Mortgage Refinancing: Reality Check

I met today with a "Premier Relationship Manager" at HSBC. We are going ahead with the mortgage refinancing. They will send a valuer to value our house tomorrow...

So, she first checked whether I could service the loan based on the data I submitted. Based on just my salary of AUD 176k per year and our spending and a AUD 500k loan the answer was no. Given my salary is supposedly in the top 5% or higher, our house value is only a bit above the median price for houses here, and lots of people drive luxury cars etc. and we don't, you'd think this wouldn't be a problem. She said our spending was "very high". Either government income data is too low (but the banks ask for tax returns), or people somehow hide spending from the banks (but the banks ask for bank statements), or what? It's hard to reconcile what I see with the data.

Our net worth is in the top 300,000 or so of households and my income in the top 400,000 of taxpayers according to this official data.

By the way, five plus years ago, when we were looking to buy a house, the banks were willing to lend us much more money. Lending standards really have tightened.

Capitalise

Capitalise is an automated trading platform that uses commands written in near natural English at a very high level. I heard about it when Interactive Brokers told us that we now have access to it. At the moment the service is free. You can put in commands where buy/sell levels and stops depend on functions of past prices and also various technical indicators. There is no need to learn a formal programming language like Python or understand any of the intricacies of actually executing strategies. They are based in Israel.

This would be great for me except at the moment it doesn't allow position sizing based on functions of prices. You have to give it a numerical position size. I chatted with Arica on their platform and she said that they might develop that functionality in the future. For now I can handle updating my orders each morning (Australian time) as I am only systematically trading in 3 markets (Bitcoin, palladium, and oil). Maybe they will have this functionality by the time I can't handle trading manually anymore and I won't need to learn Python etc or collaborate with someone who does know that stuff.

Mortgage Inversion Complete, What Next?

I completed the transfer of money into our brokerage accounts from the "mortgage inversion".  That completes a major step in our financial restructuring since the inheritance. We've completed the first two steps on this list. I am thinking of refinancing our mortgage to get a lower interest rate now I don't care about having an offset account with my main bank. But how to go about this? Should I go to a mortgage broker or just contact a bank, like HSBC, who are offering a low rate?

Silver, Six Losing Bitcoin Trades in a Row...

I tested silver futures as a possible addition to the trading portfolio. When combined with Bitcoin, palladium, and crude oil its optimal portfolio weight was 2%. So, I'm not going to be trading that.

Overnight and in today action in Bitcoin has been insane. I was up around USD 5k on my last Bitcoin trade and then it became a USD 1k losing trade, the sixth in a row. We switched to long from short and subsequently bitcoin skyrocketed to over 10,000 from around 7,500. This long trade is only one contract though compared with two contracts on the previous short. It seems like this spike might have been generated by Xi Jinping's new enthusiasm for blockchain. He told party members to study blockchain. This is despite China banning cryptocurrency exchanges, though a lot of Bitcoin mining takes place in China.

Five Losing Bitcoin Trades in a Row

The bad news is that the worst historical losing run in Bitcoin is eleven losing trades in a row. The good news is that least we now have the losses more under control after adopting position sizing and a constant (more or less as we use rounding of contract numbers) maximum dollar risk. I am also now 100% disciplined in following the algorithms. That was a big struggle. We are now back to short again.

Without slippage the previous trade would have been a $120 win. We had a $30 loss. The last trade though was a $2,000 loss when rounded up to two contracts.

Mortgage Redrawn

Just enter the amount, press the button, and:

Now to transfer the money to investment. This is how I account for this re-structure:

Almost all our historical savings from wages etc ("current savings") have now been converted into housing equity and extra retirement contributions. Housing equity is now a few hundred dollars short of the value of the house as I left a small amount of the mortgage unpaid in order not to potentially trigger something undesirable by totally paying it off.

Mortgage Almost Paid Off

It won't be for long!

Trading and Mortgage Inversion Update

We switched from short one contract of Bitcoin to long two this morning, booking a USD 30 loss on the short trade. We are long two as the per contract risk is lower now. After four losing Bitcoin trades, hopefully this is a winning one...

I sold a lot of shares this morning and already was allowed to move some of the proceeds to our offset account. I also paid down AUD 100k of the mortgage and was surprised to see that I could redraw it immediately. I had thought I would need to wait to 4th November for the redraw balance to update. This means that I might be able to complete the inversion this week.

P.S.

So I paid off another AUD 300k later in the day. Am still waiting on a transfer of AUD 100k from my margin loan. When I get it I should be able to complete the "inversion".

Optimizing Trading Portfolios and Shifting to Return on Risk Metric

I started exploring testing portfolios of trading strategies. For this, I decided that in looking at return on capital where capital is the face value of a futures contract doesn't make much sense. It seems to make more sense to look at the return on money at risk. It makes the most sense to measure that in dollars as a share of a total risk budget. This then leads me to making the primary measure of return also to be in dollars. Here is an optimized portfolio of Bitcoin, oil, and palladium:

The portfolio has a total risk budget of USD 5,000. This is then allocated across the three markets with the resulting profit curves. The analysis assumes that you can trade fractional futures contracts. Oil and palladium help diversify Bitcoin and increase the information ratio. Using a zero benchmark and daily returns on risk the portfolio IR is 2.96 rising from 2.17 for Bitcoin alone.

Oil hasn't gone anywhere in the last year, but did well in 2018 when Bitcoin struggled. Going forward, I will test whether each new market I look at improves the portfolio IR or not.

This approach then also leads to computing the prices for continuous futures contracts additively rather than multiplicatively – so that differences in dollars are preserved -– and to focusing on a constant risk budget in dollars. It also allowed me to simplify the back-testing program quite a bit. In the following chart the blue line is the daily profit curve for trading one contract of Bitcoin futures:

The red curve is based on completed trades only. The green curve has a constant dollar risk equal to the average of the single contract. To be more realistic I have rounded the number of contracts to the nearest whole number, which could be zero. This keeps the strategy out of the market in late 2017 and early 2018, when the single contract strategy had a big drawdown. The constant risk strategy has a higher return and a smaller maximum drawdown than trading a single contract. So, this is the strategy I am adopting for Bitcoin going forward. This morning, we switched from one contract long to one contract short...

2018-19 Income and Spending Breakdown

After doing our tax returns I can now report the breakdown of income and spending for the 2018-19 financial year, following up on the breakdown for 2017-18:

On the right there is a breakdown of some of the larger categories into sub-categories. Unlike some bloggers I can't say what we spend on food, or clothes etc. I just know how much we spend at different sorts of retail outlets.

One of the biggest changes from last year is the reduction in cash spending from 13% to 3.5% as we started to use credit and debit cards more to track our spending better. Restaurants is up as former cash spending was converted to spending using cards. Other major changes are:

• An increase in health spending from 7% to 16% due mainly to costs of pregnancy/childbirth. 
• A major increase in housing spending from 16% to 26% as we undertook renovation work and paid more mortgage interest due to having less money in our offset account.
• A major reduction in travel from 14% to 3% as we only went on a trip to Sydney this year instead of to Europe and Japan.

These trends all continued in the first quarter of this financial year, just completed.

Income was up strongly on the previous year, mainly due to futures trading. As a result, taxes were also up strongly to over AUD 100k. OTOH total spending and saving also rose strongly. Note that "current saving" here is much higher than my usual definition of saving, which only includes saving from salaries and similar income. Here, total income includes investment income and so saving is correspondingly higher.

Planning the Mortgage Inversion

I first wrote about this four years ago. I realized today that I could actually pull this off next month. At this point, I have close to AUD 300k in our bank account (which is an offset account). The mortgage is AUD 490k. If I sell some shares, which are currently in the red, like Tribeca Global Resources, realizing capital losses and transfer some Australian dollars from Interactive Brokers I can reach half a million dollars in our bank account. The amount of cash that can be redrawn is only updated on the 4th of the month, so I will wait to a little later this month to sell the shares and transfer the cash and pay off almost all the mortgage. Then in early November I will redraw the cash and transfer it to our brokers. As the mortgage is in both our names, I will transfer the money 50/50 to accounts in each of our names. After that, almost all of our mortgage interest should be tax-deductible. Of course, I could just pay off the mortgage. But the interest rate for a home equity loan is higher than for an owner occupier mortgage and am happy to have debt at relatively low interest rates and invest it in stuff that hopefully will pay a higher return.

2018-19 Taxes

Here are my taxes for another year:

On the income side, Australian dividends, capital gains, and foreign source income are all up strongly. I finally ran out of past capital gains tax losses and so recorded a net capital gain for the first time in a decade. Foreign source income is mostly from futures trading and bond interest. My salary still dominates my income sources. As far as replacing salary with other income goes, you need to consider the joint picture with Moominmama's tax return below and the earnings of our superannuation accounts...

Increased deductions are mostly due to increased margin loan interest.

Franking credits (from Australian dividends), foreign tax paid, and the Early Stage Venture Capital (ESVCLP) offset are all deducted from gross tax to arrive at the tax assessment. Unlike in the past, I expect to pay a lot of extra tax.

Gross cash income deducts franking credits and adds the long-term capital gains discount to gross income. The former aren't paid out as cash and the latter are but aren't included in taxable income.
Net after tax cash income then deducts tax and deductions from gross cash income.

Moominmama's (formerly Snork Maiden) taxes follow:

Here there is more dramatic change. Salary was up further in the bounce back from maternity leave and in preparation for the second maternity leave now in progress. Foreign source income was up dramatically due to futures trading. We do more of our trading in this lower taxed account.

Work related travel expenses were down to almost nothing, as the tax year started during our last big trip to conferences etc. I haven't yet managed to do the mortgage inversion that should increase deductions and so deductions are down.

As a result, income and taxes were up dramatically and we will owe a lot of tax. I expect we will have to start making quarterly tax payments from now on.

Trading Progress

I've now tested Bitcoin, ASX200, palladium, and crude oil futures trading using Barchart data. So far, only ASX200 futures were not profitable. I'm now trading one contract long or short of Bitcoin futures, trading palladium with position sizing using CFDs, and have put in an order to short crude oil futures.

With palladium I am aiming to risk about 10% of the CFD account on each trade. My current position is long 10 ounces of palladium and I have an order to short 20 ounces of palladium. The typical risk for trading a 100 ounce palladium futures contract is too big at this stage. The contract face value is around USD 160k. So, even if the stop is 5% from the current price you are risking USD 8000.

On the other hand, a crude oil contract has a face value of around USD 50k (1000 barrels of oil). I am targeting 5% of the face value as the risk we can take on. To compute the number of contracts we can trade we calculate: 0.05*price/abs(price-stop) and round it up or down to the nearest integer. If that is zero then we don't put an order in. This is why I only have a short order at the moment and no order to go long.

Both oil and palladium have longer optimal periods for measuring breakouts against than Bitcoin does. My palladium strategy looks for breakouts from the last seven days of prices in either direction. My oil strategy uses breakouts from the last eleven days. However, it will exit a long (short) position if the price falls below (rises above) the previous day's low (high).

Palladium has about the same risk/return trade off as Bitcoin, but oil isn't as good a risk/return ratio. Here are the average maximum potential loss and the average trade profit for trading with a single contract:

Bitcoin: Risk =  USD 3,722, profit = USD 1,036, ratio = 0.28
Palladium: Risk = USD 4,910, profit = USD 1.462, ratio = 0.30
Crude oil: Risk = USD 2,030, profit =  USD 225, ratio = 0.11

Compared to face value of the contract, the average Bitcoin profit is a 2.7% return, while for palladium and oil it is 0.9% and 0.4%, respectively. Relative to required margin, though, Bitcoin is not so good compared to the others.

The reason for trading all three of them at this stage is for diversification. I want to have more consistent returns rather than boom and bust. That's why I am still allocating the largest amount of risk to Bitcoin. I also still have a treasuries futures trade on and am long more than 100 ounces of gold via the IAU ETF.

At this point, I think I got beyond the experimental stage of trading and am now in a more developmental period. My backtesting programs work pretty well, I have good quality data, am more used to trading in a disciplined way, and am now testing which markets and position sizes make most sense.

September 2019 Report

In September the Australian Dollar fell from USD 0.6729 to USD 0.6752. The MSCI World Index rose 2.15% and the S&P 500 1.87%. The ASX 200 rose 2.08%. All these are total returns including dividends. We gained 0.52% in Australian Dollar terms and 0.87% in US Dollar terms. The target portfolio lost 0.28% in Australian Dollar terms and the HFRI hedge fund index lost 0.27% in US Dollar terms. So, though we under-performed all three stock indices we out-performed our target portfolio and the HFRI. Updating the monthly returns chart:

Here is a report on the performance of investments by asset class (futures includes managed futures and futures trading):

Private equity and hedge funds did very well while gold and futures did poorly. The largest positive contribution to the rate of return came from hedge funds greatest detractor was gold, which was the exact reverse of the previous month. The returns reported here are in currency neutral terms.

Things that worked well this month:

• Hedge funds shined as Platinum Capital, Regal, and Cadence gained significantly but Tribeca lost more money.
• Pengana Private Equity gained.

What really didn't work:

• Gold and Winton Global Alpha lost significantly, partly reversing recent gains.
• Tribeca lost as noted above.

Trading: We gained modestly in Bitcoin and US treasuries futures and lost moderately in Palladium and big time in gold. Using a narrower definition including only futures and CFDs we gained 0.48% on capital used in trading. Including ETFs we lost 1.53%. Using both definitions we are a bit ahead of where we were at this point last year. This graph shows cumulative trading gains year to date:

The picture is better using the broader definition.

We moved a further towards our new long-run asset allocation.* Cash increased most and private equity and bonds decreased most as we received the proceeds from the IPE.AX delisting:

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, dividends, and interest. Other moves this month:

• We sold $50k of Tenet Health Care bonds when they were called and $50k of Discovery Bonds matured. We bought $50k of HSBC bonds So, our direct bond holdings declined by $50k.
• We traded with moderate success, as discussed above.
• I bought a small number of Platinum Capital shares as their price was a lot below net asset value.
• We started buying Australian Dollars again, buying AUD 20k this month.
• We received the proceeds from the delisting of Oceania Capital.
• As a result of all this our cash holdings increased by around AUD 120k.

* Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged funds. We currently don't have any leveraged funds.