Wednesday, March 27, 2019

Reduced Incentive to Access Superannuation as Early as Possible

Currently, Australian superannuation earnings are taxed at 15% and 10% for capital gains while you are in the "accumulation" phase (before you retire). When you retire you can switch up to $1.6 million of assets into pension mode and then the earnings are taxed at 0%.* The downside is that then there is a minimum payout ratio every year which increases with age. Unlike the U.S., there is actually no requirement to make any withdrawals from super. But making withdrawals is incentivized by the reduction in tax rate.

But if you have shares that pay franking credits, you can use these franking credits to offset the 10-15% tax. You might not pay any net tax on your super fund in the accumulation phase. When you switch to pension mode you will get cash refunds of the franking credits.**

Labor plans to abolish these refunds of franking credits. This means that there may actually be no net change in tax due when switching from accumulation to pension mode. The incentive to switch disappears. This means that if you have assets outside super you probably should spend them first in retirement as they are relatively highly taxed. Only if you run out of such assets, should you access your super.

* Any excess remains in accumulation mode.
** You might even get some cash refunds in accumulation mode if you have enough shares paying franked dividends.

Planning Permission Refused

I got an email today from the city planning office that the development in our neighbourhood that I had objected to was refused planning permission. The plan violated many individual rules, but basically the developers were trying to cram too much development into a small space. They planned on 56 town houses and commercial space and 12 apartments in a 5 storey building. The development occupies the two greenish blocks on the map:

You can see the size of townhouses and houses in the neighboring development (yes, we live there) to get an idea of how crammed this development was planned to be.

I objected to the height of the 5 storey building, which we would see from the front of our house, largely blocking our existing view to a wooded hill. Only 7 members of the public had filed written objections to the original plan despite wide advertising by the government of the application and consultation sessions in the neighborhood. I was the only person who wrote an objection against the revised plan the developers submitted.

I have been surprised how much work the developers have been doing on site. Apart from demolishing the existing office buildings, they have done most the excavation for underground car parks and then started building individual underground garages for the townhouses on the east of the site. They also recently installed a big yellow tower crane on site. How could they submit a plan that violated so many rules and then invest so much money on the basis of such a flawed plan. Will they have to change the work they have already done or will they get away with it? They have a month to appeal the decision, or they will need to submit a new plan.

Saturday, March 23, 2019

Leave Liability

Here in Australia, employers nowadays seem to be very concerned about people not taking their annual leave entitlements. If your balance gets above a certain amount you are likely to get a message from HR telling you take vacation days before some deadline. I got one of these recently and promptly ignored it. It's not that I haven't taken some breaks. Maybe formally though I was only on leave for a couple of weeks this financial year. I think they might just put me on forced vacation from 1 July which is OK with me (see below why)...

I supervise one other academic. I was told to make a plan with him to reduce his leave liability. He has ended up scheduling a bunch of mini-vacations when he plans to work anyway.

My wife also got a request from her employer to schedule a lot of leave before 1 July. She contacted HR and told them that she couldn't take leave as she has a lot of work to get done. She only works 3 days a week. Their solution? She should switch to full time and take leave on the days she wouldn't be working! This is a win-win solution :)

It might be an even bigger win for us. Moominmama will be going on maternity leave from the end of May. Yes, we are going to have a second child. She plans to be on leave for at least a year.

I think this means that the 18 (?) weeks of maternity pay from her employer will be paid at the full time rate. Also, last time, they made employer superannuation contributions (15.4% of base salary) for the whole year. These too look like they'll be at the full time rate now.

This seems really crazy from the employer's perspective. I don't understand why employers are so concerned about having this "leave liability" on their balance sheet. At her employer apparently you can cash out the leave instead of taking time off. So that is a real liability. My employer allows only allows it in cases of "financial hardship". There is an "annual leave loading" of 17.5% extra pay for the vacation days. The surplus is paid out on termination. But if you do take leave now, it is paid out now and elementary economics say that the employer should want to get it paid out later rather than earlier! It's the employee who is missing out on getting the money earlier. That said, I should take more leave earlier :)

Sunday, March 17, 2019

Pengana Private Equity

Pengana Capital is launching a listed investment trust that will invest in global (but mostly North American) private equity funds. I am participating in the IPO.  I have been looking for an investment to replace IPE, which was taken over by Mercantile Capital. It's not an exact match as IPE invested in mostly Australian private equity. But now I am investing in Australian venture capital, so geographical diversification is good.

The fund will effectively be managed by Grosvenor Capital Management. I attended the "roadshow" where there were presentations from the CEO, Russel Pillemer and from a representative of Grosvenor, Aris Hatch. These were very helpful in understanding the potential value of this IPO. For U.S. regulatory reasons, the prospectus is missing any information on GCM's track record. However, there are two research reports on the IPO website, which are very informative, though technically they are only meant to be accessed by financial professionals.

The fund has really high fees. The base fees are about 2.4% p.a. If the investments exceed the 8% hurdle rate then three (!) levels of performance fees kick in. I estimate that the performance of the fund is related to that of the underlying investments as shown in this graph:

That's right, if the underlying performance reaches 25% the fees will be around 9%! Based on all the information I have, I still think the fund could return around 10% p.a. and so I think it is worth investing in.

An additional feature is that each $1.25 share will be stapled with $0.0625 worth of shares in Pengana Capital (PCG.AX). These shares will be distributed to investors after two years. Pengana will also absorb the costs of the float. Therefore, the initial NAV will be $1.3125 for a $1.25 investment. Pillemer justified PCG's 20% performance fee, for effectively doing nothing but choosing GCM as manager, on the basis of these giveaways. It seems that they won't get to keep much of the base management fee. Therefore, the fund will have to do well for Pengana to get paid.

The fund will take 4 years to get fully invested. In the short run they will invest in debt instead of equity. If there is a recession in the US in the near future, the fund can hopefully make some investments at good prices. So, the timing could be good.

Finally, it's interesting that the fund will not be a listed investment company but a trust. This means all earnings are passed on to investors in the form they are received rather than being converted to franked dividends. This is partly to make the investment more attractive to self managed super funds etc. if franking credit refunds are abolished.

Saturday, March 09, 2019


As we move further away from an equities oriented portfolio, I think that benchmarking against equity indices makes increasing less sense. We are also in a multi-year process of investing inherited cash, which means our portfolio is more cash and bonds heavy than it will be in the long run. As we near "financial independence" I am also becoming more risk-averse. This is the opposite of the usual textbook economics prediction that risk-aversion decreases with wealth. Part of it is that I feel like I should take less risk with the inherited money than with the money I saved myself. My goal is to pass on to my children at least as much as I inherited myself.

So, I am increasingly thinking that an index of hedge fund returns makes more sense as a benchmark. Hedge funds in general aim for lower volatility than equity indices. And hedge fund returns are after fees and so are a more realistic goal to aim at. This is why I have been researching hedge fund performance.

The returns of the typical hedge fund have declined over time and the typical hedge fund no longer produces alpha relative to the MSCI world stock index. Hedge fund returns are increasingly correlated with stock returns. Our own returns are converging towards those of hedge funds:

The graph shows rolling regression estimates of our alpha and beta relative to the HFRI fund weighted index. Our alpha is now around 0% and beta is 2. For a 1% change in hedge fund returns our returns typically change 2%. Mostly in the past we had a negative alpha to hedge fund returns. Comparing our actual returns (in USD terms) to those of the HFRI index, at times we have underperformed and at times outperformed the index:

The graph shows how many percent per year extra you would have earned by investing with me instead of in hte HFRI index starting in each month on the graph. So, if you invested with me in October 1996 you would have received about 2% per year less since then than investing in HFRI. But from November 2002 you would have been 2% per year better off by investing with me instead. By contrast, there have been few months in the last couple of decades where my subsequent cumulative return has been better than the MSCI World Index:

May and June 2003 was one such short period. I have outperformed the index since then. August 2015 and May 2017 were two other recent cases. But there are long periods where my subsequent performance was more than 3% p.a. worse than the index. On the other hand, perhaps the hedge fund index is too easy a benchmark to beat:

Saturday, March 02, 2019

February 2019 Report

In February stock markets continued their rebound. The Australian market rose especially strongly. The Australian Dollar fell from USD 0.7274 to USD 0.7106. The MSCI World Index rose 2.72% and the S&P 500 3.21%. The ASX 200 rose 6.32%. All these are total returns including dividends. We gained 3.18% in Australian Dollar terms and 0.90% in US Dollar terms. So, we underperformed the markets. This is not surprising given the weight of cash and bonds in our portfolio. Our currency neutral rate of return was 1.94%. I estimate that the target portfolio gained 3.08% in Australian Dollar terms.

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

The table also shows the shares of these investments in net worth. At the bottom of the table I also included the Australian Dollars return from foreign currency movements and other net investment gains and losses - net interest and fees.

Things that worked very well this month:

  • CFS funds - they all did well. Future Leaders continues to outperform Developing Companies.
  • Our two UK listed stocks - 3i and Pershing Square Holdings.
  • Medibank. It continues to bounce back nicely though we only have a very small posiiton.
  • Unisuper made the largest gain in dollar terms, though we are still below the peak value last year.
  • Many investments hit new profit highs including PSS(AP), Generation, and Hearts and Minds.
What really didn't work:

  • Yellowbrickroad... I exited this investment at 6.5-6.6 cents per share following the release of the Royal Commission report. I should have gotten out much earlier. The shares are now suspended as the company has not filed its interim financial report. They are still working on writing down their assets... The last price they traded at was 5.4 cents.
Bonds mostly had negative returns. When you buy a corporate bond you have to pay the interest accrued since the last interest payment to the previous holder.

We moved towards the new long-run asset allocation:*

The main driver is continued movement of cash from my US bank account to Interactive Brokers where I am buying bonds before eventually transferring some of the money to our Australian bank accounts when the broker allows. The increase in rest of the world stocks is mostly due to updating the allocations of various managed funds for their current allocations. We are near the long term allocations for each of the stock categories and real estate. We are overweight cash and bonds and underweight commodities, private equity, and hedge funds.

On a regular basis, 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:

  • I bought USD 300k of corporate bonds and USD 100k of treasury bills matured. Our monthly bond ladder now extends to September.
  • We sold 569 China Fund (CHN) shares back to the company at 99% of NAV in the tender and then bought 669 in the market for a lower price.
  • We sold out of Yellowbrickroad (YBR.AX) at a big loss.
  • I made a quick (losing) trade in gold futures (Included in gold above).
  • We switched our choice of option in the PSS(AP) superannuation fund to "balanced" from a mix of "balanced" and "aggressive".
  • I switched from Geared Shares to Imputation (leveraged and unleveraged Australian shares) in my CFS superannuation fund.
  • At the end of the month I also switched to the balanced option in the Unisuper superannuation fund.
So, there was a big deleveraging/derisking theme that will continue. There are no capital gains tax implications to shifting the super funds, so I am doing them first.  We can still switch from the "Geared Growth" fund to an unleveraged version.

* Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged funds.