Paid Off Balance Transfer

I paid off my balance transfer on my Amazon.com Chase credit card. I've had a balance transfer for the last couple of years and have been rotating it around my cards. It's relatively cheap finance but I've decided I've had enough of messing around with it and I won't be doing any more balance transfers in the near future. It only amounted to about 1.5% of net worth at this point.

In other news, our lawyer phoned my brother to tell him our second property in eastern Germany sold and we should have our share of the money in the near future. Near future in legalspeak can be a near eternity :) When it's done it will finally close the lid on this saga that has been ongoing since 1995 and in the broader time scale a last vestige of our family's history in Germany. This property will be redeveloped, other buildings and family graves still stand, but we won't own anything in Germany anymore. In fact, we don't already except some money in a German government account.

I Did Make a Trade After All

Just before the close and going to my meeting of Graduate Porgram Directors I bought one Apple June $90 call. Looks like it worked out well. But if I'd been available at 4:30pm I might have bought 500 AAPL shares instead...

Money Arrives

The money arrived in my HSBC savings account today, even though 25 April is a public holiday in Australia (ANZAC Day). HSBC charge another $US25 fee. So I paid 1.4% in total for the transfer. I could get the percentage cost down for the next transfer if I borrowed some money on my Aussie margin loan to bring it up to the maximum $A10k allowed per transfer or waited longer for $A10k to accumulate in cash in my money market account (CMT in Aus-speak). I didn't trade today due to a bunch of awkwardly timed meetings, but it would've been a great trading day....

Token Arrives

The "token" arrived from Commonwealth Bank in a bright yellow box with real Australian stamps stuck to it. Inside is this tiny electronic device:



Very cute. I registered it and shifted money to my account from a money market account in Aus ready for the actual transfer to the US. Everyone seems convinced the USD is going down - including a colleague who teaches international economics that we went to dinner with together with a bunch of students from her class yesterday - so a contrarian move seems to be the right thing to do. Anyway, I'm only moving my dividends and distributions back to the US at this point. Not a huge amount of money. Snork Maiden was here to give a presentation in the class yesterday that was like a mini-preliminary-job-interview. But there isn't a position here for her at the moment. Today maybe we will hear if she got offered the job in Europe. In the meantime she got a phone interview lined up in Aus for a couple of weeks time.

Obsessions

The Money Diva tagged me to write about my obsessions, obsessive thoughts etc:

1. Obviously investing and especially trading. Even though I posted yesterday that I wasn't going to trade I made 6 roundtrip or still open trades in the 24 hours after making the post :)

2. Obviously, too economics but really economics is just a symptom of my underlying obsession with understanding the world. Which is why I studied geography and economics, became an academic researcher, have always been a news junkie - reading newspapers since age 10 or younger, obsessed with maps and now Google Earth etc.

3. Obviously I am currently obsessed with personal finance and trading blogs. It's just fascinating to read how all kinds of different people address the issues facing them and I hope to learn something practical from the more investing and trading oriented ones.

4. Rabbits. This is an inside joke with Snork Maiden.

5. Bears. I am more and more convinced that I was a big fuzzy bear in a past life.

OK, so I need to tag some people. How about Millionaire Artist and Ms MiniDucky.

Trading Update

In the last couple of days I've wanted to place trades but just can't do it. Partly due to being up and then back to zero for April - while the model is doing well - and partly because I am very busy and will be nervous if I can't monitor the trades more. So maybe I'll take a break from trading pretty much till the end of April and then after things quieten down a bit (I hope) get back into it. My investment portfolio has a relatively low beta and so shouldn't be hard hit if there is a market decline. The rise in the Australian Dollar means I'm up a lot in US Dollar terms at this point in the month. It is hard being a serious part time trader if you aren't in charge of scheduling your other activities.

P.S. 5:16PM

I did do a trade in the end. Trading Google after its earnings announcement. Held 100 shares for 3 minutes and made $878. So maybe this trading month will be a small positive after all.

IPO Update

I just placed a couple of bids in the IB IPO. Very simple. I bid to buy 200 shares if the IPO price is $27 and below and 100 shares if it is between $27 and $36. I can always alter these. So my maximum bid is for only 1.28% of my net worth roughly. Should I bid for more? I can bid for up to my account value ($14500) and it doesn't seem to have an effect on my buying power in the meantime.

Organizing

That's the theme of the moment.

1. Have everything I need to fax in the stuff to set up the transfers from my Australian account to my US accounts. But seems there is a need for a security calculator - two factor authentication. We'll have to see if they'll send that here to the US. The representative told me they will phone me after I fax them.

2. Almost have all the forms and info for the next stage in my green card application - getting police records from the 3 countries I've lived in apart from the US. Britain wants me to mail them original IDs with my date of birth and name! I think Aus looks easier now they finally sent me the forms. Israel wants me to come in person to the consulate in NYC - that will have to wait till next month.

3. Ameritrade e-mailed Snork Maiden yesterday and said that we didn't sign one of the forms for her Roth IRA. If she can get it faxed to them by today maybe we can get the 2006 contribution in. Though you only need the postmark on the letter with the check, apparently the account must be open before the deadline too to make a 2006 contribution. Hopefully, she can sort this out today, though it is a big hassle. I understand this. I have been procrastinating on these police records.

4. Looks like my brother is going to come visit us, so when that's fixed some travel planning.

5. Snork Maiden had a phone interview yesterday with a university in Europe. By next Tuesday we should know if they want to hire her.

I haven't been doing any trading the last couple of days, though I could have made some money yesterday if I did because I would have been long. Will wait till I feel comfortable. This is going to be a busy couple of weeks though as the semester nears it's end.

P.S. 1:55PM

We failed in the race to make a 2006 contribution to Snork Maiden's Roth IRA. Ameritrade are giving her a lot of trouble because she is still on a foreign student visa. We told them that she is now resident for US tax purposes but they want us to mail in a signed copy of the W8-BEN, fax the signed application form, and send a photocopy of bank statement! Anyway there was something they said couldn't be faxed. Anyway, we can now wait a while to see if a 2007 contribution is going to make sense.

P.P.S. 9:14PM

Commonwealth Bank e-mailed me to tell me I was approved for online international money transfers. Another one says they are sending me the "token" - a calculator used in two factor authentication. Let's see when it arrives.

Borrowing

I still need to cover the trading, liquidity, and borrowing categories in my asset allocation series. Liquidity is pretty boring - I have checking and savings accounts in the US and overseas - and I have covered trading extensively. Borrowing on the other hand is worth covering as my borrowing arrangements are rather different to most pf bloggers and a lot of investment bloggers too. In particular, a lot of real estate bloggers seem to be unaware of the possibilities of borrowing against stocks.

My borrowing capacity is split between credit cards and margin accounts. I have a credit line of about $21,000 on the three credit cards I actually use. I have a zero percent balance of about $6500 on one of them and rotate it to wherever there is a good deal. My credit limits are low because my credit history is short as far as FICO is concerned. Anyway, I think that's the reason. I don't aggressively try to up the limits either. The balance transfer is very cheap financing and worth doing I think.

My main borrowing capacity is in my three margin enabled brokerage accounts. If you have a brokerage account I can't think of a reason not to ask for the ability to borrow on margin. Well, actually I pay some extra fees in Australia in my margin account. But that's not the case in my US accounts. Here's the current rundown on one of my US accounts (the other one just has about $15k in cash in it at the moment - so I can't actually withdraw more than the cash in the account without first buying some stocks):



I could immediately withdraw $19,982, $4,772 of which would be a loan secured by the stocks in the account. You don't need an emergency fund sitting in cash when you have a margin account. I could also spend that much on options or non-marginable stocks (e.g. stocks under $5 in price). But the interesting thing about margin is that if use a loan to buy stocks you can then borrow more money against the stocks you buy. So if I use my borrowing capacity to buy stocks I can borrow another $37,092. Intraday, I can borrow even more - this is so-called "day-trading buying power". The only problem is that my interest rate is currently 10.5%. Larger accounts pay lower rates. So I only borrow for short term trades on the long-side.

My Australian account is much bigger and so are my borrowing capacities:



All the figures are converted to US Dollars. My interest rate is 8.9% and I have an outstanding loan of $33k. I could withdraw or buy non-marginable securities of up to $62k. I really, really, don't need an emergency fund :) But if I buy marginable stocks I could buy more than $200k more of stocks. Recently I bought an extra 4000 shares of EBI.AX using my loan capacity. BTW, EBI.AX is already a levered product.

I often wonder if I should be more aggressive and borrow more. There are lots of potential sources of leverage which are cheaper than margin loans. So until I exhaust those options (no pun intended :)) my borrowing is likely to be very conservative.

Moom vs The Model

More dumb trading moves today and back to pretty much zero for the month. The chart is a regression of my monthly trading rate of return against the model rate of return:



I've scaled up April's returns for the entire month.

The beta is 3.95 and alpha -23.8% per month. Ouch! This means that if the model returned zero for the month - something that hasn't happened - I would lose 23.8% of my account. It also means I am using 4 times leverage. I'd expect to have a negative alpha, which means that I'm not implementing the model correctly. But I'd like it to be much smaller! The R-Squared is 0.77.

Some months obviously are better than others. This is shown by the positive and negative residuals above and below the regression line. September 2006 was the worst month given how well the model did that month. Though October-December 2006 also all lost money the model was not doing as well in those months.

There are many trading blogs out there and a lot of the traders struggle to make money even if in the long-run they are making money. Making money trading is possible but obviously it is not at all an easy thing to achieve. It makes it clear that the ads telling you how easy it is to make money with the trading method they want to sell you are at best not telling the whole story and at worst scams.

Pay Raise

Today I received a letter from my Dean. The annual pay raise letter. This year's pay raise was 1.75% which is slightly better than last year but still less than the rate of inflation. The maximum possible raise was 2.5% though the Provost can in special cases award a little extra. This is $66.50 extra per month in take home pay, which is almost a 2% increase. Maybe you can see why I am so determined to become a consistently profitable trader. These below inflation pay increases are just demoralizing. A successful trader's income will rise at the rate at which he or she saves. So if you could save 20% of your income you'd get a 20% income increase in the next year, all things being equal, or as economists like to say, ceteris paribus. Up till about age 40 my rate of wage income increase was around 7.5% per annum.

Income does tend to rise fast until people reach about 40 years of age at which time the rate of increase slows until maximum income is typically reached in the mid-50s. After that it tends to decline. This is the US profile from Finn Kydland's Nobel Prize lecture:



Snork Maiden said: "Is that why people have mid-life crises?"

IPO

I have an opportunity to participate in an IPO, in this case the IPO of Interactive Brokers - one of my US stockbrokers. When I lived in Australia I participated in several IPOs some of which were very profitable and some of which were disastrous. I've learnt how to tell them apart upfront. My guess on this one, even before reading the prospectus is that it would be intermediate between the two extremes. Only 5% of the company is being IPOed. Owners don't do that if they expect the value to fall. They will sell the whole company then (see HIH). On the other hand they are going to use a Dutch auction to set the price and they are opening it to all the account-holders of the company. This encourages a full valuation of the company as it is an efficient auction mechanism. The indicative pricing ($23-27) gives a P/E of around 20. I haven't participated in a US IPO before. Maybe I'll do it just for fun. I'm thinking of bidding for 100 @ $27 and 100 @ $36. If the issue prices from $27-36 I'd end up with 100 shares and below $27 200 shares. What do you think?

P.S. 9:54PM

Another IPO - Platinum Asset Management - these guys are the manager of Platinum Capital (PMC.AX) , which is one of my passive alpha investments. They are selling 20% of the company valuing it at $A2.8 billion. They have $A22 billion under management. I can't participate in the IPO as I'm not resident in Australia. But this one is going onto my watchlist.

Can You Get at Your Money?

This is the kind of problem that people that move internationally have. A little while ago I began to receive most distributions and dividends from my Australian investments as cash payments rather than having them reinvested. Now I want to begin transferring them to the US. At the moment the distributions are accumulating in a money market account in Australia, so they are earning interest and the Australian Dollar so far continues to rise. My regular checking account in Australia allows online international wire transfers. Initially the limit for a transfer is set at zero and you need to phone the bank to raise the limit. Last night I phoned them and things were going well until the representative asked me for my Keycard number (this is an ATM card):

"Umm", I said, "I don't have one of those as they wouldn't send me a new one when the old one expired because I don't have an address in Australia."

The truth is that I didn't want to bother my friend there with having to send me a card which I wasn't really going to use at the time. I could have used his address. The representative then told me last night that I need to download a change of details form and send a fax including that, two copies of my signature and a photocopy from my passport. I couldn't find that form on the bank's website and so now e-mailed the bank to send me one electronically. Maybe I'll end up phoning again. But it looks like we can sort this out and begin transferring money bank to the US. I have done transfers from my bank here back to Australia. But to do them I needed to go into the branch, let them photocopy my passport etc. I even transferred money to China that way.

I'm just feeling a little worried this morning that if I move out of the US again I won't be able to get my hands on my money. This is an irrational fear because I will find a way. One option is HSBC's Premier Service. Seems you can set up accounts in multiple countries and then do online wire transfers between them. You need to have either $100k with HSBC or pay $50 a month. I doubt I'd have $100k with them any time soon as I like to have my money doing something more productive than sitting in bank deposits and savings accounts and I don't particularly want to set up a stockbroking/investment account with them. $600 a year is also quite a lot at this stage too for this service. At the moment I am likely to spend just $A88 a year with my Australian bank for transfers and $A60 to maintain the account and in the past I spent maybe $50-75 a year making transfers from here to Aus. But probably down the road I will eventually set up an international banking service of this sort to be sure I can get my money easily wherever I am.

Some people ask me why I maintain investments and accounts in Australia. There are three reasons:

1. I can't get the money out of my retirement accounts or transfer the accounts out of Australia until I am 60.

2. If I sell out my positions in regular accounts I'll owe capital gains tax.

3. From 2002 till now investing in Australia has been an extremely good move. The Australian Dollar has gone up and the Australian stock market has been very strong.

Tax Extension

Yes, I'm going to file an automatic extension. I just printed out the form. I think I am probably quite close to break even on my taxes. So not desperate to get a refund. And the interest/penalties on paying late are pretty small (as long as you pay before October 15) so I'm not in a rush to pay up either. I think people must be scared by that word "penalty" and think something awful will happen to them if they don't pay on time. But it ends up not being much worse than a credit card interest rate (7% p.a. + 1/2% per month = 13% p.a. and if 90% of your taxes are already paid by April 17th then the 1/2% per month penalty isn't added) on the amount that you owe in excess of withholding. In May I'll have plenty of time to sit down and work it all out correctly.

Beta

This part of my portfolio is where I hold traditional long-only mutual funds invested in stocks and bonds, I do modify my exposure to the stock market over the course of the four year stock market cycle. In retrospect I made a mistake though in getting too conservative in 2005 and switching into the CFS Conservative Fund (actually I switched into another fund first - the CFS Diversified Fund) and the CREF Bond Market Fund and out of stock only funds. The Conservative Fund is invested about 30% in stocks and 70% in fixed income and cash. Both stocks and bonds include Australian and global investments. The return has been reasonable - certainly better than switching into cash but I would have been better off to stay in the types of funds in the lower part of the table. Returns on those funds have all been very nice. I first invested in Future Leaders in 1997 and have held ever since. It was my first mutual fund investment in Australia. It's invested in mid-cap Australian firms. Developing Companies is invested in smaller listed Australian firms. I kept holdings in those funds because they are closed to new investors. Maintaining a holding means that I will be allowed to switch back into them at some point. I invested in the Global Resources Fund in 1999 when commodity prices seemed to be at a low. I had to go into my brokers office back then (to get the load rebated). I think she thought I was nuts. This fund is invested in resource stocks all over the world. It biggest holdings are in BHP, Rio Tinto, and CVRD - each composes about 10% of the fund.

At some point I am going to switch out of the more conservative funds to equity only funds. If the yield curve inversion ends , the stock market seems to be going up, and the economy speeding up, I'll drop the bonds. If there is a significant fall in the stock market and a bottom seems to be reached I'll do the same. Maybe I should have switched last summer. The inverted yield curve kept me in all these bonds. Bonds should do well in a recession and the yield curve has usually signalled a coming recession. However, the sample of recessions is too small to assign any statistical significance to the prediction power of the yield curve.

Industrial Stocks

As I've mentioned many times, my investment style doesn't depend on being able to pick individual stocks which aren't in fact companies making other financial investments. I think is is hard for an individual investor to do this. Few mutual fund managers are any good at it. Which is why you have to be very selective about the managers you invest in. I'd love to get comments from people who are good at stock picking if you can back it up with a track record.

I only have four of these industrial stocks. Croesus Mining has been an unmitigated disaster. I was trying to trade it when the stock was halted and then the company declared bankruptcy. I'm still waiting for the situation to be finally resolved. I originally invested a small amount when I read about how it was undervalued and the most likely Aussie gold company to be taken over. Apparently not undervalued in fact and only taken over once bankrupt :) OTOH Ansell and Powertel have been good investments and Symbion a poor but at least moneymaking investment.

Before Telecom NZ announced the acquisition of Powertel, this investment returned to me an annualized 132% I invested in May 2006 @ $A1.20 a share and the buy out price is $A2.30 a share. We are now just waiting for the buyout to proceed. Unfortunately we are going to get cash but I'll just squeak into the holding period for the long-term capital gains rate. If we received Telecom NZ shares then there would be no tax to pay. But who wants them? I bought into Powertel on the recommendation of an online acquaintance in Hong Kong. He sent me the research reports by Goldman Sachs etc. I was very impressed when I looked over the accounts and decided to give it a shot. The story was here was a small telecom owning an important infrastructure asset that was just about to break into profitability. If they didn't become profitable an acquisition was then likely.

I originally bought into the then Mayne-Nickless when it was announced that Peter Smedley who had managed Colonial very successfully - I owned Colonial from the IPO to its acquisition by the Commonwealth Bank - was coming in as CEO. Initially Mayne's stock price rose, but then it eventuated that his management style wasn't working in the healthcare parts of the business. The stock price then plummeted again. It's been a long story. Eventually the company was dismantled and Mayne Pharma was spun-off and then acquired by Hospira. Symbion is the remaining Australia based healthcare businesses. There is ongoing talk of consolidation in this sector and Symbion's price goes up and down with the news and speculation. I'm still holding on to see if something eventuates. It looks like in the long-term my rate of return has been 9.7% which is OK I guess.

My rate of return on Ansell has been 18.2% annualized. My current cost basis is -$2965. So I have pulled out my initial investment and almost $A3000 in profit. Another restructuring, turnaround story. I invested in the then Pacific Dunlop in September 2001. I can't remember what the exact rationale was, but clearly it was cheap. Today Ansell makes, surgical and industrial gloves and condoms. It is a global player headquartered in the US but still listed in Australia. In fact they have dropped their US listing. Rising rubber prices have negatively impacted the company recently but I'm still willing to trust management but with a reduced position in the stock.

In order to buy into another industrial stock I'm going to need a good business case, plus a low valuation. Sure I'll miss out on some growth stocks that would be great investments. But I find it hard to tell ahead of time. That's not where my edge is and I'm happy to leave it to the fund managers.

Moominhouse Fund

Snork Maiden sent in the paperwork for setting up her Roth IRA :) The plan is to use these Roth IRAs a few years down the road to maybe buy a house if we stay here in the US. So this is part II of the Moominhouse Fund:



On the other hand, we might end up leaving the US. Or maybe we still won't want to buy a house. But all the options are out there. Even with a 10% withdrawal penalty I hope the returns are going to be better than the money sitting where it currently is.

Real Estate Investments

Continuing in the "passive alpha" theme we get today to my real estate investments. These include the TIAA Real Estate Fund, Newcastle (NCT), Challenger Infrastructure Fund (CIF.AX), and Hudson City Bank Corp (HCBK). The TIAA fund, which TIAA-CREF call very confusingly a "variable annuity" - it can be automatically converted to a variable annuity when you retire as I understand it - is effectively an open-ended mutual fund directly invested in real estate. They own office, retail, industrial, and residential properties around the US (and one overseas investment). Currently I put 50% of my incoming 403b contributions into this fund. It has performed excellently since September 2002 when I first invested with an annualized 11.4% rate of return and a very low variance. It's had only two slightly negative months. As a result, its Sharpe Ratio is an almost unheard of 4.5! My annualized rate of return is 12.9% as I've changed my contribution rate over time. It also has only a 0.078 correlation with the returns of my overall portfolio. I'm thinking to roll over my 403b into a Roth IRA when I one day quit my current job, but it is certainly tempting to hold onto this fund!

I've held the other investments for shorter periods and they haven't been as good as this one. I bought into Challenger Infrastructure around the time of its IPO (I couldn't participate due to being non-resident in Australia) in August 2005. It's returned 9.7% annualized since then. CIF is a closed end fund that is invested in infrastructure assets in Britain - gas distribution networks and broadcasting towers etc. It is supposed to be a global fund but ended up only investing in the UK for some reason. It's accounts have been pretty impenetrable. I originally bought 3000 shares and when the fund was trading below NAV I bought 2000 more. Later I sold 3000 due to the factors I mentioned above. I like to understand how an investment makes money and be confident in management's strategy. I didn't sell all my shares as I believed the investment was still udnervalued but I sold some to reduce my risk. Maybe I should think about selling the rest? One thing I do like about this investment is that the management company is heavily invested in the fund itself.

NCT and HCBK have both lost me a little money so far. Newcastle is a mortgage REIT managed by the Fortress Investment Group (FIG). It is mainly invested in commercial mortgages. I figured that in a real estate slump this fund could gain by buying assets cheaply. The assets it already held were high quality. And it has begun buying up assets from distressed institutions. So I'm going to hold for now. It also has a very high dividend yield - 9.9%. HCBK's main assets are high end residential mortgages. It also has immense amounts of cash and stockholder equity for a bank. So it has been buying back shares and I figured it too could win in a real estate slump. Also I anticipated it being added to the S&P 500 index. This has now happened but was a non-event as far as the stock price went.

The only passive alpha investment left to discuss is Berkshire Hathaway... and I don't think I need to explain that one! :)

Long-Short Funds

I just saw an interesting post on levels of competence in investing. In this passive alpha section of my portfolio I am being an evaluator - the second level of competence. I think I am getting better at it. The third level applies to my trading. That is an ongoing struggle and I don't think I have proved yet that I am a consistent performer. But I have a good idea of what is needed there.

On to today's passive alpha investments. I have three long-short funds: Hussman Strategic Growth, TFS Market Neutral, and Platinum Capital (HSGFX, TFSMX, PMC.AX). Each of these has very different strategies and so they make sense as complementary investments. I've discussed the first two before, for example here and here. Hussman is long individual stocks and then hedges using derivatives based on his research on past market conditions. The fund does very well in bear markets and quite well in strong bull markets but seems to underperform in moderate bull markets as we have seen recently. Hussman is good at picking stocks. His stock picks have outperformed the index. I am concerned though that economic conditions may have changed and he may be too bearish. He argues that the share of profits in GDP must return to its historic levels. I am not so sure. It is possible there has been a permanent change in the economy. I don't know for sure. I wouldn't make a bet on this either way at this point.

The TFS Market Neutral Fund is much smaller and mainly invests in smaller cap stocks. It is always long and short stocks and doesn't alter its hedging in response to market conditions. Recent returns have been much better than at Hussman. But the track record is much shorter. Both these mutual funds are invested in US stock markets.

Platinum Capital is a closed-end fund that is invested in stock markets globally. They are also always short some stocks but have a long bias. They change the weighting they give to different countries based on their assessment of global macroeconomic conditions. They also actively hedge foreign currencies. But interestingly they don't just hedge foreign exposures back into Australian Dollars. They may hedge into Yen, or Euros or any other currency. So this fund is also a bet on currencies. As Platinum Capital is a listed fund its price relative to NAV varies. But unlike most closed-end funds it usually trades at a significant premium to NAV. I believe this is due to the fact that the fund has considerable undistributed profits, which under the Australian taxation system have attached "franking credits". In Australia closed-end funds pay taxes (unlike the in the U.S.). When they pay out dividends, those dividends have credits for those taxes paid. Platinum Capital reports the franking balance. I maintain a spreadsheet that regresses the share price on NAV and the franking balance and tells me when PMC is under or over-valued. I buy when the stock is undervalued and sell some when it is overvalued. This has significantly boosted my returns over a buy and hold strategy. BTW, trading closed end funds is one of TFS's strategies too. Because of all my trading in and out it's hard to come up with an accurate estimate of my rate of return. Also I invested in 2001-2 and then again in April 2004. In the recent period it's been about 20% annualized. Platinum Capital does charge a performance fee with a hurdle of beating the MSCI World Index. Like Hussman, they performed better in the past. The MSCI has returned 20% p.a. over the last two years. I matched it by trading PMC, the fund itself has not performed as well.

Clime

Another pair of fabulous twins today - Clime Capital (CAM.AX) and Clime Investment Management (CIW.AX). Clime Capital is the closed-end fund and Clime Investment Management the management company. CAM is a long-only stock fund. The manager, Roger Montgomery, worships Warren Buffett and has been achieving Buffettoid results. My annualized rate of return is 54% (in Australian Dollar terms). I met Roger Montgomery when he gave a presentation at the Securities Institute in Sydney. After that I followed what he did and found that he had floated this closed end fund. Initially, the fund was mainly in cash as he looked for good investment opportunities and I didn't buy shares till the fund was mostly invested in February 2006. I doubled my holding in September 2006 when there was a steep sell-off relative to net asset value as the infamous David Tweed tried to unload his holdings. I am looking to double my holding again when there is a good opportunity. This is one of the big advantages of investing in closed-end funds over open-ended mutual funds. Sometimes they are on sale at a steep discount. Montgomery's main strategy is similar to Buffett's and he is also not afraid to hold large positions in small companies. Some of the money though is also invested into the cheapest big cap Australian stocks on a systematic basis. Seems that he likes to play with various capital raising strategies, the latest being converting preference shares.

I first became aware of CIW.AX when they took a stake in Clime Asset Management which was the unlisted management company that managed CAM. At that point CIW was known as Loftus Capital Partners and was a closed end fund that took stakes in both listed and unlisted companies. Since then CIW has acquired the rest of Clime Asset Management and changed its name and strategy to become a broad based financial management company that will acquire other management companies (and it also has a substantial investment in CAM). Essentially, it is an embryonic Australian version of AMG. Its P/E is 17 and given the growth potential I think the shares are cheap. My annualized rate of return is 43%. All the founders including Montgomery now have large stakes in CIW as well as shares in CAM.

Everest Brown and Babcock

This is my first post on a specific investment in my asset allocation series. Well, actually two investments: Everest Brown and Babcock (EBB.AX) and Everest Brown and Babcock Investment Trust (EBI.AX). EBB is an alternative investment manager. Mainly they manage funds of hedge funds. EBI is a closed end fund of hedge funds that trades on the Australian Stock Exchange. You can learn all about the company and their funds here. I want to discuss why I bought this investment - most readers won't be able to buy into this specific investment and so the rationale is probably of much more interest than the specifics.

EBB originally floated on the ASX in early 2005 as a stapled security that included one share in a fund of hedge funds and one share in the investment management company. The idea was that the investment manager charges, like most hedge fund managers, a performance fee. By also investing in the investment manager you would get part of the fee rebated back to you. As you'll know by now, I like hedge funds and other alternative investments, and I especially liked the idea of getting some of the fee rebated. On top of that, when I invested in August 2005 the shares were trading at a discount to net asset value. That meant you were getting the management company practically for free! Also the managers were invested in the shares as well as in the management company (only part of the management company was floated in this transaction). I like to see this in the "passive alpha" investments I make. The founders also had the backing of Babcock and Brown - an upcoming global investment bank headquartered in Australia.

The shares continued to trade at a discount to NAV. In August 2006 it was decided to destaple the securities and let the management company and the investment trust trade separately. This was a brilliant move. The value of the management company shares has since soared. Looking at the two securities as a single investment my annualized rate of return has been about 54% since investing (pre-tax)! Total profit is now over $A13k. I originally invested $A9350 and in August 2006 invested an additional $3400 in the management company shares to double my holding. Yesterday I bought $A15,000 more of the investment trust to almost triple my holding of that stock.

EBB.AX now has a P/E of 52. Though I expect the firm to continue to grow, that does seem rather pricey and so I don't plan to add to my holdings. Anyway, I already have 3% of my net worth invested which is more than I really am comfortable to invest in a single stock that isn't a closed end fund. The only US listed hedge fund manager so far is Fortress Investment Group (FIG). Of course firms like Goldman Sachs are also in this business. FIG's pricey and I'm not looking to invest in it. But I'm not planning to sell EBB yet, either. The EBI.AX fund of hedge funds is undervalued at today's closing price. It in fact has had quite a high beta to the stockmarket. That might decline a little when the newly raised funds are deployed in other less correlated investments. There are no such investments listed on US stock exchanges yet, to the best of my knowledge.

Ex-Rights Price Correction

That's the reason for the halt in trading in EBI.AX:

"Everest Babcock & Brown Alternative Investment Trust (EBI) requested a trading halt in relation to its units earlier today following an irregularity in the theoretical ex-rights price published this morning. The price published was $3.785. EBI confirms that the theoretical ex-rights price of EBI units is $4.165 based on the close of 3 April 2007 price of $4.26 and the entitlement issue price of $4.07."

So my bet was correct. I didn't see this theoretical price. But I thought the market price was too low. A nice $A1600 in profit as a result with very little downside risk. Seems trading has restarted and the price is still at $A3.85. Hmmm.

Passive Alpha

I promised a series on asset allocation, here is the next installment. I'll cover the investments I call passive alpha first. As I mentioned before, it's a bit of a misnomer. This category includes all actively managed funds that aren't broad bets on stocks or bonds or aren't strongly correlated with an underlying benchmark index as well as all other financial stocks. The individual investments are as follows:



There is a mix of Australian and US investments here. Though the Australian investments won't be of direct interest to most readers, the reasons why I invested in them may be. I hope to discuss that in more detail in future posts.

Real Estate TIAA Real Estate, Challenger Infrastructure, and Newcastle are three different sorts of real estate funds. Hudson City Bank Corp can also be thought of as a real estate fund. Both it and Newcastle have mortgages as their primary assets though Newcastle is a REIT and HCBK a bank.

Closed End Funds Clime Capital, EBB Investment Trust, and Platinum Capital are all exchange traded closed end funds but they are all rather different. Clime is a long-only stock fund, EBI is a fund of hedge funds, and Platinum Capital is a long-short hedge fund.

Hedge Funds TFS Market Neutral and Hussman Strategic Growth Fund are mutual funds that employ quite different hedging strategies. Platinum Capital and EBI are also of course hedge funds - and as they charge incentive fees they are more traditional ones. Challenger Infrastructure also charge a performance fee. Is it a hedge fund?

Management Companies Everest Brown Babcock is a hedge-fund-of-funds management company that among other things manages EBI.AX. Clime Wealth Management is also a fund management firm and included in its managed funds is Clime Capital.

Insurance Berkshire Hathaway is an insurance conglomerate. But clearly, people don't invest in it just to invest in insurance, or even the many unrelated subsidiary businesses BRK owns outright. Money management by Warren Buffett is a big part of the attraction.

As you can see it is a little tough to exactly classify all the entities in this category. But none of them is your traditional long only stock or bond mutual fund. And that is why I've placed them here.

P.S. 9:03pm

I just bought 4000 more shares of EBI.AX @ $A3.75 taking my holding up to 4.73% of net worth - financed by an increase in my margin loan. Today is the ex-date for a rights issue that is part of a capital raising. The price of shares under the rights issue is $A4.07 while institutional investors are paying $A4.29. The price today opened at $A4.1 and then plummeted as low as $A3.65. Now it is true that the rights offer also includes 1 EBB share (the management company) for free for every 4.5 EBI shares bought. But from my understanding the rights offer and placement doesn't reduce the net asset value of the fund per share at least not below $A4.07. The NAV at the end of February was $A4.29 at the end of February. So this seems irrational. Even if there is something I don't understand here I can't see that I am paying more than NAV. Therefore, the purchase this evening. I am not allowed to participate in the rights issue because I am not resident in Australia. This is one of the pitfalls of direct international investing.

P.P.S. 10:55pm

And then EBI was put into a trading halt when the price was at $A3.85 pending an announcement from the company. It can't be anything very bad as shares in the management company EBB are up 5.23% on the day at this point and not in a halt. I am guessing they want to either: Calm the market and say there is no grounds for the price drop, or one of the hedge funds they invest in (there are around 20 in the fund) blew up and therefore some fall in price was justified in fact. Those are my guesses of best and worst case scenarios. We'll have to wait and see. They did a trading halt last week to announce that the placement was oversubscribed. These things are common in Australia. But I still remember when Croesus Mining went into a halt so it makes me nervous. But there has to be a floor to the share price for a closed end fund of this sort.

March 2007 Report

All figures are in US Dollars unless otherwise stated.

Income and Expenditure



Expenditure was $2625 - 80% of take home pay ($3,299). Spending on travel boosted this month's level. 403b contributions totaled $1,792 and Roth contributions $333.33. Non-retirement investment returns were very strong again this month ($10,348). Retirement investment returns were also nicely positive ($4,315). The rise in the Australian Dollar again contributed significantly to returns.

Net Worth Performance
Net worth rose by $US16849 to $US406,544 and in Australian Dollars gained $A7812 to $A501,658. I am way ahead of my goals for this point in the year. Each month I think that I will suffer a loss and things instead keep turning out positively. The Australian Dollar again rose this month resulting in a relatively large gap between performance in the two currencies. Non-retirement accounts reached $US223,017. Retirement accounts also saw nice gains to $US183,527.

Investment Performance
Investment return in US Dollars was 3.76% vs. a 2.05% gain in the MSCI (Gross) World Index, which I use as my overall benchmark and a 1.12% gain in the S&P 500 total return index. Non-retirement accounts gained 4.87%. Returns in Australian Dollars terms were 1.04% and 2.11%. U.S. Dollar returns also beat the indices over the last 12 months:



The contributions of the different investments and trades is as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. This month, trading conditions were tough and I made some stupid mistakes. But I still eked out a positive result for QQQQ/NQ trading ($794). The biggest gain was from Everest Brown and Babcock - an Australian listed fund of hedge funds and hedge fund management company - and from a balanced mutual fund - the CFS Conservative Fund.

Progress on Trading Goal
Trading in my US accounts netted $1,021 a 3.3% return on trading capital. The model gained 6.7% while the NDX rose 0.6%. My goal for the year is to end up with at least as much in my three accounts - regular trading, Roth IRA, and IB - as I've put into them. The accounts in total gained a net $1,096 and I have now achieved $9,048 of the annual goal of about $19,000. Since the beginning of the year the trading capital gained 41.7%, the NDX has gained less than 1% and the theoretical model gained 28.4%.

Asset Allocation
At the end of the month the portfolio had a beta of 0.33. 40% of the portfolio was in stocks, 42% in bonds, 13% in cash, and loans totalled -7%. The remainder was in hedge fund type and real estate investments, futures value etc. Looking at asset allocation the way I prefer, 22% was in "passive alpha", 66% in "beta", 8% allocated to trading, 7% to industrial stocks, 4% to liquidity, and I was borrowing 7%.

Back to the Moominhouse

Back at the Moominhouse after a visit to Snork Maiden. I helped her open an Online Savings Account with HSBC. We got everything ready to set up a Roth IRA with Ameritrade. The jury's still out on whether she'll actually mail in a check (when I did it there was an electronic funding option - I don't know why this wasn't offered to us this time) with other relevant paperwork. And umm my collection of toy rabbits doubled in size (to 2). The TSA guy at the airport seemed to be looking long and hard at my bag in the machine. Maybe he was looking at this:



Or maybe it was my portable hard-drive :)

Trends in Losses and Wins

Crazy day... Can't tell you all the craziness or I'd blow my cover as it's out there in the news media :) On top of that, Snork Maiden got an interview with a university in Europe for a post-doc type of position. Pays better than any US post-doc but prices and taxes are high there. I reckon 50/50 she'll get it. Maybe better than that as one of her former grad student colleagues is on her interview commitee. And she is more expert than he is on this topic. Good chance, therefore, that we might move to Europe where I am also a citizen. Give up on the green card quest here. And give up my tenured position here...

Been juggling all kinds of grad school applicants, from China, US, Chile, Pakistan, and Ghana today - getting close to the crunch date when people have to give decisions to universities about whether they are accepting offers. And I'm a graduate studies director. Trying to do deals on scholarships and tuition waivers etc. Some US students will be visiting campus tomorrow. And tomorrow evening I'm going to go visit Snork Maiden in the next state over.

OK, so here is the stuff that is in the title of this post:



All my losses and wins in NQ trading. The size of the losses and wins is on a per contract basis - each trade though might have from 1 to 8 contracts. There is a definite upward trend in the losses, which is good news. You can see the "blow-ups" though. I just need to get rid of them and I will be fabulously successful :P The t-statistic for NQ trades is now 1.87. I figure I've traded about $13 million of underlying value for $6400 in profit at an average gain of $17 per contract... Starting value of the account was $10,000. I also lost $2000 in Australian Dollar and SPX (ES) trades. Wins are at $23.2k for $95 per winning contract on average and losses at $16.8k for $130 in loss per contract. I'm making money because 2/3 of the contracts I trade are profitable.

It's been a tough month for trading but at this point at least I am up on the month and only have 3 QQQQ put contracts outstanding.

Emergency Funds

I have a whole list of planned posts on investment performance and asset allocation - but they can wait. This is a great post. Yes, it's all about financial freedom. I think the term "emergency fund" is bad. First it's negative rather than positive. Maybe it works for some people to scare them into saving. But by defining the only purpose for saving outside of retirement accounts and house buying as dealing with emergencies keeps people away from financial freedom and pushes them towards the standard wage/mortgage slave until some far off retirement date. As I wrote in my comment on English Major's post - why do people want to live "paycheck to paycheck"? Of course that's rhetorical... Obviously, some people can't save without the forced mechanisms of retirement schemes and mortgage paydowns. But I think others are brainwashed into thinking this is normal. Not all PF Bloggers fall into this model of behavior but quite a high proportion of them do. This isn't the case among "investment bloggers". They are trying to create financial freedom right now. Of course these aren't mutually exclusive sets - there is a lot of overlap.

Freedom fund is a better term than emergency fund, but once you have a decent amount of money you don't want to be holding it all in cash...

P.S.

I'm now back to being ahead for the month in trading after a couple of good days. When I am in the groove it seems really easy to make money at this. But then there are times when I completely screw up... I just closed out the short I had set up to hold overnight. The oil price suddenly spiked at 4:53pm and stock futures fell. But now the oil price is going back down. Not clear what rumors exactly triggered the huge spike - from $63 to $68 in 8 minutes! I didn't notice that that was the cause of the fall in stock futures until someone on Silicon Investor pointed that out to me. Following on from Sunday's post - this sounds somewhat similar but even less coherent :)

Asset Allocation: The Big Picture

In response to Finance Girl's request I'm going to do a series of posts on my asset allocation. Today's post will look at how I think about the overall big picture and then the next few posts will drill down to the level of individual investments. Most bloggers out there are either stock pickers, traders, or index investors though there are more complex allocations too. My approach is one of those more complex ones. This is how I think about asset allocation at the highest level:



You're seeing my position when I have almost no active trading positions. Let me explain each category in turn:

Passive Alpha This is a bit of a misnomer - as these funds are invested with active managers - these positions are passive from my point of view because it is largely buy and hold. Included in this category are closed end funds, financial firms (including Berkshire Hathaway and Hudson City Bank Corp for example), REITs etc. The point of these investments is to try to generate returns that are relatively uncorrelated with the stock market and uncorrelated with my own trading. That's why I call these investments "alpha". But as you can see I estimate that these investments actually contribute 0.138 points towards my portfolio's total beta. They aren't pure alpha by any stretch of the imagination. I include the financial firms in this category because really a bank, for example, is involved in investing funds in loans to a diversified portfolio of customers. So in some ways it's similar to a closed end fund. There are also fund management companies in here. In the long-run I'd like to increase the proportion of net worth invested in this category from 22% to 40-50%.

Beta Another misnomer - as all the mutual funds in this category are actually actively managed. So they aren't pure beta. The reason they are all actively managed is something of a legacy of the past - and there still aren't many indexed mutual funds available in Australia. In the future I would probably add some ETFs in this category, but as I want to reduce the allocation to 40-50% of net worth, this won't happen any time soon. You'll notice that this "beta" actually contributes little beta to my portfolio. I adjust my holdings in this category over the course of the four year stock cycle. At the moment I am as conservative as I will get and most of what is in here is in fact bonds rather than stocks. I try to hold these mutual funds for at least a year to get the long-term CGT rate in my taxable accounts. The largest part of these funds though are in my retirement accounts.

Trading This includes cash in my trading accounts and open trading positions. This is where I actively try to generate alpha in my portfolio. My policy is not to add any more money to my trading accounts until I can show that I have recaptured the losses I generated earlier in my trading career. At the beginning of the last week there were about $10,000 of losses to recapture. Now we are back to about $13k. The beta of this category can be either positive or negative. My most extreme positions add or subtract about 0.7 beta to my portfolio - taking me from fully long to net short. Trades are generally directional bets on the market and most are held from 1 day to 1 week, though there are also occasionally longer-term trades.

Industrial Stocks This is the extent of my "stock-picking". Any non-financial individual stock is in here. I don't think it is easy to pick stocks that will outperform (at least not for me) and, therefore, I don't do much of it. If I see something that does look good I'll do it. In the past I had much more allocated to this. In the future, I'll probably have even less.

The final two categories are simpler - Liquidity is cash in non-trading accounts - 3% is around $12,000 - this isn't an emergency fund in any sense though. I use credit cards for emergencies. It's just money I haven't decided yet to allocate to investment or spending. Borrowing - the basic idea is that I am 100% invested and borrowing funds to trade with. You'll see the two categories have about the same allocation. Where possible, though, I try to use products with embedded leverage (futures, options, leveraged mutual funds) rather than borrowing explicitly as the interest rates are generally much lower than I can get myself.

My portfolio is also invested in assets associated with different currencies. In the first few years after I returned to the US I sent a lot of savings back to Australia as the Australian Dollar was cheap. Now that the Aussie Dollar has risen a lot I am accumulating all savings in the US and will begin transferring dividends and distributions I receive in Australia back to the US. In the long-term I would like to bring down my AUD allocation to around 40-50% of my net worth. The other category includes some global closed and mutual funds that are not hedged back into a single currency such as AUD or USD.

For another view of my asset allocation you can check out my NetWorthIQ Profile.

Benchmarking Your Performance

I've been teaching Yoyo and you, the reader, how to compute your investment performance. In today's class we'll compare our results to some broad market indices and get to make a colorful chart. Yoyo definitely prefers pictures to numbers :)

There are two indices I compare my performance to - the MSCI World Index and the S&P500 Index. I use these because one is a broad measure of global stock market performance and the other has traditionally been used as a US market benchmark. But very importantly I have free access to total returns for both indices. This last point is very important. A lot of people out there and especially those in financial publications (like Barrons) compare total returns of a mutual or hedge fund to just the price performance of a stock index. This totally ignores the dividends received by the stocks in the index and dramatically exaggerates the relative performance of the fund in question!

You can download total returns for the S&P 500 here. The monthly total return is the second to last column. You are going to need to construct the total return index yourself as I showed you in the day before yesterday's class. For the MSCI I go to this page to get the latest number for the "All Countries", "Standard", "Gross" World Index. Gross indicates that all pre-tax dividends are reinvested. The option "Net", takes out local taxes from dividends, and "Price" is, well, just the price without dividends. Make sure you also use the number in US Dollars. If you click on the name of the index, you'll be asked to register for free to get to download the historical data.

OK, so I've downloaded the data, computed a total return index for the S&P 500 and come up with the following table:



At the bottom of the table I've given the total return since the end of 2004 and the annualized rate of return, which we learned to compute yesterday. Clearly, being invested in the S&P 500 instead of global stocks resulted in a much lower rate of return over this period (9.8% vs. 16.02% per annum). My returns are somewhere between the two (12.88%).

We still need to do one more thing before graphing these indices - set the values for December 2004 equal to 1000 for all indices. Using Excel we can paste the following formula into a new column:

=1000*b2/b$2

where b2 is the value of Moom's index in Dec 2004. And then paste =1000*b3/b$2 etc. in the cells beneath it to get a new column with Moom's total returns index standardized to start at 1000 in Dec 2004. Does that make sense? We do the same for the MSCI and then we can finally get the pretty picture that Yoyo has been waiting for:



I chose the colors to reflect how hot the performance has been :)

Computing Your Annual Rate of Return

Once you have your total return index computed it's real easy to compute your annual rate of return for any period you choose. Here is my total return index for the last couple of years:



To compute the annual return for 2006 we just divide the index for December 2006 by the index for December 2005:

1951.8/1642.52 = 1.1883

and subtract one:

1.1883-1 = 0.1883

In percentage notation that's 18.83%.

Of course we can work out the rate of return for any period of more or less than 12 months. From the end of January 2005 to the current date in March 2007 we get: 2088.22/1652.11-1 = 26.40%. We can also work out what that is at annual rate. Here we'll need a program like Excel:

AnnualizedROR = (2088.22/1652.11)^(12/26)-1 = 11.42%

The hat sign is how Excel represents "to the power of". 26 is the number of months from the end of January 2005 till now and 12 is the number of months in a year. We can do the same thing for periods of less than a year... for example my annualized rate of return so far this year is:

AnnualizedROR = (2088.22/1951.8)^(12/3)-1 = 31.03%

If you wanted to compute the average return per month for a given period, you'd just replace 12 with 1 in the formula. Next, I think I'll cover comparing your performance to benchmarks. I'm happy to take suggestions for topics on this theme to cover.

Computing the Total Return Index

Yoyo the green rabbit can help cheer me up this morning :) I get upset when I make stupid trading mistakes, primarily because I see my goal of making a living from trading recede a little bit. After a successful period I'm thinking: "I can do this". And then after a big stupid loss (caused by trading against the model rules) I think: "Maybe I'm not smart enough to do this".... oh well, onto the next step in measuring investment performance.

This step is computing a total return index, or in Australian, an "accumulation index".

Yoyo has computed her monthly returns for three months now:

December 2006: 2.71%
January 2007: 2.28%
February 2007: 2.38%

(Actually those are my returns). The first step in computing the total return index is to choose a base period. Here it is the end of November 2006. We'll give that point in time an arbitrary value, say 1000, though we could choose 100 or any other number, it doesn't make a difference.

Now to compute the value of the index at the end of December we do this calculation:

Index(Dec06) = 1000*(1+0.0271) = 1027.1

And in a general formula:

Index(t) = Index(t-1)*(1+ROR(t))

Make sure that you use 0.0271 as the rate of return and not 2.71! Just divide any percent rate of return by 100 to get the rate of return not in percent. Then:

Index(Jan07) = 1027.1*(1+0.0228) = 1050.52
Index(Feb07) = 1050.52*(1+0.0238) = 1075.52

It's easy to set this up in an Excel spreadsheet. Next up, computing annual and annualized performance.

Stupidest Trades Ever

I did what must be some of my stupidest trades ever today. I did nothing until the FOMC announcement. Then when the market began to rise when they announced that they were softening their bias towards tightening I went long. Very good up to this point. Then I went short and initially the market fell, but then it soared and I remained short. Despite the model being long! Eventually, I gave up and then started doing some more trades 8 NQ contracts at a time. Initially, I got back part of my loss, but then I lost more.... I blew up about half the profits I have made so far on my IB account - about $2500. The stupidest bit is I know these are bad trades as I am doing them almost... Maybe I just should ignore the market on Fed days like Trader Mike does. Some of my other worst disasters were on Fed days. I lost more than $4000 on that day in June 2006. So maybe I am getting better!

As the Australian Dollar soared after the FOMC announcement I am still above $US400k in net worth. But back below $A500k. My t-statistic for NQ trading (z-score) fell to 1.86. Well, at least I am above the low after my previous blow-up. And the t-statistic is way above the level it was when I first computed it. So I am making progress of sorts.

Here is a chart showing today's trades:

Contributions of Investment Returns and Savings

Following up from trainee investor's question on my previous post I made a jpeg of the Excel Chart that I maintain on the relative contributions of savings and investment returns to my net worth growth. Yoyo is patiently waiting for her next class on measuring investment performance :) Clearly, most of the current growth is coming from investment earnings, while in 2005 most growth came from savings. Back in January 2003 my accumulated investment earnings were negative to the tune of -$23,944. Now we are at a positive $173,768. So I have gained almost $198k. In the same period I've saved $142k. So there you have it. By the way the investment returns are primarily pre-tax (the exception is my Australian Superannuation Fund where the 15% tax on earnings is deducted at source). By the way any tax payments would be recorded as negative saving. But so far I have only had tax refunds as my withholding from salary has been sufficient to cover everything.

$400,000

Yes my net worth is now above $400,000. But there are no guarantees that I'll still be here at the end of the month for the reasons I discussed in my post about exceeding half a million Australian Dollars. Nice to see that 4 at the beginning of the number :)

Measuring Leveraged Investment Performance

Following up on Enough Wealth's comments on my previous post, I'm going to do an example here where Yoyo has borrowed money to invest. This could apply for either stocks bought on margin or an investment property bought with a mortgage.

31 January 2007:
Brokerage - stocks and cash: $45,500
Brokerage margin loan: -$10,000
Retirement: $93,000
Total: $128,500

28 February 2007:
Brokerage - stocks and cash: $45,500
Brokerage - margin loan: -$12,100
Retirement: $94,200
Total: $127,600

Yoyo computes the value of her accounts by adding up all the assets and deducting the value of the margin loan. If she invested with Ameritrade for example, she wouldn't even need to do this as they give you the net value of your account already computed. I am assuming that she pays $100 in interest and borrows an additional $2000. It's usual to capitalize all these costs onto a margin loan, so she doesn't even need to do the calculations.

She also collects the following information as before:

February retirement contributions: $550
15 February put $500 into brokerage account
28 February withdrew $600

The calculation proceeds as before:

Investment gain in brokerage account = ($45,500-$12,100)-($45,500-$10,000)-$500+$600 = -$2000
or: monthly change in account value - net contribution to account.

The calculation for the retirement account is unchanged - a gain of $700. Yoyo's net loss is now -$1300.

Her rate of return is now:

ROR = -1300/(45500-10000+93000) = -1.01%

If your broker reports the net account value like Ameritrade does then there is no additional calculation at all compared to the non-margin case.

For an investment property bought on a mortgage, all payments towards paying the mortgage count as contributions. Payments for maintenance, insurance etc. also count as contributions to the account. All my financial investment examples compute pre-tax return so I would not include payments for taxes in the real estate calculation either in order to derive the pre-tax return.

The main point here is that borrowing money or paying off a margin loan by selling stock can be completely ignored when you are calculating return on investment.

One final point - the calculations EnoughWealth gives are annual rates of return. I recommend to first compute monthly rates of return. My examples so far are all for monthly rates of return and are not annualized.

Getting Started in Measuring Investment Performance

I've been posting a lot of different analyses of investment performance recently. They all rely on the same underlying data which are in fact fairly easy to compute. I have the impression that people think it is harder to compute that data than it is. Several trading blogs I read report daily trading results and several PF bloggers report some annual investment performance figures, but I haven't seen anyone else compute the kind of statistics that I've been discussing here. Let me know if you know other blogs that are computing longer term investment performance statistics.

What you need to know is the value of the accounts you want to include in your computation at the end of each month and how much money you put into and out of the accounts. I use my total net worth and calculate how much I earn from salary etc. and how much I spend each month. But you can look at just investing and trading accounts and ignore checking accounts, credit cards etc.

OK, so here is a simple example. Let's assume that Yoyo has a brokerage account and a retirement account. Yoyo checks up her statements for the two accounts for the last couple of months:

31 January 2007:
Brokerage: $35,500
Retirement: $93,000
Total: $128,500

28 February 2007:
Brokerage: $34,400
Retirement: $94,200
Total: $128,600

She also collects the following information:

February retirement contributions: $550
15 February put $500 into brokerage account
28 February withdrew $600

That's all the data needed. Now let's help Yoyo do the calculations for February's rate of return.

Investment gain in brokerage account = $34,400-$35,500-$500+$600 = -$1000
or: monthly change in account value - net contribution to account.

And for the retirement account:
$94,200-$93,000-$500 = $700

So Yoyo's loss for the month is the sum of these two investment returns = $700-$1000 = -$300.

To get the rate of return we divide this number by the value of her accounts at the beginning of the month:
ROR = -300/128,500 = -0.23%

The hard bit is doing this for every month you want to include in your statistics. I'll explain some basic statistics in an upcoming post. Please let me know if anything is unclear here!

Aussie Dollar Trading Above 80 US Cents

It hasn't been above 80 cents in a long while. My Aussie Dollar model gave a sell signal yesterday. It's good I'm not trading forex anymore as I would have shorted the AUD and probably gone long the Yen, which would have made things twice as bad! This model is a previous generation model that is not as precise at all as my NDX trading model. One day maybe I will apply this new model to forex. But in the meantime I've decided to take a slow and steady approach to foreign currency management. Over time I plan to move my portfolio towards 50:50 Australian and US Dollars by accumulating savings in the US and transferring dividends and distributions from Aus to the US. After reaching the 50:50 level I would do regular quarterly, or whatever, rebalancing. Currently I am approximately 67% in AUD, 26% USD, and 7% other (global mutual funds that are unhedged or hedged into other currencies).

BTW I just shorted 2 NQ contracts @ 1781.75. The model is still not giving a very clearcut signal, so this is a hunch based on a bunch of stuff. I'll see in the morning whether I should add to it. Maybe this evening already I'll decide to get out of it if there is a very strong rally in Asia.

Closed Positions Too Soon

Looked this morning to me that the major indices were going to try to close the opening gap. So I closed all my long trading positions. I got to campus now and the indices are up nicely. As I read recently: "It's better to be out of the market wishing you were in than in the market wishing you were out" :) This is especially true if your method generates a high percentage of winning trades. Then it is less important to let the winners run. The model signals are very ambiguous here, so I'll wait for a clearer signal to do that. I'll do a post or two soon on the basics of computing your investment and trading performance. I think it is much easier than most people think it is.

Time-Varying Alpha and Beta

When estimating alpha and beta, a big question is how much data to use? 36 months? 60 months? Different periods will result in different estimates and those estimates will change as new data comes in. Advanced time series econometrics methods can use all the data available to estimate alpha and beta coefficients that vary over time. To produce the chart above I used the Diffuse Kalman Filter to estimate alpha and beta. I assumed that alpha and beta could each be modeled by what is called a local linear trend model.

Alpha increases smoothly over time. The model couldn't distinguish any changes in the slope of this learning curve. With more data over time it might be able to. It could distinguish a lot of variation in beta. I increased my beta from when I started investing from around 0.35 to a maximum of 1.35 in September 2001. Increasing my beta in this period after March 2000 was not a good idea! In recent years beta has fallen to its current level of 0.42. Alpha is currently 10.3%. The expected rate of return is, therefore, 17.6%.

We can also use this model and the actual monthly returns to the MSCI Index and the risk free rate to compare actual returns to those that are predicted by the model and the MSCI index:



Deviations from the predictions are the "noise" that is not explained by the MSCI and the risk-free rate or the smoothly trending estimate of alpha.

Expected Returns

Following on from my previous post, one of the uses that this alpha/beta analysis can be put to is estimating your future expected rate of return. You just need to plug in the expected risk free rate and benchmark rate of return into the following formula:



The "hats" indicated "estimated value". This formula ignores the uncertainty in the estimates of the coefficients. You could do a Monte Carlo simulation to find the expected distribution of future returns. But for now I will assume that the coefficients are known with certainty. Based on my MSCI analysis I come up with:

alpha = 11.26%
beta = 0.72

For the S&P 500 I get:

alpha = 16.07%
beta = 0.58

(see what I mean by the MSCI being a steeper hurdle?). Now if I assume that F = 4.98% (its current value) and M = 10.5% I come up with expected rates of return of 20.2% and 20.1% based on the two benchmarks. Of course, you can assume a lower rate for M if you want. How do these compare with my actual returns?



All these rates are annualized. For the last 12 months and the last 3 years my annualized rates of return are 23%. However, 2005 was a bad year and so for the last two years the mean is just 14%. The MSCI achieved 11.6%, 14.4%, and 15.9% for the same periods. So the index was a bit above trend in those years and my own results for 1 or 3 years are also above trend. The S&P 500 has been at or below trend, however. Over the last 5 years I averaged 13.6% compared to 10.7% and 5.8%. My alpha has been increasing over time so this makes sense. Over a ten year horizon I underperformed the indices.

Let's assume that the 20% rate makes sense, then what does it imply? 20% of my $215k in non-retirement accounts is $43,000 roughly the US average salary. It is enough pre-tax income to cover my current expenses. I could "retire" now. The quotation marks mean that I would become a full-time active investor and trader. My retirement accounts would continue to grow at a rapid rate. Real retirement could happen at a later date if I wanted it. Of course, I would like to have a huge margin of safety so that if the rate of return is lower or my expenses rise rapidly I wouldn't run out of non-retirement money. The bottom line is though that all non-retirement saving I do from now on is increasing that margin of safety.

What Does Alpha Look Like?

We hear a lot about "alpha" - the risk-adjusted average rate of return for an investment portfolio such as a mutual or hedge fund. Technically, alpha is the coefficient in the following regression equation:



R is the rate of return on the portfolio measured in each period t, F is the risk free rate of return (return on a 90 day U.S. Treasury Bill), and M is the rate of return on the market portfolio, which is often approximated by the S&P 500 total return index or the MSCI World Index etc. Usually monthly data is used to compute the series of returns - typically 36 to 60 months of data. Alpha and beta are then the coefficients of the ordinary least squares regression of R-F on M-F. You can do this in Excel using the function LINEST.

Beta shows the sensitivity of the portfolio to the market rate of the return. Alpha shows the average of the returns that are not explained by the market rate of return. The last term epsilon is a series of error terms that represents the variations in return not explained by the market rate of return - the noise in the regression.

But what does alpha actually look like? The following chart shows a scatter of my rates of return for the last 36 months against the returns of the MSCI All Country Gross World Index:



The trendline computed by Excel shows the part of returns explained by the MSCI index - its slope is beta. Alpha is the height of the trendline above the zero, zero point on the chart (I haven't deducted the risk free return here by the way). This is a monthly alpha - the annual alpha here is something like 12%, which compared to most mutual funds is rather high. But I am mostly struck by how fragile alpha looks when surrounded by the wild monthly fluctuations in the portfolio returns.

Don't Worry About Missing Out on Big Gains

Worrying about missing out on big gains often leads to foolish actions. Whether it is first time home buyers worrying about being "priced out of the market forever" or me a couple of days ago thinking I wasn't taking big enough positions. This led to me breaking my trading rules yesterday - taking on positions in the middle of the day that I wasn't intending to just turn around for a quick scalp but instead hold overnight. My rules say to close trades in the morning and start opening new ones towards the end of the trading day. I kept trying to go short and the market kept rising against me. And I missed the best opportunity to cover my short positions at a profit earlier in the day. I'll close out at least half my position later this morning whether it is profitable or not. The economic releases at 8:30am this morning have pushed the futures into the red from the green so the damage is at least not going to be as bad as it seemed it would at one point I think.

My current goal for trading is to demonstrate that I can consistently generate some level of profits. I don't need to capture all the market movement. But I keep wanting to hedge my investment portfolio against adverse market movements, though that is not my goal for trading - the long-term goal is to generate returns that are uncorrelated with the market (over periods of a month or more - obviously they are highly correlated in the short run as I am taken directional bets on the market). I'm almost half way to my annual goal of $19k in trading profits. I don't need to take big risks as I am earning a salary, I don't depend on trading for a living.

P.S. Great article on the economics of homeownership

Increasing My Position

I shorted 800 QQQQ @ 42.62 and 2 NQ contracts @ 1752.75. Now I am short the equivalent of 3200 QQQQ shares and have a negative portfolio beta overall (similar to being net short overall but I take into account the sensitivity of each financial instrument to movements in the S&P500) of -0.18. Let's see if this works.

Right Idea, Insufficient Followthrough

I closed out the short NQ futures contract just before 12 today as I was going to go teach my class and the market didn't seem to be going anywhere. Then the market collapsed of course while I was teaching. It looks to me like this is the beginning of the next wave down to match the initial one that peaked on February 27. At this point though I only have 3 QQQQ put options and a short position of 500 QQQQ shares. Between them they contribute beta of -0.15 to my portfolio. My overall portfolio beta (to the S&P 500) is 0.25. I should have more confidence but after the trading break I was stepping into the waters again nice and slowly. I'm up $1580 in short-term trading this month at this point, but could be doing a lot better.

Getting Back into Trading

Last week I took a complete break from trading while we were in Florida and after we returned. Today I initiated a small position. This morning I used half the cash in my Roth IRA to buy 3 April $46 QQQQ puts and I also shorted 500 QQQQ shares in my regular trading account. This is a minimal position equivalent to 1 NQ contract. Only one of my indicators was on short today. This afternoon the market rallied and I shorted 1 NQ contract in addition. So now I am at 1/3 of my maximum position. Two more of my indicators are close to a short tomorrow. There are retail numbers out in the morning at 8:30am. If the market does turn to the downside this could be the second downwave of the correction. Or it could just be a wiggle inside a sideways correction of the first downwave. I don't really need to form an opinion about that. I will just keep on building up my position as things get more bearish or vice versa. But the downmove should last way beyond the end of this week based on the forward forecast. Of course if the stochastic some how manages to get above 80 the short signal will be negated.