More Bailout News

While no-one was paying attention the US Congress agreed to lend $25 billion to the three big US car manufacturers at 4% interest to help them develop fuel efficient and alternative energy vehicles. The US Treasury has added about $450 billion to the national debt since June already apparently (can't find the link for this now).

In the meantime, the FDIC seized Washington Mutual and sold the good assets to J.P. Morgan already. This deal means no loss to depositors and the shareholders wiped out. Not clear what happens to preferred stock etc. yet.

The Republican Plan that has derailed the financial bailout talks makes no sense at all. It calls for the Treasury to charge insurance premia to insure mortgage back securities a la FDIC. Yeah, let's take more money out of the banks, rather than vice versa. There is increasing talk of a emergency Fed rate cut in the next few days.

The proposed bailout plan might not be the best and it has been explained very poorly if at all to the public. But it seems that something needs to be done to stop the banking system in the US completely collapsing. Most people have no idea why the Great Depression happened. Primarily, it was due to bad policy allowing 1/3 of US banks to collapse. The economy still had the same real assets in terms of factories, land, machines, workers, and ideas, but they couldn't be put to work without the ability to borrow money. And that is what is in danger of happening again.

Up till now the Federal Reserve and the Treasury have been battling a potential collapse. They've made a lot of mistakes and now they're running out of firepower or realize they need bigger guns. The Democrat suggestion to reduce the package size while leaving the door open to granting more spending ability might be a good move as is adding oversight for sure. The other $350 billion might be needed for buying stakes in banks to recapitalize them. If the goal is to increase bank's net worth it is far more efficient for the government to buy new shares from them where each dollar goes 100% into recapitalization than to buy assets from them at a small premium where only the premium goes towards increasing net worth. But the Paulson plan is primarily for the government to act as market maker and it seems to jack up the value of mortgage related assets on the balance sheets of banks that don't actually participate in the scheme, which is a good thing.

BTW, the U.S. Government made money on the post 9/11 bailout of U.S. airlines. So it is possible and it's definitely a misinterpretation to think that the whole $700 billion represents government spending.

Soros and Kaletsky on the Crisis

Soros weighs in as does Kaletsky. Not surprisingly they have similar views. Kaletsky has very good contact with Soros. Letting Lehman collapse was not a good idea, despite all the bloggers and pundits who'd like to see all these banks go bankrupt. That would lead to at best a Japan style stagnation and at worst another Great Depression.

Macquarie Winton Global Opportunities Trust

I promised a follow-up to my post on Australian managed futures funds. Obviously, I'm not currently in the market for any new investments in Australia, but one day I will be. And one area where I want to increase exposure is in managed futures funds.

The Macquarie Winton Global Opportunities Trust is a managed futures fund listed on the Australian stock exchanges. The advantages of this is that there is no minimum investment required and you can redeem your investment at any time. The downside is that there is usually a large spread between buy and sell prices and the stock is not marginable with CommSec. It does trade at a discount to net asset value though. Also the stock is in fact a seven year capital protected product similar to the Man OM-IP funds. At the end of this period you can receive units in an unlisted fund. For the 2007-8 year earnings per share were 31.8 cents but only 5.8 cents were paid out as a distribution. It seems the distributions are interest on the funds cash, while net capital gains will be paid out at maturity. This allows investors to take advantage of the long-run CGT rate. By contrast, the unlisted Macquarie Winton Global Alpha Fund pays out all earnings, is not capital protected and as a result has somewhat lower fees. Returns are comparable to the other Winton funds:



The fund has been about flat since the end of July. The Winton funds appear to be beating benchmarks.

Independent research on the fund was lukewarm - with "approved" or "recommended" assessments rather than higher ratings. One analyst was worried about the capital protection structure and costs, while the other regarded the underlying fund as too much of blackbox. I think neither critique is now particularly relevant after three years of fund existence. In conclusion the fund has some pros and cons relative to the other products available. You'd have to assess how important each of those is to you when deciding which to invest in.

You can get lots more info on the fund from Macquarie's website.

What Happened Last Week is Getting Clearer

New York Post article. Stuff on the level of the Dow is spurious though it would have been bad. This is why the US government appeared to go crazy. Letting Lehman collapse was in retrospect not a good idea. It started a run on money market funds that either held short-term Lehman debt or may have done triggered by The Reserve "breaking the buck".

Portfolio Changes and Asset Allocation

The margin call and other actions has restructured the portfolio quite a bit:



Now we're only only borrowing 23 cents for every dollar of net worth and reduced the net worth allocated to both stocks and bonds. While the view above looks at how many dollars of net worth is allocated to each investment class, we can also look at the actual exposures to each asset class as shares of total assets. These total assets include net worth, borrowed funds, exposure provided by leverage funds, CFDs etc:



Also, for the first time I've broken down the stocks asset class into Australian large and small cap stocks and US and rest of the world stocks. For each dollar of net worth we are exposed to $1.78 of assets, which is still a high degree of leverage in my opinion. Exposure to bonds is now very low and exposure to Australian stocks very high. I don't really know how much should be allocated to each asset class. Posting this breakdown is a step towards thinking about that in the long-run. There are tax advantages to Australians owning dividend paying Australian stocks, which have to be weighed against the benefits of diversification. If we also include funds that I may inherit the picture looks a lot more balanced:



The combined portfolio is much heavier in bonds and cash, has only 45% of assets in stocks and only 41% of those stocks are Australian. Exposure to private equity and commodities is still small but it's looking a bit more like an "endowment portfolio".

EBI Proposes to Delist from the ASX

The Everest Brown and Babcock listed fund of hedge funds, EBI, proposed today to delist from the ASX. This is the same fund whose downgrading by CommSec triggered my margin call. BTW, the redemption of Colonial First State Funds seems to have gone through OK. Now you can see why I just didn't sell the downgraded stocks! The proposal is a little complicated and has some similarities to the recent delisting proposal of Ellerston GEMS:

Prior to delisting (expected to occur in December 2008): A “Withdrawal Offer” of 10% of units on issue at a fixed price equal to a 7.5% discount to EBI’s then stated NTA per Unit.

At 31 December 2009: A one–off redemption facility for 25% of remaining units on issue at a 7.5% discount to EBI’s then stated NTA per Unit.

From 31 December 2010: On-going semi-annual redemption facilities at EBI’s then stated NTA per Unit.

Large shareholders will be able to be paid their investment in specie into a separately managed account.

I'll probably look to decrease my holding on market or at the first "withdrawal offer" and then participating with 2-3% of net worth in the unlisted fund. Currently EBI is about 5% of my net worth and at the 7.5% discount to NTA would be about 6.5% of net worth.

Carrousel Capital and Babcock and Brown who are both major shareholders are supporting the proposal but Laxey Partners is calling for an EGM to wind up the trust. Shareholders are still squabbling over the Ellerston GEMS delisting.

Australia Bans All Short Selling of Stocks for at Least Thirty Days

This move might make some sense on the basis given that if short-selling of financial stocks is banned in the UK and the US there could be pressure on Australian financial stocks. But why then ban shorting all Australian stocks? If this list is complete then almost no shorting is going on anyway. But the situation with shorting in Australia is so unclear I don't know if this is a complete inventory. It seems that even in the Great Depression the US didn't make any blanket bans on short-selling.

Of course you can still short stock index futures. They'd have to close down the futures market to stop that.

U.S. Government Goes Insane

That's what it feels like. Bears won't be happy. UK stock market is up 9.3% at this moment.

In other news, I went to pick up my Mac laptop but when I got it home I found it hadn't actually been fixed at all. It's been lying in the storeroom at the Canberra City store for the last two weeks I think. In fact they didn't know where it was at first and phoned up all the other stores to see if it had accidentally been sent there. Outrageous.

I didn't hear anything on the outcome of my margin call. At least closing prices in Australia will have been a bit higher today. It's a shame that they decided to downgrade EBB and EBI and force me into selling something. I guess I should never be near the margin limit in case something of that sort happens in the future.

Lloyds Bank

In the UK, Lloyd's TSB is taking over HBOS. My very first savings account when I was rather small was at TSB - Trustees' Savings Bank - later when I was about 18 I got an account with Lloyds - I entered some competition where they gave a prize of £10 in a Lloyds account. That was my first ATM card too - this is in 1982 or 1983. I think I also had a savings account with the UK Post Office. My parents also banked with Lloyds and my Mom still does. I shut my Lloyds account around 1997 after moving to Australia. Anyway, so Lloyds merged with TSB. Apparently they also took over Cheltenham and Gloucester Building Society where my Mom has an offshore savings account. I was beginning to worry about the money in that account, but it's reassuring that it's part of what seems to be one of the UK's strongest banks. I think my parents had a mortgage with Halifax Building Society - I remember visiting the branch in our home town of Sutton - it had a very peculiar smell. Halifax became HBOS and now will become part of Lloyds too. So in the end most of our UK financial institutions have all been rolled up into one.

Margin Call Resolution

After a lot of rushing around faxing and phoning (I don't have a fax machine at home) it looks like we have a resolution to my margin call caused by the downgrading of EBI and EBB by CommSec. I am selling units in CFS Conservative Fund (all my non-superannuation units) and half of my CFS Global Resources Funds. Both of these sales will actually be capital gains, though off their best prices of course. This will about halve the size of my margin loan with CommSec to about $50,000. The downside of selling these funds is that they are marginable and so I need to sell a large amount to get back inside my margin limits. I would have to sell only about a quarter as much of my non-marginable stocks. But I'm loathe to sell stuff that is trading way below book value or what I think is fair value, which is the case for most of my non-marginable stocks and my other marginable stocks in fact like Challenger Infrastructure Fund.

A tip - CommSec said they didn't get my fax yesterday because I faxed it to the "back office" - the number on the redemption form and on the website - and of course there is chaos there at the moment. So this morning I faxed it again to the "front office". And then I phoned up to check they really did have it. So it's worth checking where to fax required forms to in an emergency.

Margin Call

Things continue to get worse. I am now in margin call territory with CommSec because they reduced the lending ratio on EBI and EBB to 0% as these two stocks are supposedly are "Babcock Satelites". The main worry with EBI would be their total return swap with Macquarie Bank. Maybe some of the joint investments they did with Babcock, though these are a small part of the portfolio. I sold Qantas but it makes little difference. I'm going to have to sell more stuff if they don't revert this loan ratio back to something positive.

More Sales

Sold SHLD and CNY. Former because it's been strong recently and is very overvalued on a P/E and earnings forecasts basis. Figured that if the market finally turns up instead of imploding it could reverse down. Took a small loss on the trade. Overall I made a little net money on two SHLD trades. Sold CNY because it doesn't look like there is going to be any RMB appreciation now in the near future and Morgan Stanley is being pummeled. It is an ETN and so actually is a debt of Morgan Stanley as I understand it. Took a small loss now rather than a bigger one later. Hard to see Morgan Stanley going broke after yesterday's earnings report but at this rate anything could happen. Yesterday seemed like the bottom and then came today. The VIX volatility index is hitting the levels of the January and March bottoms while the 90 day T-Bill interest rate must be at an all time low. Somewhere there will be a bottom but as usual I was much too early and way too undisciplined. What survives of my portfolio will eventually be managed quite differently I think.

Halfway Through the Buffer

I'm now halfway through the buffer on my CommSec margin loan. The Australian market is surprisingly down at the moment. I'm adding $1000 from my Adelaide CMT.

Global markets seem uncertain what to think about the Fed's move to effectively takeover AIG. Some markets down, others up.

Reserve Primary Money Market Fund Falls Below $1 a Share

I used to be a shareholder in this in my Roth IRA account. Luckily Ameritrade switched to their own money market funds instead. Money market funds are safer than bank deposits in one sense as they are diversified across the debt of many entities rather than being entirely concentrated in one bank. On the other hand, that makes some loss more likely though it is likely to be smaller. Usually losses are small enough, I guess, that the funds can just reduce their interest rate to cover the capital losses? In the US, bank deposits under $100,000 are safer than money market funds because of the FDIC insurance. There is no deposit insurance in Australia. We have a bank account with Commonwealth Bank and a "Cash Management Trust" with Adelaide Bank. You'd think the latter which is structured as a mutual fund is a money market fund. And I think it used to be. But in fact the fund's only asset is a loan to Adelaide Bank. I don't think there is any risk of Adelaide Bank going under but worth knowing what the risks are all the same.

Sold Hudson City

For $19.60 - a $740 capital gain. The stock is near all time highs and has a very high price/earnings ratio which is difficult to see being justified by future growth. Good company but pricey stock. I'm assuming the price has been pushed up as one of the most solid banks out there, which is why I bought it in the first place. It's been moving against the market recently and so may be topping out if the market is bottoming out.

Update on Mutual Fund Market Timing

The TFS Market Neutral Fund Annual Report arrived, allowing me to update my analysis of the market timing abilities of fund investors. The previous report was for the second half of 2007, while this report is for the full year from 1st July 2007 till 30th June 2008. By subtracting the data for the second half of 2007 from the annual report data we can produce a report for the first half of 2008:



The average investor did better in this period than in the previous six months buying shares at an average price of $14.82 and redeeming shares at $14.41 a 2.8% loss vs. the average 6.9% loss in the previous six months. As you can see they still lost from market timing, though not as badly. Additionally, the fund saw massive inflows of a net $100 million vs. outflows of $50 million in the previous six months. Far less money was collected for early redemptions. Only 7% of redemptions were of purchases within the last six months.

On the other hand, not only were redemptions at prices below purchases, it also looks like that they were below average prices for the period, while purchases were at above average prices:



So, shareholder behavior was better in this six month period than the previous six months, but far from optimal.

Since June 30th the fund has not done well at all, but neither has the market. The fund underperformed the market in July and has about matched market performance in August and September so far:

Lehman Bankruptcy Filing

The first part of this post was revised on 17th September

Here it is. The majority of the money is in bonds that apparently Citibank and Bank of New York Mellon administer. So we don't know who holds them. None of the other debts look like they are going to bankrupt anyone. Some Japanese banks are owed a few hundred million each. National Australia Bank and ANZ are each owed about $25 million. Wells Fargo is already writing off Lehman related losses .

I'm about $1,000 into the margin buffer now with CommSec and it will get worse yet. I also sold some bond funds and bought stock funds in my retirement accounts, however nuts that seems...

S&P futures are down 20 points post close on the downgrading of AIG. Yves is bullish though. And he's been pretty good recently:

Lehman Impact

It's looking like Lehman brothers will be liquidated. The result could be worse or more worse depending on whether a systematic plan can still be concocted by the start of US trading, tonight Australian time. Stock index futures opened half an hour ago on Globex and the S&P contract is down about 36 points. A substantial break from Friday but around recent lows. If that's the worst impact then that's a pretty good outcome. No way to know at this point though whether that holds, or futures bounce back or decline further before the open 15 hours from now.

P.S. 9:51am Australian Eastern Time

ES futures have bounced a little. Australian share price index futures (SPI) are opening down about 120 points or 2.4% near recent lows.

P.S. 10:20am Australian Eastern Time

I'm into the buffer zone on my margin loan from Commonwealth Securities. This is a warning that a margin call could come if the market falls further. You can't buy any more stuff but don't have to sell yet. This hasn't happened since 2002... The All Ordinaries is only down 60 points though at the moment and when Friday's Australian managed fund values post later today I'll be out of the buffer zone again. I'm most likely to sell Qantas first if I really faced a margin call. Following that, I'd ask CommSec to redeem some of my units in the CFS Conservative Fund as it is 70% bonds and cash and 30% stocks and property.

A Sensible Housing Crisis Proposal

For a change, someone is proposing a pretty sensible initiative in the housing market. The Australian Federal government will give tax breaks worth $8,000 per apartment per year for a decade to developers who build rental apartments and rent them for 20% below the market rent to qualifying low income people. This is a sensible move to alleviate the housing shortage in Australia, because it increases the supply of housing rather than increasing demand. Most schemes, like the proposed housing savings accounts, just given people more money to bid for the existing housing stock, which solves nothing. But unfortunately this new scheme does make things more complex and increases transaction costs. So it's not perfect by a long stretch.

Clearly, the Australian tax and maybe regulation system works against developers constructing rental accommodation or institutions and wealthy individuals managing apartment complexes. There are essentially no unfurnished rental apartment complexes in Australia. We have a rental market but it is almost entirely single houses and single apartments (condos in American). Institutions do own property, but it is mostly commercial, retail, and industrial. None is regular residential. (Senior housing does seem viable). One reason is that the effective rate of state land tax increases as you own more property - it's progressive (owner occupiers and agriculture don't pay land tax). I haven't uncovered all the other reasons, but the tax review makes clear that property taxes are relatively high in Australia. Ideally, the tax review will remove some of the distortions in the tax system that discriminate against institutional ownership of rental property. That would help significantly.

P.S. The Australian "housing crisis" is an issue of way high house prices and a very tight rental market. Basically a shortage of housing. At least where anyone wants to live. It's ironic that Australia has the second lowest population density of any country with more than 1 million population. Mongolia has the lowest density.

Moom's Taxable Income 2007-08

I've used the same format as I used for Snork Maiden's income statement. The main twist here is that I started off trying to treat my derivative trading (options, futures, and CFDs) as a business, which of course made a loss. But it turned out that I would have to defer the loss until my business made an income.

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Only if your business passes any of the following criteria, can you deduct a loss for the current year:

1. The business is a primary production or professional arts business and our assessable income for 2007-08 except any net capital gain from other sources us less than $40,000. So poor artists and farmers - go ahead and take a risk - at least your losses will be deductible.

2. There was at least $20,000 of assessable income from the business activity for this income year. I don't get this one. If you made $20k there isn't a loss to deduct?!

3. The business has produced a profit for tax purposes in three out of the past five years including this year.

4. The value of real property assets (excluding any private dwelling) used on a continuing basis in carrying on the business activity is at least $500,000. Make sure you rent a big enough store or office!

5. The value of certain other assets (except various vehicles) used is at least $100,000. Don't worry about over-capitalizing your restaurant :)

6. The taxation commissioner gives you special permission in writing.

These rules are very unfriendly to small start-up businesses. Especially, home-based ones. If your business fails, you may never be able to deduct the losses from income. These rules are intended to stop people claiming tax losses for hobbies. But I feel they go too far in an anti-entrepreneurial direction. Please let me know if you understand how to interpret #2.

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So I, instead, attributed the costs I was going to attribute to business to "Australian Interest and Dividend Deductions", which also includes my Australian margin interest. I attributed my net derivative loss to "Other deductions" along with my foreign margin interest. The downside is that as an investor you can't deduct home office occupancy costs, which are deductible to a home-based "business". But I don't when, if ever, I'll make a relevant business profit and so I preferred to be able to deduct the other losses immediately.

As you can see, adding back in the CGT discount for long-term capital gains almost doubles my net income. After subtracting out franking credits which aren't actually received as cash income my income was $16,184 vs a taxable income of $10,662.

It looks like my income is too high for Snork Maiden to be able to claim much of a "Spouse Offset". In retrospect, I should have sold my Croesus Mining shares and claimed a massive capital gains loss that would have wiped out my income for the year.

BTW, I estimate Snork Maiden's tax at 20.6% of net income. She should get a $1,234 refund. Moom's tax rate is negative (-18.7% of the bottom line income number above due to franking credits). He should get a $3,520 refund. After tax cash income was for Moom $19,704 and Snork Maiden $38,658.

U.S. Clearly in Recession

For anyone out there who still thinks the U.S. is not in recession this chart pretty clearly refutes that view. It's a view only held by some business economists anyway, I think. U.S. GDP increased by more than 3% y.o.y. in the second quarter of this year. But GDP growth is only one of the factors that the National Bureau of Economic Research takes into account in declaring recessions. The chart shows that in terms of unemployment the U.S. is now clearly in recession. The recent upward trend clearly broke the previous downtrend in terms of any signal to noise test you'd want to construct. And upward trend defines an unemployment recession. This isn't a case of some indicator that is coincident with recessions. I've seen a lot of those charts with commentary that says "in 8 out of the 9 last recessions this indicator rose ". Which isn't much of a statistical sample. I don't think this chart is that kind of an example.

Franking Credit Balance

Platinum Capital - a listed investment company or Australian closed-end fund - used to report the balance of "franking credits" on its books with each monthly report of the fund's net asset value. Franking credits are credits for Australian tax paid that companies can pass onto Australian shareholders when they pay dividends. This helps reduce the double taxation of dividends. Unlike US closed-end funds, Australian LICs do pay corporation tax. Also, unlike U.S. listed funds, they do not, therefore, need to pay out all their profits annually as dividends. If they pay out less than they earn, they accumulate a balance of unused tax credits, which are of no value to the company and, therefore, not included on the balance sheet, but potentially valuable to shareholders. I was informed that at the end of July Platinum Capital's balance was 14.51 cents per share. If we regress the share price on NAV, the franking balance, and a constant, we find that historically, shareholders have valued the credits more highly than the actual NAV, which is perhaps why PMC has usually traded at a large premium to NAV. Recently, the premium has been less than the franking balance and even negative a couple of times:



Obviously, something changed post-credit crisis. Unfortunately, I didn't sell in time.

Anyway, I was told today that the finance committee has decided not to report the franking balance on a monthly basis but only in the annual report. I wonder why they thought this was important information up till now but that it no longer is?

Snork Maiden's Taxable Income

I've computed Snork Maiden's 2007-8 income for her Australian tax return (the tax year runs from July 1st to June 30th). I can't complete the return or work out how big a refund she should receive until I've done my tax return, which is the next project. The first two sections of the table should be pretty self explanatory. Income distribution from trusts is Australian source income, not including capital gains from managed funds (mutual funds). For some reason this has its own special section in the tax return (well combined with partnership income) while capital gains and foreign income from managed funds is reported in other relevant sections of the return together with income in those categories from ordinary shares and other assets. Net income at $48,629 is firmly in the 30% marginal tax rate bracket (31.5% including the Medicare levy). Income is reduced this year by only being in the country for nine months of the tax year. Rather than applying a lower rate to long-term capital gains, Australia only requires taxpayers to report half the gain. I've added back the "concession" in the line "net income without CGT discount". On the other hand you have to report dividends in terms of the gross dividend before the company paid Australian corporation tax on it. You then get to claim the tax they paid back to avoid double taxation of dividends. These credits are called "franking credits". I've deducted this notional income in the final line of the table. Neither of these changes make much difference to Snork Maiden's return, but will make a big difference to mine. Snork Maiden had $11,272 in tax withheld (including franking credits). I estimate she should have paid from $7,962 (if my net income is zero) to $10,062 (if my net income is above the maximum threshold for a "spouse offset" to apply). Her refund should, therefore, be between $1,209 and $3,309. The effective tax rate is, therefore, between 16.3% and 20.6%. There are no state income taxes in Australia. Unlike the US, Australia does not require you to compute your tax yourself. All you need to do is report income, deductions, credits etc. They do show you how to compute the tax at the end of the "Taxpack". There is also a calculator on the ATO website.

Three Sorts of Regrets

I was just commenting on Chris Guillebeau's Blog and came up with an economic perspective on regrets using the ideas of efficiency and uncertainty. We can regret efficient choices and inefficient choices as well as certain choices and uncertain choices.

The most basic principle of economics is that we can't have everything we want - things, including time, are scarce and our choices are constrained. When we optimize and choose the best option (doing the best we can under the circumstances is economically "efficient") we may regret the things we didn’t do because they clashed with our choice. If we want to live life with no regrets as Chris is discussing, we need to learn how to not regret (too much at least) what we had to sacrifice to get where we wanted to go.

The second case is where we make inefficient choices. Where there are things which we could have done with little loss or trade off and we didn’t do them. We just lazy or fearful or whatever and didn't overcome that barrier. We didn't use the resources at our disposal effectively. This is the "no regrets" that Chris is actually talking about.

A third case is where we thought we were doing the best we could but were wrong because either we had bad information or due to pure randomness or uncertainty. Here the regret is similar I think to the first case. We can focus on regretting the bad choice we made or try to “move on”.

Increasing Regular Savings Plan

I'm increasing our regular savings plan into Snork Maiden's account with Colonial First State to $(A)400 a month from $300 per month. She just got about $165 per month extra take home pay due to the reduction in taxes and promotion by one "increment" (In government jobs here, each rank has a number of pay increments and each year you progress by one step until hitting the top pay for your rank. To go higher you then need to apply for promotion). This is now about 10% of take home pay. Of course, an additional 15.4% of gross pay - an employer contribution on top of salary - is going into her superannuation account. The ingoing funds will be allocated as follows:

CFS Geared Share Fund: 23% (Leveraged investment in large Australian companies)
CFS Global Geared Share Fund: 20% (Leveraged investment in global shares)
Souls Australian Small Companies: 15%
Platinum International: 10% (Global long-short fund - Australian manager)
Acadian Global Long-Short Equity: 10% (Global quantitative long-short fund - US manager)
Generation Global Sustainability: 10% (Al Gore's fund)
BT Property Investment: 12% (Mainly Australian REITs)

This is the same as our original plan with the addition of REITs. I still need to add a remaining $4,000 of the $8,000 seed investment that was originally planned. I will, as I receive distributions from my own funds.

Generous Move by Apple and Mac1

Just before I was going to reluctantly buy a new laptop - as putting a non-warranteed logic board that would cost about what my computer is worth into a laptop that already had two serious malfunctions didn't seem to make a lot of sense - Josh, who was the guy dealing with me at Mac1's Fyshwick branch, suggested that I call Apple customer care. I was a bit skeptical, but went ahead. Apple decided to make an exception given that I brought the computer in for repair on the day after the warranty expired (actually, now I think about it, the computer failed on the last day of the warranty on US time - which is relevant as I bought it in the US). Anyway, Mac1 will go ahead and repair it and Apple pay for it. Which is great news and very nice of them. Hopefully, the repair will last a decent amount of time, but even if doesn't I'm neither having to take that risk nor put up the money for a new computer right away.

Bad Luck

One day after the warranty expired on my MacBook Pro laptop the screen went black and today I heard from the repair guys that the graphics chip is gone, which requires replacement of the logic board - an $A1,900 cost. A new laptop costs $A2,700. Of course, there are cheaper Mac laptops. Doing the repair doesn't make a lot of sense, especially given that a new computer will have a warranty included. Downgrading one's standard of living is tough too. Will discuss with Snork Maiden when she gets back this evening from a business trip to Melbourne.

I've read on personal finance blogs that paying for extended warranties never makes sense. This is a case where it would have made a lot of sense. That computer seemed to be inherently faulty - the screen was already replaced under warranty several months ago. The question is whether to pay for the insurance on a new laptop. From an economic perspective it probably doesn't make a lot of sense. The potential loss is only 0.6% of net worth and if occurring after a year as it did this time is a lot less than that (the computer has to be replaced some time - we can assume about a three year life).

Given my tax is so low, I'm not going to get much of a tax benefit from this either.

August 2008 Report

This month was OK, we lagged the MSCI index by about 1% resulting in a negative return and loss of net worth in US Dollar terms and gains in Australian Dollar terms, due to the 9% fall in the Australian Dollar over the month. The pound fell 8% and the Euro 6% against the USD.

As result, total returns (or accumulation index) in Australian Dollar terms have now caught up with total returns in US Dollar terms, which had been outperforming in the last few years, as measured from the 1996 inception point:



MSCI total returns are now also back in line with SPX total returns over the entire period though still outperforming over the last 5 years. It's depressing that we've made very little progress since the beginning of this decade, but neither have the major stock indices. The SPX has returned just 0.22% per year (this includes dividends) since 31st December 1999 while the MSCI has returned 1.98% per year. I've returned 4.66% per annum in USD terms and 2.10% in AUD terms. After taxes and inflation all of these are probably negative returns. In Australian Dollars the MSCI has returned -1.15%.

So there was again negative progress on our annual goals, which is reported on in the first part of this report. 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 In US Dollars we fell back $12,979 to $391,463, while in Australian Dollars we gained $A27,728 to reach $A457,209. Despite the increase in Australian Dollars, we are still way below the year's starting point at $A511,281.

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 my preferred time-series method, our returns had a beta of 1.07 and an alpha of 6.0% with respect to the MSCI World index, which lags our annual goal and is worse than last month. The risk adjusted excess return for August based on this analysis was -0.8%. Multiplying this by net worth gives a loss of $3,124. For the year so far, the risk-adjusted excess return in dollar terms has been $3,982. Using the estimate of alpha, the smoothed annual income is $23,715. Most other performance metrics are equally poor in recent months. I "re-equitised" too soon and then didn't "de-equitise" enough at the May peak though I did do some rebalancing. I then increased leverage again too early in the down wave from the May high to the July low.

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. So far this year these accounts have declined by 5.11% more than the MSCI return so that we are dissaving, by this measure.

4. Achieving Break-Even on U.S. Taxable Accounts We made a $1,636 or 2.26% gain this month on US Taxable and Roth IRA accounts. My Interactive Brokers account gained 9.24%. The NDX gained 1.26% for the month. We are still more than $10,000 from breakeven after achieving breakeven in May.



5. Make at Least $10,000 from Trading Realised gains this month were $1,059 and so far this year $3,149. Even though I didn't do any active trading I closed positions in PSPT and NNDS and I mark to market my CFD position.

Background Statistics

Income and Expenditure



Expenditure was $3,598, which is what it typically is when there are no unusual expenditures and just day to day living costs. Non-investment income was also at baseline levels. Non-retirement accounts had $3,579 in underlying gains while retirement accounts did much better this month with $9,383 in gains. Foreign currency movements removed $25,348 from USD net worth.

Investment Performance

Investment return in US Dollars was -3.06% vs. a 2.11% loss in the MSCI (Gross) All Country World Index, which I use as my overall benchmark. Returns in Australian Dollars and currency neutral terms were 6.71% and 3.20% respectively. So far this year we have lost 14.05%, while the MSCI has lost 14.55%.

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



The big winner was Australian shares as represented by the CFS Geared Share Fund, Conservative Fund, Developing Companies Fund, and Future Leaders Funds as well as Clime Capital, the SPI CFD, and Qantas among others. Takeovers of NDS and PeopleSupport also generated nice returns. The worst performer was the EBI listed hedge fund of funds whose decline mostly represents an increase in the discount to net asset value. On the other hand, Allco Equity Partners saw a decline in its discount. Resource stocks also declined and the former Loftus Capital Partners continued its miserable share price performance. At least the company is buying back stock.

Asset Allocation

Allocation was 47% in "passive alpha", 73% in "beta", 2% was allocated to trading, 8% to industrial stocks, 3% to liquidity, 3% to other assets and we were borrowing 36%. Due to the use of leveraged funds, our actual exposure to stocks was 134% of net worth. Leverage declined and we increased exposure to private equity and reduced exposure to stocks:



The first two columns of percentages in the table indicate how much of net worth was allocated to investment in each asset class in July and August. The fourth column gives the percentage of total underlying assets in each asset class. In other words, rather than accounting for a levered share fund by how much we are investing in it, we are counting the shares that they own. In total we are borrowing an additional 85 cents explicitly or implicitly for each dollar of net worth. Due to using levered stock funds and derivatives the shares of the non-equity asset classes are lower than their shares in net worth. I didn't account for leverage in non-equity funds, but probably I should in future. I also broke out managed futures for the first time under "commodities". We have less than 1% exposure to this asset class.

Our currency exposures were roughly 54% Australian Dollar, 24% US Dollar, and 22% Other and Global.

Carbon Planet

Carbon Planet is a privately held Australian company "whose mission is to enable every individual and business on the planet to manage their contribution to the defining issue of our age, global warming. Established in 2000, Carbon Planet has been working with businesses around the world, helping them quantify the risks and explore the opportunities emerging in the carbon constrained economy." They are raising money through both a retail and institutional fundraising round to help in their expansion. This kind of venture fundraising from retail investors is legal in Australia if sufficient disclosures are made in the offer document. But it's rare. Which makes me wonder why they are prepared to go through the hassle of raising money from the public. They plan on listing on the ASX by the end of 2010.

The plan is to raise $(A)4 million from retail investors in amounts as small as $2,000 and $10 million from institutional investors. The shareholders equity of the company was -$2.7 million at the end of 2007 and they lost $2.3 million in 2007. The main liabilities are loans from directors. Since the end of 2007 the firm has already raised $6.3 million from private equity placements for it seems 151 million shares for an average of 4.2 cents a share. But 82% of issued shares to date are held by the directors. The retail placement share price is 50 cents. A massive paper windfall for the the investors (mainly the directors) so far this year. The company states it has $2 million in the bank at the moment and has not repaid the director loans. So did it burn $4 million so far this year? It would be really nice to have accounts for more recent months, but none are provided. The expansion plans are ambitious but vague beyond the very near future and they admit to a very large number of competitors in Australia and doubtless plenty more elsewhere. On the plus side, the directors and key employees have a strong entrepreneurial track record including founding and profitably selling a technology company.

Given the short track record, ambitious but vague plans, lack of up to date financial information, and seemingly exorbitant valuation placed on already issued shares (the company is valued at $85 million based on this placement or about 100 times 2007 sales) I'm not planning on participating in this investment. Maybe I'm missing out on the next Google, but I don't think so.

Preliminary Report for August

August was an OK month and better than recent months. Our investment return was around 5% in Australian Dollar terms, 3% in currency neutral terms, but -3% in US Dollar terms due to the fall in the Australian Dollar. The MSCI World Index fell 2.11% but the Australian All Ordinaries was up 3.2% according to the AFR. As a result, net worth rose in Australian Dollars but fell again in US Dollars. Trading realised gains were $(US)1,062 and non-403b US accounts rose by around $2,000. There were no major expenditures and our car didn't depreciate so expenditure was just under $4,000. I'll post a full report after the end of the month.

Leveraged ETFs

A lot of nonsense is written about leveraged ETFs (ETFs that usually provide 200% long or short exposure to a given index) on the internet. These funds perform exactly like a margined portfolio of the unleveraged ETF would be expected to perform. In other words (on the long side) two times the index minus the interest cost of leverage minus the expense ratio (which is typically higher than for an unlevered ETF). This means that in the short term they tend to track two times the index very closely but in the long-term drift away from the index due to the interest cost and expense ratio generating a negative alpha. The Proshares annual report gives interesting information on how these portfolios are constructed.

The short funds exposure is achieved through a mix of swaps (similar to CFDs) and futures contracts. The long funds though also hold actual shares. For example, QLD's (I have 200 shares) exposure is achieved 85% through actual shares, 14% through futures contracts, and 100% through swaps. The money not invested in shares is invested in repurchase agreements with investment banks - in other words they lend their cash to these investment banks in return for US Treasury and Agency securities collateral. These provided margin for the futures contracts. The equities were partly used as collateral for the swap agreements.

Looking at the income statement, QLD received $3.6 million in dividends and $4.4 million in interest. Total expenses were $6.9 million. The interest cost of the swaps is apparently capitalized into the swap values. My only puzzle is why not construct the equity market exposure 100% out of swaps and/or futures? I'm guessing it's for tax reasons. Capital gains on stocks removed from the index can be distributed at the long-term rate while distributions from dividends earned may also be taxed at the lower US qualified dividend rate rather than the regular rate that would apply to interest. I could be wrong though. It seems that net gains on futures do not have to be distributed.

Which Type of Hedge Funds Give the Most Diversification Benefits?

I recently read a very interesting article about using hedge funds to diversify that was discussed by AllAboutAlpha. Adding hedge funds to a portfolio can both increase returns and reduce variability. Even if a hedge fund's returns were perfectly correlated with your existing portfolio's, if it had a positive alpha, allocating some money to the hedge fund might increase return and reduce drawdown relative to your existing portfolio. See my discussion of alpha-beta separation. But usually what is meant by diversification is adding assets whose returns are imperfectly correlated to the returns of the original portfolio. But you can go beyond that to also take into account "the higher moments" of the return distribution.

So what are "higher moments"?

The first moment of a distribution is the mean or in ordinary English the average. The second moment is the variance or its square root the standard deviation, which captures how tightly packed values of the variable are around the average. The "normal distribution" - the classic bell curve - can be entirely captured by these first two moments:



The mean is at zero and the numbers on the x-axis are standard deviations from the mean. The normal distribution always looks exactly like this, though the actual numerical value of a standard deviation could be larger or smaller and the mean might be different to zero.

The third moment of a distribution is skewness. A distribution is skewed if one side of the distribution is much more stretched out than the other:



A positively skewed distribution has a long-tail to the upside. The fourth moment is kurtosis which measures how sharply the distribution peaks and how fat the tails are:



The distribution marked in red is the most kurtotic. No longer is there a plateau of many values clustered around the mean, but values are dispersed towards the extremes.

An investment with negatively skewed and positively kurtotic returns is prone to "crashes". The MSCI world index has negative skewness and positive kurtosis.

The standard "beta" in the finance literature measures how much an investment's returns change when the returns on another investment change. Usually we are measuring how much a security's or an asset class' returns change in relation to the returns of the "market portfolio" or a stock index like the S&P 500. But we could also measure the relationship between the variances of two investments and the relations between the higher (3rd and 4th) moments of the distributions.

An investment with a low (less than one) or negative conventional beta to an existing portfolio will reduce the volatilty of that portfolio. A low variance beta means that when the volatility of the portfolio rises due to market conditions the additional investment will mitigate that increase in volatility by contributing less or even a negative amount to the increase in volatility. As is well known, the correlation between most investments seems to rise when market volatility rises. It would be really nice if we could find investments that reduced the tendency of our portfolio to experience extreme negative events. Investments with low and negative skewness and kurtosis betas will be best at achieving this.

Finally getting to the point :), the paper computes these higher order betas for a variety of hedge fund indices with respect to the MSCI index (the estimates are for monthly data from January 1994 to February 2006):



Any betas below one have diversification benefits. By far the best diversifier is managed futures. Fixed Income Arbitrage, Equity Market Neutral, and Convertible Arbitrage are also good diversifiers. The least good diversifier is long-short equity, which includes the likes of 130/30 strategies. Only managed futures and equity market neutral have normal returns, though Global Macro and Long-Short Equity also both have zero or positive skewness:



The author adds a mixture of the best diversifying hedge fund indices to a 60% equities and 40% bonds portfolio and finds increased returns and reduce variance for all mixes up to a 35% allocation to diversifiers. I have a feeling that if he tried pure managed futures the gains would be even better.

Given these results, and the high returns to some managed futures funds a large allocation to managed futures could be very advantageous (subject to tax considerations). For more on the advantages of commodities and managed futures see the Ibbotson-Pimco study.

BTW, another new category today: "Hedge Funds".

Recent Moves

I sold out of NNDS and PSPT because the expected rate of return until the takeover deals close is less than my rate of margin interest. Yes I'm paying too much interest... Over time, I'll reallocate capital to my cheaper broker (Interactive Brokers). I also doubled my position in CHN. That's only about a 1/3 of the proceeds from the sale of the other two stocks.

Gain on my most recent NDS trade was $820.97. Total profit from trading and investing in NDS totalled $1826.84. The internal rate of return since the beginning of this calendar year has been 154%! PSPT is being sold at a loss of $555.94 or -29% at an annualized rate.

Glaring Market Inefficiency

Allco Equity Group continues to trade at a ridiculous valuation of $(A)1.75 per share while having net assets of $4.76 per share. The value of shares and convertibles it holds in IBA Health based on their current ASX listed price is worth $1.81 per share of AEP according to today's earnings release. The firm has $1.28 in cash and other marketable securities per share and its outstanding loan to IBA is worth $0.60 per share. The loan is due to be repaid in October. Its unlisted investments are worth $1.01 per share according to the company. Assuming these are worthless (which they're not - they earned $3.5 million in after tax profits for AEP this financial year while AEP's share of IBA's earnings was $4.4 million) AEP is still worth $3.75 per share. Obviously, we know that closed end funds can trade at a discount, but this is nuts.

The company is issuing a franked dividend of 6 cents per share in October (record date in early September) and will buy back 5% of its stock starting in mid-September.

BTW, I just created a new label category: "Private Equity".

Where Do Visitors to Moomin Valley Come From?

Sydney and Canberra are joint most popular cities - I do eliminate my own visits but not any Snork Maiden does from work :) New York is the third city. Around three times as many visits come from the US as from Australia with the United Kingdom a distant third. The remaining top ten countries are: Canada, Hong Kong, Israel, China, India, Japan, and Finland. Sorry to all those people in Finland looking for moomins :( Moomins are big in Japan too.

Qantas Chart

This is a pretty classic inverted head and shoulders. The target is around $4.50 if it plays out.

Managed Futures Funds

The Australian Financial Review recently (16-17 August edition) highlighted two lesser known managed futures funds offered in Australia that were developed by alumni of AHL which was acquired by Man Investments. The Select Futures Fund has a minimum investment of $A25k and has performed nicely:



though it then lost 8.6% in July. The Macquarie Winton Global Alpha Fund returned 27.2% in the year to June 30 compared to 16.9% for select futures. It lost 4.4% in July. The minimum investment though is $A50k. An advantage the fund has over the Man Funds is it is considered to be an Australian fund for taxation purposes and, therefore, not subject to the FIF regulations. Neither is the Select Futures Fund a FIF. The Man-AHL Diversified Fund has a minimum investment of $A20k while Man's various OM-IP offerings have $5,000 minima. The latter have very limited liquidity while the Winton fund allows daily redemptions and the others are in between in liquidity. Only the OM-IP and Global Alpha funds appear to be marginable through CommSec.

But, interestingly, there is a totally liquid alternative: The Macquarie Winton Global Opportunities Trust which is listed on the ASX. Is this a free lunch? That will be the topic of another post :)

US and Australia Sign Deal on Financial Markets Access

Does this mean that Australians will be allowed to buy unlisted US mutual funds? Or does it only cover exchange traded products? Currently new purchases of US mutual funds are only open to US residents and Australian IPOs are only open to Australian residents. US residents aren't allowed to trade foreign options including Australian options etc. US investments already have special status in the Australian foreign investment fund rules. US regulated investment companies (which includes mutual funds and exchange traded funds) are not subject to mark to market accounting, while such funds in other countries are. Will need to learn more on the implications of this deal.

P.S. 28th August

I just read in the AFR that the deal does not cover IPOs. Looks like it may lower costs for trading shares by allowing direct trading by US brokers on the ASX and vice versa rather than through intermediary local brokers.

Attitudes to Money and Gifts

As I've mentioned we're going to China later this year. Yesterday Snork Maiden's mother told her she wants to give her or us a total of RMB20,000 (almost $US3,000, which is a lot of money for the average person in China ) when we visit. Snork Maiden is then meant to give several thousand RMB to her grandfather and we also will pay for two family get together meals that are estimated to cost RMB2,000 a piece. What's left over - more than RMB10,000 - is for "spending money" when we are in China. From my perspective the arrangement is rather odd and I feel uncomfortable with receiving the "spending money". I don't understand the point of the gift to the grandfather - seems like fooling him that the money is coming from us rather than his daughter - though I'm sure that's not the intent. But anyway, if they want to do that, it's fine with me. Also I'd be happy if my parents-in-law paid for a wedding/get together celebration meal in China. Seems odd to give us the money to pay for it. But again if they want to do things that way it's OK with me.

I told Snork Maiden that I'm not so comfortable with the spending money arrangement. We've got the money to spend whatever we want in China. When I said that I think her parents may need the money, she said "my mother will spend it soon anyway, she can't have money lying around". Snorkmama and her husband receive government pensions - they both worked for government - which seem to cover all their costs and they own an apartment that the husband received when he retired.

Snork Maiden's parents already gave her a gift of money for "getting married" and we spent a lot less than that on the wedding, though more than that on setting up our apartment when we moved to Australia to live together. My mother also gave us a monetary gift for our wedding (as well as paying for herself and my brother to come to the other side of the world for the ceremony). So I have no problems with monetary gifts for specific events or regarding inheriting money. There's something though that I find culturally difficult with the "spending money" thing. I guess one thing is it makes me feel like they see us as children who need "pocket money".

The flipside to this, is that if and when Snork Maiden's parents visit us here will be spending money on them. I wouldn't think to give them cash to spend though. That would feel very peculiar for some reason whereas giving in kind does not for some reason.

My family have obviously different attitudes to money, gifts etc. which are result of both our cultural background, life experiences, and personalities.

Link to Snork Maiden's aka Yoyo's blogpost on this.

Large European Listed Private Equity Firms

The firms discussed in this post are the European firms among the top 10 in the LPX index. I've already covered (and invested in) 3i - the firm with the largest weight in the index.

Wendel: This French firm seems to be more of a buy and hold investor in the mode of Berkshire Hathaway or Loews than a private equity firm. RoE is less than 10%. So this doesn't look attractive as a LPE investment.

Partners Group: "Is a global alternative asset management firm with over CHF 25 billion in investment programs under management in private equity, private debt, private real estate, listed alternative investments, hedge funds and alternative beta strategies. Partners Group is headquartered in Zug, Switzerland." In other words, investing in this is like investing in BX. You are investing in the management company, not the fund.

Ratos: Is a pure listed private equity firm investing in Scandinavian firms. But its share price is way above book value and its RoE is not very impressive. Analysts are not positive on it.


Eurazeo: Private equity investor that also has significant stakes in listed companies and real estate. Almost all its investments are in France but many of those companies are multinationals. Analysts like it and the financial data I've examined looks pretty positive but erratic over time. It's worth considering.

Are Australian LICs Better Investments than Index Funds?

There are many "listed investment companies" (LICs) in Australia, which are similar to closed end funds in the US with the difference that they pay tax on their profits and then pay dividends with "imputation credits" attached for the tax paid, whereas US closed end funds do not pay tax and distribute capital gains and dividends in the same way that unlisted open end mutual funds do. Many of these LICs are rather small, but there are several fairly large "traditional LICs" that mainly invest in large cap stocks:

Argo Investments
Milton
Choiseul
Australian Foundation
Djerriwah

The interesting thing is that these large funds have very low expense ratios. Argo's expense ratio is 0.12%. Choiseul's is 0.11%, Milton 0.14%, Djerriwah 0.26%, and Australian Foundation 0.14%. By contrast, Vanguard charges 0.75% for its flagship Australian index managed fund for amounts under $50,000 and Colonial First State charges more than 1%.

Also they are pretty much buy and hold funds with very low turnover compared to traditional actively managed funds, which means they are tax efficient and they typically offer dividend reinvestment programs with new shares available at a discount.

During the bull market which ended in 2007 they outperformed the index. This was due to their preference for shares with high dividend yields, typically banks. Surprisingly, this has not overly impacted them since the start of the bear market. In the six months till June 30th 2008 the ASX 200 Accumulation Index lost 13.4%. Australian Foundation lost 11.5% and Argo 15.3%. Dejerriwah lost 13.9%. Moom lost 13.1% in Australian Dollar terms.

One issue is that these stocks typically trade at a premium to net asset value. For example, on 31 July, Argo's shares traded for $A6.72 while it's net tangible assets were $6.54.

I'm not in the market for these at the moment as I am fully invested in Australia so I'm not going to dig any deeper into this investment class. But you should certainly consider these stocks if you are interested in broad exposure to the Australian stock market.

How Come Australia Has Less Government Spending than the US and Has Free Healthcare for All?

Following up from my comments on this post of Madame X, I thought I'd have another go at comparing Australian and US government spending:



As you can see from the chart, Australia spends less as a share of GDP than the US does. Only Korea and Switzerland spend less than Australia among the OECD countries for which there is data. Australian government revenue is slightly higher as a share of GDP than the US, because we have a budget surplus whereas the US has a large deficit. But we have more or less free healthcare for all, while the US does not. Australia encourages people to get private health insurance through tax incentives, and around 35% of people do have private healthcare. This makes free healthcare easier to provide than in other OECD countries where there is less private insurance. So how does Australia achieve universal healthcare when the US does not? Here are some suggestions:

1. Our defence budget is smaller. Also we have far fewer people in prison. The US has 4.5 times as many prisoners per capita as Australia.

2. Because we run surpluses our government has net assets rather than net debt. So we don't have to pay any net interest on the non-existent national debt. There are government bonds outstanding just to keep the market open.

3. Retirement benefits are means tested and less generous than average US social security benefits. Whereas the US gives more retirement and unemployment benefits to people with previously higher incomes, Australia does the opposite. Over time retirees will be more and more self-funded due to compulsory superannuation saving in Australia. Since 1992, employers have been required to put at least 9% of salary into a superannuation fund - the equivalent of a 401k. It's much harder to get the money out before retirement too.

4. Our medical care is much cheaper than the US. Reasons include the high level of litgation and consequent insurance and overtreatment in the US and price discrimination by drug companies due to the fragmented nature of demand for drugs in the US. Doctors earn less in Australia.

So, in order to get "socialised medicine" you don't need "socialist" levels of government spending ;)

3i vs SVG

After finding that I couldn't invest in the Bear Stearns and Lehman Brothers funds I considered investing in two large UK listed private equity funds - 3i (III.L) and SVG (SVI.L). 3i is a private equity firm that invests on its own account and also manages funds for investors. SVG has the same combination of businesses but does not originate its own private equity investors, investing instead in Permira's funds. SVG was created in the reorganization of Schroder funds which also resulted in the creation of Permira. This adds an extra layer of costs, which is one reason that I think SVG appears to be underperforming 3i.

3i mainly splits its investments between buyout and late stage venture or growth investments, while Permira is primarily a buyout outfit. Both SVG and 3i have some infrastructure investments as well. 3i is mostly invested in Britain and continental Europe with smaller amounts elsewhere. SVG has a large part of its investments in North America. 3i invests in smaller companies than Permira typically does. This is reflected in the commentary from the chairman and CEOs of the two firms in their most recent annual reports. 3i's management dismiss the credit crunch as mainly affecting deals larger than those in their portfolio, while SVG's management are gloomy about prospects.

Compared to conventional stock or fund investments 3i looks very cheap:

• It trades at a discount to book value. And it is well known that private equity book value is usually conservative. Most realisations of investments yield higher prices than the carrying value - so-called "uplift". Recent book value is £10.60 while the share price is £9.09. A 14% discount. It has traded at a premium in the past.
  
  
• The trailing P/E is only 5.
  
  
• Total investment return after expenses for the 2008 financial year that ended at the end of March was 18.6% on initial shareholders funds. In 2007 3i earned 26.8%. The underlying gross portfolio returns were 23.9% and 34%. From 2004-6 the gross returns were 19.4%, 16.7%, and 24.4%.
  

The buyout line of business has done even better with a 54% gross rate of return in 2008. The IRR of the different buyout funds has ranged from 35-62%. SVG reports that Permira's underlying buyout funds averaged a 20% IRR while SVG's NAV has grown at an average 14% p.a. since listing. It's not surprising that most analysts that track 3i rate it an buy or outperform. The modal recommendation on SVG is "hold".

I bought 200 shares of 3i for £9.06 each. Commission was £6 plus a 0.5% stamp tax which is a transaction tax on share trades in the UK. No wonder CFDs are so popular in Britain. The stamp tax doesn't apply to them. It'd be hard to day trade with a 0.5% tax on top of commissions.

Next I'll look for a second European private equity investment.