Hedge Funds Beat the S&P 500 in December

It's rare to see hedge funds beating the major stock indices to the upside these days, but that's what happened in December when the HFRI returned 4.47% and the S&P 500 3.84%. The MSCI World Index gained 4.68%. As a result our target portfolio actually returned 6.13% in US Dollar terms, though we still beat it, gaining 7.21%. In Australian Dollar terms it gained 1.26% rather than just breaking even as I reported a few days ago.

Contributions of Individual Investments 2020

 

As promised, here are the contributions of each of 62 investments to our annual investment return. Of course, these numbers (in Australian Dollars) depend on the size of each investment and I don't make any attempt to work out or compile the annual rate of return on all these investments (I do compute it for some). 

Compared to last year, gold again is a top contributor and Hearts and Minds and Pershing Square Holdings are gain near the top. Cadence Capital had a turn around this year for the positive and Platinum Capital for the negative. The large super funds did OK but last year they were the two top contributors.

There were two big disasters this year. Winton Global ALpha had a terrible performance losing 18% and Virgin Australia bonds were almost totally wiped out in the airline's bankruptcy.

The total number of investments was smaller this year as we gradually ran off our individual bond holdings and traded much less.

Annual Report 2020

Overview 
The main financial themes of this year for us was continuing to invest the money we inherited in late 2018 and surprisingly strong investment returns for the year after the sharp fall in markets in March due to the COVID-19 pandemic. In my academic career I was also surprisingly productive in the second half of the year following the struggle of dealing with closed schools and our move to online teaching in the first half of the year. We spent less for the year overall because of a reduction in spending during the lockdown and no travel. Our house fell in value, which was against the trend in the Australian housing market.

 

All $ signs in this report indicate Australian Dollars. As I did last year, I'll do a separate report on individual investments.

Investment Returns 
In Australian Dollar terms we gained 11.9% for the year and in USD terms we gained 23.2% because the Australian Dollar gained 10%. The MSCI gained 16.8%  in USD terms and the ASX 200 only 2.6% in AUD terms. The HFRI hedge fund index gained 8.9% in USD terms. Our target portfolio is expected to gain 6.8%. So, we beat all benchmarks this year.

 

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

 

We tracked the MSCI World Index very closely till May. After that we started to diverge. I posted equivalent Australian Dollar returns in the December monthly report. Here are annualized returns over various standard periods:

US Dollar returns are not very good over longer periods, but they still beat the HFRI, especially over the 3-5 year horizon. Here are the investment returns (currency neutral) and contributions of each asset class in 2020:

 

The contributions to return sum to the total portfolio return. Hedge funds and private equity had the highest returns and hedge funds by far the largest contribution to total return. Gold had the third highest return and the second highest contribution to total return. The rate of return on bonds is surprisingly good actually given the almost total loss of our Virgin Australia investment.

Investment Allocation
The main changes in allocation over the year was that we ran down our bonds allocation while increasing hedge funds, private equity, and gold mostly:

We started investing in art, which for the moment is grouped together with real estate.

Accounts
Here are our annual accounts in Australian Dollars:

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

We earned $128k after tax in salary, business related refunds, medical payment refunds, tax refunds etc. This was down 13% on 2019 because Moominmama worked less and we had large tax bills due to investment income (investment income is reported pre-tax). We earned (pre-tax including unrealized capital gains) $370k on non-retirement account investments. The latter number was up on from last year. The former number continued its decline. The investment numbers suffered from the rise in the Australian Dollar ($67k in "forex" loss). Total current income was $498k. Not including mortgage interest we spent $121k. Total spending was down 18% on 2019 due to reclassifying mortgage interest as an investment cost since we paid off and redrew the mortgage and reduced spending due to the pandemic. Not counting mortgage interest, spending was down 9%.

$10k of the current pre-tax investment income was tax credits – we don't actually get that money so we need to deduct it to get to the change in net worth. We transferred $45k into retirement accounts from existing savings in "non-concessional (after tax) contributions. I list $2.4k of "inheritance". This is mostly due to adding the value of a painting I inherited, which I already had but hadn't included in net worth. The only other "things" included in our net worth are our car, a gold coin, and our house.

 
The change in current net worth, was therefore $324k. Looking at just saving from non-investment income, we dissaved $37k. So, before the transfer to retirement accounts we saved about $8k from salaries etc.

The retirement account is a bit simpler. We made $44k in pre-tax contributions (after the 15% contribution tax) and made an estimated $65k in pre-tax returns, which was strongly down on 2019. $8k in "tax credits" is an adjustment needed to get from the number I calculate as a pre-tax return to the after tax number. Taxes on returns are just estimated because all we get to see are the after tax returns. I do this exercise to make retirement and non-retirement returns comparable. Net worth of retirement accounts increased by $146k.

Finally, the housing account. I estimate that our house lost $34k in value. As our mortgage is now included in the current investment account there are no other entries in the housing account now.

 

Total investment gains were $401k, up 8% on 2019.

Total net worth increased by $436k,  which was up 12% on last year. $51k of this was from saving from non-investment sources, up 7% on last year. Thanks to employer superannuation contributions this was 30% of our total after tax non-investment income. Including investment gains our savings rate was 78% of our comprehensive after-tax income.

How Does This Compare to My Projection for This Year?
At the beginning of the year, I projected a gain in net worth of $425k, which turned out to be almost exactly correct. The baseline projection in my spreadsheet for 2021 is for a very high 19% rate of return, a 6% increase in spending, and flat other income, leading to an $800k increase in net worth to around $5.7 million. A more sensible projection would be for another $400k increase to around $5.3 million. Of course, anything could happen.

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

 

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

 

For current accounts "core expenditure" takes out business expenses that will be refunded by our employers and some one-off expenditures. This year, there are none of those one-off expenditures. "Saving" is the difference between "other income" net of transfers to other columns and spending in that column, while "change in net worth" also includes the investment income.

Closing Plus 500 Account

 

 

I opened a CFD trading account with Plus 500 in Moominmama's name in order to hedge Bitcoin trades over the weekend and do other trading experiments with small position sizes. I no longer need the account and they are charging monthly inactivity fees. So, I tried to withdraw the cash in the account. But they wouldn't transfer the money to our joint Commonwealth Bank account. They also refused to transfer the money to Moominmama's Interactive Brokers account, even though it has a BSB and bank account number. So, I opened a new bank account in her name at HSBC. But now we have to wait a month to get a statement that would be acceptable to Plus 500... To be continued

Aura Venture Fund II Still Accepting New Investors

Recently, I invested in the Aura Venture Fund II. There was a "first close" but the fund is still accepting new investors before a final close. From my experience with Aura Venture Fund I, these later investors will need to pay interest together with their initial investment to account for possibly benefiting from the funds initial investments that were made before they joined. You can get more information about the fund here. Usually, you will need to be qualified as a wholesale investor and the minimum investment is likely AUD 250k. Note that you will only need to invest a fraction of that at first with capital calls then spread over the life of the fund. My initial investment was AUD 62.5k.

My IRR on VF I is 27% so far, but of course there is no guarantee that the new fund will perform as well or that the final IRR will be that high for VF I when all investments are wound up. A big advantage is that the tax rate for Australian investors on early stage venture capital investments is negative. There is a 10% offset on your investments and zero capital gains or income tax. Also, investment in the fund may make a foreign investor eligible for an investor visa to immigrate to Australia.

December 2020 Report

The rallies in the Australian Dollar and the stock markets continued this month. The Australian Dollar rose from USD 0.7361 to USD 0.7725. The MSCI World Index rose 4.68%, the S&P 500 by 3.84%, and the ASX 200 rose 1.27%. All these are total returns including dividends. We gained 2.16% in Australian Dollar terms or 7.21% in US Dollar terms. The target portfolio is expected to have gained 0.07% in Australian Dollar terms and the HFRI hedge fund index is expected to gain 2.03% in US Dollar terms. So, we outperformed all benchmarks. In recent months, we have been tracking the target portfolio quite closely but with a positive alpha:

 

 

The target portfolio is a mix of indices (ASX200, MSCI World, HFRI, price of gold, Australian Dollar, private equity indices) and actual funds (TIAA Real Estate, TIAA Bond Market, Winton Global Alpha). If I was more industrious, I would use indices for the latter too... Hopefully, we can continue to beat the target portfolio by selecting better than average hedge funds etc. 

 

Increasingly our assets are in more illiquid investments that report with a lag. I am now using estimates for all of these:

• Our house - we might change the value based on local sales up to a year after the month end! We will stick with last year's value until there is another local sale. Our house  isn't included in the calculation of the rate of return, though, only in our net worth calculation.
  
• Aura VF1 - reports every 2 months and more than a month after the end of the month, I am using the IRR so far to project the return.
  
• Aura VF2- reports every 2 months and more than a month after the end of the month. For the moment we will stick with the IPO price.
  
• Winton Global Alpha - lag is only 2-3 days.
• Cadence Opportunities - not sure how long the lag will be. I am using the historic alpha and beta to compute an expected return.
  
• APSEC - seems to be 2-3 weeks after month end. I am using the expected HFRI return to project the return.
  
• Masterworks - none of my paintings is yet tradable in the secondary market, so we are just using the IPO price.

Some of our other investments are listed on the market or quoted daily, but their NAV adjusts with a lag, such as Wilson Alternative Assets (WMA.AX) and TIAA Real Estate.

Here is a report on the performance of investments by asset class (currency neutral terms): 

 

Hedge funds added the most to performance followed by gold. Things that worked well this month:

• Pretty much everything! But gold was the strongest performer in dollar terms, gaining AUD 28k.
  

What really didn't work:

• URF.AX which invests in residential property in New York and New Jersey lost most – AUD 3.5k. Hearts and Minds (HM1.AX) had its first decline since March, losing AUD 1.3k. That's after gaining AUD 95k since the March low!
  

The investment performance statistics for the last five years are:

The first two rows are our unadjusted performance numbers in US and Australian Dollar terms. The following four lines compare performance against each of the three indices. We have the desired asymmetric capture for all three indices now and positive alpha compared to two of them. 

 

We moved further towards our long-run asset allocation. Real assets (real estate and art) are the asset class that is furthest from their target allocation (7.6% of total assets too little) followed by bonds (4.8% too much): 

 

 

We are now over-allocated to hedge funds, so will look to trim some positions over time. On a regular basis, we invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Other moves this month:

• I rebalanced my US 403b retirement account to 50% in the TIAA Real Estate Fund (direct real estate) and 50% in the CREF Social Choice Fund (balanced fund). I eliminated an allocation to the Money Market Fund and reduced the allocation to the Social Choice Fund.
• I bought 5,000 Treasury Wine Estates shares.
• I sold 1,000 CBAPI.AX Commonwealth Bank hybrid securities (convertible bonds).
• I bought 3,000 shares of the IAU gold ETF, taking our position to 20,000 shares and finally around 10% of gross assets. 
• I bought AUD 160k by selling US Dollars to get our currency exposure to 50% Australian Dollars and I bought GBP 25k by selling AUD.
  
• I bought 1,000 Pershing Square Holdings (PSH.L) shares. This took me more overweight hedge funds, but I self-justified it by the fact that the shares are still trading at a big discount to NAV but the gap is narrowing. And anyway, the target portfolio weights are arbitrary, aren't they? I will look to trim the lower performing listed hedge funds once prices are nearer NAVs again.
  

Restructuring Baby Moomin's Portfolio

About one and a half years ago I opened an account for baby Moomin with Generation Life to invest the money he inherited from my mother. For this calendar year, the account made about 6.6% on a pre-tax basis.* 

 

This wasn't as good as our portfolio, which returned about 12% in Australian Dollar terms. So, I felt that it was time to make some changes. I decided to switch out of the Dimensional World Allocation 50/50 Fund and the PIMCO Australian and Global Bond Funds. I am switching into the Dimensional World Allocation 70/30 and Vanguard Growth Funds, 50% in each. This is my first time investing in a Vanguard fund! The Vanguard fund is better tax optimized, while Dimensional has more of a tilt to value stocks, which are maybe back in favor. This will result in a total portfolio that is 60% stocks, 20% bonds, 10% infrastructure, and 10% hedge funds.

* This assumes that 30% tax was deducted. Actually, the tax was lower due to franking credits and offsets for foreign taxes. The post-tax return was 4.65%.

2020 Performance of Interactive Brokers Accounts

Inspired by Financial Samurai's post, here are the track records of our two Interactive Brokers accounts over 2020.

Moominpapa (in USD and compared to the S&P500):

This is the kind of result we are trying to achieve with our investment strategy and why we don't just invest in index funds. The only ETF we invest in is IAU - a gold ETF.

Moominmama (in AUD):

On the IB platform, I can only compare this inappropriately to US Dollar indices. By comparison, the ASX200 gained only 1.27% for the year. At the end of March it was down 23% for the year and so probably fell about as much as this portfolio did at the worst point a few days earlier. This is a pleasing result, though less downside would be nice, but then this is just a relatively small part of our total portfolio.

2020 Update on the Yale Endowment

Inspired by Financial Samurai's latest post, I am updating my post on the Yale Endowment. They have released preliminary results for the 2019-20 financial year (ends 30 June) and so we can update with three years of data. They returned 6.8% for the 2019-20 financial year, which is just below the S&P500's 7.5%. On the other hand, HFRI lost 0.6% and I lost 0.1% in USD terms. In the long run, since the financial crisis they have tracked the MSCI index with a little extra return and a little less volatility:

Their asset allocation continues to evolve, with domestic equity now only 2.5% and private equity now 41% of the portfolio:

Natural resources are now down to 4.5%. This is much more extreme than the typical family office portfolio, which has 49% of assets in alternatives including rela estate and commodities vs. 78% of the Yale portfolio.

Breakdown into Taxes, Spending, and Saving

Following up on yesterday's post on our spending over time in different categories, I made another pretty graph, this time of the breakdown of income into taxes, spending, and saving. Everything is in Australian Dollars:

 

 

Total income is our gross income on our tax returns plus superannuation contributions that are not on our tax returns. This means that it includes taxable investment income. As a result, current saving looks quite big, but saving from our salaries is much smaller than this, nearer to AUD 20k per year. Superannuation contributions include employer and salary sacrifice contributions and not "non-concessional contributions", which I treat as transfers from current savings totaling AUD 180k during this period.

Mortgage principal payments were low last year when I paid off and redrew the mortgage. Even though in my investment performance reports I now include mortgage interest as an investment cost, for the purposes of these posts on spending I include it in housing costs to make our numbers more comparable to other people's. Investment costs are mostly margin interest as well as other fees. Taxes include income and property tax.

Spending Over the Last Four Years

The chart shows our spending over the last four Australian tax years. The 2020-21 figures are an estimate based on the first five months of the year:

This year's spending is predicted to be lower than last due partly to COVID-19 and a lack of major house maintenance expenditure this year. Travel and cash spending have gone from significant items in 2017-18 to almost nothing or nothing this year. I deliberately reduced cash spending when I started this tracking of our spending in order to make tracking easier. The category that seems to have increased the most is childcare and education, which is not surprising as we went from one child in daycare only a few days a week to two children for more days of the week. The childcare subsidies we got have also been reduced. 

Also of interest are restaurants, which are the tiny sliver above supermarkets, which also declined a lot this year for obvious reasons (I think I got food delivered from a restaurant maybe a couple of times ever in my life). In 2017-18, restaurants were very low because I would usually pay with cash then. Really, restaurant spending was much higher than shown in the first two years. Last year it was AUD 3k and this year is estimated to be AUD 1k. Travel only includes flights and accommodation.

Currency Exposures

 I took a more granular look at currency exposures:

So, actually I still have less than 50% exposure to the Australian Dollar. This probably still exaggerates Australian Dollar exposure. I couldn't find any information on the Australian vs. international bond exposure in any of four Australian balanced funds we are invested in. So I ascribed all their bond exposure to Australian bonds. I am always frustrated by the low level of disclosure regarding investments by most Australian funds in comparison to American funds.