Croesus Mining Rises from the Dead

The stock will again be traded on the ASX from 9th May. My shares are likely worth only $20 or so. After the capital reconstruction I have 2666 shares and new shares have been issued at around 1 cent per share. Though I already wrote them down to zero in my accounts. When the company last traded in March 2006 they were worth upwards of $A11,000.

First task will be to make sure that Commonwealth Securities reinstates my shareholding correctly. I probably don't need the capital loss this year (my current taxable net gain is $A589) unless my Australian managed funds distribute significant capital gains on 30th June but I guess I might as well sell and then carry forward the excess capital loss to next year. Last year, though, my funds distributed $A12,000 in capital gains. But as most of that was long-term gains, only $A6,600 would have been taxable in Australia (I lived in the US at the time). After this year's negative share price performance I doubt distributed gains will be so high.

I'm expecting my Australian tax bill to be zero for 2007-8 (Australian tax years run from July 1st to June 30th the next year). My tax liability on dividends will be wiped out by interest deductions and franking credits (in Australia we get credits for corporation tax paid by the company paying the dividend to avoid double taxation, unlike C-corporations in the US). Snork Maiden will certainly get a refund as she didn't work till October 1st and if my bill is zero she should be able to claim me as a dependent. An additional advantage of a zero tax bill is that I won't have to pay quarterly estimated tax payments during 2008-9 (I think).

Monthly Report: April 2008

This month I'm trying out a new format, which focuses on how we are doing in meeting our annual goals. Other statistics appear towards the end of the report. All amounts are in U.S. Dollars unless otherwise stated.

1. Net Worth Goal: Reaching $500k We made progress on this goal as net worth again rose over $450k. Net worth rose by $US33,685 to $US466,625 and in Australian Dollars rose $A21,318 to $A495,461. The US dollar gain is my largest ever. USD results were strongly boosted by the rise in the Australian Dollar.

2. Alpha Goal: Alpha of 8.5% The point of this goal is to earn at least an average wage from risk-adjusted excess returns. Using a regression on the last 36 months of returns gives a beta of 0.71 to the MSCI or 0.58 to the SPX. Alphas are 5.26% and 10.32% respectively. A more sophisticated time-series method yields a beta of 0.91 and an alpha of 9.62% for the MSCI index, which meets our annual goal. The risk adjusted excess return for April based on the latter analysis was 2.58%. Multiplying this by net worth gives an income of $11,624. For the year so far the risk-adjusted excess return in dollar terms has been $21,952. Using the estimate of alpha the smoothed annual income is $43,300. In Australian Dollars terms returns are somewhat lower, while they are higher using the S&P 500 as a benchmark.

3. Increasing Non-Retirement Net Worth by More than the MSCI Index The point of this goal is to make sure that we only spend out of non-investment income and excess returns and don't use the normal market return on investments to fund spending. In other words, this makes sure we have positive saving. Non-retirement accounts rose by 10.07%, while the MSCI index rose by 5.65% So far this year these accounts have grown by 3.99% in excess of the MSCI return.

4. Achieving Break-Even on U.S. Taxable Accounts At the end of the month we were $559 from the breakeven point with a gain of $5,379 for the month. The rate of return on these accounts was 7.68%. Following the month's close we met this goal. The chart shows the remaining gap to reaching breakeven over the last year and a half:



5. Making More Money from Trading Than in 2008 Realised gains this month were $915 and so far this year $2,062. I've now had three positive months in a row. Futures trading though has not been going well, but I have been making money trading stocks and options. Last year I made $9,500 from active trading. Currently, I'm lagging behind last year's performance but I think the goal still may be achievable.

Background Statistics

Income and Expenditure



Expenditure was $3,996 in line with recent numbers. Spending included $334 of implicit car expenses - depreciation and interest. Snork Maiden was paid three times this month and Moom paid his New York State Taxes, which we treat as negative income :(

Non-retirement accounts gained $21,661 with the rise in the Australian Dollar contributing $6,201. Retirement accounts gained $11,911 but would have gained only $7,108 without the change in exchange rates.

Investment Performance

Investment return in US Dollars was 7.75% vs. a 5.65% gain in the MSCI (Gross) All Country World Index, which I use as my overall benchmark and a 4.87% in the S&P 500 total return index. Returns in Australian Dollars and currency neutral terms were 4.47% and 5.21% respectively. So far this year we have gained 2.58%, while the MSCI and S&P 500 have lost 4.04% and 5.03%, respectively.

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



The returns on all the individual investments are net of foreign exchange movements. There are no clear patterns this month in what gained and what lost. The biggest gain was in the CFS Geared Share Fund which is our biggest investment. Australian listed hedge funds such as Everest Brown and Babcock and Platinum Capital began to recover from steep discounts to book value.

Asset Allocation

I completed the switch from bonds to stocks this month and we are now as long stocks as I think we will ever be.

Allocation was 40% in "passive alpha", 71% in "beta", 3% allocated to trading, 5% to industrial stocks, 3% to liquidity, 3% to other assets and we were borrowing 25%. Our currency exposures were roughly 55% Australian Dollar, 23% US Dollar, and 22% Other. In terms of asset classes, the distribution was:



Due to the use of leveraged funds, our actual exposure to stocks was 113% of net worth.

How Well Do Leveraged ETFs Track Their Benchmarks?

There's been some debate on and off about how well various ETFs track their underlying benchmarks. Debate has focused on commodity, currency, and leveraged ETFs. For example, CNY - the recently issued ETN for the Renminbi - has gone down recently as the RMB continued to revalue relative to the USD. The reason is that the ETN is tracking the RMB futures traded on the Chicago Mercantile Exchange. Those futures also declined in value during the relevant period. People have also questioned whether QID, QLD, SSO and other leveraged ETFs track their underlying indices. For example, this discussion on Roger Nusbaum's blog about SSO, which attempts to return twice the S&P 500's return. I made some comments but I was getting confused and so I decided to do a statistical analysis to answer this question definitively.

I downloaded daily prices for SPY and and SSO from Yahoo Finance and computed the daily percentage returns since 21 June 2006 for both ETFs (N=469). I used Yahoo's adjusted prices, which account for distributions paid. I then regressed the daily returns for SSO on those for SPY. The results: the slope coefficient (equal to CAPM beta) = 1.99 and the intercept coefficient = -0.000225. Converting this daily intercept to an annual intercept results in a value of -5.4%. The R-squared in the regression is 0.98:



So in terms of reproducing two times the index, this fund is very good with a beta of 1.99. But why does it have an intercept of -5.4%? One factor is the higher expense ratio of SSO - 0.95% vs. 0.08% for SPY. The remaining intercept term is -4.53%. This appears to be because I didn't subtract a risk-free rate from the returns as is usually done for CAPM regressions and it represents the implicit borrowing costs of the fund. The basic CAPM equation is:



where r is the rate of return (of SSO in this case), f the risk free rate, and m the market rate of return (here SPY). Rearranging we get:



For SSO beta is 2 and, therefore, the intercept term in my regression is equal to the sum of the true CAPM alpha (here negative due to the higher expense ratio) and the negative of the risk free rate. 4.5% sounds about right for the average risk free rate over this period.

The bottom-line: SSO appears to track SPY leveraged two times as well as can be expected taking into account higher expenses and borrowing costs.

Achieved One Annual Goal

As you can see in the righthand column, I've achieved one of my five annual goals - that of reaching breakeven on my U.S. investment/trading accounts - trading accounts at Ameritrade and Interactive Brokers, my Roth IRA and my holding in the TFS capital mutual fund. I first began investing in the US back in 1997 and have kept a record of how much money has gone into those accounts - until now I have mostly been in deficit - i.e. I've suffered a net loss. Finally, I've recouped my investment - kind of like my tuition fees for learning about trading etc. Of course when compared with inflation or the returns on an index fund I'm still losing. To match the NASDAQ 100 index since August 1997 I'd need to show an 80% gain. Luckily, I've more than made up for this poor performance in retirement accounts and Australian trading accounts. Performance in the last 1 1/2 years has been pretty good (alpha = 25%):



The challenge now is to hold on to these gains in the next few months. My very short-term trading is still not going well. I had another bad loss on May 1st - though not as bad as the one on April 1st. Maybe I should just keep away from trading on the first day of the month!

On Friday we also made progress on Snork Maiden's immigration process. We need to get a police check from the FBI in the US and to do this we need to send them her fingerprints. Seems that the only people who can do that here are the police, but there is a two month waiting list in Canberra! Nearby locations in New South Wales refuse to do this for ACT residents. We finally got the Goulburn, NSW police to agree to do it and headed up there (about 85km away) on Friday afternoon to successfully accomplish the mission. Goulburn is also the home of the "Big Merino" (one of Australia's many "big things"), shown above while moving to its current location. There's a "wool museum" inside and a gift shop alongside of course.

How Popular are Various Option Strategies?

Lakonishok J., I. Lee, N. D. Pearson, and A. M. Poteshman (2007) Option market activity, The Review of Financial Studies 20(3): 813-857.

I've been searching for more papers on put trading but there only seem to be a few out there with more or less the same message. I came across the fascinating paper cited above in this process. The authors analyse CBOE data for the period from 1990 through the end of 2001 that is disaggregated according to type of investor: proprietary traders, full-service broker clients, discount broker clients, and other public clients (which includes foreigners, unassigned trades etc.). When you trade in the options market you are trading against a market maker - your trade does not have to be matched by another public client. So the public has unbalanced amounts of written and bought calls and options, which are balanced by market-maker positions. The most popular strategy in this period was writing calls, followed by buying calls, writing puts, and buying puts. Most trades were bets on direction of the market rather than hedging transactions. Also writing and buying of straddles and strangles, which are trades on volatility, was a very small part of total activity. So, surprisingly, contrary to popular wisdom, market makers are net buyers of options! Discount customers increased their purchases of calls over the period (one not surprising result) but also increased their put writing.

Given the lack of popularity of buying puts, the empirical high price of puts is all the more surprising.

Sold Call Options on BWLD

Sold a couple of May covered call options on BWLD. From a realised gain perspective it's a certain win - I bought the stock at less than $25 and I received $2 per option. So if the stock is called I make a gain on the options and the stock and if the options expire worthless I just make a gain on the options. From a true economic perspective, though, I lose notionally if the stock expires above $27 or below $23. But even that isn't so clear cut, as maybe I would have sold anyway before the stock reached $27 if I hadn't sold the options (in the case where the stock is destined to keep rallying) and yesterday the stock was above $25 and I could have just sold then which will have been better than selling the option at expiration prices less than $2 below yesterday's price ($24 and below - assuming the stock is destined to fall). Sometimes, working out what the opportunity cost is is not so clear cut. Taken to the extreme, the opportunity cost of making any investment is not investing in the best performing asset available. But would you have really invested in that other asset?

The model is very unclear here about direction. I am guesstimating that a steeper downtrend will start around the FOMC announcement on Wednesday before the next leg of the rally gets underway. Towards the bottom of any downtrend I'll start implementing my put selling strategy.

White Swan Trading

A much simpler to understand study about the profitability of selling put options. I've sold options in the past - several years ago - and am thinking of doing so again in a small way. Selling a put credit spread - selling a put option and buying a more out of the money put - is safer as you buy insurance against a market crash while selling insurance against a small market dip. This reduces returns and increases the probability of losing money but eliminates the possibility of losing big. I'm thinking of entering these transactions in stages using my model to find optimal points to sell and buy. I'll sell some puts in order to acquire stocks and also sell index puts.

I was very interested in the iron condor strategy, but after research over the weekend it looks a lot less attractive. The iron condor involves selling a put credit spread as described above and also selling a call credit spread. A call credit spread means you sell a call option and buy one further out of the money in order to insure against a runaway market rally. (Selling a call option means giving someone the right to buy the stock from you - if you don't own the stock you need to go into the market and buy it at the current price. This is costly if the market rises a lot. From an economic perspective it actually doesn't matter whether you own the stock already or not as selling a stock at less than the market price to someone has an opportunity cost).

The interesting thing about the iron condor (I am assuming that both the sold put and call are at the same strike price) is that the maximum amount you can lose is less than the maximum you can lose from the put spread and the maximum profit is higher than the maximum profit from the put spread. This sounds like a "free lunch", which economics tells us does not exist :) The reason is that you keep the credit from both options transactions but only one of the sold options can end up in the money at expiry. With the put spread you only have one credit and so when you lose you lose bigger and when you win you win smaller. But, alas, there is no free lunch. The probability of a loss is now more than doubled! And the probability of getting the maximum profit has declined from more than 50% to near zero. In the case of the put spread you only lose if the market goes down. But with the iron condor you might lose if the market goes up or down. And in the long run the stock market tends to go up. Therefore, the probability of loss is more than doubled. And, in the case of the put spread as long as the market is above the sold put strike at expiry you make the maximum profit. Which happens more than 50% of the time (if you enter the market randomly). But in the case of the Iron Condor, you only get the maximum profit if the market is exactly at the strike price at expiry, which has a low probability.

The Iron Condor looks like a win-win to the naive observer, but deeper analysis shows that selling put spreads and naked puts has a higher expected return.

There is an interesting reference at the end of the article to Nassim Taleb's black swan strategy, which involves buying out of the money puts and suffering through many small losses in the hope of scoring the occasional big win on a market collapse. It's interesting that Taleb doesn't provide any evidence of his strategy's returns. The academic evidence on put selling involves selling near or at the money puts. Perhaps a buying strategy works if the puts involved are sufficiently out of the money? Michael Statsny argues that the black swan strategy doesn't work. By contrast, the white swan strategy involves collecting regular profits and occasionally taking a big hit. Famously, Victor Niederhoffer blew up from put selling. This can be avoided by not using too much leverage. You should never sell more puts than you'd be willing to buy stocks even if margin requirements allow you to. The same goes for futures trading and options buying.

How Good Do You Have to Be to Make Money by Shorting?

I was reading this interesting paper on returns to option strategies (heavy econ paper) and was thinking about how good a trader needs to be to make money from shorting stocks. The expected return in the long run from buying stocks is something like 10%. Therefore, the expected return from shorting stocks is -10%. In order to make any money at all from shorting - i.e. beat a checking account - you need to have an alpha - an average excess return - of 10%! To beat the market by shorting you need to have an alpha of 20%! I raised a lot of skepticism when I suggested that my alpha was 9%. Buying puts has similar implications. Selling puts is, however, on average, a money-making strategy. The paper finds that buying puts loses money even more effectively than shorting stocks. The problem with selling puts is the risk of a crash - you need to have some very good risk control in place. Selling puts also is psychologically difficult -the downside maximum loss is potentially very large and uncertain with a limited and known upside, even though the mean return is positive.

By the way selling calls is also a losing strategy - selling covered calls doesn't "add income" - it reduces expected returns.

Not Only Bloggers are More Open About Money

Contrast this with a boomer Australian friend that told me not to ask people what suburb (neighborhood) they live in, because that will tell you how well off they are.

Is the Market About to Break Through Resistance?

The market is very strong. Prices are going up while stochastics are falling:



The market is achieving this by pushing ahead to new highs intraday and then falling back. This means that the market closes lower relative to the now extended recent range and the stochastics which measure price relative to the recent range fall, though price itself is higher than the previous day. Everytime I sell to take profits, the stock seems to go higher (e.g. Apple). Going short is particularly hazardous. Yesterday I made a little money on some SPI puts but happy I closed the position.

SPX and many other indices are bumping up against a major resistance line that provided support last year:



Basic technical analysis says that if the line is breached we should go back to the old highs. With the market this strong, a breakthrough seems likely next week. Now probably the market will fall just to prove me wrong :)

Back to Square One in Futures Trading

Don't pass go and don't collect £200.

That was a phrase on one of the cards in the Monopoly Game we played when I was growing up. After a year and a half of futures trading I'm pretty much back to square one, moneywise, at less than $200 in profit. At one point I was up $9,000, though I was also down $2,000:



I've lost trading all contracts apart from the NQ E-Mini NASDAQ.



This month, though, I'm losing in them and doing OK on the other contracts. In the meantime, I've been doing OK trading stocks and options, which has turned around my trading performance in the last few months. I'm going to keep trying. I know what to do, but still am not quite doing it right. Most of this month's loss was in a single trade on 1st April where I completely lost control. I've been reading the story of Jesse Livermore. He blew up many times, early on (and apparently later), and kept coming back. I haven't blown up that bad, but I haven't been up in the way he was either, because I don't take those kind of risks.

BHP

I realised that about 8% of our net worth is invested in one company: BHP Billiton. This is because we have 35% of net worth in the Colonial First State Geared Share Fund which has 11%+ (at the end of 2007) in this stock - and because the fund is levered, the actual exposure is near double the stated number. Then we also own shares in the CFS Global Resources Fund, which is also invested in BHP, and our other Australian funds undoubtedly also have exposure to BHP given its weight in the Australian stock market. This seems a lot to have in one company, given my guideline to have less than 2% in any individual company stock (except listed funds). You can try to diversify via mutual funds but then end up less diversified than you expect.

Is this a problem? Obviously, a big theme that has done well in recent years is investing in resources. And many would recommend investing in BHP. BHP is very diversified across resources and geographical locations so there is less concern than there might be in most cases in investing in a single company.

But, its price earnings ratio is 17 and free cash flow is only about half earnings. That seems very pricey. According to Yahoo, analysts are not forecasting much earnings growth going forward. That actually seems rather strange to me given the increases in iron ore and coal prices that are underway. So I checked up on Australian analysts' reports through my broker, CommSec.



These numbers are a lot more positive. Australian analysts are forecasting 36% profit growth for the 2008-9 financial year relative to 2007-8 and their forecasts have risen over the last three months. One analyst is forecasting 44% growth. That's reassuring. However, forecasts for the year ending 30th June 2008 are for only 4.6% growth over the previous year.

I guess if i was still worried about investing so much in BHP I could buy put options or short the stock to hedge my exposure. My feeling that that would be a losing trade, tells me that for the moment I am OK with this, I guess.

Reverse Adverse Selection

Interesting article in Freakonomics on "pay as you drive insurance". In the case of health insurance, those people who most need insurance are most likely to pay for it, while young healthy people are not. This adverse selection pushes up the price of insurance for those that have it (and is one advantage of a government mandated system or government provision). In this car insurance example, people who drive less would be given a discount, which will encourage low mileage drivers to sign up with the company who gives the discount, especially if they raised rates on high mileage drivers. Not all insurance risks are proportional to miles driven. The risk of the car being stolen for example only declines a little. Drivers who drive very little are likely to be more dangerous, but so are those that drive a lot if they are more likely to fall asleep etc on long distance journeys.

I wish we could pay less insurance for not driving much. Here third party damage insurance is paid through the government with our annual vehicle registration, though a private insurer covers the policy. Registration cost us $A760 or so for the year. We have separate insurance for loss or damage of our car, which cost a similar amount. It would be nice if the registration could be proportional to kilometres driven.

On other externalities discussed in our article, our car is not very fuel efficient. It has a 4 litre engine. As we don't drive much - Snork Maiden walks to work - I've joked that we are doing society a service by taking this large high carbon emissions vehicle off the road for most of the time :)

The Best Market-Timers are Bullish

The best market-timers are bullish on average and the worst are bearish on average currently. Yes, some market-timing gurus do beat the market. And those ones are currently bullish. However, they are fewer in number than all those bearish commentators out there who generally don't beat the market. So what does that tell you? :)

Today the Australian market was down. The only catalyst I could find was Brambles (BXB.AX) saying that Walmart might reduce its contract or something. Gold remained strong, oil remained strong. The Japanese and Hong Kong markets were up and U.S. futures, especially of the Q variety were strongly up following Google's earnings announcement, which I got up before 6am this morning Australian time to follow (just wish I had more GOOG :)). Given all this, I didn't see much risk in buying some SPI (ASX 200 Index) call warrants near the bottom today. I plan to sell them Monday either way. My model is pointing down for the Australian market but it looks like another double-peaked stochastic wave is taking shape, which has been pretty common lately. My position is only a fifth of the size of a SPI futures contract. So I feel very little fear trading this in comparison.

Great Article on the British Housing Market:

Great Article on the British Housing Market:. Click on the links. It's nuts that the average two bedroom apartment in inner Canberra costs about £185,000. But they are pretty nice compared to what you probably get for that "lowest price" property in East London mentioned in the article. One of the apartments in the building I grew up in in South London recently sold for £250,000. I remember my parents bought for £4,500 (1966) and sold for about £60,000 in 1995. That was an investment mistake. Would have been much better to rent it out (with an agent managing it).

And in Ireland a one bedroom apartment in a suburb of Dublin for $575,000 (£290,000 or $A620,000). Suddenly, Canberra looks cheap :)

Meanwhile in California:



On another note, Intel's earnings report has boosted the futures up. Maybe wave 3 from the March low is starting?

Gold and the Australian Dollar

Since November 2004 when the GLD gold ETF was introduced gold has had a beta of 0.92 to the Australian Dollar (not including interest) and an annual alpha of 18%. This is based on a regression on monthly data. In other words a 1% rise in the Aussie is associated with a 0.92% rise in gold. I was under the impression from looking at the charts that gold was more volatile than the Aussie. It is more volatile - the standard deviation is 4.58% vs. 2.87% but it isn't exaggerating the moves in the Australian Dollar. Rather the excess volatility is idiosyncratic to gold. On the other hand it has averaged a 1.84% a month return vs. 0.47% for the Aussie in USD terms. Interest would have almost doubled that monthly return for the currency though. So holding gold was a bit less than twice as good as holding the Australian Dollar. The MSCI returned 1.06% with a similar volatility to the AUD. For a US investor, Australian Dollars were about a wash with investing in a globally diversified stock portfolio during this period. Gold and the AUD had a negative correlation with stocks.

What this analysis means is that going forward this relationship between gold and the Aussie could be maintained without the Aussie appreciating and with gold rising at 18% per year. I think the Australian Dollar will remain strong in the near future, but it is hard to see it rising much more given purchasing power parity considerations and the fact that the Reserve Bank of Australia's next move is likely to be an interest rate cut. The Fed is likely near completion of its interest rate cuts. The recent rise in the Aussie has been driven both by Australia's strongly improving terms of trade and the rise in the interest rate differential between Australia and the US as the RBA raised rates and the Fed cut them. Coal and iron ore prices have recently jumped tremendously, but this move is not just due to demand growth in China and elsewhere but supply constraints in Australia and elsewhere (limited port facilities, floods in Queensland). David Uren wrote an interesting article yesterday in the Australian. The print version has charts of the marginal cost curve for iron ore supply to China. Even a small drop in demand would lower marginal cost and spot price radically. And supply is likely to increase. So the record prices for these two resources are not sustainable. Oil and gold are a different matter. High oil prices make gold more expensive to mine and I haven't heard of a lot of new mining capacity coming on. The same for oil despite the huge new oil field discovery in Brazil - it is only about one year's global oil consumption.

Disclosure: Short gold, long AUD, long stocks (especially Australian ones) :)

Losing While Winning

Of course, an excess return simply means that you are beating the market on a risk-adjusted basis and if the market is down badly and your excess return is not sufficiently large you will also be losing even though you are beating the market. From November through March I've experienced a total of five losing months in a row for the portfolio in Australian Dollar or currency neutral terms. So has the S&P 500. In US Dollar terms, February was a slight gain, as it was for the MSCI World Index. The only other time I lost five months in a row was from November 2002 to March 2003. There were no periods of four losing months in a row in my investment history (since 1996) and only one of three months (July to September 2001). The indices did have more 4 and 3 month losing periods. So this period does feel especially dispiriting. This month is showing a gain for the indices and myself so far, but progress is still very fragile. The S&P is only up 0.89% so far for the month.

More on Excess Returns

If you can estimate your portfolio beta it is pretty simple to compute your excess return:



In the equation, e(t) is the percentage excess return in month t. r is your portfolio return, m is the market percent return given by your benchmark index, and f is the risk free rate. The normal return is a mix of the market return and the risk free return weighted by beta. I use the MSCI index as my benchmark. Specifically, the All Country Gross Index. Make sure when you choose a benchmark to include dividends. The net and gross MSCI indices do include dividends - the gross is pre-tax and the net post-tax. Total return data for the S&P 500 can be found here. I use the 90-day Treasury Bill rate as the risk free rate (you'll need to compute the monthly rate from this annual rate).

You can estimate beta in more or less sophisticated ways. If you are 100% in stocks and guess your stocks are average and you are using no leverage, you can use a default of one. In this case, the excess return is just your return minus the market return. A more sophisticated approach is to compute the weighted average of the betas of all your stocks and funds, which you can find on Yahoo Finance for example. More sophisticated still is doing some kind of regression analysis - you need a track record of your monthly returns to do that. My preferred method is a time series model that allows my alpha and beta to vary over time.

To find how much your actual excess income is per month, you then need to multiply the percentage excess return by your net worth. I've done it here, using the S&P 500 as the benchmark:



The bars are the monthly "risk-adjusted excess incomes (or losses)" while the light green line is the total of the last 12 months. A strong cycle is very clear - I've gone through periods of above and below par performance fairly regularly. Alpha smoothes all this out into an estimate of the average excess return. The following chart does this using the MSCI instead as the benchmark:



There is no guarantee though that this level of performance can be maintained. The huge fluctuations on the SPX chart above make that clear. In this post, I was wondering out loud whether I could maintain that performance in the coming year by looking at where the returns would come from. I wasn't saying I could maintain that indefinitely. I don't know.

How Could I Produce an Alpha of 9%?

A recent discussion on Roger Nusbaum's blog typified the diametrically opposed positions of those who think it is easy to beat the market and those that think it is impossible. I'm targeting an alpha of about 9%, so how do I think I can produce it (apart from pointing at my recent track record)? There are three main potential sources:

1. Active trading: 2-4%. 2% means earning the same amount in trading as last year. One of my annual goals is to beat that number. 4% would be doubling last year's result, which is, realistically, the best result I can imagine at this stage.

2. Passive Alpha: 2-4%. About 40% of my portfolio is dedicated to what I call "passive alpha" investments. These are actively managed funds and other financial companies which I believe can produce significant risk adjusted returns. I assume they could attain 5-10% each. Multiplied by the portfolio share that is 2-4%. 5-10% is not just hypothetical. TFSMX has an alpha of 8%. Berkshire Hathaway has been credited with an alpha of 10%. Man Financial has averaged at least 10%. And so on.

3. Timing and Security Selection: 2-4%. These numbers are purely hypothetical. But let's assume that my portfolio beta was 0.5 for the first two months of the year and I then increased it to 1. I would have avoided half the losses in the first two months of the year by timing. This assumes that the markets are relatively benign for the rest of the year and I timed in the right not the wrong direction. The MSCI lost almost 8% in January and February, while my portfolio lost around 2% in total (both in USD terms). Therefore, avoiding 2-4% of losses here through timing sounds reasonable. Of course, if I never changed the beta upwards then this result would be purely due to low beta. Hopefully, some of my few industrial stock selections will add a little value too.

To explain the timing effect, let's imagine that the market goes down for six months of a year at 10% a year and goes up the other six months at 10% per year. Also imagine that the investor has a true beta of 0.5 when the market is going down and 1.0 when it is going up. If we use a regression to estimate a constant beta for the whole period, we'll come up with the average: 0.75. Then in the declining six months my predicted market return will be -7.5% p.a. but I'll in fact only lose -5% p.a., while in the rising part of the year my predicted return will be 7.5% but I will in fact gain 10% p.a. The investor's alpha from this source will, therefore, be 2.5%.

The average of each of these categories is 3% and adding them all up we get to 9%. Of course "alpha" technically is the average excess return over a period of reasonable length. Looking at just one year is probably stretching the concept. Maybe, I should just say a "risk-adjusted excess return of 9%". But it's easier to say "alpha" :)

About as Long as I'll Get

The market started to rise tonight a day or two ahead of what my model was projecting. This recent correction was pretty shallow. So after re-running the models I bought every stock on my buy list in the US:

RICK, NNDS, SHLD, AAPL, GOOG, IFN, BWLD, HCBK, XLF, LUV and LCC puts

This is about as long as I'll get. Estimated portfolio beta is 1.2 and borrowing is 30% of net worth. Going forward I aim to gradually reduce the margin loans. RICK is not cooperating. NNDS is doing nicely since I bought back in.

P.S.

This post partly explains why. My model indicators also show a potential large rally ahead.

Global Switch Complete

I put in an order to switch the remaining amount of CREF Bond Fund that I wanted to switch to CREF Global Equities. The order will execute at Thursday's closing price. This completes my switch from bonds to equities. I still have about a 10% exposure to fixed income. In the next couple of days I'll probably be buying a bunch of stocks in the US again after selling them off during the recent rally. On the potential buy list: SHLD, XLF, HCBK, BWLD, NNDS, RICK, AAPL, GOOG, PSPT, SSRX, IFN, and LUV. Southwest airlines looks very undervalued. RICK and NNDS will probably be my first candidates as it looks like they are at support.

Trading the SPI

I'm beginning to focus on trading the Australian Share Price Index (SPI) futures and seem to be improving. This morning is pretty typical. Typical trades only last for 2-5 minutes. First I was short, then short again, then long, short, and finally long. All the trades made money. As soon as a trade goes in my favor I move my stop which is initially 5 to 10 points away to give a one point profit. I often get stopped out of those trades for a one point profit. If the move continues to go in my favor I start moving the stop to trail about 2 to 3 points from the current price. Often though I get out of the trade with a market order and then cancel the stop. All of this is pretty easy on IB's platform. One point is worth $A25 (a contract is currently $A137.5k of underlying value) and commission is $A5 either way. So a one point gain is a $A15 profit. We'll probably see plenty of these and $A10-35 losses as well as the $A40, $A65, and A$215 type of trades you see here and less common $A260 or so kinds of losses if my original stop is hit. The next challenge will be hanging on through 20 point or so moves. Yesterday I managed to hang on for 15 points. Of course, widening my trailing stop is the way that is going to happen... More risk for more gain.

Revising Annual Goals (Up)

Following yesterday's post about what alpha really means I've been thinking to revise a couple of our annual goals. Specifically, the first two:

1. Net Worth Goal While I was in my trading slump late last year and the markets were going downhill the goal of just increasing net worth in 2008 seemed ambitious enough. But as I pointed out then even, Snork Maiden's employer will contribute around $A10k in retirement contributions and between the inheritance from Germany and my Mom's wedding gift, we got another $US10k. So, an easy hurdle would be to add $20k to last year's net worth. This takes us to $US470k. The contribution from alpha would be another $US40k taking us to $US510k. Allowing for taxes, some spending from investment income, and assuming the markets are pretty much flat for the year gives me a goal of $US500k.

2. Alpha Goal I'm going to revise the alpha goal to state that alpha must provide roughly the average wage. Assuming that is around $US40k alpha needs to be around 8.5% (40/(450+.5*40)). According to the time series model I'm a little above that at the moment. The previous goal was simply positive alpha.

What Does Alpha Really Mean?

In my recent posts analysing Madame X's portfolio I used various indicators to assess the performance of mutual funds. One, alpha, is the "risk adjusted return relative to the benchmark index" we are comparing the fund to. We use regression analysis to find how much the monthly percentage returns of the fund respond to the percentage returns of the index. For example, the fund might return -4.3%, -1%, and -0.2% for the first three months of this year while the S&P 500 returned -6%, -3.25%, and -0.43%. Clearly, the fund did a lot better than the index, but how much of this is due to being less invested in the index and how much is unrelated to the market? A simple regression (same as fitting the best straight line when the fund returns are on the Y axis of a graph and the index returns are on the X axis) shows that for a 1% rise in the index the fund only goes up 0.73%. In other words this fund is taking on only 73% of the market return. The intercept term on the Y axis, or regression constant, is 0.54%. This tells us on average how much return the fund derived from other sources, such as manager skill in timing and security selection per month. For a whole year, this works out to 6.6%. This number is "alpha".

But what does that really mean? One way to look at this is to imagine investing 73% of your money in the S&P 500 index and 27% in 90 day government bonds (T-Bills) - this is a passive investment with the same amount of market risk as the fund in question. The average difference between the return on this investment and your returns from investing in the fund are "alpha". If you invest $10,000, this manager will deliver you additional income of $660 per year above what the risk-adjusted passive investment will return you. On average. There will be months and years where he or she will produce higher or lower excess returns.

I routinely compute my own alpha relative to the MSCI All Country World Index and S&P 500 (with all dividends reinvested in each case - the total return indices). Against the S&P 500 my advanced time series model (Kalman filter) estimates my beta at 0.87 and my alpha at 17.8%. Our net worth is currently $464,000. This means that I am earning $82,500 a year above what I would get from investing 87% of our money in the S&P 500 and 13% in T-Bills. A regression for just the last 36 months gives an alpha of 10.23% or $47,500 per year. Returns relative to the MSCI are not as spectacular - ranging from $24,750 to $44,900. A big caveat is that this past performance may not continue going forward, but it gives some idea of the value derived from actively investing instead of passively investing. If you actively manage your portfolio you should ask a similar question about how much value you are adding.

The nice thing about investing/trading is that these returns can scale up. There is no reason why I couldn't do exactly the same thing with several million dollars instead at some time in the future. This is one of the reasons that trading is an attractive career option to me.

Investing for Snork Maiden: Part II

I've looked through the Colonial First State (CFS) First Choice prospectus and come up with this tentative allocation of funds. The plan would be to invest $A3,000 initially and then do a regular investing plan of $A300 per month. We can always add money in chunks when we have it available. I'm wondering whether six funds is overkill. But it seems to me this is a reasonably balanced stock portfolio and there are no minimums for investment in each individual fund. Roughly 50% is in Australian stocks and 50% in foreign stocks. Two of the funds are geared (levered in American) - that is they borrow money - and so actual investment exposures for those funds are greater than the money invested. The portfolio overall would be borrowing 35% on top of the money actually invested. The two core investments are the CFS geared funds with 75% of the Australian exposure in the core fund and 50% of the foreign exposure in the core fund. I believe that CFS is the best manager of large cap Australian stocks. On the other hand their foreign stock performance has not been that good, but does seem to be improving, therefore, I allocate less to them on the foreign side. On the Australian side I include some small cap exposure - Souls seem to be doing better recently than CFS and this diversifies management.

Of the other three foreign managers - two - Platinum and Acadian are long-short funds - while Generation is the fund co-founded by Al Gore. Retail investors in the US can't invest in it, but ironically, Australians can. Acadian is a 130/30 fund - they maintain 100% long exposure to the stock market by investing 130% of net assets long and 30% short. Platinum is a more traditional long-short fund that at the end of December 60% net exposure to the market, with 25% short and 15% in cash. This gives us some exposure to alternative investments. There is an Acadian 130/30 Australian fund available on the platform, but given there track-record in managing Australian shares (they are based in Boston and Singapore), I'm skeptical that they can add value here.

Any other suggestions?

I could just invest the whole thing in one fund to complement the rest of our portfolio, but like the idea of having a mini fund-based portfolio to experiment with and see what happens.

Permanent Portfolio

Barrons reminded me today of the Permanent Portfolio Fund. I first read about the permanent portfolio concept in Mark Tier's excellent book. The concept is a very diversified portfolio that doesn't need to be changed dramatically with market conditions. After my recent changes to my Mom's portfolio it will have a similar allocation to stocks, bonds, cash, and other. In our case, the other is hedge funds and managed futures, in their case, mostly direct holding of gold and silver. We only have a little gold held by one of our managers. We have 50% of the portfolio allocated to the US Dollar and 50% to other currencies and PRPFX also seems to be doing some currency diversification through investing in the Swiss Franc. Somewhat idiosyncratic. Permanent Portfolio has been in the top 2% of its peer funds on all time horizons. They made money in each of the last ten years (though they didn't beat inflation in every year). Barron's also recommended Aussie bank stocks in this week's issue.

Oil

OIl might be tracing out a triangle formation as shown above. Triangles are common as 4th wave formations according to Elliott Wave Theory. Failure to break through the upper green line will be a good short opportunity and failure to break the bottom green line a good long opportunity. Once wave E is complete a move higher in wave 5 would be expected before a larger scale correction takes place in the oil market. First we'll have to see what happens on Monday vis a vis the upper green line.

Emerging Market Investing for my Mom

I've mentioned that I wanted to reduce the allocation to bonds in my Mom's portfolio. I targeted the ACM Global Bond Fund in her portfolio, which has been underperforming:



It's not quite as bad as this chart :) They've paid out a 3 cent a share dividend each month, so we've made about 3% a year since 2003. I asked the manager at her bank to suggest some equity investments to replace it with. Given we have more equity exposure to the US and Europe than to Asia he suggested adding Asian equities. So we'll put most of the money into a UBS Asia ex-Japan fund and smaller amounts in an HSBC India fund and a UBS Brazil fund. Yes, I know Brazil isn't in Asia :) We won't re-invest all the money from this bond fund. I plan to take $100k from the profits of this, the alternative investment that matured and other cash in the account and invest it with Thomas White through our other broker. When all this is done we should have signficantly more equity exposure and roughly equal amounts in the US, Europe, and Asia. Unlike most investors who overinvest in their domestic markets the only investments we have in my Mom's home market are her apartment and a couple of small bank accounts.

Next Investment for my Mom

We had a structured note product - managed futures with a capital guarantee. It has now matured and it is time to reinvest some of the money. I'm planning to reinvest the amount we originally invested in this product and transfer the profit to our other broker to be added to our investment with Thomas White. Our manager at UBS sent information on some products we could re-invest in:

1. Man/AHL managed futures - This is a very similar product to the Man fund I have invested in myself. I did some analysis of the data supplied - it's returned 16.5% p.a. since September 2002 with a 4.9% monthly standard deviation. The MSCI returned 17.2% with a standard deviation of 3.1%. So it gives stock like returns but with more volatility. However, it has low correlations with other investments. 0.11 with the MSCI, 0.23 with CREF Bond Market, -0.03 with TIAA Real Estate, zero with the S&P 500. The only strong correlation I found (0.73) was with Superfund Quadriga B another managed futures product. Is there a managed futures beta (systematic risk factor) ? Yes, I like this product :)

2. UBS A&Q Alternative Solution Index Certificates - This provides access to UBS internal hedge funds. A&Q stands for "Alternative and Quantitative" - these are quant driven hedge funds. 75% of the money is in hedge funds, 10% in commodities, 5% in real estate, 5% in private equity, and 5% in cash. Between June 2006 (inception) and the end of February the Certificate returned an annualized 10.46% with a Sharpe ratio of 1.02, which beat the various benchmarks presented (The SPX did 4.91% including dividends). So this product seems to be of good quality.

3. UBS Multi-Strategy Proprietary Index Certificate - This also provides access to UBS internal hedge funds - but these are the O'Connor funds which are not quantitative funds. Both hedge fund products diversify across individual funds and strategies. From May 2004 to October 2004 it returned 6.09% with a Sharpe ratio of 0.68, which is not particularly attractive compared to equities in that period but better than bonds. Interestingly, at the end of October they terminated their U.S. long-short equity program due to underperformance. So maybe returns will improve going forwards?

4. UBS Agribusiness (USD) Strategy Certificate - 80% is invested in agricultural related stocks and 20% in commodities. I wonder if this is a sign of a bubble - selling this stuff to investment bank retail clients? Maybe a little bit in this one? There is no data as it is a new product.

Minimum investment in these products is typically $10k with $1k increments above that. You don't need huge amounts of money to invest in hedge funds, at least outside the U.S.

He suggests investing most in option 2 and less in each of the three others. We're looking at a $US200k investment. I'm going to suggest to weight the Man/AHL fund more highly than the O'Connor funds or the Agribusiness Certificate and give him the benefit of the doubt on the other two.

I'm also looking to replace a bond fund with an equity fund. The bond fund only returned about 3% per year since we bought it in 2003 and we have too many bonds. More on that in another post.

March 2008 Report

The crisis in the financial markets seems to be abating and so does our own personal mini financial crisis. Though we made a net loss this month and net worth is down again, I made gains in trading, the wedding etc. is paid for and our credit lines and bank account are freed up, and I have a lot more buffer available between me and a margin call on my Australian margin loan. Earlier in the month, while I waited for payment from Primary Health for the Symbion takeover I was into the 5% buffer where you can't buy more shares but they don't give you a margin call yet.

All figures in the following are in US Dollars (USD) unless otherwise stated.

Income and Expenditure



Expenditure was $4,573 - core expenditure was $3,349 - in line with average months. Spending included $324 of implicit car expenses - depreciation and interest. The non-core expenses were paying for our wedding photos and spending from the wedding present money my Mom gave us. The latter is included in the "other income" of $4,964 as well as Moom's US Federal tax payment, which we treat as a negative income item and Snork Maiden's salary.

Non-retirement accounts lost $11,501 with the fall in the Australian Dollar contributing $3,815 to the loss. Retirement accounts lost $843 but would have gained $3,057 without the change in exchange rates. Trading contributed $2,794 in realised gains.

Net Worth Performance
Net worth fell by $US12,034 to $US432,934 and in Australian Dollars fell $A799 to $A474,146. Non-retirement accounts were at $US215k. Retirement accounts were at $US218k. So we did not make progress on our first and third annual goals as net worth decreased and non-retirement net worth fell by more than the decline in the MSCI index.

Investment Performance

Investment return in US Dollars was -2.77% vs. a 1.42% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 0.43% loss in the S&P 500 total return index. Returns in Australian Dollars and currency neutral terms were -0.24% and -1.04% respectively. So far this year we have lost 4.80%, while the MSCI and S&P 500 have lost 9.18% and 9.59%, respectively.



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



The returns on all the individual investments are net of foreign exchange movements. This month trades mostly resulted in gains. The biggest gain was in the CFS Geared Share Fund which I've been switching into from the CFS Conservative Fund at what I think are low points in the market. The latter experienced a loss partly as a result of this switching, which has so far managed to time the market well. Time will tell whether it was a good idea longer-term. Several Australian financial stocks were again major losers. However, the proposed takeover of the Challenger Infrastructure Fund gave that fund a nice boost.

Progress on Trading Goals

As I've mentioned, realised gains for the month were $2,793.

My three US trading accounts gained $1,315 (or 2.35%, which is much better than the market) and there is now $6,731 to go till I reach breakeven across those three accounts, which is one of my annual goals. My Interactive Brokers account gained 7.82%.

So, we made progress on annual goal 5 (making money from trading) and goal 4 (achieving breakeven in my US accounts).

Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.92. Using a regression on the last 36 months of returns gives a beta of 0.74 to the MSCI or 0.59 to the SPX. Alphas are 1.4% and 5.9% respectively. A more sophisticated time-series method yields a beta of 0.79 and alpha of 8.8% for the MSCI index. Therefore, we are doing well on our second annual goal (positive alpha).

Allocation was 39% in "passive alpha", 70% in "beta", 2% allocated to trading, 6% to industrial stocks, 5% to liquidity, 3% to other assets and we were borrowing 25%. Our currency exposures were roughly 55% Australian Dollar, 27% US Dollar, and 18% Other. In terms of asset classes, the distribution was:



After all the changes in investments and trading this month here is an update on our exact portfolio allocation:



Summary
We made progress on three out of the five annual goals this month.

Investing for Snork Maiden

Snork Maiden had a lot of cash in a U.S. checking account. We've decided to invest $8000 of that. As you know, I am bullish on the US Dollar, though so far that hasn't paid off :) Anyway, I don't want to transfer the money back to Australia and buy Australian Dollars. On the other hand I don't want to set up a U.S. investment account for her. In the long-run I think an Australian account will be a better idea tax-wise and simpler. I'm looking at a more or less buy and hold managed fund (mutual fund) strategy for her. Also I do want to get some assets in her name. Because married couples are taxed separately in Australia there are tax advantages to each partner having investments in their own name. Right now, my income is lower and so it doesn't make a lot of sense to have investments in her name, but I hope this situation won't persist :) On the other hand, judicious choice of investments should result in little additional taxes for her to pay. There is no gift tax in Australia (or inheritance tax), though transfer of assets between a married couple triggers the capital gains tax even if the asset is not sold. So my plan is to transfer the $8000 to one of my brokerage accounts in the US, reducing my margin loan and investing money we have here in Australia in its place in an account in her name. I won't do the full $US8000 right off the bat but dollar cost average over a period of time.

I am thinking of buying her funds on the First Choice platform of Colonial First State. This provides access to many different managers. There is a $A5000 minimum investment which is rather steep I think. CFS's own funds only require $A1000 as an initial investment. I wonder why that is? Is the additional diversification worth it?

We would invest via Commonwealth Securities, a discount broker, who will rebate 100% of the fund application fees (loads). Though I'm an advocate of not paying too much attention to fund expense ratios, never pay a fund load if you can possibly avoid it!

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.