Madame X: Summing Up

Here are all the posts I've written on this topic:

Miscellaneous Funds
U.S. Large Cap
U.S. Mid Cap
U.S. Small Cap Funds
International Stock Funds
Bond Funds
Individual Stocks
Asset Allocation
Portfolio Overview

Overall, the portfolio is OK as a stock-bond portfolio for someone of Madame-X's age. It is reasonably well diversified across US and international stocks and stock capitalization classes and has a reasonable allocation to bonds. It has some good actively managed funds and some poor ones as well as index funds.

I've suggested increasing the international and large cap allocation a bit using new contributions as well as dumping some losing funds and getting a more rational allocation to actively managed and index funds in some cases.

I would also look at diversifying further. This can be hard to do without losing exposure to the stock market - as long as the additional asset classes have good expected returns this shouldn't be a real problem. The other solution is using leverage to gain more than 100% exposure. I invest in a variety of funds and financial firms that I classify as "passive alpha" - these are all investments which I expect to have a lower correlation with standard stock or bond index funds. They include:

• Real estate

• Hedge funds

• Private equity

• Commodities

• Very actively managed stock funds - where the manager makes no attempt to benchmark against an index. Examples are FAIRX and CGMFX. All those readers who think it is impossible to identify a good fund, have a look at these two. I also like Fidelity's Contrafund (which has nothing to do with Nicaragua :)) and Janus' Contrarian Fund.

• Other financial firms - such as Berkshire Hathaway - an insurance conglomerate - or Interactive Brokers - a market maker in the financial markets.

You have a strong exposure to real estate through your condo - though that is just one investment in one market. As real estate prices fall, funds that invest in real estate could become attractive.

Hedge funds are obviously usually out of bounds to retail investors in the U.S. But there are mutual funds that take short positions. I have shares in TFS Capital's Market Neutral Fund. I also have the Hussman Strategic Growth Fund, but I'm not recommending it :).

Private equity is another hard to access asset class. I don't recommend investing in Blackstone. On the other hand, Leucadia National is in effect a private equity company.

Commodities - you have an energy fund - there is also the option to buy ETFs exposed to commodities like gold. I don't have any in my portfolio - my exposure to a resource fund and the Australian Dollar and Australian stock market is sufficient I think. A non-energy mining oriented fund might make sense in addition, but that's very optional I think.

I'd look at 5-10% in any of these categories in the long-term.

Remember - all these suggestions are what I would do but aren't necessarily what you should do. As they always say - seek a second opinion, I am not a qualified/registered investment adviser.

Fund Switch Completed in Australia

I just switched the another 35% of my super fund from the CFS Conservative Fund to the CFS Geared Share Fund. I am maintaining 15% in the CFS Conservative Fund to retain exposure to bonds. The model forecasts that the Australian stock market is going into a significant rally. For example, yesterday the index rose on falling stochastics in the overbought (above 80 zone):



This is typical very bullish behavior. The forward forecast of the model shows that more of this will continue to happen. I doubt that the next dip in the market will be below today's close and, therefore, despite the market rallying significantly today I bought. I also have orders in at CommSec to switch $A25k from CFS Conservative Fund to CFS Future Leaders and CFS Developing Companies funds (small cap funds). Small caps are likely a buying opportunity here in the Australian market. They've been hit badly, possibly even worse than in the US market due to margin calls resulting in the liquidation of small cap portfolios and large holdings.

The US market is not looking as bullish (but still bullish longer term). So I'll hold off completing the switch from bonds to stocks there until the next dip which might be below Tuesday's close.

European and American markets went just crazy on Tuesday on news of Lehman Brothers and UBS managing to raise more capital. Clearly investors think that the credit crisis has been neutralized - no significant bank will go under because they will either be saved by a central bank or private investors. UBS wrote down $19 billion of bad debts - but the past doesn't count in stock valuation, only the future. I stupidly went short and then pulled my stop and got blown up. Total lack of discipline. Hubris after a good month. Still I am only down about $500 on the day in trading when all is said and done and gaining massively for the moment on the investment side.

27 Months of Trading Results

As Enough Wealth pointed out, I lost $107 per month from trading during the period I posted data for this morning. But that sample is biased to include the last good month before "the slump" started (May 2007) till the first month that I consider good again (March 2008). This chart shows monthly results since the beginning of 2006 in terms of realised short term gains on securities, options, and futures:



On average I gained $560 per month but as you can see progress was very erratic and the average is not statistically different from zero at conventional levels of signficance. On the other hand, the trend of cumulative gains appears to be positive in a very statistically significant way. But cumulative gains is a random walk - and so this is known as a spurious regression - the results appear significant to the naive observer, but they are not. When we are looking at a random walk we need to do statistical tests on the changes in the series.

Anyway, results in 2006 were highly variable and erratic - some big gains and some huge losses. Things calmed down in 2007 and 2008 but there were more losing months. The jury is still out on whether I can make a success of this.

Madame X: Miscellaneous Funds

And to the final three funds:



There's not a lot invested in these three funds which are all pretty decent. FFFEX is a 2030 target fund and so contains a mix of stocks, bonds etc. in a diversified portfolio. The expense ratio is reported as zero - that is the extra expenses on top of the sub-funds that compose the portfolio. So we don't know the actual expense ratio without some research. The fund ranks highly against its peers. It takes more market risk (beta greater than one) than the benchmark portfolio that Yahoo is assessing it against. Results seem OK.

ICENX is an energy fund, with stunning results relative to the S&P 500. But look at how it ranks against its peers - not as hot. Natural resource funds have had tremendous returns. I think that will continue for a while though maybe not to the same degree. You don't have so much in this fund. If you had a lot I might be suggesting to rebalance. Maybe you already sold some?

I probably should have included the Royce fund - RYTRX - with the U.S. small cap funds. I was misled a little by Yahoo's description of it. It's held up nicely in the last year in comparison to some of those, but FSLCX has very similar performance. Both are good funds. While it makes no sense to have multiple index funds except due to having different accounts - retirement and non-retirement, I think it makes sense to have multiple actively managed funds within a given category - and the more actively managed they are the more diversified you want to be - this is why there are hedge funds of funds - to diversify away active management risk. So I'd be holding on to both of these.

Tomorrow, I'll have some further ideas about the kind of funds that I like and summarize some of my suggestions.

One conclusion is that it is pretty much impossible that you are below cost basis on your accounts though a few funds have performed poorly in recent years.

Tradingwise it Was the Best Month Since May 2007

Full report to come shortly. But here are the realised gains results for the last several months:



After losing in January, I didn't do any futures trades in February as I practiced paper-trading. I did OK trading stocks and options. This month I did even better trading securities and gained a little in futures too. My NQ trading is OK, the other contracts need work :) I feel like I'm turning the corner. Hopefully, I can keep it up.

I also have more or less complete cash flow income figures for the first quarter in comparison with the whole of 2007:



Passive income is pretty much in line with last year. Typically, I receive my largest mutual fund distributions in the second quarter, which is the end of the tax year in Australia. Final dividends, which are larger than interim dividends in Australia also tend to be paid out in the second half of the year. Securities trading is in line with last years result. Futures trading obviously needs much improvement. Long-term capital gains are negative due to the switching of mutual funds I've been doing. It's not that these investments lost money but they have paid out in distributions more than the total gain since I bought them. Therefore, I realized a capital loss, which is a tax benefit, when selling. As I understand it, in Australia, all capital losses are deductible as if they were short-term losses and rebated at regular income tax rates, while only 50% of long-term capital gains are treated as taxable income. This makes capital losses particularly valuable. Also, in Australia, there is no formal rule against "wash sales" unless the tax office deems they were done for tax reasons only.

Would You Invest in this Fund?

Madame X: U.S. Large-Cap Funds

Here we have one index fund (FUSEX) and four actively managed funds:



FDGRX (Fidelity Growth Company) appears to be an excellent fund. It has been at the top of its rankings and shown a positive alpha and Sharpe ratio in all time frames. It has outperformed the index substantially in all time frames. It's down a little more than its peer fund year to date, but this is expected as it has a beta (sensitivity to stock market movement) above one. The other Fidelity actively managed fund (Fidelity Growth and Income, FGRIX), is below par. It has a negative alpha in all time frames, and except over a ten year horizon it has underperformed the index. It is in the bottom quartile of peer funds. Muhlenberg and Thompson Plumb are two funds that are good on the ten year horizon (and Muhlenkamp over five years too) but have both deteriorated in performance more recently. I'd heard Muhlenkamp had a great reputation while I've never heard of the other fund. Year to date Muhlenkamp is actually down less than 6% despite a high beta. I would hold this one - my impression is it will turnaround from some bad investment decisions in recent times. Thompson Plumb's manager believes that the economic cycle will again favor his fund soon again. I'm pretty skeptical about his explanation.

I don't have any problem with the allocation among these funds. The biggest chunks are in FDGRX and the index fund.

It's possible that you lost money in MUHLX and THPGX, but not as much as shown on your statement. So again the cost basis must be at fault.

Madame X: U.S. Mid-Cap Funds

Hopefully this series isn't too much like water-torture :) I just don't feel like looking up more than 3 or 4 funds at a time and anyway comparing like funds with like is more instructive I think.



(Yahoo treats these funds as being in various peer categories like mid-cap blend, mid-cap growth etc - so the ranks are not strictly comparable across these funds)

These mid-cap funds are similar to the small caps in that the mid cap sector has declined in performance over the period relative to the S&P 500 which Yahoo uses as a benchmark. Over the full ten years all the funds outperform this index with the margin of outperformance generally declining over time. FSEMX is an index fund for the Wilshire 4500 and if we add back on the expense ratio we should have a good idea of the performance of the index. However, in a departure from the small-cap case, three of the managed funds are inferior to the index fund at least in the last 5 years as shown by both crude and risk-adjusted performance measures. In the last three years all the non-Fidelity funds are in the lower half of the performance ranks, with ARGFX being particularly poor. VSEQX did OK over the last three years, but based on beta appears to be taking more risk than CAAPX and has underperformed in the last year. On the other hand FMCSX looks to be a fairly decent fund, though Yahoo rank it worse than 71% of funds in its category in the last year, which is hard to believe.

I'd certainly look at getting rid of ARGFX. Unlike the other categories I've already examined you have more money in the poorer funds (ARGFX and CAAPX) here and less in the better ones (FSEMX, FMCSX). I'd look at rebalancing this at least to have equal amounts in CAAPX, FMCSX, and FSEMX.

Though VSEQX has lost 13% in the last year, assuming you put money in before this year too, it can't have lost 16% as reported. The cost basis must be at fault. You have a lot in ARGFX which has lost net for the last three years - it's quite likely you've lost money here. It's possible in CAAPX too, depending on how long you've been investing. But unless you recently switched in, your absolute loss shouldn't be high.

Trading Boils Down to Three Things

1. Choosing high probability entry points to trades (and executing them well).

2. Getting out of losing trades fast.

3. Hanging on to winning trades for as long as possible (but not letting them turn into losers).

During my poor performance in the second half of 2007 my main problem was failing to do 2. By paper trading I seem to have trained myself to be pretty disciplined now in getting out of losing trades. Sometimes I'm setting stops too tight - especially with the Australian Share Price Index futures contract. So I'm working on that. Recently my problems have been more areas 1 and 3 - especially 3. I've been jumping out of winning trades after only a fraction of the move has occurred. And I've been either too impatient to get into trades or waited too long to get into trades. So I'm working on those things too. At the moment I'm up for the month and the year (a little) in terms of realized gains. It's a nice change.

Roundup

I took more profits (in XLF and in HCBK which was downgraded) and opened small short positions in GLD and SPY. I'm expecting a lot more downside in gold and there is a good chance that the rebound from the first wave down is now complete. I might also short oil soon but it still looks strong in this rebound.

I completed Snork Maiden's tax U.S. return - she should get a $1462 refund from the Feds and $334 from Vermont. We got notices delivered at our U.S. forwarding address about the tax stimulus rebate. Hopefully we'll be getting a total of $1200.

My Mom tracked down her account manager in Switzerland at UBS. He had a "sabbatical" in Africa. Interestingly, now I am no longer in the US he sent me an e-mail with all the details of what he proposes to do for me to look over. When I lived in the US he wouldn't communicate with me directly, I presume because SEC regulations prohibit promoting securities that are not registered in the US especially with non-accredited investors like myself even if I was merely advising my Mom on what to do. Australia doesn't care about any of that stuff. We do have a definition of "wholesale investor" and some funds are only offered to that class but things seem to be much less strict than in the U.S. The U.S. is way overzealous on this I think while very lax in other areas leading to such things as the Bear Stearns debacle.

Yes, I'll be continuing the Madame-X series :)

Babcock and Brown Combat Shorting

I noticed yesterday that Babcock and Brown had set up a new prime broking arrangement with Deutsche Bank. I didn't look into the details though. Apparently it avoids margin calls and does not allow their stock to be lent to other parties (for short-selling). Short-selling is currently very controversial in Australia as in some cases short-selling has pushed stock prices down resulting in margin calls to directors or companies that results in their stock being sold in a cascade effect. This affected Allco and ABC Learning Centres and rumours were that Babcock and Brown was also being targeted. In the US, unless you are a market-maker you have to borrow stock first before short-selling it. Naked short-selling where stock is not borrowed is not approved though ti goes on. In Australia things are reversed. The ASX has a list of approved stocks that can be short-sold - nakedly short sold. You don't need to borrow the stock if it is on the list. This is the only sort of shorting that is reported to the exchange. On the other hand a market has developed where stock is borrowed and short-sold. The reason is that only the biggest companies by capitalization are on the approved naked shorting list. Borrowing to sell short is not regulated and so no-one knows the actual short-interest in smaller Australian stocks and it seems many people are only just waking up to the fact that this going on.

Anyway, I hope this move helps the stock prices of Babcock and Brown related stocks such as EBB.

Smoothing the Ride Through Trading - Different Approaches

Roger Nusbaum often talks about "smoothing the ride" - trying to get stock like returns (or better) in the long run with a little less volatility in the short-run. There are a lot of ways to do this. The first and most obvious is to diversify beyond a stock only portfolio to include other asset classes that are relatively uncorrelated with stocks. Mebane Faber's blog has a lot of discussion of such approaches and combining them with some long-term trading to switch asset class exposures. However different asset classes will likely have different average returns. We can include lower returning assets and still maintain a higher overall return with the judicious use of leverage. As I've explained before, one approach is to apply leverage to stocks or real estate and, therefore, use less of your equity to get the desired exposure to these asset classes and then also include perhaps lower returning asset classes such as bonds to the portfolio (bonds have often returned stock like rates of return over significant periods but can't be expected to do so over say a half-century time scale).

Let's say you've constructed a portfolio something along these lines, what role can shorter term trading play?

We can categorize trading by how coupled it is to your investment portfolio:

1. Trading the Whole Portfolio If you listen to Cramer or read most online discussions about trading it seems this is the only way to go - you have to trade the entire portfolio all the time. After all, who wants to be exposed to a stock or sector that might be falling significantly? You only want to be in stocks or sectors that are going up, or you want to short the weaker ones. To my mind this approach is both tax inefficient - you lose out on discounts on long-term capital gains tax and taxes on dividends that many countries offer - and very high anxiety inducing. You have to be watching the market the whole time as something might happen which means you have to trade your portfolio.

2. Soros Style I was originally inspired to get into trading by reading The Alchemy of Finance. In the period discussed in the book, The Quantum Fund established a stock portfolio which was adjusted slowly and then borrowed against this core position to trade futures in a variety of macro-markets. Soros would develop hypotheses about what was likely to happen with currencies, gold, oil, bonds, stock indices etc, often in combination and put on trades to "test" these macro ideas. Early on I found that it is hard for an individual to do that kind of trading unless they are really full time at it and very talented. Yet a lot of people try. Again this seems a recipe for a lot of anxiety. There is always some trade, you have to be doing. You are trying to actively smooth out the troughs in the market with your trades - your stock portfolio is falling for example and you are trying to counter that in your macro-portfolio.

You could instead split your portfolio between a long-term investment and short-term trading sub-portfolios and invest in stocks in both, possibly farming out the long-term to other managers - this is getting more manageable, but there is in my opinion an even less stressful way to trade.

3. Alpha-Beta Separation You can in fact "smooth the ride" by trading without actively trying to smooth out the bumps. The key is generating returns from trading that are uncorrelated with the returns from your portfolio. Day-trading stocks, or currencies, or anything could qualify. This chart shows the MSCI index and a portfolio with beta of 0.82 and alpha of 9.3% over the last ten years:



Those are my estimated beta and alpha currently.* The portfolio is exposed to 82% of the market fluctuations in the short-run as well as a source of uncorrelated 9.3% annual returns - in practice I've derived these alpha returns from a variety of sources - including choosing skilled managers, gradually market timing the entire portfolio, and active trading. As you can see the addition of the alpha returns mean that though the portfolio is still volatile, the drawdowns are much smaller in percentage terms than the index. I think drawdowns (percent decline from peak to trough) are more psychologically important than volatility per se. The attraction of day trading is that once the day is over you don't (in theory) have to worry about the market. Your investment portfolio might get hit, but if you know that your trading can add returns that smooth the ride over the long-term you don't need to worry too much about that. I am trying to get to that psychological state. It's a struggle. I'm not there yet. Hopefully, I'm on my way.

* Unfortunately my alpha was much lower in the past and so I haven't had such nice gains :)

Madame X: U.S. Small-Cap Funds

This project is becoming bigger than I expected :) I want to keep things down to writing about 3 or 4 funds a day and so I'm going to have to split the US stock funds into sub-categories. I'll start with the small cap funds:



Yahoo have selected the S&P 500 as the benchmark - but that is a large cap index so the alphas and betas give us an idea of return and risk relative to large cap stocks rather than the small cap universe. ETRUX is an index fund which tracks the Russell 2000 index so adding back the expense ratio of 0.22% we can get an idea of what the Russell 2000 index has done. Over the last five years small caps gained 14.67% per year vs. 11.64% for large caps. But in the last three years that performance deteriorated so that in the last year small caps lost 12.39% vs. a 3.6% loss for large caps. Note that 35-40% of small cap funds out-performed this index fund. The Bridgeway fund would have been one of them over the last five years, but it's performance has deteriorated sharply to a loss of 16.4% in the last year. It certainly has not had "persistence of returns". On the other hand the Fidelity fund which is also an actively managed fund has done very nicely. It has only lost 5.29% in the last year, which is much less than the Russell 2000 has lost. This fund also has gone up the ranks relative to other small cap funds. In fact, the Bridgeway Fund is a micro-cap index fund - it tries to mimic an index of all AMEX and NASDAQ stocks smaller than the 10% smallest NYSE stocks (weird definition). So this just shows that the very smallest stocks have done even worse than other small caps in the last year.

Bottom line - active management wins here again. The small and micro cap index funds may have contributed to negative performance, especially if you have mainly invested in them in the last two years. Luckily, they are only a small part of your portfolio.

Madame X: International Stock Funds

On to Madame X's international stock funds and a hopefully interesting lesson in passive vs. active management:



(something seems to be seriously wrong with Yahoo's index return figures for the last few years).

ETINX and FSIIX are both international (developed countries) index funds and as you can see almost exactly replicate each other. Madame X has both of these because they are in different accounts. The Fidelity one is just slightly better than the E-Trade version until this last year when it has slightly underperformed. On the other hand FDIVX, an actively managed fund has positive alpha (market-risk adjusted return) and better performance than either of the index funds despite its much higher expense ratio and much larger size. Low expense ratios are not the be all and end all of fund selection. This fund was in the upper quartile of its category in the last 5 years but has drifted downward in performance in the last few years. I wouldn't sell it, but it wouldn't be on my buy list either.

VEIEX is an emerging markets index fund. Its alpha and beta are measured relative to the developed country international index - its performance relative to emerging market funds is not as fantastic, but still respectable - in the last year it was in the top 20%. It's probably not a bad fund for exposure to emerging markets.

None of these international funds could be responsible for the possibly negative performance of Madame X's portfolio.

China Trade

I bought some CHN - the China Fund - and CNY - a new RMB ETF. The latter should appreciate against the USD in the long-term as the Yuan is revalued - I'm investing some of the dollars in my Interactive Brokers account into it. The former seems to me to be the best of the various China funds. They have access to Shanghai A shares as well as the ability to invest in private equity in China. But they recently moved money out of the PRC and into the Taiwanese market before the recent fall in the mainland markets. The fund has outperformed both TDF (Templeton Dragon Fund) and GCF (Greater China Fund) and FXI (H shares index ETF). I like what I read about the manager. Clearly, as shown by their recent moves and their portfolio they are not an "index hugger". I also trimmed some risk in XLF, BWLD, and SHLD in this morning's rally. I sold out of SHLD entirely. Likely, I will buy back in again at some point.

Madame-X: Bond Funds

There are two bond funds in the portfolio: CGFIX and FTHRX. Neither is particularly good, nor particularly bad. Both have been near the middle of the rankings of funds in that category on any time scale we can see. That means they have generally underperformed the market, particularly in recent years. Still, they have mostly had positive returns and are not the cause of any losses in the account. Some key statistics:



Both funds are evaluated against the Lehman Aggregate US Bond Index. This makes the Credit Suisse fund look good as it is in international bonds which have done better than US bonds. It has ranked better than 66% of international bond funds in the last year, 54% in the last 3 years and 39% in the last 5 - so it's not as good as its supposedly index beating performance might make you think.

The Fidelity fund is very much in the middle of the pack of US bond funds. It has underperformed the index by almost two percentage points in the last year and by 0.63 to 1.18% in previous periods. Given that the expense ratio is 0.44% this would seem to indicate that the manager have negative skill - they don't add value but subtract it. However, beta which is an indicator of how much the fund moves given a 1% move in the index, shows that they are taking less than market risk. This makes sense as the aggregate index includes long term bonds too which have higher risk and return. So maybe here the benchmark isn't so appropriate either. Still, for the three and five year periods alpha - the risk adjusted excess return - is more negative than would be warranted by just the expense ratio. The performance of the fund also seems to have fallen off over time as seen by a declining alpha. The Sharpe ratio is a risk-adjusted measure of how much returns exceed the risk-free interest rate. A negative number means you would have done better putting your money into 90 day US government treasury bills. This is the case for the last three years for this fund.

Bottom line is the Fidelity fund is not too hot. You could do better investing in an indexed bond fund or an ETF like AGG if available. But this may not be an option. Fidelity have a couple of treasury bond index funds. These don't cover the corporate bond universe where there may be opportunities going forward as corporate interest rate spreads hopefully fall. Switching some of this fund across those three might make sense, though raise the ire of commenters who say you already have too many funds :)

I have fewer constructive comments to make about the Credit Suisse Fund. It has quite a high expense ratio but ranks slightly better among its peers than the Fidelity fund. There are very few international bond ETFs, but lots of closed end funds. Maybe readers have some suggestions? Are there any bond funds that really add value? Or is indexing the way to go here?

What about PIMCO? This fund has beaten its benchmark despite a 0.95% expense ratio. You'd want to avoid the sales load (up to 3.75%) though!

Wealth Much More Evenly Distributed in Australia

Wealth appears to be much more evenly distributed in Australia than the US. The lowest 10% of households have a median net worth of $A175k, which is greater than the US median for all households (around $US100k). I think the Australian figures include cars and household effects which pushes the numbers up a little. One important factor is probably compulsory superannuation - employers must contribute at least 9% of salary towards a retirement account and cashing those accounts out before age 60 or so is near impossible. The median for all households is $A340k and for the top 10% $A975k. This probably places us ($A470k) a little lower in the continuum than we would be in the U.S. According to recent taxation data we live in the 8th richest (out of 26 in terms of income) district of the Australian Capital Territory. About where we fall in the national net worth spectrum too.

Madame-X: Individual Stocks

These form a very small part of the portfolio but maybe it's useful as an example to show what I look at when first thinking about a stock. There's not much to like about ALU (Alcatel-Lucent), while XRX (Xerox) could be interesting. Both stocks are pretty cheap here and so I wouldn't be selling either unless you want a tax loss and that won't be much. The commission to sell ALU hardly is worth paying :)

Both companies didn't really go anywhere much until the great NASDAQ bubble when they soared only to crash back to a lower level. Since then XRX recovered somewhat while ALU has continued to perform poorly:




Xerox has a forward price earnings ratio of 10.7 while analysts estimate that its earnings will increase at 12% per annum over the next five years. Earnings have actually increased by 36% p.a. over the last five years. The company has had a series of positive earnings surprises. Analysts have tended to upgrade or recommend the stock. Several mutual funds and other managers have massive holdings in the firm including Dodge and Cox (almost 10% of the company), Neuberger and Berman, State Street, Fidelity, Vanguard, Backrock and others. Digging deeper into the accounting data, cash flow from operations exceeds net income and capital expenditures are low. This means free cash flow per share exceeds earnings per share. The company is buying back shares rather massively and pays a 1% dividend. So all this tells me this is a cheap stock doing some good things with moderate growth potential and good "sponsorship". It's at least a hold if not a buy IMO. Now I'd do further research obviously before actually buying the stock or not but this would qualify as something for further investigation.

Alcatel-Lucent also has a low forward P/E based on analysts estimates - just 8.5- but the company lost money last year - though it appears this was due to a writedown. The company has had massive negative and positive earnings surprises, so it's hard to take analyst estimates seriously. Analysts have been more likely to downgrade this company, especially recently. It seems that institutions have been selling down their holdings though I don't have detailed information on institutional holdings. Operating cash flow has been erratic - positive some years when the company made a loss and vice versa. Capital expenditures are high and as a result, free cash flow is low or negative. The company is borrowing heavily, paying a dividend of 6.9% and not buying back stock. The share price has fallen 54% in the last 12 months, while XRX only fell by 12%. It has a beta of 2.23 according to Yahoo - exaggerating movements in the market (probably has a negative alpha...) XRX has a beta of near one - moves in line with the market. In sum ALU looks pretty horrible. I wouldn't investigate it further as a potential investment.

Madame-X: Asset Allocation

I've done a rough computation of Madame-X's allocation by asset class. This is by no means precise, but my errors probably cancel each other out over the 22 funds :) She has 89% in stocks and 11% in bonds. The rule of 110 would suggest something closer to 75%, 25%. I think that is overly conservative, especially as in the long-term I don't expect bonds to perform as well as they have in the last 25 years. So probably this is a decent mix.

Overall her investments are split 73%, 27% between the US and foreign investments. This is pretty typical of U.S. investors. However the U.S. stock market is just under half of global capitalization and the US economy is maybe 20% of global GDP (depending how you measure it). On that basis you'd want more foreign investments. Personally, I am massively overweighted Australia - which is around 2% of global capitalization and economic activity but constitutes more than 50% of my portfolio. The argument for overweighting ones own country is that you need to spend money eventually in your own country. On the other hand, there is a strong case for diversifying away from own country risk.

Within her stock allocation, her exposure to large cap stocks is 53%, mid cap 30%, and small cap 17%. The benchmarks are roughly, 70%, 23%, and 7%. So she is very overweight the small cap end of the spectrum. There is a strong argument for overweighting small caps - most companies are not listed on stock exchanges, and most of those unlisted companies are small. So overweighting small caps, gives more exposure to a proxy for unlisted stocks. The downside is that at our current point in the business cycle, small caps tend to underperform (but maybe a good opportunity to buy more?).

The bottom line is there is nothing radically weird about this allocation, and as you can see I can make arguments for and against changing it. If she does decide to change the overall allocation I'd suggest just directing new contributions in the desired direction - e.g. contributing more to large cap funds and foreign stocks to boost those allocations.

Madame-X's Portfolio

Madame-X has been discussing the performance of her portfolio. The data she has shows that her 401k and Roth IRA are both worth less than the money she has put into them. There are two possibilties - either performance has been poor or the cost basis has been computed incorrectly (which often happens in my experience). I'm going to do a series of blog posts in which I analyse her portfolio and see which of these is more likely. Maybe I can come up with some suggestions for improvements. Anyway, here is her current portfolio allocation:



I won't be able to come up with an answer as to how much money she has made or lost but I will report on the performance of the different funds and which I like and don't like and what I think about the asset allocation. Some commenters on her post say she has too many funds. That's one issue I don't think is important. All it means is she (and I) have more stuff to track. Another commenter said she has too much mid and small-cap funds. That looks like it is the case and this part of the economic cycle is not good for those kind of firms and may explain some of the supposed poor performance. Otherwise, she seems to have a good mix of US and foreign stocks, a smaller amount of bonds. There are both actively managed and passive investments. One or two funds that I have heard of that have a good reputation (Royce, Muhlenkamp) and quite a few firms I have never heard of (ICON, Bridgeway, Thompson Plumb?). A large part of the portfolio is with Fidelity who are generally a solid and sometimes good manager. There are two individual stocks, which in total account for less than 1% of the portfolio. Anyway, I'll be doing all this much more systematically in the next few posts.

Are Professors Better Market-Timers?

I showed in a previous post that many of the investors in the TFS Market Neutral Fund were poor market timers. I just received the CREF Annual Report, which also contains data that is useful for assessing market timing, though not at the same level of detail. The following table gives the distribution across funds and asset classes of the CREF and TIAA Real Estate variable annuities (similar to mutual funds in this case). I've estimated the holdings of the TIAA Real Estate based on data for September 30th, 2007 and projecting that the growth rate of assets in the fourth quarter was equal to that in the first three quarters of the year:

CREF also has regular mutual funds available under some retirement plans though their assets are still small. There is also the massive TIAA Traditional Account which is a kind of life insurance annuity. It's assets are just as big as those of the CREF variable annuity scheme.

At the end of 2002 the investors held 82% of their assets in stocks, 9% in bonds, 6% in cash and 3% in real estate. 2003 was a strong year or stocks and not surprisingly the allocation to stocks rose but in subsequent years of the bull market the stock allocation was gradually reduced. This might be evidence of rebalancing following the 2003 run up. In 2007 there was a sharper reduction in stocks. I'd have to dig into the quarterly data to find out whether this occurred in the first or second half of the year. It could represent either good or bad market timing. 2008's allocation will be interesting. Assets were reallocated across the spectrum but the real estate fund which was performing well through the end of 2007 was the greatest beneficiary. Stocks and real estate performed about as well as each other in 2006. Therefore, there was a clear reallocation to real estate in the year. So far putting money into the real estate fund has proven very worthwhile. It has only had one minorly negative month since October 2002 returned an average of 0.9% per month over the period with a Sharpe Ratio of 4.08. So it's hard to say whether investors are "chasing returns" or appreciating quality when they see it.

Within the equities category funds have been shifted towards global equities fund (50/50 US and foreign shares) from the massive "Stock Fund". CREF's Growth and Equity Index funds have underperformed the Stock Fund and have not seen big shifts towards them. Foreign stocks outperformed US stocks throughout this period. Looking deeper into the accounts, while investors continued to pay premia into the Global Equities fund through 2007 at a fairly constant rate, the fund saw big switches into it in 2006 and much smaller switches out in 2007. Again I don't know in which half of the year these occurred.

In conclusion the professors and other education workers invested in the TIAA-CREF accounts do not seem to be too bad at market-timing and rebalancing. There is a little evidence of return chasing but also of rebalancing. In any case, no movements as dramatic as in the TFS Capital Market Neutral Fund.

Evidence on Market Timing

Following up on my recent post on market timing, I thought I'd give you some evidence of the real-world market-timing abilities of mutual fund investors from the latest semi-annual report of the TFS Capital mutual funds. The data can be found on page 33 in the table "Statements of Changes in Net Assets". I've computed the average price per share data:



Bear in mind that one would think these investors are somewhat sophisticated as this is a market neutral mutual fund, which is a little esoteric. In the year up to June 30th, 2007 shares issued by the fund exceeded shares redeemed by investors by around a 20:1 ratio (13.4 million issued, 740,000 redeemed). The average price of shares issued did exceed the price of those redeemed but giving the benefit of the doubt, maybe the redeemers had bought shares earlier in the period or in previous years. A 2% fee is imposed on redemptions within 6 months of purchase. Redemption fees totalled 0.85% of the value of redemptions so more than 40% of sellers had bought within 6 months of selling. Based on that the average seller made little or no money on their investment.

Things changed dramatically after June 30th. The fund suffered a big loss in August:



though it has recovered nicely since then, especially when compared to the broader market. Including the dividend of 41 cents per share paid in December the fund is near its July 2007 high.

However, masses of investors rushed for the exits. Redemptions exceeded new issuance by a 2:1 margin in the second half of 2007. Redemption fees totalled 1.4% of the value of shares redeemed, so most sellers had bought in the last 6 months. The difference between the average price of shares issued and redeemed was $1.00 - buy high sell low! As you can see from the chart, prices averaged much more than $13.48 in the second half of 2007. Most people who sold, sold right near the bottom.

So the average investor, and even the somewhat more sophisticated investor, is a terrible market timer. As I commented at the time it made more sense to invest in funds such as this one in the second half of 2007 rather than sell out.

Time and Class

Social class is a tricky concept to get a handle on. For one thing, class definitions vary quite a bit around the world. The "middle class" starts at a higher level of income and education in Britain and Australia, where most people define themselves as working class, than it does in the United States, where the majority identify as middle class. It's clearly not just a question of income or net worth, or education, though all those are correlated with it. Maybe it is a question of time. Once I read that the working class is mainly concerned with the present (making ends meet and enjoying the moment), the middle class with the future (studying, saving, getting ahead), and the upper class with the past (ancestry etc.). That's certainly true to some degree. Today I read about Edward Banfield who put it in terms of "time preference" a standard economic concept. Basically, someone with a high time preference discounts the future at a steep rate. It makes sense that working class discount rates would be much higher than middle class ones. Not only is this seen in the behavior mentioned above but in the interest rates available - e.g. comparing payday loans with mortgage rates. Someone born in a working class background who develops a low discount rate will be more prepared to save time and money towards getting educated and moving to the middle class. Of course a lot of people will try and fail for whatever reason, so I'm not saying people are poor because their discount rate is too high. But comparing samples of "working class" and "class people" the average would differ in this way. Some people remain poor because they haven't learned to lower their discount rate and others because circumstances have gotten in the way of using this positive character trait.

An interesting hypothesis then is: "Is the discount rate of the upper class, even lower than that of the middle class?". This paper hypothesizes that the aristocracy and peasant class in early industrial Britain both had high discount rates while the emerging middle class did not. And that this lead to the decline of the traditional aristocracy. Of course, the paper is pure theory (speculation) with no data to back the idea. Maybe instead someone who can preserve inherited wealth and cares about dynastic succession, might have an even lower discount rate than the middle class saver and learner?

Fat Fingers

There are lots of ways to lose :) Right after the FOMC announcement I did a nice winning trade. Then my next trade was clearly a loser I was going to get out with a quarter point loss only, but I was pressing "buy" rather than "sell". This has happened a few times to me on IB's platform. I need to be more careful. And I need to get out immediately not wait any number of seconds to see if things will improve. The loss per contract was less than my gain on the first trade, but there were two contracts instead of one. Still, I am still up on the beginning of yesterday in trading, so could be worse. Maybe I should go back to bed (Fed announcement at 5.15am our time), as I feel a bit jittery about pursuing another trade.

Target Portfolio

This is the target portfolio I hope to get to by next month or so by continuing to switch funds and invest:



I classify our portfolio three ways:

• By conventional asset class - stocks, bonds etc.

• By function - passive alpha, beta, trading etc.

• By currency exposure.

It's by no means a final portfolio - that will always be evolving - in particular, I want to bring down the amount of borrowing from 29% and the amount of cash from 9%. Borrowing is high currently because I believe we are near the bottom of a stock market cycle. The margin rates I am paying are too high for keeping these loans in the long-term IMO. We'll always need some cash used in trading and some in liquidity, but the liquidity category can probably be halved from 7% in the long term. Prerequisites are increasing the credit limit on our Australian credit card and rationalizing Snork Maiden's U.S. accounts.

On currency allocation, I'd like to get to around 50% of the portfolio being exposed to the Australian Dollar and then rebalance from there. The US Dollar/other currency balance is fine. We've come a long way in the last year.

Though only 81% of assets are allocated to stocks, portfolio beta is estimated at 1.16 as a substantial chunk of that allocation will be in a levered fund. I'm planning to maintain around a 10% allocation to bonds in the meantime. Australian bonds in particular might be a good bet in the near future if interest rates come down here as eventually they'll have to. Otherwise, there is a 26% allocation to alternative investments, via a variety of funds and listed stocks. The main planned change is the addition of the Man Eclipse 3 fund which will take the hedge fund exposure to 15%. I don't have particular goals for the subcategories here, it really depends on the opportunities I see. The remainder of the "passive alpha" category includes financial stocks (Total stocks at 81% = beta - bond allocation + financial stocks + "industrial" stocks).

S&P 500 Elliott Wave Count

Here is a longer term Elliott Wave Count for the S&P 500 Index. Elliott Wave, in my opinion is rather subjective and interpretative - it is a useful framework for putting your thoughts about the market direction in perspective, but not very predictive. There are plenty of alternative counts out there, which are totally valid (and plenty which are invalid). This one seems most likely IMO. The current correction which started in July 2007 is labeled ABC (probably should be labeled WXY - see below). The capital letters imply that the correction is complete and that we are now going into wave 3 up since the 2002 bottom. Of course, it is entirely likely that this correction is simply the first wave A or W of a much longer correction. There is no way to know that. OTOH I think the immediate downside if any is very limited - we should get at the very least a substantial correction in the form of a wave X upwards first. So here are the scenarios in order of my subjective probability:

1. Correction is complete go into wave 3 up.

2. Correction is not complete - is just wave A or W of a three wave flat or complex sideways correction that will take another 1 1/2 years to play out.

3. Correction is not complete - is just wave A, the first wave of a five wave triangle that will last another 2 1/2 years or so.

4. Correction is not complete - the correction is the first abc of a correction with much more downside to go - following a wave X up there will be another abc zig-zagging downwards.

My reasoning behind this ordering (and maybe you can think of more scenarios) is that:

1. I believe the recession in the US will be relatively shallow as in 1990 and that the effects have largely been priced in by the market. See the chart of the 1990 stockmarket I posted previously.

2. Stocks are not significantly overvalued as they were in 2000 - such a deep bearmarket is not neccessary to get to reasonable valuations.

3. 2008 is a presidential year when stocks usually do well.

As an example of the relatively unpredictive nature of counts, I also posted a short-term E-Wave count. That count was that the entire correction from the July top was an ABC flat correction. This implied that the January 23rd low should be taken out by the final wave 5 of C. I no longer think this is the most likely scenario (though I labeled the correction in the longer term count ABC too - that's probably a mistake). Rather the correction would be WXY where each wave has three subwaves with wave Y ending on January 23rd. We still could see a lower low, but it probably won't exceed the January low by much. Elliott Wave does give you an idea about more or less likely outcomes.

More Buying

Adding another 4% to stocks. Old stalwarts: NNDS, BWLD, RICK and SHLD a new one. Have mixed thoughts on that latter one but fits my LTR, LUK, BRK/B theme. I wouldn't buy it to buy a retailer per se. Now have 20 US listed stocks. Analyst Brean Murray commenced coverage of 3SBio at "buy". Doesn't seem to be doing much for the stock yet though.

New Investments

Made new investments in PowerShares WilderHill Clean Energy (PBW) and 3SBio (SSRX). The former is an ETF seemed the easiest way of buying into alternative energy rather than trying to pick which technology is going to succeed in the long run. Of the available ETFs this seemed to have the best global coverage of the industry. 3SBio is a small Chinese pharmaceutical company that seems to have good growth prospects and a beaten down share price after missing a recent profit forecast. I found this one after asking on a Silicon Investor forum what stocks people would recommend if I could only buy one for a Roth IRA and investigating the suggestions.

I've been buying back into other stuff too, like Google and Interactive Brokers. My US portfolio now includes:

AAPL
BRK/B
BTF
FF
FLIP
GOOG
HCBK
HSGFX
IBKR
LTR
LUK
NCT
PBW
PSPT
SAFT
SSRX
TFSMX
XLF

Rob Hanna's CBI Indicator Hits 15

Rob Hanna's CBI indicator is now above 15 a level only seen previously in September 01, July 02, and August 98.... It means a bottom at hand, though the market could still go down and the indicator higher before bottoming.

Challenger Infrastructure Fund Receives Takeover Offer

One of my investments, Challenger Infrastructure Fund has received a takeover offer. The offer is from Arkmile Investments who already own 19% of the fund. Arkmile is associated with the British based Tchenguiz family. The offer is for $A3.50 per share, while the stock is currently trading at $A2.44. I wish I had the money to buy more, but I don't really. Anyway, this would return us nearer to net asset value which was $A4.05 at December 31st. I expect the board will try to get a bit higher offer. My average price after considering distributions received is $A2.90. So I'm underwater now but this offer if realised would result in a profit for this investment. Expect more such takeovers of undervalued exchange listed closed end funds. Another of my holdings Everest Brown and Babcock Investment Trust (EBB.AX) which is a listed fund of hedge funds is seeing accumulation by hedge funds. Ideally, I'd like to see these investments return closer to NAV and continue to be listed. Second best is a takeover of this type and an exit from the investment.

P.S.

The shares have reopened for trading, last price $A3.20. One little piece of good news in all the gloom.

Thoughts on Market Timing

I often read in the PF blogosphere or personal finance websites: "It's impossible to time the market, so you shouldn't try". This is a gross distortion of what the data show. The data show that mutual fund investors lose from market timing. The biggest fund inflows tend to come towards peaks in the market and the biggest outflows towards troughs in the market. Alpha - risk-adjusted excess returns are a zero sum game and if some class of investors is losing another must be gaining. The gainers are going to be companies that issue and buy back stock, hedge funds, and sophisticated individuals. Research shows that companies gain from market timing. Obviously some hedge funds too. But if we know that companies can market time, why can't individuals? They can, but most individual investors lose from market timing. Mutual fund managers will try to discourage you from market timing because they hate having to invest money according to their mandate when prices are high and give it back when prices are low. So the mainstream financial industry has a vested interest in getting you to buy and hold.

Recession is Local Too

USA Today has a nice map of economic conditions across the US - I've see a similar map somewhere else recently. Some parts of the US economy are doing fine, others are clearly in recession, which is one reason why it is hard to say whether the country as a whole is in recession and maybe if it is the recession could be mild?

Adding to TFS Market Neutral Fund

I'm adding $5000 from the inheritance money I received to my investment in the TFS Market Neutral Fund. It's performed very nicely recently unlike last August in the quant fund meltdown. This has increased my confidence in the fund. I'll now have 2.5% of net worth in the fund. It will take the "hedge fund" category of my "passive alpha" investments up to 13% of net worth. The remaining $3000 or so will go towards helping pay my U.S. taxes and in the future will probably be transferred to one of my US trading accounts. I don't want to add any more money to them until I reach my annual goal of breakeven on the money invested in them. My Mom also added £1000 as a wedding present. I'll keep that in my HSBC savings account for special purchases. A food mixer is on the buy list to help Snork Maiden make bread.

Does Warren Buffett have Investment Skill?

The outstanding performance of Berkshire Hathaway's stock price and book value over time is well known as is more anecdotally the performance of Berkshire's stock investments. It's very straight forward to compute an alpha and beta for the company's performance - I think alpha is around 10% - but much harder to examine the performance of Berkshire's equity investments. This is because Berkshire is mainly an operating business - insurance companies and non-insurance subsidiaries and only secondarily an investment vehicle.

A recent paper claims to be the first academic study to do so. They come up with an excess return of 6.5% to 12% depending on the benchmark. They do a whole bunch of other tests including comparing performance to a Monte Carlo simulation meant to model the differing levels of luck of different investment managers. Under reasonable assumptions, Buffett has done better than even the most lucky manager would assuming no-one has any excess investment skill. The authors also construct a mimicking portfolio which buys and sells the shares that BRK trades only when the trades are publicly disclosed. This portfolio does almost as well as the BRK portfolio. This means that copying Buffett is worthwhile and violates even a broad definition efficient market theory. Even if Buffett is rewarded for uncovering and interpreting profitable information the disclosure should result in that information being instantly priced into the market. But the mimicking portfolio assumes that you buy or sell the same stocks as Buffett only at the end of the calendar month in which the disclosure is made!

Ameritrade Fees

I just noticed that Ameritrade upped my fees from $7 per trade to $9.99 at the start of this month without any notification. I queried whether this was correct and also pointed out that higher fees would cause me to make more trades with Interactive Brokers instead :) Let's see what they do. On another note, I switched roughly 1/4 of my holding of CREF Bond Fund to CREF Global Equities at today's close. And I bought some XLF.

P.S. Sunday, 9th March

Here is Ameritrade's response:

"David Stern,

Thank you for contacting TD AMERITRADE.

Your account was previously on a temporary promotional commission schedule to receive $7.00 online commissions for 1 year. Your promotional period has ended; however, we will return your account to the $7.00 commission schedule. We hope that moving forward we can earn more of your business.

Have a good day.

xxxx xxxx
Apex Client Services, TD AMERITRADE
Division of TD AMERITRADE, Inc."

Very good!

There are several features of Ameritrade that Interactive Brokers do not provide that I like, which is why it is worth maintaining the two accounts:

1. Dow Jones news service free for Apex customers - need to average 5 trades per month or have $100k in assets.

2. The streamer includes a mini-charts that have trade by trade action, which are really cool.

3. They can have custody of mutual funds, which IB can't. The $50 fee for trading a mutual fund though is very steep.

The downsides are:

1. Even a $7 fee is high compared to the $1 that IB charge for 100-200 US shares. (The $A30-40 fees I have to pay CommSec in Australia are just outrageous by comparison. Ameritrade is cheaper than IB for trading larger numbers of shares - say 2000 QQQQs or whatever.

2. The margin interest rate is much higher than IB.

3. IB offers futures and non-US stocks.

4. IB's Trader Workstation is much better for entering orders while day trading like changing stops. To change a stop you remain entirely on the same screen that is displaying the data feed. In Ameritrade you have to go to another browser window entirely (order status) and then do a refresh to see that the change has been accepted. This is fine for longer term trades but not for fast daytrading.

But it is certainly worth having two brokers in case of problems.

People tell me that IB's customer service is terrible, but my experience of it is pretty good. Ameritrade, however, win in flexibility.

Made the Switch

I switched 1/3 of my Australian superannuation account from the CFS Conservative Option to the CFS Geared Share Option and 1/2 of a non-margined non-retirement account from the CFS Conservative Fund to the CFS Geared Share Fund. After the move our asset allocation looks roughly like this (not all numbers up to date):



As the fund I just switched into is levered, our exposure to stocks is actually greater than 51%. The estimated beta of the portfolio after the move is 0.71. But it's probably more than that as I've discussed before.

BTW, this transaction results in a capital loss of about $A1,800.

Should I Start to Buy?

I was surprised by today's fall in US markets - the forecast of an uptrend over the next few days remains intact for the NDX but the SPX entered oversold territory and tomorrow's signal is sell rather than buy - or rather hold your short don't initiate a long. Using my much older "autoregressive model" (the newer model is called the "stochastic model") buy signals have popped up on the weekly charts for the NDX, SPX, and All Ords There is a buy on the daily chart for the NDX (but not for SPX and AORD). Enough Wealth said yesterday that he was going to buy more units in the Colonial First State Geared Share Fund. This is an actively managed levered fund. I've planned to switch money from the Colonial First State Conservative Fund to the Geared Share Fund at some point. I also plan to switch funds in my TIAA-CREF 403b from the Bond Fund to Global Equities. Yesterday, I made the decision to invest more of my Mom's money in stocks (that was only a 4% shift though). So what I am thinking about now is starting a program of gradually making the mutual fund shift, perhaps a quarter of the account each time on the basis that it is possible to market time, but hitting the exact bottom is very hard or impossible. I'll read some more opinion to get a feel for sentiment before doing even this though.

New York State Tax

I've now done the computations for my NYS tax. I'm filing as a part year resident as I moved to Australia on 13th September. However, because I was losing money trading in the latter part of the year my NYS AGI (adjusted gross income) is almost as great as my federal AGI ($51,413 vs. $52,222). My total taxes come to $2652 but only $1588 was withheld. So including a 44.31 estimate tax penalty I owe $1108.

Portfolio Performance

In my ongoing evaluation of my Mom's portfolio I've calculated some annualised rate of return * performance figures:



I don't have data for every month but I do have data for four out of the last five Marches, which allows me to calculate the numbers in the table. In the last one, two, or three years we have performed favorably compared to the S&P 500 index. It's not surprising that the portfolio underperforms the SPX over five years due to its low equity content. In the first two years of the bull market we gained 11% p.a. which was below the SPX performance in those years. 8% p.a. is probably an acceptable return for a portfolio of this sort in the long-term, but it would be nice if we can increase it. OTOH we nicely beat the average hedge fund, which only earned 6.5% p.a. in 2003-2007.

* Rate of return for Moominmama's portfolio is simply the growth rate of the portfolio - so this is an after tax and net spending/saving figure. Moominmama receives some pension income which covers day to day expenses so usually there isn't much draw on the portfolio. Moom's rate of return is pre-tax and obviously doesn't include saving or spending effects.

Trading Update

Each morning I sketch out a game plan for what I think the Australian Share Price Index will do in the first part of the day. I am getting good at getting it right but finding it hard to pull the trigger since my first successful trade. Today for example the model is calling an uptrend and so I don't really want to go short. My game plan was for the market to open up, then sell off (because stochastics were topping out) and then maybe have a renewed rally later in the day. The first two parts happened, but I missed the rally because it's hard to be sure what's happening in the first few minutes and missed the short, because, well, I didn't want to go short. I'm reluctant to long now because the Japanese market seems to be trending down to close its opening gap.... Seems like there is always a reason not to do something.

On a more positive note I added another swing trade in the US - long Interactive Brokers. These trades are very small. Below the level where I could get worried about losing money. I think I have to gradually build up a profitable trading record with small size before going to larger size and maybe more trades down the road.

U.S. Federal Taxes

I did all the calculations for my US federal taxes yesterday for 2007. I owe them $556 which is below the $1000 threshold where a penalty applies at least. Total federal tax for the year was $5888 on an AGI of $52,223 or a rate of 11.3%. My AGI was reduced by around $7,750 due to my maxing out my 403b in the first six months of the year. Of the remaining AGI, 57% came from wages and salary. Interest, dividends, and capital gains were all up on last year. I had $11,533 of qualified dividends and long-term capital gains taxed at a maximum rate of 15%. The remaining $30,949 of taxable income was also subject to a maximum marginal rate of 15%.

Now on to the New York State form.

At this rate we'll need to file an extension for Snork Maiden's US taxes. We still need to get her W-2 and some other documentation. I can either file for her as a dual-status alien who was non-resident at the end of the year or as a US resident for the year with the exclusion for foreign earned income using form 2555. The latter might be simpler.

We'll have this fun all over again later in the year when I do both our Australian taxes for the 2007-2008 tax year (ends 30th June). But at least we won't have to file US tax forms next year (or hopefully ever again!).

Changing Portfolio Mix

The chart shows the composition of my Mom's portfolio over the last 5 years. The main trend has been a reduction in the allocation to cash. The portfolio she inherited from my father, who died in 2002, was very heavy in cash. It had between one and a half and two times as much in equities as the March 2003 position, but no alternative investments and little if anything allocated to bonds. The equities were in a separately managed account with a UK broker who wasn't exactly much good... By March 2003 we had about half the portfolio in an account with a well known investment bank, the rest mainly in cash and mainly in Sterling. Over time we shifted more to the investment bank, then changed banks and allocated part of the portfolio to a small independent broker who provides access to US based separately managed accounts. In late 2005 I prematurely reduced our equity allocation (with the pretext of rebalancing) and increased our bond allocation. Since then we have increased the equity allocation further through the independent broker.

Our next major change to the portfolio I think should be to reduce the bond allocation. I don't see bonds performing as well going forward as they have in the last 25 years or so. There is a limit to how low interest rates can go so that yields are now low and capital gains unlikely. The question is how to reallocate the money now in bonds. My Dad's approach was very conservative in his later years, which isn't surprising as he was 15 years older than my mother. But it is a mistake to allocate a portfolio based on your age alone when you are leaving it to family members who are much younger. My father was a much more aggressive investor when he was younger (and poorer). So it is probably also a mistake to allocate the portfolio based on my mother's age alone (Seventy-six). Rather we should think like a university endowment or similar fund.

On the other hand the 110 rule of thumb implies that a 76 year old should have 34% of their portfolio in stocks and we only have 26% actually even now. So we can certainly increase our allocation to stocks further without doing anything unusual. On the other hand, including our alternative investments in the stock category puts us at 46% in higher expected return assets.

How low should we go with the bonds? Given we have 17% in cash?

P.S.

I started a new category today "Family Finance" to cover the finances of our extended family.

International Equity Managers: The Data

This is a synopsis of the key data I received on the three potential international equity managers. In a "wrap account" of this type we pay the same fees irrespective of the manager we choose. We pay less percentagewise as our account gets bigger. From this data it is a pretty clearcut case, in my opinion. Thomas White is the best manager. Though McKinley did very well in 2007 their longer term performance is less attractive. My main question is: "If Thomas White are so good, why are they so small?" (being small probably helps them be good). The portfolio was founded in 1991, so they have had time to grow. However, the firm also has other assets under management including two mutual funds - total assets are on the order of $1 billion. The figures for the other two managers are total assets under management, not just in the program in question (Neuberger-Berman is a division of Lehman Brothers while the other two firms are employee-owned).

From the blurb:

"All of the company's portfolios share a common value-oriented
investment philosophy and process. The basis of its investment process
is in-house stock research produced by the company's research division,
the Global Capital Institute. The Institute is recognized worldwide for its
expertise in valuing domestic and international companies. Initially
designed for Sir John Templeton in 1976 by Tom White and his
associates, the firm sells this research to several of the world's largest
investment managers."

Thomas White's international mutual fund. TWWDX has lost 9.4% YTD, so their down capture ratio in this period has been much worse. Portfolio turnover for this fund is 46% which is acceptable.

Neuberger-Neuman's blurb would describe the process of most mutual funds. The managed account only invests in ADRs. Their international mutual fund's performance bears no relation to that of the managed account, so no insight is possible there.

McKinley uses a quantitative growth approach - they claim to apply "modern portfolio theory" to finding inefficiently priced securities. I wonder whether this puts too tight of a straightjacket on their ability to find value? Digging into McKinley's website, I found that the portfolio in question is also in fact a growth oriented ADR portfolio. As you can see from the pdf it is rather volatile. Since inception the fund outperformed the market strongly- 11.26% p.a. vs. 8.4% p.a. and had an alpha of about 3.3% and beta just above one. But this result is largely due to the first two strong years when the fund was probably much smaller than today. Performance has declined despite 2007's excellent results.

I'd like to be able to see results for January for McKinley and Neuberger-Neuman before making a decision but that would mean waiting another couple of months to invest as data is released quarterly. Given the information available, I'm deciding to invest with Thomas White.

Trading Update for Tuesday

With the NDX up today, we don't look like getting to oversold in this round and with Thursday still forecast as an up day and the Wednesday effect perhaps bringing that forward a day, seems it is the time to get long again. In fact one of my indicators for the SPX is formally long for Wednesday. So I sold my Beazer puts and bought some Google shares near the close. Google's chart looks like it could have bottomed for this bear market or at least for a little while. There are a nice five waves down from the February high. Still, I'm treating this as a trade.

In case you think mid to late March is still too early for calling a bear market bottom, Bespoke point out that most stocks are already in serious bear market territory. Energy and a few large caps are holding the indices up.

New Investment for my Mom

Occasionally, I've mentioned that I advise my Mom on investing. We've now completed our allocation of funds to the Aletheia separately managed account - we initially invested the minimum $100k and then added $10k a month for ten months. Dollar cost averaging paid off with the combined value of our Aletheia and money market accounts with this firm having gained 2% while the S&P 500 lost about 5% over the same period. Aletheia is a manager of US shares. I now plan to add an international equities manager. We will initially invest $100k and then over time will likely transfer some money from our other accounts to reach $200k invested with this second manager too. We have $58k in a money market account that we could transfer right away. We also have a structured investment note that will mature this year (this is similar to the Man investment I discussed). We could move $50k of that and reinvest the rest in another alternative investment to be advised by UBS.

I recently reviewed my Mom's investments for the first time since May 2007 (my mother brought out to Australia a required security device for accessing one of the accounts). We are about flat with May 2007 currently performancewise. Everything is doing fine with one glaring exception. A Janus short-term bond fund that is supposedly down 27% since May. The only way this could be true is if they stuffed a huge chunk of the fund into short-term mortgage backed securities of dubious quality. It appears, though, that the reason the fund is down is because the price of the class of fund we own is quoted in Euros and UBS's account display is forgetting to convert this fund from Euros to US Dollars! I'm getting my Mom to follow this up with UBS. Check that your broker is using the right data if you find any discrepancies like this!

I'll report more on the international managers in another post.

SPI Trading: Day 2

I planned to do live trading again today. My idea about what would happen at the open was correct - A pop up followed by a decline, but I missed the shorting opportunities, the first time because of caution and the second time because of inattention. Then I tried some simulated trades and lost three times in a row (-$10, -$185, -$225). No disasters, but I knew these were low probability trades, which is why I didn't try them with real money.

On the investing side, we are getting close to the potential buy point. The model is signalling Thursday as the beginning of an uptrend in NDX, SPX, and AORD. The Wednesday effect means that this could be brought forward. However, if we get into oversold territory then all bets are off until the market decides to reverse itself. The lowest my proprietary stochastic for the NDX can go on Tuesday is 23.4. But then even a decent 15 point bounce on Wednesday would still leave us oversold. But if the market falls less on Tuesday then even a small bounce will keep us out of oversold on Wednesday and then the reversal would be intact for Thursday.

NDX is getting close to the January lows but, based on the triangle formation since the January low, we should expect a low of 1610-ish. SPX is further from its lows. Stochastics on the weekly charts have also crossed and are now moving down, which is a necessary precondition for a meaningful low. The All Ordinaries is behaving very much like the SPX.

Bottom-line - if the market only sells off a little on Tuesday expect a bounce starting Wednesday. This week will not be the ultimate low. A strong sell-off on Tuesday is likely to result in the current downtrend producing the ultimate low for this bear market.