Save 4% on Transferring Money to Australia

My brother is planning sending me my share of the proceeds of selling my mother's apartment. If we sent the money in Falafeland currency to our account at Commonwealth Bank in Australia we would lose around 5% of the value relative to the exchange rate on the forex market (representative rate). The spread between their buying and selling rates is around 10%. This is just crazy. I can think of another word that starts with "cr". I checked the rates of other Australian banks. HSBC and Macquarie are better, but not that much better.

My brother got a quote from his bank in Falafeland to convert the money to Australian Dollars and then send to Australia. The cost is about 1% relative to the representative rate. Online, I found that TorFX is recommended for such transfers. I now have a quote from them which is about 1.2%. So, we will go with the Falafeland National Bank.

You can get much, much better rates by trading in the forex market yourself using a broker like Interactive Brokers. But I can only hold currency in AUD, USD, GBP, and EUR at IB. So, I can't make a conversion from Falafeland money to AUD.

Restrictions on Withdrawing Cash at Interactive Brokers

If you move money to Interactive Brokers through the American banking system, they put a hold on your money so that you can't withdraw it to another bank for 44 days. This works in a very strange way. If you have more than the amount on hold in US dollars you can obviously withdraw that excess money in US Dollars. But if you want to withdraw money in Australian Dollars you also have to have more than that amount in Australian Dollar cash! Well, this is what an IB representative just told me to explain why I can't withdraw any money in Australian Dollars despite having cash in that account, including cash I received from dividends that absolutely wasn't transferred from a US bank.

This will slow down my financial restructuring plan. I don't want to buy that many Australian Dollars all at once, though I could use futures contracts to retain exposure to the US dollar... but for psychological reasons I find that harder to do. And I would have to sell the US corporate bonds I bought to do it. The only thing that I really want to do that is time bound is to make a non-concessional contribution to superannuation before the end of the financial year. I guess I will sell some Australian managed funds to come up with the money.

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 :)

All of Labor's Tax Increases

The Labor party is at the moment likely to win the next federal election in Australia in May. Labor has become increasingly left wing in recent years and has a long list of policies to raise taxes. This is, I think, a comprehensive list:

1. Abolish Liberal plan to raise the top tax threshold to $200k: This was supposed to happen in 2024. The top tax bracket will still cut in at $180k (about USD130k) where it has been for many years. Bracket creep is pushing more and more taxpayers into the top bracket. This will affect us if I am still working then. If I'm not, probably my taxable income will be lower.
   
2. Raise the top tax rate: Add 2% to the top rate to raise it to 47%. With Medicare that is 49%. This will immediately raise our taxes.
   
3. Abolish plan to eliminate 37% tax bracket: This also was supposed to happen in 2024, so may not affect us except to the extent of how many franking credits will get used up offsetting our taxes, if I retire by then.
   
4. Repeal already-legislated tax cuts for companies with turnovers of between $10 million and $50 million: Small businesses pay 27.5% corporation tax and larger companies 30%.  The government wanted to extend the low rate to larger companies. This is unlikely to directly affect us.
5. Reduce the long-term capital gains tax discount to 25%: The discount is now 50%. This will have an immediate impact on us as we have run out of accumulated tax losses. OTOH existing investments will be grandfathered. It makes it more attractive to incorporate and pay CGT of 27.5% instead of 37.5%.
   
6. Abolish refundability of franking credits: Since 2000, if you have excess tax credits from Australian companies beyond those that offset the taxes you need to pay you can get a cash refund. I did benefit from this once or twice soon after we moved to Australia and my income was low. This will have a big impact on superannuation funds in pension phase that have zero tax to pay and possibly even in accumulation phase if they have a lot of franked dividends. It will affect lower income self-funded retirees with money outside superannuation too.  Some listed investment companies (closed end funds) are already paying out special dividends to get franking credits out of the fund and to investors before the end of the financial year. On the other hand, I don't think these funds will radically restructure due to this proposal. I don't think it will have a big impact on us as I've planned to put the least tax advantaged investments like managed futures into our planned SMSF. And I expect we would be in the 32.5% tax bracket when retired. If I retire at 60 say and start a superannuation pension we could use franking credits inside our SMSF to offset Moominmama's superannuation earnings tax liability as she is 10 years younger. And then maybe we could add Moomin to the superannuation fund :)
7. Abolish negative gearing: This is the ability to deduct investment costs beyond the earnings of an investment from other income. This mainly applies to property investors who mostly lose money in Australia in the short run, hoping for a long-run capital gain. We don't negative gear so it shouldn't affect us. Wealthier property investors who also own shares or other investments will be able to offset their losses in property against dividend and other income. So, like many of the Labor measures they mainly hit lower income investors...
   
8. Tax discretionary trusts as companies: These are trusts that have multiple beneficiaries and can alter what earnings they stream to which beneficiary on a year by year basis. Actually, they are proposing to tax trust distributions at a minimum of 30%. So, it's not like a company which pays 27.5% tax in the case of a small business and then distributes franking credits. I don't see any justification for allowing this kind of tax dodging. However, I think they should just require all trusts to be unit trusts with defined shares and everyone sharing in all income. These operate just like unlisted managed funds (mutual funds). I think most discretionary trusts will just do this if it's allowed.
   
9. Reduce annual non-concessional superannuation contributions to $75k: This would mean it would take us more years to make all the non-concessional contributions we want to make and means I probably should already get one in this financial year.
   
10. Reduce the threshold for 30% superannuation contributions tax to $200k: Currently the threshold is $250k. The threshold includes employer superannuation contributions, so this will definitely affect me.
    
11. Remove the right, already legislated by the government, of superannuants to make catch-up contributions when their super balance is less than $500,000: I don't think this is probably a big deal. It will mean stretching contributions over more years.
    
12. Reduce ability to take tax deductions for additional concessional superannuation contributions: People will need to have 90% of their income or more from sources other than employment to do this. I don't understand why concessional contributions for employees are limited to salary-sacrificed contributions and you can't make more concessional contributions unless you really aren't an employee. The Liberals tried to fix this anomaly.
13. Limit tax free pensions to $75k per year: Currently you can transfer up to $1.6 million into an account to fund a tax free superannuation pension. At a 4% initial withdrawal rate (required rate for under 65s) that is $64k per year. At 5% (65-74 y.o.) it is $80k per year. So, Labor's proposal is not that restrictive. However, if the $1.6 million earns a lot more than that a year, it will be taxed a lot more than at present.
14. Limit deductions for tax advice to $3,000 per year: I am assuming that this won't apply to companies or superannuation funds, just to individuals. In which case, it isn't a big deal.

I think most people are probably aware of one or two of these but don't have a good idea of the extent of the proposed tax increases. A big question is whether Labor will have sufficient control of the Senate to pass all these measures.

Crowdfunded Real Estate

A relatively new investment concept is crowdfunding real estate investments. The idea is that an individual could directly invest small amounts in a range of properties or development opportunities thus reducing their risk. Rather than a fund manager picking the properties, investors could evaluate deals themselves.

I read about Fundrise on Financial Samurai. It seems to actually be closer to a traditional unlisted real estate managed fund, except there is more of a property development angle. They allow investments in both real estate debt and equity. They claim very high historical rates of return. I find it hard to understand how they could be so high. Equity investments could have leverage but debt investments must return the interest rate on the mortgage minus costs? I didn't feel that there was enough transparency around how returns are generated. In any case, unfortunately, it is not open to non-US investors.

So, I looked for crowdfunded real estate opportunities in Australia. This is what I found:

Crowdfundup – I only found one active project on the site.

Estatebaron – This website has more active deals. It focuses exclusively on property development. There seems to be very little information about each project and the site is much less polished.

Brickraise – The link seems to be dead.

Domacom – This is an ASX listed company. The company looked like they were heading to bankruptcy before a recent fundraising. The new money will only last just over half a year as their burn rate is AUD 5 million a year. They will need more than AUD 0.5 billion assets under management to break even given a 0.8% of NAV management fee. However, they have the largest number of deals on their site and have high quality information. Deals include a wide range of projects including solar farms and bioenergy as well as more conventional real estate. This is something I might consider when we have an SMSF up and running if it looks like the company will survive.

Based on this, real estate crowdfunding is not well developed in Australia. Do you know of other better websites?

December 2018 Report

You'll probably have heard that this was the worst December for US stocks since 1931. December is seasonally a positive month for stocks. Things weren't quite that bad in Australia and because the Australian Dollar fell, our returns for the month in AUD terms ended up being positive.

The Australian Dollar fell from USD 0.7302 to AUD 0.7049 The MSCI World Index fell 7.00% and the S&P 500 9.03%. The ASX 200 fell only 0.01%. All these are total returns including dividends. We gained 0.24% in Australian Dollar terms and lost 3.24% in US Dollar terms. So, we outperformed the Australian and international markets. This is not surprising given the weight of US Dollar cash in our portfolio. Our currency neutral rate of return was -1.74%.


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 quite well this month:

• US Dollars cash 
• Gold
• Property, including:
• My jointly owned apartment with my brother. We got an offer for the apartment near the end of the month and I raised the carrying value in line with that.
• TIAA (direct US investments) and Pendal (REITS) real estate funds.
• On the other hand BlueSky lost a lot...
• Our direct share holdings in Medibank and Yellowbrickroad.
• Again, the PSS(AP) superannuation fund did relatively well (though losing) compared to Unisuper. But on the way up it gained just as much as Unisuper. It has both lower beta and higher alpha... At least based on the investment choices I have made within the fund.

These all show the value of diversification pretty nicely.

What really didn't work:

• Cadence Capital, again fell sharply. It's performance in the last three months has been very bad. It's not surprising that they have cancelled their IPO of the Cadence Opportunities Fund. They received only AUD 8 million of subscriptions. It will still go ahead as an unlisted public company, whatever that is. Overall, we have lost money investing in Cadence.
• BlueSky fell back too.  We still have made some money on this investment.
• 3i, China Fund, Pershing Square, and CFS Geared Global Shares all fell in line with global stock markets. The latter would have benefited from the fall in the Australian Dollar, which for an investment denominated in Australian Dollars is included in the return on that investment, but is separated out for the investments denominated in foreign currency...

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

This is partly because I am classifying cash in trading accounts as "commodities". I started moving cash from my US bank account to Interactive Brokers. Another large part of the change was due to the fall in the Australian Dollar raising the value of our USD cash in AUD terms. From next month we should see a big increase in allocation to bonds instead.

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 400 shares of the China Fund (CHN) early in the month. Not a good idea.
• I bought 25,000 shares of Bluesky Alternatives in the middle of the month (BAF.AX). Another bad idea.
• I bought 500 shares of Pershing Square Holdings (PSH.L) at the end of the month. So far, not a bad idea.
• I received cash from UBS in my US bank account and started moving it to Interactive Brokers and from there to our Australian bank account. After this first transfer, most of this money will go into buying a US Treasury Bills ladder in the short run. Today, I discovered that I have to keep the cash at IB for 2 months before I can move it to another bank account. So I am looking to buy some Australian bonds (probably bank hybrid securities) in the interim.

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

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.

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.

FIRE?

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.

Trust Accounts

As I mentioned before, my mother's will leaves money for each of her grandchildren – currently six of them including Moomin. They can't get this money until they are 23. The two eldest grandchildren are already 23 or over and so will get their money right away. We now have a clearer picture of what will happen with the other's money. My brother will set up trust accounts with his bank for each of them in his (and my mother's country). These accounts can then invest in any investments they like though probably only through managed funds/shares available in that country. The income will be taxed at source at 25%. I did some research and if we get Moomin a tax file number here in Australia and open a bank account for him, we can submit a tax return each year and get the foreign tax refunded as cash. I used the ATO's tax calculator to check that. As he is inheriting GBP 25k (no, the account isn't in Britain but somewhere to the southeast, let's call it Falafeland :)), the refund might be a few hundred dollars a year. Once he is old enough to understand money a bit he'll be able to decide whether to spend or save that money...

In the meantime, I'm going through the hassle of getting a copy of my passport notarized. This isn't the normal method of proving identity in Australia, which is to go the post office or a police station to get the postal clerk or police officer to stamp and sign the copy as true (actually there is a broad range of people who can do this, including tertiary teachers like me). But this standard certification in Australia isn't valid outside the country, but a "notary public" is needed to certify the document. It seems these people have to be lawyers. Anyway, the bank in Chocolateland (yet another country) wants to get this notarized copy before they will release the main chunk of inherited money to me. Actually, there seem to be four levels of certification available in Australia: regular certification, "justice of the peace" (including police officers), notarization, and an "apostille". Initially, my brother said the Chocolateland bank wanted an apostille...

Self Managed Superannuation

I am exploring setting up a self managed superannuation fund (SMSF). I want to do this so that I can implement our target portfolio investment strategy and so I can put higher tax investments into the lower tax superannuation environment. Managed futures are a tax ineffective investment outside super when your marginal tax rate is 47%. Inside superannuation they will be taxed at 15%.

Setting up an SMSF is very complicated in Australia compared to the US where you can just open an IRA account with a broker like any other brokerage account and the only issue is limits on contributions and later on minimum withdrawals. For standard IRAs you pay tax on withdrawals only, on your regular tax return. The main reason Australian SMSFs are complex is taxation but some of the bureaucracy just seems to be for the sake of it... In Australia, pretax or concessional contributions are taxed at 15% (or 30% for high income levels) going in, and you can also make after tax contributions. Its necessary to keep track of which were taxed how. Then earnings are taxed at 15% (10% for capital gains) and can be offset by franking credits and foreign tax paid. When you finally withdraw your money, no tax is due and earnings of the account are untaxed if you set up a pension, though now there is a cap of $1.6 million on the amount of assets whose earnings are untaxed. So funds need to submit tax returns separate from their members. And they need to be audited annually and there are lots of ways they could become non-compliant with the rules. And an SMSF is a trust which is set up as a separate legal entity. You might also want to set up a company to act as trustee!

You could go to a lawyer to set up the trust and to a local accountant to help audit the fund and do everything else yourself. But there are many providers who streamline the set up and administration of SMSFs. You can get "year-end" administration which just helps get everything in order for the tax return and audit, or you can get a full daily service. Though I do our own tax returns, I have decided to go for the full daily service as I want to outsource this as much as possible (looks like I am going to have to do tax returns for my son too and am also looking at setting up a company...) and want to be confident that I am compliant with the rules, because the penalties for non-compliance are very severe.

This is a great site with information about different providers of services for self-managed superannuation funds. I visited the websites of all the providers that offer a daily service. Some sites have a lot information and some have next to none. The latter want you to phone them to give you the details. I have a strong preference for financial services that are as transparent as possible. I also investigated Commonwealth Securities and Dixon Advisory, which are not on this list.

Dixon are based in Canberra and I often go past their offices on Northbourne Avenue. Years ago, I used to read Daryl Dixon's column in the Canberra Times. Their service combines admin and investment advice and costs from $3,000 for a $333k account to a maximum of $6,000 for accounts above $666k. To make investments, you have to call their broker and the commissions for shares are 1.1%, which is capped at $400 for Australian shares and uncapped for foreign shares. I don't need investment advice and trading is way too expensive.

Commonwealth Securities is a more realistic option. Including audit fees, they charge a flat $3,000 a year. On a $900k account that is 1/3%, which is reasonable. Trading fees are 0.12% for Australian stocks, which is good though not the lowest, and 0.31% for US stocks and 0.41% for shares in the UK and many other countries, which is expensive but not as outrageous as Dixon. You can't trade CfDs (which are offered by CommSec for other accounts) or futures (which aren't offered by CommSec).

You can set up a trading account for an SMSF with Interactive Brokers, which can trade anything you like for low fees, and then find an administration provider who is prepared to work with them. Determining who can work with IB is what I need to do next. You can trade futures in an SMSF as long as it fits within the written investment strategy (yes, you are required to write one) and other risk related rules.

Two providers on my list, who have won awards and who I am going to investigate next, are Heffron and Super Guardian. I am impressed with the transparent information on Super Guardian's site. They also have an endorsement from Chris Cuffe. Super Guardian charge more the more investments you have. If we have up to 20 investments then they are a similar price to CommSec. Heffron charge a flat fee of $3,300 for their top level service.

Regal to Float Hedge Fund LIC on ASX

Regal Funds Management plans to float a hedge fund LIC (closed end fund) on the ASX in March or April next year. Regal was on my future potential investments list but you need to be a certified wholesale investor to invest in their existing hedge funds. I might qualify next year, but investing via the stock exchange would be a lot less hassle assuming I could get in at a reasonable price.

The Hearts and Minds LIC started trading today and is trading above the IPO price. I topped up the allocation that I got in the IPO to the number of shares I originally wanted to invest in. I don't classify this as a hedge fund, as they are not planning to take short positions and there are no performance fees. Actually, there are no management fees. Instead 1.5% of NAV will be donated to charity each year.

I Will Do What the Model Says to Do

Maybe today will finally knock my tendency to not follow the model out of me, but I kind of doubt it. I am getting better though. Today, I closed my short position early. That's not such a bad move. But then near the close I went long, because I thought the model was saying to go long tomorrow. But I had forgotten the correct way to read that rule and read it wrongly – I used today's value of the indicator instead of the forecast of it for tomorrow. The model in fact says to stay short into Thursday. The market continued to plummet and took away most of my gains for the day. Still, I am up for the month, for now.

I must fast-track model automation. First step is to convert the decision rules, which I now execute manually and record in an Excel spreadsheet into computer code (in my econometrics package) that can make decisions without errors. Then I need to get better at just doing the decisions at the right time while learning Python etc in order to build an automated system or getting someone else on board to do that. In the meantime, I will stick to trading a single contract to minimize risk.

Generation Global Share Fund Closed to New Investors

It turns out that the Generation Global Share Fund is closed to new investors and so I couldn't do the fund switch I tried to do yesterday. CFS's systems allowed me and the guy I phoned to select this option but then rejected the complete portfolio. So I recomputed the numbers and did the switch online now. New allocation is:

CFS Geared Share Fund: 7%
CFS Geared Growth Plus: 40%
CFS Conservative: 11%
Platinum International: 23%
CFS Developing Companies: 19%

Gearing in the Geared Growth Fund is lower than in the Geared Share Fund. Still it is quite aggressive and I will likely delever further at some stage.

Moominmama Allocation

Following up from yesterday's post on delevering in my retail superannuation (retirement) account, here is the desired allocation compared to actual allocation in Moominmama's (formerly Snork Maiden - I mention this because I used to refer to my mother as Moominmama on the blog) Colonial First State managed funds account (in American: taxable mutual fund account). Desired allocation:

CFS Geared Share Fund: 19%
CFS Global Geared Share Fund: 9%
Platinum International: 27%
Generation Global Share: 13%
BT Property Investment: 13%
CFS Developing Companies: 19%

Actual:

CFS Geared Share Fund: 28.3%
CFS Global Geared Share Fund: 16.0%
Platinum International: 11.0%
Generation Global Share: 16.4%
BT Property Investment: 12.6%
CFS Developing Companies: 15.7%

The funds are in: geared (leveraged) Australian shares, geared  global shares, global equity hedge fund, global shares, REITS, small cap Australian shares.

We are moving towards the desired allocation slowly by only adding each month to the underweight funds and by not reinvesting distributions. If things looked worse, maybe I would then actually switch funds, but then there will be a capital gains tax bill. Unlike the US, even at low income levels you have to pay capital gains tax (unless you earned less than AUD 18k a year and paid no income tax), though the long-term rate is half the normal income tax rate (for the moment).

This is how our asset allocation has evolved since the financial crisis:

 This doesn't include our house. The main trend is a reduction in allocation to Australian large cap srtocks since the recovery bounce from the crisis and an increase in other asset classes.

Delevering

I just made a big switch in my Colonial First State superannuation account to reduce risk. Stock markets still look bullish but the Fed shows no sign of stopping raising interest rates, risking an inversion of the yield curve. They have been saying that this time is different and that an inverted yield curve doesn't mean that there will be a recession. But though the sample size is very small, it has been a good predictor in the past. We are not yet at yield curve inversion but it still could make sense to reduce risk. My CFS superannuation account has been invested very aggressively. At the end of September this was the allocation:

CFS Geared Share Fund: 48.9%
CFS Geared Growth Plus: 20.2%
CFS Conservative: 10.2%
Platinum International: 10.2%
CFS Developing Companies: 10.5%

So about 70% was in geared (leveraged) funds. Geared Share Fund is large cap Australian shares. Geared Growth is diversified. The new allocation, which is much closer to our new long-term allocation is:

CFS Geared Share Fund: 15%
CFS Geared Growth Plus: 18%
CFS Conservative: 4%
Platinum International: 23%
CFS Developing Companies: 20%
Generation Global Share: 20%

Both Platinum, which is a hedge fund (long and short global equities) and Generation performed well in the Great Recession. Doing this transaction in a superannuation account is tax free - capital gains tax of 10% is paid on unrealised gains on a continuous basis. There is just the cost of the entry/exit spreads.

I changed the allocation for new investments in Moominmama's CFS account, which is not a superannuation account to only buy the non-geared funds going forward. If things look more bearish, we may yet do a switch there too.

Longer Term Planning

I was rejected for the two jobs I recent applied for. One in Australia after interview and one in the UK pre-interview. So, it looks like we stay in Australia in this city for the moment. It also looks like I will continue in my job next year, but I am seriously thinking about "retiring" at the end of 2019 when I will be 55.

Hopefully, the probate situation is finalized before the end of this year and we can start to restructure our finances. This is what I am thinking to do:

1. We will need to set up a trust account or something less formal for little Moomin for the relatively small amount of money he will inherit. Need to wait to hear what we need to do. According to the will, he won't get the money till he's 23 years old...

2. Almost pay off our mortgage and then redraw it and use it to pay off margin debt and add to a trading account. We can then deduct the mortgage interest from our taxes and it is a lower interest rate than the current margin loan.

3. Set up a self-managed superannuation fund (SMSF) and roll my existing Colonial First State superannuation fund into it as well as contributing AUD 300k for each of me and Moominmama. This would then have about AUD 900k to start with. The reason to go down the road of self-managed super is to be able to invest in managed futures, which are a tax ineffective investment outside super. We would put all our high tax investments into the fund as well as some Australian shares with franking credits to reduce the tax.

4. Scale trading up to full size. At the moment, I am thinking we will need to set up a company for trading. Corporation tax on small businesses is 27.5% vs. top personal marginal rates of 47% +.* My understanding is that you don't need to pay out all profits as dividends and so retained earnings are more lightly taxed. But I will need advice on this. It would also protect the rest of our assets against something catastrophic happening. The company could also be the trustee for the superannuation fund, which would allow us to maintain the SMSF if we left Australia.** These are just my current understandings – obviously I am going to need to get professional advice on all of this.

5. Estate planning. Currently we don't even have wills. This is an area I know little about but will need to deal with. What I want to avoid is the situation we faced with my mother where the government dictated investment policy to us after she wasn't capable of making decisions - despite giving us power of attorney.

* The downside of companies is that they don't get a capital gains tax discount. Individual investors in Australia only pay half the marginal rate on capital gains on investments held for more than a year. But the advantage of only paying 27.5 or 30% tax on trading income rather than 47% tax before investing it in other investments outweighs the discount. If Labor reduce the discount, this will be even more the case.

** You can't be the trustee of an SMSF if you aren't resident in Australia. Using a corporate trustee gets around that. There is a problem in leaving Australia and receiving income through an Australian company as it means we would suffer from double taxation. In Australia, dividends from the company would have attached franking credits so that we would only need to pay the difference between 27.5% and 47% on dividends. But if you live outside Australia in a location where you need to pay tax on foreign income (obviously one reason to move might be to reduce tax...) then we would need to pay the foreign tax on top of the Australian company tax. Investments already inside the company are invested in Australian stocks that pay franked dividends, then the franking credits on the dividends received would mean that the company wouldn't pay net tax on its investment income, so that won't be double taxed if we moved overseas. But trading income would be taxed at 27.5% and then again if paid out as dividends. So, we would need to do a restructure in the most tax-effective way at that point. In an earlier version of this post, I did think about having the company being the beneficiary of a discretionary trust that actually did the trading and then just changing the flow of income. But the trustee of the fund has to pay tax for offshore beneficiaries. So, that doesn't help.

Stopped Out...

My long position was stopped out on Wednesday. Now back to more or less zero profit on this account - still have a positive overall result from the trading experiment. Also, I realised that I still can't really psychologically handle trading overnight futures positions at the moment even at the smallest trade size. I am losing sleep because of it. So, I am going to stop trading for the moment. I need to get a lot of academic work done in the next two weeks before going on another overseas trip. At some point after I am back I will do some further research on trading models. My thinking is I could design a model that would only make trades when the odds were most in favor of winning. The current model trades all the time regardless. The ultimate long-run goal is automation of trading or taking it out of my hands in some other way. To achieve these goals I don't need to be trading continuously at the moment if I'm not making good money at it and  it's having negative effects instead.

I am also at the moment on a trip for a job interview. As I am learning more about the position it seems more challenging and to need leadership skills beyond what I have. I would be shocked at this point, though, if they offered me the position.

Backtesting and Hedged Portfolios

So, I backtested for all of 2017 using the latest model rules. The model makes money for the year, but there are several losing months, and the model underperforms the market. I could quite easily predict which months would be more profitable and which were more likely to be money losing by looking at their volatility. So, that idea works out of sample.

 

The graph shows the NASDAQ 100 index (close) for 2017 and the model return. The interesting thing is that a hedged portfolio of the market and the model, tracks the market quite closely. The hedging strategy would invest 75% of net worth in the QQQ ETF and use 25% of net worth to trade NQ futures with 3 times leverage according to the model. So it is 1.5 times leveraged with 50% of the total exposure long and 50% traded. Of course, you wouldn't really want all your portfolio into the the QQQ ETF. At least I wouldn't. But this is a step towards seeing what a realistic strategy with investment and trading would look like. Now if we look at 2018:

The hedged portfolio tracks the model, which vastly outperformed the market, closely instead now. It seems that you can get the best of both worlds with this strategy.

Tax Optimization for Trading

I still have some capital losses left over from the financial crisis. I will probably use them up for this tax year ending 30 June. After that, trading profits would be taxed at my marginal rate of 47% (and even higher if Labor get back into power and implement their tax policy). So, I am opening an account at Interactive Brokers for Moominmama (formerly Snork Maiden). Trading in her account will only attract a marginal rate of 34.5% initially and then higher if we make lots of profits. This will reduce our overall tax bill and is totally legitimate in Australia.

Actually, given that franking credits are fully refundable, even if they exceed your tax bill (but Labor wants to change that too), it also would make sense to have other investments in Moominmama's name. The reason we don't, is that up to a couple of years ago, when my income went over AUD 180k per year and she went part-time we were in the same marginal tax bracket. But perhaps I should direct new investments to her account?

In somewhat related news, the minimum wage in Australia has just been raised, so that someone working full time at the minimum wage earns just over AUD 37k a year (about USD 14.25 per hour). This means that the marginal rate for such workers is now also 34.5%! That really seems crazy to me.