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.

Got Online Access to My US Bank Account

I couldn't get online access to my account at Keybank because they required a US phone number as a security measure. This meant I also couldn't transfer money between Keybank and Interactive Brokers. So, I now bought a US phone number through Skype! I now have access to my account (my old password and username from First Niagara still work, and I managed to initiate a transfer of money to Interactive Brokers. Have to wait and see if it really works, though.

Private Equity and Venture Capital Indices

I commented that I didn't have a good proxy for private equity and venture capital. So, I went and found one and came up with these indices from DSC Quantitative Group. What they do is regress a quarterly indices of private equity buyout and venture capital funds from Thomson Reuters on various sector indices of listed stocks. They update these weights each time Thomson Reuters produce a new number. Because they are using listed stock indices as proxies they can then produce a daily index for private equity. The fit of the proxy to the underlying index is not too bad. This is for venture capital:

 The biggest deviation is during the financial crisis - unlisted private equity fell by more than the proxy index had predicted. When we compare the proxy to the NASDAQ total return index, it looks superficially like a leveraged version of the index:

When I regress it on monthly NASDAQ total return index data for 2008 to 2018, I get a beta of 1.15 and annual alpha of 6%. This suggests that venture capitalists add value by rotating the sectors that they invest in over time and it's not just about leverage:

Alpha is given by the intercept of 0.4% per month. I didn't do the proper CAPM regression where you are supposed to deduct risk free returns from the two returns series first. Given the volatility here and low risk free rates since 2008, I doubt it would make much difference.

Interestingly, the Cambridge VC index estimates much lower returns, close to the returns of the NASDAQ index itself.

You could do all this analysis for the buyout private equity index too. You'd want to regress that on the S&P 500 total return index instead.

Target Portfoilo Performance

In October the target portfolio lost 2.83% in Australian Dollar terms. In USD terms the model portfolio lost 3.43%. This model portfolio doesn't include a proxy for private equity, as I don't know a good one. The ASX lost 6.04%. It was hard not to lose money last month. In the last 10 years the model portfolio returned 8.63% p.a. vs. 11.54% including franking credits for the ASX. In the longer term though the target portfolio ("composite") has about matched the returns on Australian shares with lower volatility:

So it's not that necessary to leverage the portfolio to get good returns. The chart shows returns in Australian Dollar terms though bond and real estate are US dollar returns to two TIAA funds invested in those sectors.

Model Performed Badly Since I Stopped Trading

Since I decided to temporarily stop trading the model has performed badly losing about 9% while the NASDAQ 100 index is down about 4%. It still gained 5% for October overall while the index was down 8.7%. I gained 18% on capital invested due to leverage. It's good I stopped trading when I did.

October 2018 Report

As I'm sure you know, this month was very volatile, which is good for trading but not for the performance of investments generally. This was a good test of our overall strategy, except that I abandoned trading after 17 October when I found the model was overfitted (and I also got ill with flu/pneumonia or something for the rest of the month). At the end of the month we received the grant of probate and so I am now adding in the inherited assets (cash and half an apartment) from the end of this month. This will suppress returns on both the upside and downside in the near future but doesn't affect the numbers for this month.

The Australian Dollar fell from USD 0.7228 to USD 0.7083. The MSCI World Index fell 7.47% and the S&P 500 fell 6.84%. The ASX 200 fell 6.04%. All these are total returns including dividends. We lost 5.30% in Australian Dollar terms and 7.20% in US Dollar terms. So, we  outperformed both Australian and international markets.


Because of the high volatility this month here is a detailed report on the performance of all investments and asset classes:

The table also shows the shares of these investments in our post-inheritance portfolio. Futures contracts are at the bottom. It doesn't make sense to compute shares or rates of return for those. Yeas, we lost a total of AUD 117k, which is our worst ever monthly result in absolute dollars. Things that worked quite well in this market crash:

• PSSAP Superannuation fund - this fell very little, by contrast with Unisuper, which surprised me.
• International hedge funds: Platinum, Tribeca, and Pershing, each did fairly well in relative terms. We should invest fully in these (12.5% is allocated to them in the model portfolio and 10% to Australian hedge funds).
• Futures: Our own futures trading worked perfectly until I stopped and Winton's downside was not too bad (better than in February), but still not performing with zero or negative correlation to equity markets. Gold rose (will be a priority to invest in it). We need to get trading working, but it will take me a lot of time to do the needed research.
• Real estate, CFS Diversified Fund etc all had more limited downside as we'd expect (estimated return for CFS Conservative Fund was negatively affected by trading).

What didn't work:

• Cadence Capital, which fits in the (mostly) Australian hedge fund category, fell sharply. 
• China Fund - this isn't surprising given the supposed drivers of the market correction.
• Yellow Brick Road - I should have sold out of this when the Mercantile offer terminated

The following is table of investment performance statistics computed over the last 60 months (extended from 36 months previously) of data:

The first two rows gives the annual rate of return and Sharpe ratio for our investment performance in US dollars and Australian dollars. The other statistics are in comparison to the two indices. Based on beta, compared to the MSCI World Index we seem to be slightly geared, while compared to the Australian index we are less sensitive to market movements. We have a positive alpha compared to the Australian and a negative alpha compared to world markets. We capture more of the up movements and less of the down movements in the Australian market and the reverse in the international markets. The fall in the Australian Dollar over this period explains the poor performance compared to international benchmarks. The rate of return in USD terms is just horrible. US markets have been super strong over this period compared to the rest of the world.



This month I made USD 6k trading futures. This is the second best result to date and occurred as the NDX declined for the month. As I stopped trading partway through the month, I won't post the usual comparison of market, model, and my own performance. There seems to be potential here, but we need a system that is robust to different market conditions.

We actually moved away from the new long-run asset allocation in quite a dramatic way with the infusion of cash:

Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged funds. All asset classes apart from cash and real estate fell as I added the inherited assets. My share of the inherited apartment is about 6% of net worth. Australian large cap fell by more as I switched out of the CFS Geared Share Fund just before the market correction got going.  Hedge funds were boosted by the addition of Tribeca (TGF.AX), which started trading on the ASX and Pershing Square Holdings, which I made a new investment in.

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.

Hearts and Minds IPO Oversubscribed?

I just got an email with my allocation of shares in this IPO. It's 82% of what I requested and the settlement dates and first trading date have been brought forward. So looks like the IPO is oversubscribed and closing early.

Overfitted

When I started trying to backtest the model with my new program the performance was bad, worse than I expected and worse than backtests I'd done previously. Recent changes to the model seem to have overfit it to the recent data. Therefore, we can't rely on the model going forward. This will need thorough investigation and in the mean time I'll stop trading.

Hearts and Minds IPO

Another Australian IPO of a listed investment company (closed end fund). This one has a twist – there are no management fees and the directors have waived their fees too. Instead of receiving a fee, the managers will donate 1.5% of NAV each year to charity. The board of directors include local investing luminaries like Geoff Wilson and a long list of wealthy Australian families (such as the Lowy family) have agreed to make investments in the fund.

The fund is a long only fund investing in Australian and international stocks. Each year several Australian investment managers present at the Sohn Hearts and Minds conference their best investment picks for the coming year. 40% of the fund will be allocated to these picks. 60% will be allocated to "high conviction ideas" from a number of other "core" investment managers. In total the fund will invest in about 25 securities.

The picks from the last two conferences have done very well:

One of the core investment managers is Regal, whose hedge funds have done extremely well.

In summary, I think this looks like being another good investment opportunity.

Results for the S&P 500

These are the results of the year to date for the S&P 500 model, again without stops. As volatility is lower than the NASDAQ index, returns are lower but are still very good:

Alpha       0.47948 Beta      -0.22355 ror       0.46115 Sharpe       2.62376

Again these are annualized values. Annualized rate of return is 46% for this year.

P.S.
I've now written all the code including stops for NQ and ES. Stops only detract a little from performance for ES but quite a bit for NQ. This suggests that we should use wider initial stops, just to avoid catastrophe, rather than to get out of ordinary bad trades.

More Progress on Programming the Trading Model

Now this is a nice equity curve! This was produced by the computer making daily decisions for each day this year so far, using the full version of my model but without stops. The idea is it tracks what happens to $1000 compounded (without commissions or any slippage etc. - former is not important latter might be). The blue line is the NASDAQ 100 index also rebased to 1000 as the beginning of January. The computer is also printing out a list of instructions one for each day like this:

5082    7637.43018       1.00000       0.00000  D buy. Stay long
5083    7490.00000       0.00000       0.00000  K sell. Go short
5084    7399.00977       0.00000       0.00000  K sell. Stay short
5085    7352.81982       0.00000       0.00000  K sell. Stay short
5086    7371.62012       0.00000       0.00000  K sell. Stay short
5087    7044.50000       0.00000       0.00000  D sell. Stay short
5088    6964.02978       0.00000       1.00000 R buy not confirmed by pdD D sell. Stay short
5089    7157.20996       1.00000       1.00000 R Buy outside BB confirmed by pdD
5090    7068.67041       1.00000       1.00000 R Buy outside BB confirmed by pdD
5091      NA       1.00000       1.00000 R Buy outside BB confirmed by pdD

These are the most recent decisions, including today's decision to stay long. The "NA" indicates that we don't yet know the index value for today...

It also produces some performance statistics:

Alpha       1.76456 Beta      -0.21425  ror       1.68344 Sharpe       5.47108

That means 176% p.a. of alpha... This is based on compounding the daily alpha over the year. Beta to the market is slightly negative and so compound rate of return for the year is a little less than alpha. I don't expect that high rates of return in other years. Conditions are ideal this year and probably the model is a bit overfitted. One of the reasons for doing this programming is to make it easier to test the model on larger samples.

Next I will add some refinements like using futures prices instead of index prices for performance results. Oh yes, and adding stops!

P.S.
When I ran the algorithm on the S&P 500, I found at least one bug which also needs ironing out.