1997

I feel that 1997 might be a good analogy to 2025. After an aborted recession in 1994 (2022) the stock market went up strongly in both 1995 (2023) and 1996 (2024). But when I left the US in 1996 for Australia the mood was that the economy was struggling and maybe another recession was coming. There was also a feeling that the stockmarket was overvalued. Alan Greenspan first mentioned "irrational exuberance" in December 1996. But the stockmarket, or at least tech stocks, went up for three more years to crazy heights in 1999 (2027) before the tech wreck. Then the boom was mainly internet related stocks, now AI and maybe quantum computing. Oscar Carboni, who is very slightly older than me, often says: "This boom is just getting started." 

So, does that mean we should go all-in on tech stocks? There are no guarantees, and so I always diversify. My largest exposures to tech are through my venture capital exposures. If I am right, venture capital should do well for a while and maybe we can get some exits. And then I have WCM Global (WCMQ.AX), Generation Global, and Hearts and Minds (HM1.AX). Pershing Square Holdings (PSH.L) has investments in Google and Uber. Unisuper has some exposure through the Sustainable Balanced Option I am mainly invested in. But overall it would only add up to around 15% of net worth (and less of gross assets). On the other hand I have 18% of net worth in crypto-related assets that tend to move with tech stocks. Given that, perhaps my exposure is big enough?

Investments Review 4: Mature Private Equity Investments

3i (III.L) is one of our more successful and larger investments with an IRR of 24% and a net worth share of 4.4%. Note that the scale on the graph is in Pounds Sterling. They are a UK based private equity manager. Most of the capital they manage now is proprietary capital and so you are investing in the combo of fund manager and fund. I first invested in 3i in 2008 but the position was very small until we started ramping up our investment in 2018 peaking at 5,000 shares in 2022. Since then, I sold off 1,500 shares because I was concerned that the majority of their portfolio was in a single company - Action, a European chain of discount stores. This took our net investment down to zero. A classic mature investment.😀 Obviously in retrospect we would have done better by just sticking with 3i.

 

Pengana Private Equity (PE1.AX) did well for a while but then went sideways since early 2023. Overall it has achieved an IRR of 19%. With good timing, I reduced my investment dramatically at the start of the sideways period. The money was redeployed in another undervalued PE fund - CD3.AX. Since then I have added some back when it seemed a lot undervalued relative to NAV. It's now at 1.6% of net worth, which isn't that big. Hopefully, it will close more of the undervaluation gap and private equity will again do better.

Aura VF1 is a conventional Australian venture capital fund that preceded Aura VF2. Net worth share is 2.8% and IRR is 15%. Both the ramp up and now down in invested capital is dictated by the fund manager. The fund has one big success story - Shippit - and a mix of smaller successes and failures. Management fees will erode the value gradually if there are no mark ups... So we just need to wait for an exit from Shippit to get our money back. Unfortunately, exits from venture capital are still relatively few and far between.

Investments Review 3: Mature Alternative Investments

We start with our best investment ever in dollar terms: gold. 

I first invested in gold back in 2006. Then there was a long period where there was no gold investment or trading till 2018 when I inherited a gold sovereign. Maybe this sparked my interest in investing in gold again starting in 2019. We invest via gold ETFs. We gradually ramped up our investment as cash became available to the end of 2021. Since then we have maintained the gold allocation at around 10% of gross assets and withdrawn cash of around AUD 350k in total. This has gone primarily to funding venture capital investments. Total AUD profit has been almost $500k and it now constitutes 9.9% of net worth with an IRR of 16.9%. At this point this beats our venture capital investments hands down. So, on a short-term basis we should have stuck with gold. In the long term, who knows? On the other hand, this remains a large investment.

Next is our investment in Regal Investment Fund (RF1.AX). It now includes hedge funds, venture investments, real assets, and private credit. We bought at the IPO and then doubled our investment a little while later. We cashed out around the post-pandemic peak and then bought back in. However, the fund has not replicated its amazing performance of 2020-21 but on the other hand has not done badly and so we have been content to let our net investment drift down with dividends and occasional trades. More recently we have added to our position again including through a share placement:

At this point, I am happy to wait and see, as it has gained 26% over the last year. Lifetime IRR is 26.5% and net worth share is 3.6%. 

Wilson Alternative Assets (WMA.AX) is another diversified alternatives fund. Unlike RF1 it continues to trade at a large discount to NAV. We ramped up our investment into 2021 and then let it drift down with distributions paid out. As a result the value of the investment has been constant for a few years but profit has slowly increased. Here I am waiting for some more closing of the gap to NAV, as when Wilson took it on they promised to close the gap or put the future of the fund to a vote.

IRR has been 10.7% and currently it makes up 3.0% of net worth.

Updated Annual Performance

I said that I would update the annual performance numbers after receiving all private investment returns for the year. The final number for 2024 in AUD terms was 23.30% up from 23.18%. Aura Venture Fund II made a nice gain in the final quarter but Aura Venture Fund I was marked down a little due to ongoing management costs probably.

Integrated Portfolio Solutions Acquired

Back in 2021, I co-invested alongside Aura AUD 100k in Integrated Portfolio Solutions, a private company. At the time, I thought there wasn't a lot of downside risk as an acquirer would be willing to pay to obtain the client accounts they were advising. The company didn't manage to execute on the expansion plans that they touted at the time. In the wealth management/advisory/platform business there are economies of scale needed to achieve profitability. Today it was announced that the company is being acquired for roughly the value at the point when we invested. Various closing costs are going to result in about an 8% loss. Part of the consideration for the acquisition is going to be in terms of equity of the acquirer, DASH Technology Group, but now my position will be a much more reasonable amount for an investment in a non-profitable private company. I feel lucky I didn't lose more!

Sold 500 Shares of 3i

I sold another 500 shares of UK private equity firm 3i. At the peak I had 5,000 shares and a net investment of around £41k. Now I have 3,500 shares and a net investment of £2k. So, I have taken out almost all my original investments. The holding is worth £103k, which, therefore, is almost all profit. The firm has a very oversize position in Action, a chain of European discount stores and so I am reducing my exposure to this single firm risk. Of course, I also have ideas about what to do with the money instead...

3i has been an excellent investment to date, so I plan on holding the remaining shares till something fundamental changes. The IRR has been 21.8% and has been a 23-bagger. I haven't multiplied my investment 23 times though, as for the longest period I had only 600 shares. My original investment in 2008 was a purchase of 200 shares and at the low point I had only 100 shares. I reached 5,000 shares only in 2022. Still it is the highest notional multiple on any of my investments ever. The second best of those I currently hold is Platinum Capital at about 10x.

Regal Partners Acquires Merricks Capital

Regal Partners announced that it is acquiring Merricks Capital, a private credit manager. The performance of their main fund is quite remarkable:

The rate of return is high and there was only one down month. It reminds me of Bernie Madoff's fund. I am not saying there is anything wrong here, but this kind of performance shouldn't be possible according to efficient market theory! The fund is way outside the envelope of the other assets on this risk-reward graph:

We are investors in Regal Partners (13k shares).

New Investment: Putnam BDC Income ETF

I just bought 1,000 shares of the Putnam BDC Income ETF. This is an actively managed ETF that invests in US business development companies. These are basically private credit lenders. The dividend yield is 9.19%, which is high, but lower than many BDCs. I am thinking of this as an enhanced cash investment (though formally I am listing it under US stocks) and so I wanted to avoid the idiosyncratic risks of individual BDCs. I learnt about this investment from Armchair Income. I did think of investing in the KKR BDC, FSK.

This is what I did with much of the cash from selling The China Fund. As it is in our SMSF, only 15% tax applies to the income. I also have Australian Dollar cash in the fund. I didn't want to convert to US Dollars at this low exchange rate and so will research bank hybrids to invest in.

Capital Calls

So, as soon as I had increased the cash buffer in our offset account, I got AUD 40k of capital calls, so back to square one again. The capital call from Unpopular Ventures was expected. We have completed our first 2 year subscription period and are renewing for another two years. We need to make quarterly contributions of USD 10k. This is an act of faith that our investments will eventually be as good as their earlier investments. Ten years of fees come out of the investments up front, so we are underwater on our investment so far.

The other call is from Aura Venture Fund II for AUD 25k. These don't come on any schedule. When they need more money they make a call with about two weeks of notice. We have now contributed 55% of the total capital we pledged. There is no choice about this one. It's also losing at the moment.

One of Our Venture Investments Goes Bust

Expected that some or even many companies will go bust in this space. This is the first individual venture investment of ours that went bust. Luckily I only invested USD 2,500 so it is about a 0.1% loss to our portfolio. One of my main criteria for making an individual investment rather than through a fund is that there is a clear pathway to profitability or breakeven laid out. So, surprising this went under relatively quickly. I was going to mention the company involved but see that the email is marked confidential so can't give you more details. I think it should be OK to mention the company when they are no longer going to be in business but I'm paranoid about getting removed from AngelList so won't do so...

Fixed My Margin Loan Interest Rate

I fixed my margin loan interest rate for the next year at 7.69% instead of a variable rate 9.15%. I am paying the interest in arrears. At the moment I can't see the RBA really cutting interest rates by an average of 1.5% over the next year. It's the first time I have done this. One reason for that is that my balance is relatively low at the moment and I expect it will increase, so I won't have the problem of early termination. I am withdrawing AUD 15k every quarter to invest in the Unpopular Ventures Rolling Fund.

New Investment or Trade

I sold some Pengana Private Equity (PE1.AX) shares as they are trading above NTA and bought some Cordish Dixon Private Equity Fund III (CD3.AX) shares, which are trading more than 30% below NTA. Of the three traded Cordish-Dixon funds, I selected this one as it is youngest and so I figured has the most potential. Maybe the oldest fund maybe has only more problematic companies left in it, which are harder to sell? It is also the biggest of the three funds because it has made fewer distributions to date.

This was spurred by news that PE1 has made offers to acquire the CD funds, though these have been rejected to date.

In other updates, I have been tied up in other projects and haven't had time to reconcile the accounts for the last couple of months. When I do, I will post reports.

Not Renewing Wholesale Investor Status

I got a message from Interactive Brokers that I needed to renew my wholesale investor status as two years had passed since I submitted an accountant's certificate. They currently only allow retail investors to borrow a maximum of AUD 50k in margin loans. The accountant agreed to do it again and I sent her all the relevant material to prove my net worth was more than AUD 2.5 million that took me 2-3 hours to put together. I came up with a number of AUD 3.7 million – the test is done on an individual not family basis – and so thought it would be easy. But now she has come back and said she can't include any superannuation in the number! So she estimates my net worth for the purpose of the test is AUD 2.4 million. She suggested I get a professional valuation of my house to prove the higher number I suggested for it (AUD 1.25 million).

It doesn't make any sense to me that an SMSF would be excluded but home equity included.

Anyway, I looked carefully at my Interactive Brokers account. Currently, I could borrow a maximum of AUD 96k. The saving in interest per year for the amount above 50k compared to CommSec is about AUD 5k. But I am unlikely to borrow that much, as I don't want to get a margin call if things go pear-shaped. So, I've decided not to do the property valuation, because it might come in lower and I still wouldn't qualify. I will wait till when I actually want to borrow more or make a new venture capital investment in Australia and I am closer to qualifying. 

Of course, it is much easier to qualify as an accredited investor under US rules. Moominmama qualified in order to participate in AngelList even though her net worth including super is definitely under AUD 2.5 million.

History of Franking Credits

This year's tax returns include large amounts of franking credits connected to Australian dividends. I almost managed to wipe out Moominmama's tax bill with them. The franking credits are added to income and then deducted from the tax bill. As the corporate tax rate for large companies is 30%, if you are in the 34.5% marginal tax bracket (including the Medicare Levy) like she is, it would seem that franked dividends will slightly increase your tax bill. Say you got a $1,000 dividend including the franking credit. Your tax on the dividend as a whole is $345 and you deduct the $300 franking credit from that, paying $45 in tax on the dividend. The magic of franking credits is that if you have investment deductions like margin interest, you will end up with surplus credits. Let's say you have $500 in margin interest in this example. Then your tax on the net $500 in income is $172.50. After deducting the franking credit from this, you have $127.50 in tax credits, which you can apply against the tax on your salary etc. 

Foreign source income tax offsets work in a similar way. These are tax paid to foreign governments on dividends etc. Finally, there are also Early Stage Venture Capital Limited Partnership tax offsets. If you invest in an ESVCLP you can get a credit worth up to 10% of your investment. This totally offsets tax on other income even without any deductions!

Over time, the amount of franking credits and foreign source income tax offsets we have received has increased, as you would expect, though this year's credits are off the scale:

This doesn't include any tax credits received by our SMSF or any other superannuation fund for that matter.

HSBC Everyday Global Account

Back at the beginning of 2021 I opened an HSBC account for Moominmama because Plus 500 refused to send money to an account in our joint names. Moominmama has just been using it for shopping getting 2% cashback some months. I just realised that it can hold foreign currencies. So, instead of using OFX to convert and transfer money to the US to invest in Unpopular Ventures and Masterworks I could convert the money at Interactive Brokers at the best exchange rate, transfer it to HSBC and then transfer it to the recipient from there for an AUD 30 fee. OFX have about a 1.4% exchange rate cost plus an AUD 15 fee for small orders. And one day when there are distributions from Unpopular Ventures we could transfer the money back to HSBC without converting it.

Invested in Another Startup

Unpopular Ventures offered a syndicated investment in the seed round of a start-up based in Europe. I can't give any details of the investment. Based on their projections, which I think look pretty unrealistic, it would be a fantastic investment but they have been growing very rapidly so far, have a lot of experience, and the valuation doesn't seem too crazy.

The investment is basically in a separate fund, where the general partners get 20% carry. They suggested investing USD 2,500 (minimum was USD 1,000) and I did that, following Meb's advice to invest a little in lots of different start-ups. I'm used to investing 1-2% or as little as 1/4% of the portfolio in an investment and this is more like 1/16%. On the one hand, I don't want to make too many different investments because of information overload. On the other hand, I can't do anything about this investment unless there is an exit or opportunity to invest more, so I don't really need to pay much attention to its performance.

Unpopular Ventures

We have invested in a rolling fund – Unpopular Ventures – on the AngelList platform. We invested in Moominmama's name (because she is in a lower tax bracket) following a failed attempt to invest through our SMSF. We will invest USD 10k each quarter for eight quarters, which is the minimum investment. The fund will invest in new startups each quarter. In effect, you invest in eight different subfunds. I learnt about Unpopular Ventures from an episode of Meb Faber's podcast, which featured an interview with Peter Livingston, one of the general partners. The attraction of this fund are: 

• It has good historic returns.
• Meb is an investor, which I see as a good sign.
• It not only invests in the US but also in other countries, and in particular, developing countries and regions like India and Latin America. These regions are not as competitive for venture capital as the US market and so it should be able to get into investments at better valuations in theory. I guess exits might not be as highly valued either... but diversification is good.

Until now, we only had venture capital investments in Australia through Aura Ventures funds and the listed Wilson Asset Management Alternative Assets Fund (WMA.AX).

Related-Party Asset

I have been trying to invest in a fund on the AngelList venture capital platform. But my SMSF administrator flagged that there might be issues because the fund is organized as a limited partnership. The auditor has now provided the following information:

"A partnership can elect to be taxed as a Limited Liability Company (LLC) in USA or a partnership under the tax law due to the elections that the LLCs make with the US Internal Revenue Office. It is common for such partnerships (US) to be taxed as a company.

To support compliance with SISA/SISR for investments in Limited partnerships we note the following potential scenarios and information for audit purposes:

1. Where the entity is taxed as an LLC, this supports that the LP should be treated as a company where the members of the Fund are not members of the LP and the investment therefore is considered as an investment in an unrelated entity. This is usually able to be ascertained from the financial report of the LP. 
2. Where the entity is taxed as an LP, and the members of the fund are not members of the LP, and the investment is in within a limited capital account arrangement. This is usually able to be ascertained from the financial report and the application agreements. 
3. Where the entity is taxed as an LP, and the members of the fund are members of the LP.

If the investment falls into scenario 2 and 3 then the investment would classified as an in-house asset which would mean it needs to be below 5% of the SMSF’s total assets."

It seems that this falls under scenario 3. I just sent AngelList an email to check. The problem is that the minimum investment required, let alone subsequent hoped for appreciation, would take us over the 5% limit. So, it seems it is not really true that you can invest in anything you like through an SMSF. It seems silly to me to treat a fund where I am only investing through the SMSF along with 1500 other investors as a "related-party asset". Probably, I will need to invest in this fund using my own name and pay higher tax than I would through the SMSF.

Effect of Updates on Reported Returns

The final numbers are now in for the first half of this year with the report of a venture capital fund for June. I was curious how different the final monthly returns were to the ones I reported after each month on the blog:

There is a big change for the final month, mostly because of the strong return of the venture capital fund.

Coinvestment, Revised Target Allocation, and Rights Issue

I'm making an investment in a pre-IPO company alongside a venture capital fund and other investors. I valued the company based on their forward projections for EBITDA and the multiples similar companies listed on the stock exchange have. Of course, the company could fail and so it is sensible to take a middle valuation between the extremes of zero value and the value if the company succeeds as planned. This still gave a good gain on the current valuation. In reality, total loss is unlikely as the company is already approaching profitability. The funding is for expansion. The worst outcome is more likely a sale for the current valuation or something less to a competitor. I am planning to invest about 2% of our portfolio in this company.

This means I will have to raise my target allocation to private equity and reduce my allocations to hedge funds and long-only equities. To also take into account my future commitment to a venture capital fund I am increasing the private equity allocation of gross assets from 10% to 15%. I am reducing the hedge fund allocation from 24% to 22%, Australian large cap from 9% to 8%, US stocks from 6% to 5%, and rest of the world stocks also from 6% to 5%. I would be happy to have an even higher allocation to private equity if I had access to enough diverse good quality opportunities. So, changing the target allocation isn't just like the US government raising its debt ceiling every time they hit it :)

By contrast, I am an investor in listed company Domacom (DCL.AX), which has been suspended from the ASX for a while, pending completion of a deal to effectively acquire a company called AustAgri. The ASX instructed them to raise more capital before relisting. I don't intend to participate in the rights issue, especially as the issue price is slightly above the last traded price of the shares on the ASX. Success of the company in the short-run really depends on this AustAgri transaction and it is still hard to be certain why it is so delayed and what will happen. Even after that transaction, the company will not be in anywhere near as good a position as this pre-IPO company.