds trading at a discount to NAV it could be attractive, as shareholders would gain wealth (but see below). To the extent that the funds receive franked dividends from companies, they would still have to distribute franking credits, but capital gains would no longer create franking credits.

Another option I didn't know about, is that they could instead convert to a listed investment trust like an ETF that doesn't pay taxes. This solves the problem of wealth destruction for funds trading at a premium to NAV.

But the article I linked says that this would result in realization of the portfolio for tax purposes. This could be a huge tax bill for companies like Argo that do little trading. The funds will need to pay out a massive special dividend to distribute the associated franking credit. According to Argo's website they will need to pay 72 cents in tax for liquidating the portfolio. That means they would have to pay a $1.68 cash dividend and so actually sell 23% of the portfolio to pay the dividend out. Some other funds have undistributed franking credits and so would also need to sell shares to generate the cash for such a dividend. They will need to do this soon, as there will probably be an election next May. So, I am a bit skeptical that many will.

Sunday, December 09, 2018

Was It a Good Decision to Switch to Defined Contribution Superannuation?

Back in 2009 when I started with my current employer, I carried out a cost-benefit analysis to see whether it made sense to stay in the default defined benefit scheme or to switch to the defined contribution scheme. As a result of the analysis I switched to defined contribution.

Was that a good decision. Using the info in the Unisuper PDS and my data I compute that if I retired at the end of this month I would get a lump sum of AUD 213k. My actual Unisuper account is at AUD 284k. So, so far it's been a good decision.

For context, in Britain, there have been strikes and demonstrations against the plan to switch academics from  defined benefit to defined contribution. But I see defined benefit as a regressive form of socialism where people who are promoted near the end of their career suck the benefits from the system. This is because the lump sum benefit is proportional to the members salary in the last 5 years. I've seem quite a few people promoted to professor in their last few years and of course, deans and other senior administrators benefit heavily from the scheme. This is at the expense of successful researchers who are promoted early and stay in research at a more or less constant salary.

Saturday, December 08, 2018

Target Portfoilo Performance November 2018

The target portfolio gained 0.22% in AUD terms. Offsetting losses in Ausrtalian shares, gold, and unhedged foreign shares there were gains in particular in managed futures and buyout PE.

Tuesday, December 04, 2018


I just read what was a controversial blogpost at Financial Samurai:"Why $5 Million Is Barely Enough To Retire Early With A Family". The post analyses the income and expenditure of a family living in west Los Angeles. A lot of commenters are critical of the assumptions and spending behavior of this family and some people provide some alternative numbers. That got me thinking about the numbers for our family in a bit more detail than I had thought about previously. In the following, I assume we retire where we currently live in Canberra, Australia.

Our net worth is only a bit over half that in Ken's blogpost: AUD 4 million (USD 3 million). We spend about AUD 10k (USD 7k per month) including mortgage interest (but not taxes) compared to their USD 14k per month. If we retired, most of our spending would be unchanged. We don't wear fancy clothes to work and we don't commute long distances. Assuming we continue daycare for 3 days a week (a very good idea in my opinion) we would lose the government subsidy, increasing our spending by AUD8k per year. Anyway, we would progress to private pre-school and likely private school after that going forward so we will have schooling expenses of a similar level. Unlike the American case studies, our health insurance would be unchanged at AUD 6k per year. In fact, it would make sense in my opinion to drop the private health cover and rely on the government system as we will no longer need to pay the Medicare Levy Surcharge if we don't have private insurance. Moominmama will probably want to keep the coverage, though, because she thinks private everything is better (see schools above). Also, unlike the US, we don't need to worry about saving for college tuition because almost all Australian universities are public and students borrow the tuition costs from the government and pay it back as their post-graduation income allows.

Another thing that would be more expensive for us is international travel. This year we traveled as a family for a month to three Northern European countries and Japan. As I went to three international conferences, my fare was paid my employer. I also deducted two weeks accommodation for two conferences which were in the same city and half my wife's airfare from our taxes. She also attended one of the conferences. If we had to pay for everything ourselves, it would have cost us about AUD 5k more.

On the income side, if we stop working, our tax will fall to effectively zero. We will put as much as possible into superannuation and two tax-free thresholds and franking credits should mean no tax on the earnings of the "taxable" part of the portfolio. If I get back into trading successfully, we probably will have to pay tax again, but then our income will be higher too.

So AUD 130k or so per year is about 3.25% of the net worth, which is close to ERN's recommended withdrawal rate. So, in theory we could retire now. As, I'm in my mid-50s, this would still qualify as early retirement. However, I am a bit worried about rising expenditure and a looming economic downturn. Also, at the moment I am happy with my job and so it doesn't make sense to sacrifice the salary. So, at least for the next year we won't implement the RE part of FIRE.

Monday, December 03, 2018

November 2018 Report

Volatility in financial markets continued this month but I hardly traded at all and for us it was a fairly quiet month financially with mostly background prep work. The Australian Dollar rose from USD
0.7083 to USD 0.7302 The MSCI World Index rose 1.51% and the S&P 500 2.04%. The ASX 200 fell 1.96%. All these are total returns including dividends. We lost 1.88% in Australian Dollar terms and gained 1.15% in US Dollar terms. So, we  outperformed the Australian market and underperformed international markets. Our Australian Dollar returns are now strongly driven by changes in the exchange rate as cash in US Dollars and other currencies are a large part of our portfolio. Our currency neutral rate of return was -0.14%.

Here again
is a detailed report on the performance of all investments:

The table also shows the shares of these investments in net worth. Futures contracts are at the bottom. It doesn't make sense to compute shares or rates of return for those. Things that worked quite well this month:
  • Bluesky Alternatives rose sharply after Geoff Wilson engineered the firing of most of the board and Pinnacle Investment withdrew their proposal to manage the fund. It now looks like Wilson Asset Management will end up managing the fund. Most Wilson LICs (closed end funds) trade above net asset value.
  • The Hearts and Minds IPO started trading and performed well.
  • International hedge funds: Tribeca and Pershing each did well in relative terms as did Winton.
  • The China Fund had a decent bounce and Boulder Income Fund bounced back very nicely to almost return to it's September value.
What didn't work:
  • Cadence Capital, again fell sharply. It's performance in the last three months has been very disappointing.
  • Perhaps relatedly, small cap Australian funds also performed badly.
  • Medibank Private fell sharply after the Australian Defence Department didn't renew its contract with them.
  • UK private equity firm, 3i, fell further, though it bounced from its lows.
We moved slightly back towards the new long-run asset allocation:*

Most of the change was due to the rise in the Australian Dollar reducing the value of our USD cash in AUD terms...

We also invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. Other moves this month:
  • As mentioned above, Hearts and Minds began to trade and I increased my holding up to the amount I originally requested in the IPO.
  • I sold some Platinum Capital (PMC.AX) and bought the equivalent actively managed ETF PIXX.AX instead. The idea was that PMC was overvalued. So far this trade hasn't worked out.
  • I bought more Pershing Holdings (PSH.L) and 3i (III.L). Though I increased each position by 50%, each is still only around 0.8% of net worth.
  • I did a couple of trades in futures options and futures.
* Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged funds.