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 :)

Pengana Private Equity

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

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

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

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

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

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

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

Benchmarking

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

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

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

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

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

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

February 2019 Report

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


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

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

Things that worked very well this month:

• CFS funds - they all did well. Future Leaders continues to outperform Developing Companies.
• Our two UK listed stocks - 3i and Pershing Square Holdings.
• Medibank. It continues to bounce back nicely though we only have a very small posiiton.
• Unisuper made the largest gain in dollar terms, though we are still below the peak value last year.
• Many investments hit new profit highs including PSS(AP), Generation, and Hearts and Minds.

What really didn't work:

• Yellowbrickroad... I exited this investment at 6.5-6.6 cents per share following the release of the Royal Commission report. I should have gotten out much earlier. The shares are now suspended as the company has not filed its interim financial report. They are still working on writing down their assets... The last price they traded at was 5.4 cents.

Bonds mostly had negative returns. When you buy a corporate bond you have to pay the interest accrued since the last interest payment to the previous holder.

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

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

On a regular basis, we also invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. Other moves this month:

• I bought USD 300k of corporate bonds and USD 100k of treasury bills matured. Our monthly bond ladder now extends to September.
• We sold 569 China Fund (CHN) shares back to the company at 99% of NAV in the tender and then bought 669 in the market for a lower price.
• We sold out of Yellowbrickroad (YBR.AX) at a big loss.
• I made a quick (losing) trade in gold futures (Included in gold above).
• We switched our choice of option in the PSS(AP) superannuation fund to "balanced" from a mix of "balanced" and "aggressive".
• I switched from Geared Shares to Imputation (leveraged and unleveraged Australian shares) in my CFS superannuation fund.
• At the end of the month I also switched to the balanced option in the Unisuper superannuation fund.

So, there was a big deleveraging/derisking theme that will continue. There are no capital gains tax implications to shifting the super funds, so I am doing them first.  We can still switch from the "Geared Growth" fund to an unleveraged version.

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

Retiring in Australia and Spending Dividends Only

Big ERN has a new blogpost about the safe rate of withdrawal in retirement. He takes on people who say that you can avoid the problem of selling assets when their price is low by investing in high-yielding assets and only spending the dividends or interest. The highest yielding portfolio he looks at has yielded an average of 3.6% p.a. and it looks like it ends up selling capital in the great recession of 2008-9.

Australian shares have a high dividend yield. They yielded 4.25% last year not counting franking credits. If as ERN assumes you withdraw 4% of the portfolio in the first year and then increase that withdrawal by the rate of inflation can you avoid selling shares? The short answer is: yes!

These are my assumptions: We invest in the ASX 200 index without fees (could be replicated by a portfolio of 20 stocks maybe?) and we don't pay taxes (it's a superannuation account in pension phase) and so we get the grossed up value of the dividends (Labor plans to eliminate these refunds if they win the next election). I start with $900k in shares and $100k in cash and get the Reserve Bank interest rate as interest on the cash. Then all dividends and interest are paid into the cash account.

My first simulation assumes we retire at the end of March 2000. This was not a good time to retire as it was just before the dotcom/tech crash. But the ASX200 index started in April 2000 and so data before then is not very reliable. This is what happens:

Starting in 2000 we would now have almost $1.7 million in shares and $900k in cash. If we'd reinvested some of the dividends we probably would have been even better off.

To stress test the model, I also do a simulation that assumes you retire at the end of December 2007 just before the great recession/global financial crisis. This is what happens then:

Obviously, it's not as good and you would have $970k now, more than 10 years later. In real terms the value of the portfolio will have fallen substantially. But so far, you won't have had to sell a single share with $138k in cash currently. Over the last couple of decades this strategy has worked well.

This suggests that investing in stocks in countries with traditionally high dividend yields like Australia and only spending the dividends is a viable investment strategy. If you need to pay taxes on withdrawals as in the case of a U.S. 401k account then you will need to start with more money invested to fund the same level of spending.

Today's Moves

I bought more corporate bonds. This time in Royal Bank of Canada and Welltower. These were the highest yielding investment grade bonds that I could actually buy that mature in April. $US25k in one and $US35k in the other. Not ideal, as the commission is higher for the first $10k but those were the amounts on offer. I was looking to buy bonds of Siam Bank Corporation, but the minimum purchase turned out to be $US200k for some reason. I also tried to buy Glencore bonds, but when I put my bid in the market, the offer disappeared from the screen. I waited a while and I didn't get the bonds. Very weird. Probably it makes sense to wait until I have enough cash to buy $US100k and buy Treasury bills unless there is a sufficient amount of corporate bond with a high enough yield to make it worthwhile. After commissions these two purchases probably end up breakeven with a Treasury bill. As I begin to buy bonds at longer maturities though, the commission will be spread out over a longer period. I use the bond scanner provided by Interactive Brokers to find available bonds with the right characteristics.

I also am looking at shifting our allocation in the PSS(AP) superannuation fund from 50/50 "balanced" and "aggressive" to 100% balanced as part of our general de-risking. I am again reminded of how shocking the lack of transparency about investments is for Australian funds compared to US funds. All the information they provide in the annual report is the percentage of the fund allocated to "equities", "alternatives" etc. with no further details. PSS(AP) actually used to provide more, but not a lot more, information than this. An interesting fact from the annual report is that employer contributions totaled $A1.154 billion and employee contributions $A55 million in the 2017-18 financial year. Not many people are making additional contributions or they are not making very large contributions. This makes sense as the employer (the Public Service) contributes 15.4% on top of the official salary to the fund. It's only interesting because for the defined benefit fund at Australian universities – not part of the public service, though they are in the public sector – employees are required to contribute 7% on top of the employer 17% in order to get full benefits. I opted out of the defined benefit fund. Our employee contributions at PSS(AP) are actually as big as the employer contribution at the moment.

P.S.
Basec on reading the Unisuper report, employee contributions might only include non-concessional or "after tax" contributions and not salary-sacrificed or "pre-tax" contributions. This is because the stated contributions tax in the report is 15% of the employer contributions. By contrast with PSSAP though, Unisuper defined contribution members make massive non-concessional contributions (see p52 of the report), even though the employer makes 17% contributions to the fund.

Do You Feel You are in a Lower Wealth Percentile Than What the Official Data Say?

People tend to think they are less relatively wealthy than they are. You can check out your perceptions against reality for a number of countries here. I'm not surprised. According to the official statistics we are in the top 4% of households in Australia by wealth. But looking around, it certainly doesn't feel like that could be true. Our house is only valued a few percent above the median for our city. Our car is a 15 year old Ford when it feels like the roads are full of luxury vehicles. But it's not like we are saving like crazy. In 2018, we spent almost all of what we earned from salaries. Apparently, a lot of people feel the same way.

January 2019 Report

In January stock markets rebounded but because the Australian Dollar rose, we didn't gain a lot in Australian Dollar terms. The Australian Dollar rose from USD 0.7049 to USD 0.7274 The MSCI World Index rose 7.93% and the S&P 500 8.01%. The ASX 200 rose 3.87%. All these are total returns including dividends. We gained 0.49% in Australian Dollar terms and 3.79% in US Dollar terms. So, we underperformed the markets. This is not surprising given the weight of cash and bonds in our portfolio. Our currency neutral rate of return was 1.89%. I estimate that the target portfolio gained 1.57% in Australian Dollar terms.


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

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

Things that worked very well this month:

• The China Fund - the fund has announced a tender for 30% of outstanding shares at 99% of NAV. The share price is rising towards NAV as a result. I tendered my shares into the buyback. At least it will probably realise a small capital loss.
• Pershing Square Holdings. This bounced back nicely from December losses and we are now up in this investment.  
• Unisuper. This is after a steep fall in previous months. I continue to be surprised how much higher the beta of Unisuper is compared to PSS(AP). Both are public sector superannuation funds and we supposedly have a similarly aggressive stance in each.

What really didn't work:

• US Dollars - The Australian Dollar rose, especially after the statement from Jerome Powell.
• Cadence Capital - It continues to lose money and is now our third worst investment ever in terms of dollars lost. The fund manager explained that they focus heavily on value stocks and those got trashed.
• Yellowbrickroad...

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

The main driver is continued movement of cash from my US bank account to Interactive Brokers where I am buying bonds before eventually transferring some of the money to our Australian bank accounts when the broker allows. Also, we sold the apartment we inherited.

On a regular basis, we also invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. Other moves this month:

• I moved AUD 30k from the CFS Geared Share Fund back to the CFS Conservative Fund in my CFS superannuation account. I originally moved this money in October to CFS Geared Share Fund. I made a small profit on the roundtrip trade, but the main motivation for closing the trade was to reduce risk.
• I bought 1558 shares in OCP.AX at AUD 2.07 a share just because they were being offered so low.
• I sold 15,000 shares in PMC.AX and bought 5000 shares in PIXX.AX as the PMC premium to NAV was still high.
• I bought AUD 24k during the "flash crash" and sold them after the Australian Dollar recovered a few cents.
• I bought 1000 shares of PERLS XI as I can't move the Australian Dollars I bought in December to our Australian bank account yet.
• I bought USD 100k of treasury bills maturing in February.
• I bought USD 100k of Santander UK bonds maturing in March. 
• I bought 1000 shares of the gold ETF, IAU.

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

Understanding Increase in Spending Better

I wanted to understand why spending in the 2018 calendar year was up 28% on 2017. The first step was computing a spending breakdown for the 2017-18 financial year. The period is different and the definitions of income and spending are different than in my usual accounts to make it more comparable with other income and spending breakdowns on the web. I now computed the spending breakdown for the second half of 2018 and we can compare monthly spending in this period to that in 2017-18:

Spending was up by 7.5%. So not as dramatic a growth rate. The biggest difference between the two periods, is that in the first period we spent a lot on travel and in the second on health. In fact, the travel spending was mainly in the second half of 2017-18 - i.e. in the first half of 2018. So, 2018 had high spending because of both travel and health spending being up strongly on 2017. The way I usually compute spending and income is to include any refunds for medical spending as income rather than reducing spending by the amount of the refund, which I am doing here. So, that pushed up spending even more. I'm glad I now understand why our spending increased so much.

Another major change is that cash spending was down in the second half of 2018. That was because I had access to the statement for my Qantas Cash card – only the last 13 months is online. In the previous period, I treated all spending on the card as cash spending.

Going forward, I expect medical expenses to be lower this half year and travel expenses to be much lower than in the first half of 2018. Given that, 2019 calendar year spending might be lower than 2018 spending.

Gold

Put my toes into the water by buying a small 0.5% position using the IAU ETF. I've posted about gold previously and it is in our long-term allocation to allocate 6% to gold.

Spending Breakdown

After a discussion with friends at lunch yesterday and some blogposts I read recently, I decided to try to find out what we are spending on. I haven't done this in more than two decades I think. I looked at the 2017-18 financial year so that I can also easily include official income and tax figures in the total. It's all in Australian Dollars of course:

Income is gross income from our tax returns plus employer superannuation contributions which which don't enter taxable income. Income includes salaries and investment income etc.

Next we deduct taxes. As franking credits – tax credits for corporation tax paid by Australian companies are included in taxable income, they need to be deducted as we don't actually get the cash.  Then there is 15% tax on superannuation (retirement) contributions. In total tax is 26% of gross income. Next I deduct some financial costs that are deducted from gross income to get to taxable income. There are more of these deductions actually, but some I have included in our spending.

Of the AUD 216k of net income half was spent and half saved.

The big spending items are mortgage interest, supermarkets etc, cash spending, mail order, childcare etc, and travel (flights, accomodation etc). Cash spending includes both spending actual cash and spending using our Qantas cash cards. I haven't gone into the accounts for the latter, though maybe I should. Some of the other spending categories very low compared to the actual amount spent on these because a lot of the spending is in cash. Possibly the most important of these is restaurants. Yes, there is a lot of fuzziness in these numbers because we don't budget and spend a lot in cash.

Am happy to get feedback on how we can save money, though I'm not really into "frugality" for it's own sake. Or maybe you would just like to compare the differences with other posted spending breakdowns.

P.S.
Qantas only provide online statements for the last 13 months. So, I can't now do a breakdown of those accounts for 2017-18. Maybe next year.