Checking in on the SMSF

 We have now been running an SMSF for almost three years. How is it doing?

The obvious benchmarks are our employer superannuation funds - Unisuper and PSS(AP). All these numbers are pre-tax. I probably over-estimate the tax paid by the funds, while I know the exact amount of tax paid by the SMSF. So the funds have a bit of an advantage here. 

The SMSF got a good start after which it gradually trudged higher. The two industry funds both declined substantially in 2022 and then recovered. PSS(AP) is almost catching up with the SMSF now.

The SMSF has had lower volatility than the two industry funds, though, at 1.85% per month, its standard deviation is only marginally lower than PSS(AP) at 1.87%. Up and down moves are both penalized using this metric. Unisuper's standard deviation is 2.23%.

Using Unisuper as the benchmark, the SMSF has a beta of 0.42 and an annualized alpha of 4.75%.* Another way of expressing this is that the SMSF captures 64% of the Unisuper's upside but only 24% of its downside. Reducing downside risk is one of our main goals.

* This is treating the risk free rate as zero. The official CAPM alpha using the RBA cash rate will be a bit lower.

Closed Two Investments

I sold our holding in WAM Leaders (WLE.AX). It was down to only 0.1% of the portfolio. Once we held a lot more but gradually sold it off over time to fund other things. I think it is a good investment and maybe we will come back to it in the future. We got a 7.8% internal rate of return on this investment.

The other was Ruffer Investment Company (RICA.L) a diversified listed investment company on the London Stock Exchange. This has not been doing well in the last couple of years and I am tired of losing money. I think the managers got too clever for their own good in being bearish. We got a -3.9% internal rate of return on this investment.

I also sold the holding of Hearts and Minds (HM1.AX) in the SMSF to tidy things up. We still hold more than 40,000 shares of that. Hearts and Minds is currently at an IRR of 3.7%. Our median investment is at 8.5% (PSSAP).

I started a new investment/trade with some of the proceeds, which I'll talk about in due course.

My Aunt's Legacy

My aunt died in 2020. She was single all her life. My father and her did not get on well. They fought each other in court over their mother's will. We wondered who she left her money to. Turns out she set up a foundation with about £5 million in assets. Most of the value came from her house and a company that seems to rent properties. The charities commission in the UK is already investigating the foundation for donating money to things that she didn't specify and maybe benefiting the trustees.... I wonder what happened to the art she inherited that they fought over? Either she had already sold it or she must have given it to someone else. 

One of my cousin's children found out about this charity when they were looking for grants for education, which did fall within one of the approved purposes of the foundation.

When Does Our Investment Strategy Add Value?

EnoughWealth wonders if our investment strategy only adds value under certain market conditions. As a first step let's look at when the out-performance relative to the 60/40 portfolio happened:

The graph simply takes away the monthly return on the Vanguard 60/40 portfolio from Moom's actual results. We see there are periods of out- and under-performance throughout the period. Not surprisingly, it was weaker in 2023 in particular. I didn't do well in implementing the target portfolio strategy last year. Here is a graph comparing the performance of this theoretical portfolio and the Vanguard portfolio:

This looks more consistent. This portfolio is theoretical because it consists of a mix of actual investible funds and non-investible indices.

Bottom line, is I think it is a good idea to add things like managed futures, gold, real estate etc to your portfolio. It makes a real difference.

Lost Money Found

Got an email from Commonwealth Bank that mentions their "Benefits Finder" button in the CommBank App. This can help you find missing money. Turns out I have about $650 with ASIC in liquidator dividends from the collapse of HIH Insurance. I owned 7,500 shares when it collapsed. Need to have a document with my name and address on at that time. I even have the ASX holding statement for my shares! Get a certified copy, a certified copy of my passport, and a statutory declaration and send it all to ASIC.... Will be paying a visit to the Post Office tomorrow to do all this...

A 60/40 Australia-Oriented Passive Benchmark

If we create a portfolio invested 50% in VDBA and 50% in VDGR we can simulate a 60/40 passive benchmark:

This requires monthly rebalancing of the portfolio. We ignore the costs of this rebalancing. Over this period, the benchmark portfolio had a compound annual return of 5.60% with a monthly standard deviation of 2.55% compared to Moom's compound return of 7.77% with a monthly standard deviation of 2.32%. Moom's beta to this portfolio was 0.8 with an annual alpha of 2.9%.

Note that our portfolio goes through three different "regimes" during this period. Up to October 2018 we had a portfolio that was about 60% long public equity. Then we received a large amount of cash, which we converted to bonds and then gradually invested in other assets. This phase lasted up to the end of 2020. Since then we have been close to the target portfolio.

VDGR

Following up on my comparison of our portfolio to VDBA, here is a comparison to VDGR. VDGR is a 70/30 mix, while VDBA is 50/50 and our portfolio is 60/40.

First, here is how $1000 would have evolved if invested either with me or in VDGR since the end of November 2017:

Put another way, the average annual return over this period was 6.97% for VDGR and 8.65% for Moom. 

VDGR is less conservative, but still underperformed. The monthly standard deviation of returns for VDGR is 2.84%, while it is 2.28% for Moom. So, we had higher returns with lower risk.

I again did a CAPM style analysis using the RBA cash rate as the risk free rate and treating VDGR as the index. Moom has a 0.72 beta to VDGR and an annual alpha of 2.58%.

Again, I conclude that the additional diversification in our portfolio really does add value.
 

Does My Investment Strategy Add Value?

EnoughWealth commented on my recent post on our target allocation:

"Have you tried benchmarking your actual and target asset allocation performance against something a lot simpler - like a basic Bond:Shares allocation with similar risk level, with appropriate split of AU vs Global within each and a basic index fund proxy for each? I just suspect you may not be adding a lot of performance by the degree of complexity and number of individual holdings. I did a quick comparison of your NW monthly figures to mine (after converting my figures using the relevant monthly avg AUD:USD exchange rate), and aside from the jump in my nW in Feb '23 when I updated my estimated valuations for non-home real estate values, the monthly and three year trend is visually almost identical -- if anything yours seem to have more volatility than mine. Since most of the individual investments in your portfolio have internal diversification, I'm not sure your role as an active fund manager of your own investment portfolio is actually adding much 'alpha' ;) Then again, your spare time is 'free' so at least you aren't charging yourself a fee as fund manager (on top of whatever fees are embedded in some of those funds you've chosen)."

My response was that I had a beta of less than one to the ASX 200 and had positive alpha... But I have now done an analysis that I think is close to what EnoughWealth is suggesting here. I picked the Vanguard managed ETF VDBA.AX, which is diversified across Australian and global stocks and bonds. So, this is a potential alternative to our current investments. It is 50/50 stocks and bonds, whereas I am targeting 60% equities. But we could lever it up a little bit if we wanted.

Vanguard nicely provide all the data needed. Most of the work is in calculating dividend reinvestment. I assumed dividends were reinvested on the ex-date increasing the number of shares. Then I multiplied the daily price by number of shares to get the total value. I carried out my analysis using month end values since inception of VDBA.

The results might surprise Bogleheads :)

First, here is how $1000 would have evolved if invested either with me or in VDBA since the end of November 2017:

Put another way, the average annual return over this period was 5.06% for VDBA and 8.65% for Moom. 

Is this because VDBA is a bit more conservative? As you can see from the graph, volatility is about the same for the two investments. Formally, the monthly standard deviation of returns for VDBA is 2.32%, while it is 2.28% for Moom. So, it's not because of that.

So, I also did a CAPM style analysis using the RBA cash rate as the risk free rate and treating VDBA as the index. Moom has a 0.88 beta to VDBA and an annual alpha of 3.33%. 1% of extra return on a $5 million portfolio is $50,000...

In conclusion, the additional diversification in our portfolio really does add value.
 

January 2024 Report

Monthly reports are back! In January, The MSCI World Index (USD gross) rose 0.61% while the S&P 500 rose 1.68%, and the HFRI hedge fund index gained 0.44% in USD terms. The ASX 200 rose 1.19% and the target portfolio 2.87% in AUD terms. All these are total returns including dividends. The Australian Dollar fell from USD 0.6806 to USD 0.6595. We gained 1.92% in Australian Dollar terms or lost 1.24% in US Dollar terms. So, we under-performed all benchmarks apart from the ASX200.

Here is a report on the performance of investments by asset class:

The asset class returns are in currency neutral returns as the rate of return on gross assets. US Stocks experienced the highest rate of return, while hedge funds made the largest contribution to returns. On the other hand, Australian small cap and rest of world stocks had negative returns in January.

Things that worked well this month:

• Pershing Square Holdings (PSH.L, AUD 19k), gold (AUD 13k), and Hearts and Minds (HM1.AX, AUD 11k) all had more than AUD 10k gains.
  

What really didn't work: 

• Tribeca Global Resources (TGF.AX) lost AUD 23k and Australian Dollar Futures lost AUD 10k.
  

Here are the investment performance statistics for the last five years:

The top three lines give our performance in USD and AUD terms, while the last three line give results for the indices. Compared to the ASX200 we have a lower average return but also much lower volatility, resulting in a higher Sharpe ratio of 0.93 vs. 0.76. But as we optimize for Australian Dollar performance our USD statistics are much worse and worse than either the MSCI world index or the HFRI hedge fund index. Well, we do beat the HFRI in terms of return, but at the expense of much higher volatility. We have a positive alpha relative to the ASX200 with a beta of only 0.45.

We are quite close to our target allocation. We are underweight private equity and overweight real assets. Our actual allocation currently looks like this:

About 70% of our portfolio is in what are often considered to be alternative assets: real estate, art, hedge funds, private equity, gold, and futures. A lot of these are listed investments or investments with daily, monthly, or quarterly liquidity, so our portfolio is not as illiquid as you might think.

We receive employer contributions to superannuation every two weeks. We are now contributing USD 10k each quarter to Unpopular Ventures Rolling Fund and less frequently there will be capital calls from Aura Venture Fund II. It was a very quiet month. I made one change to our investments:

• I sold around USD 35k of the CREF Social Choice Fund and bought the same amount of the TIAA Real Estate Fund in my US 403b retirement account.
   

Updating Target Asset Allocation

 

Not sure when I last posted about our target asset allocation, as I have tweaked it since this 2021 post. I am tweaking it again to reflect continuing new allocations to private equity (venture capital, buyout funds, and SPACs).

Overall we still have a 60% equity allocation. Now 20% of that will be the target for private equity, 20% hedge funds, and 20% long equity. Among the latter, 11% allocated to Australia and 9% to foreign shares. Within Australia, 6% is allocated to large cap and 5% to small cap. Within foreign equity, 5% to the US and 4% to the rest of the world. 

Among the 40% allocated to other assets, 15% is allocated to real assets including real estate, art, water rights etc., 5% to bonds (including private credit), 10% to managed futures, 10% to gold.

The benchmark target portfolio splits the private equity component 50/50 between venture capital and buyout. It also allocates all the Australian exposure to the ASX200 and all the real asset allocation to a specific (mainly US) real estate fund. All the managed futures is allocated to Winton in the benchmark. Maybe I should try harder on this benchmark, but this seems good enough for my purposes.

Insurance Inflation

 

This year's home contents insurance bill is 70% higher than last year's! How does that make sense? The number I am comparing to is one that the company provides that they say is adjusted for any change in policy. This seems particularly egregious but part of a general trend of rising insurance costs.

Big Moomin vs. Little Moomin

We have now re-invested Big Moomin's portfolio in the two suggested managed funds. At this point, Little Moomin has just over 8% more money than Big Moomin, despite starting investing later and paying 30% tax on gains in his investment bond account.

Individual Investment Performance 2023

 

To better understand our investment underperformance in 2023 let's dive into the returns on each individual investment. If we'd managed to avoid all the losing investments in the table we would have roughly matched the return on the target portfolio. So, as usual it is the losers which hurt. In particular, the Cadence, Cadence Opportunities, and Tribeca listed hedge funds all did poorly. The worst of all though was the Aura VF2 venture capital fund. One of their companies - Lygon - went bankrupt and was then restructured. Once you are in a venture fund you can't really get out and I invested in this fund because VF1 has done well over time.

When I reviewed the hedge fund investments two years ago, these funds were all doing well. I did mention that I wanted to reduce exposure to Cadence Capital, which I failed to do. Tribeca has turned out to be a very volatile investment. Sometimes they have big wins and some times big losses. I failed to get out when it traded above NAV at about the time of the review. I thought then they had reformed, but apparently not. 

The other two main losers are Domacom and the China Fund. I really should have gotten out of Domacom when it relisted on the ASX. Now it does look like they will turn things around, but dilution from new investors means we might never make any money. There's no real excuse for remaining in the  China Fund, as I have been bearish on the long-term prospects of China under Xi Jinping. It is hard to explain.

On the other hand, I lost on the TIAA Real Estate Fund, but correctly reduced my exposure. Not by enough. My gains in the CREF Social Choice Fund just balanced my losses in the Real Estate Fund in 2023.

I have much less to say about the winners. 3i and Pershing Square Holdings have turned into big winners. I could have done even better on 3i if I had not sold 20% of the position. Half of the fund is in one company - Action - which made me a bit nervous. Gold did well and the other two big winners are our employer superannuation funds. With gold, these are our three biggest investments. Pershing Square is now our fourth biggest investment.

Annual Report 2023

In the second half of 2023 I stopped writing monthly reports on this blog because each month's accounts had large errors.* But now I have got the errors down to not more than $500 in any one month and 0.01% of the portfolio for the year as a whole. Our private investments have all also reported their results for the year. So, now we can compute reasonably accurate annual and monthly accounts for the year.

Overview 
Investment returns were positive and net worth again increased. But I was disappointed that we underperformed the target portfolio and were far behind the gains in stock indices. So, we also fell short of the net worth projection I made in the 2022 report. In the first half of the year, I spent quite a lot of time on my new hobby of researching my family tree. In the second half of the year I was working hard on teaching. I do all my teaching in the second semester now. In the second half of the year I also took on a new editorial role that will keep me busy over the next three years. We took a vacation at Coogee Beach in Sydney in January and I made a couple of short business trips to Melbourne in March and the end of November. Maybe in 2024 we will finally travel overseas again...

All $ signs in this report indicate Australian Dollars. I'll do a separate report on individual investments. I do a report breaking down spending after the end of the financial year.  

Investment Return
In Australian Dollar terms we gained 5.6% for the year while in USD terms we gained 5.9%. The Australian Dollar didn't move much over the year. The MSCI gained 22.8% and the S&P 500 26.3% in USD terms while the ASX 200 gained 14.4% in AUD terms. The HFRI hedge fund index gained 7.3% in USD terms. Our target portfolio gained 10.8% in AUD terms. So, we under-performed all benchmarks. 

This chart compares our portfolio to the benchmarks in Australian Dollar terms over the year:

 

This is really not good. The following chart shows monthly returns in Australian Dollar terms:

 

We beat the target portfolio in four of the twelve months, but the eight months where we under-performed dragged down returns for the year.

 

Here are annualized returns over various standard periods:

We beat the HFRI over 5 to 20 year horizons but otherwise we under-perform, though we are quite close to the target portfolio over 3 and 5 year horizons.

Here are the investment returns and contributions of each asset class in 2023 in currency neutral and unlevered terms:

 

The contributions to return from each asset class sum to the total portfolio return. The portfolio shares are at the beginning of the year. Not surprisingly, US stocks did best followed by gold, Australian large cap, and private equity. The latter contributed the most to total return mainly due to the stellar performance of 3i (77.8% for the year). Australian small cap and rest of the world stocks had negative returns. Thankfully, they take up small shares of the portfolio. Returns from hedge funds were particularly disappointing despite a strong performance by Pershing Square Holdings (24.4% for the year), which is our largest hedge fund allocation.

Investment Allocation 

There were no large changes in asset allocation over the year:

 

Mainly, relative exposure to hedge funds fell, as exposure to private equity and real assets rose.

Accounts
Here are our annual accounts in Australian Dollars: 

 

 

Percentage changes are for the total numbers. There are lots of quirks in the way I compute the accounts, which have gradually evolved over time. There is an explanation at the end of this post. 

We earned $178k after tax in salary etc. Total non-investment earnings including retirement contributions were $210k, up 14% on 2022. The result is likely driven by lower net tax. We gained (pre-tax including unrealized capital gains) $154k on non-retirement account investments. A small amount of the gains were due to the fall in the Australian Dollar (forex). We gained $130k on retirement accounts with $31k in employer retirement contributions. The value of our house is estimated to have risen by $33k. As a result, the investment gains totaled $317k and total income $527k.

 

Total spending (doesn't include mortgage payments) of $151k down 1.3% on last year. It looks like my efforts to cut spending are working. We saved $28k from salaries etc. before making a concessional contribution of $20k to the SMSF. So, current net worth increased by $132k.

$31k of the current pre-tax investment income was tax credits – we don't actually get that money so we need to deduct it to get to the change in net worth. Taxes on superannuation returns are just estimated because, apart from tax paid by the SMSF, all we get to see are the after tax returns. I estimate this tax to make retirement and non-retirement returns comparable. The total estimated tax on superannuation was $40k. Net worth of retirement accounts increased by $141k after the transfer from current savings. With the gain in the value of our house, total net worth increased by $306k.

Projections
Last year my baseline projection for 2023 (best case scenario) was for an 11.2% investment rate of return in AUD terms, an 11% nominal increase in spending, and about a 3% increase in other income, leading to an $550k increase in net worth to around $6.5 million or a 9% increase. Net worth only increased by just over half of this due to much lower than predicted investment returns. On the other hand, spending actually fell despite high inflation and non-investment income rose.

 

The best case scenario for 2024 is flat spending at $151k, an investment return of 10%, and probably a 3% increase in non-investment income, resulting in a 8% increase in net worth of $500k to $6.7 million.

 
Notes to the Accounts
Current account includes everything that is not related to retirement accounts and housing account income and spending. Then the other two are fairly self-explanatory. However, property taxes etc. are included in the current account. Since we notionally converted the mortgage to an investment loan, mortgage interest is counted in current investment costs. So, the only item in the housing account now is increases or decreases in the value of our house. This simplified the accounts a lot but I still keep a lot of cells in the spreadsheet that might again be used in the future.

 

Current other income is reported after tax, while investment income is reported pre-tax. Net tax on investment income then gets subtracted from current income as our annual tax refund or extra payment gets included there. Retirement investment income gets reported pre-tax too while retirement contributions are after tax. For retirement accounts, "tax credits" is the imputed tax on investment earnings which is used to compute pre-tax earnings from the actual received amounts. For non-retirement accounts, "tax credits" are actual franking credits received on Australian dividends and the tax withheld on foreign investment income. Both of these are included in the pre-tax earning but are not actually received month to month as cash.... 

 

For current accounts "core expenditure" takes out business expenses that will be refunded by our employers and some one-off expenditures. This year, I didn't bother to note these, which amounted to about $1,000. "Saving" is the difference between "other income" net of transfers to other columns and spending in that column, while "change in net worth" also includes the investment income.

 

* The error is the difference between two different ways of computing the profit or loss from changes in exchange rates for the month. The two methods should give the same result, but they don't when there are errors in the accounts.