May 2018 Report

Another very active month financially. The Australian stock market rebounded quite strongly but then turned over as other markets did. This month was the second month of the futures trading experiment. The first month was the model development phase, while this month was about ironing out the glitches and training myself to trade the model properly (and not give in to gut instinct etc).

The Australian Dollar rose from USD 0.7540 to USD 0.7571. The MSCI World Index rose 0.21%, and the S&P 500 2.41%. The ASX 200 rose 1.09%. All these are total returns including dividends. We gained 1.84% in Australian Dollar terms and 2.26% in US Dollar terms. So, we outperformed both the Australian market and the international markets and slightly underperformed the US market.

The best performing investment in dollar terms was NASDAQ futures gaining AUD 9.5k (this is going to be a theme :)). The second best was CFS Geared Share Fund gaining AUD 8.9k. The worst performer in dollar terms was IPE, losing AUD 1.5k. The best performing asset class was "commodities", which includes futures trading, gaining 6.24%. Hopefully, this will become a near permanent feature. The second best performer was Australian small cap stocks, gaining 2.92%. The worst performing asset class was private equity, losing 0.78%, the only asset class that lost money.

A new feature starting this month is the following table of investment performance statistics. The statistics are computed with the last 36 months of data:

The first row gives the Sharpe ratio for our investment performance in US dollars and Australian dollars. The other statistics are in comparison to the two indices. Beta expresses the change in investment returns for a 1% change in the market. Compared to the MSCI World Index we seem to be slightly geared, while compared to the Australian index we are less sensitive to market movements. Alpha shows the risk adjusted excess annual return. This is how much we are beating the market (or not) adjusted for risk expressed as beta. We have a slightly positive alpha compared to the Australian market and a close to zero alpha compared to the world market. Finally, up capture and down capture breaks beta into the response to positive and negative months in the stockmarket. A greater up capture than down capture ratio is desirable. We do capture more of the up movements in the Australian market and suffer less of the down movements. A hedge fund like return would show this positive skew and a positive alpha. Compared to the Australian market we show some hedge fund like properties.

This month I made money trading futures: USD 7.2k. The table compares my performance to the markets and the models:

I also bought and sold investments in this account and added AUD 25k in cash towards the end of May, so don't expect the starting cash to change with just income earned. My rate of return in May far exceeds the models or markets because of leverage. I mostly traded one contract at a time and so was using a bit over 3 times leverage. I could also select the market where I thought the model signal was most reliable. In the early part of the month I mostly traded NQ (NASDAQ) and in the later part of the month ES (S&P 500). I also traded CL (oil). Most of the gains were made early in the month when the market rose. After that the market mostly went sideways.

I more or less successfully followed the plan for the month, which was to consistently trade one futures contract according to the trades that the model provides, while learning about entering trades more optimally and setting stops. There were some hiccups, particularly on 14 May when I lost much more than the model due to bad trading. I can say that the second of my goals in the experiment - to consistently trade the model - was a qualified success. I was much more disciplined than when I previously traded futures, but still not disciplined enough. The third goal - to earn as much as my salary from trading fell short though I was in the ballpark. I would need to make USD 12.5k to reach the goal. For the next month I plan to work on the same goals and maybe increase the position size when I am particularly certain about the market direction. This is why I added more cash to the account. After adding the money and doing some bad daytrading, which I shouldn't be doing, I had second thoughts about taking a larger position. But I maybe should be trading both stocks and oil simultaneously. Horizontal rather than vertical expansion.

We made more progress towards the new long-run asset allocation:

Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged mutual funds.

The improvement in allocation, came partly due to market movements and partly due to investment activity. We invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. During the month, I also:

• Traded futures successfully, increasing the allocation to "commodities" as a result. As mentioned above, I also added cash to the trading account. Just over 4% of net worth is now allocated to trading.
• Added another AUD 10k to the Winton Global Alpha fund, also increasing the allocation to commodities.
• Closed my investment in GMOM, due to poor performance over many years.
• Increased investments in the China Fund (CHN), Boulder Income Fund (BIF), and 3i (III.L).
• Sold my trade in Woolworths (WOW.AX) and made a quick trade in Platinum Capital (PMC.AX).
• Switched from Colonial First State Geared Share Fund to CFS Conservative Fund in a small account I have, which I am planning to close soon (after the end of June distribution). Then I switched back again. Originally, I had this account as a trading account!

Flipped Back to Short

The model was long NQ for one day and lost a little (it remained short ES, surprisingly). Now it has flipped back to short. Given yesterday's post, I'm still thinking this is a limited correction. Here is a possible interpretation based on Elliott Wave Theory:

We are now in wave C of 4. Based on Elliott Wave Theory that wave should stop before price falls below the maximum point of Wave 1, as shown on the graph. I find Elliott Wave very useful in understanding the different things that might happen, but I don't think it is an exact fit to what the market does, especially on very long and very short time scales. Over the time scale shown on this chart, it is particularly useful. On the other hand, Eliott Wave is notorious for continually morphing and following what the market does, rather than predicting it.

Of course, my model has nothing to do with Elliott Wave Theory it is just nice to have some other approach that does not conflict with the model or confirms it.

If you look closely you'll see I'm short from 6911.5 and up quite nicely, but I was up $500 when long yesterday evening too and that reversed...

P.S.
The downside didn't last long! Market turned around in the morning US time and went up, eventually reaching above the top of the triangle in the chart above. At one point I was up USD 1500, but unfortunately I didn't take profits as I was sticking to what the model said to do. Now I am considering doubling my position during the Australian daytime - the US overnight and then closing half in the US morning. If I had done that yesterday I would have ended up on the day. I am going to backtest the strategy of course. 10 years back when I previously was trading futures, I did look at "overnight trading" as a strategy, and now it has come up again.

Model has now flipped back to long. S&P model was short till today, and now has also gone long.

Getting Bullish

The model is switching back to long today. The last seven business days it was short but the market just went sideways more or less and it netted USD 1,200 a contract or 0.85% for the effort. The previous 10 days of being long, by contrast yielded USD 5k (3.67%). That's an indication of the bullishness. Australian and European markets have been more bullish throughout this period - the US market has been lagging perhaps due to relative over-valuation and to all this trade war and other nonsense.

So far for the month, the model is up USD 7k per contract and I am about matching that.

Backtesting 1987

You would want to make sure that your trading model put you in the right direction in the 1987 crash (which I am old enough to remember very well), wouldn't you? So, I backtested the model for 1986-87. The main model would be short going into the crash. But a more primitive model I am using in conjunction with the main model would switch to long on the Friday before the crash. That day the market went down 5%, so it would have already been a bad idea on the Friday. Recently, this secondary model has been doing well and I have combined its signals with my main model. So, we need some new rules about how and why to combine them. In this chart you can see that the buy signal would have come with the price already outside the +/- 2 standard deviations envelope (S&P 500 index):

These are "Bollinger Bands", though I use a 34 day moving average instead of Bollinger's 20 day MA. So, the new rule is not to take that signal when the price is outside the Bollinger Bands and the width of the Bollinger Bands is increasing. That wouldn't change much recently (NASDAQ 100 index):

The secondary model gave some very good buy signals just as price hit the Bollinger Bands in early February and late March. In these cases the price was not outside the Bollinger Bands or they weren't expanding.

The model is short for Monday.

How Big Should the Trading Program Be?

At the moment I am still in the experimental phase of the trading program. A 1 contract S&P or NASDAQ position either adds or subtracts about 0.1 beta to the portfolio. So if the beta of our portfolio to the market was 1.0, trading modifies this to 0.9 when short to 1.1 when long. My goal is to be able to hedge our portfolio against a market crash. That means we need to subtract up to 1 full beta from the portfolio. On the long side we then would double exposure. This means that the trading program needs eventually to be 10 times the size it is now. Using 3 times leverage on the cash in the trading account that implies allocating 25% of assets to trading. My existing allocation has 25% of assets allocated to managed futures. This total could be allocated between my own trading and "outside managers" such as Winton and meet this goal.

Why 3 times leverage? Simulation shows that about a 12% drawdown is possible. Remember that we use stops and or hedging to limit possible daily losses. So this drawdown means a string of large losses. With 3 times leverage that would wipe out 1/3 of the trading account. More than that and it will reduce the earning potential of the account too much going forward, I think. And be way too scary.

Formal Rules for Stops

I have decided on formal rules for setting daily stop losses. It is based on the pivot-point method. The pivot point is the average of the high, low, and close for the previous day. When short the stop loss is set at the second resistance level - the pivot point plus the previous day's high-low range - and when long it is set at the second support level - the pivot point minus the previous day's high-low range. If this results in a stop that is less than 1% from the opening price, I instead set a 1% stop. These stops increase the Sharpe ratio of the model though they slightly decrease returns. The chart below shows the last month of daily pivot points and first and second resistance levels:

The model got stopped out on 26 April when short - losing 1.42% that day. The market closed up 2.08%. So that saved 0.66% of losses The model also got stopped out on 3 May when long losing 1%. The market closed only down 0.02%. So that increased loss by 0.98%. That shows you why this reduces returns...

These numbers don't quite match what you can see on the chart as the chart shows the 24/5 futures market and the model is based on the NASDAQ 100 index. I am thinking of switching the model to use actual futures prices. Will need to pay for the data, I think.

Trying to Learn the Lesson about Narrow Stops Again

Yesterday the model said to go short NQ (NASDAQ) and long ES (S&P500). I started off the day, doing exactly that, though I entered the trade badly and ended up down on the NQ part of the trade relative to the ES part of the trade. Then, I closed the ES long for a small profit and based on "pivot points", I set a stop loss at 7010 - 50 points above my entry point. As you can see from the chart, the market briefly went through the stop but then turned and ended the day near where it started. So, I lost a lot more money than the model did. If I had set the stop at 1% (7030) or kept the hedge without stops, I would have ended the day with only a small loss. Really, it was fear of missing out on making a profit on the ES trade that screwed me up.

I also did a long CL (crude oil) trade yesterday and was stopped out too. Then the market also turned around and actually ended the day higher. The lesson I am learning from that one is to stick to the stock market for the moment so I can set wider stops and not worry about the potential loss from multiple positions going wrong.

The model is again short NQ and long ES for today. I was going to sit out for today, but writing this post has inspired me to put on that hedged trade. For the record, I sold NQ at 6969.75 and bought ES at 2729.50.

Weekly Update

Another successful week. Now up USD 8k for the month and USD 6k since the trading experiment started. On Friday I was long NQ when I should have been short. I only lost USD 150 luckily (though double that relative to what I would have got if I had done the correct trade). This was because of an error in a link in a spreadsheet. That link is now fixed. The model says short NQ (NASDAQ), long ES (S&P 500), long CL (Crude) for Monday. I think the short NQ is only a short term correction in NQ and probably it will switch back to long by Tuesday. It is a bit of an unusual feeling to see myself keep winning trades. I said to Moominmama that it felt like I was cheating or something. She said: "Please don't feel like that, please make lots of money :)". So far, this month I just have had to stay long, which isn't so easy for me as I tend to be bearish. And apart from Monday it looks like that staying long will continue to be the challenge for a little while till the model actually shifts to the short side. So, for the meantime we are still in phase 2 of this experiment, which is to see if I can stick to what the model says to do. Only, when we've been through both a long and a short phase successfully, will we be able to say that I think.

These 13F Tracking ETF's Have Horrible Performance

13F is a form lodged quarterly by US based investment funds. A 13F following strategy takes the stock picks from top hedge funds as revealed by their 13F forms. Two ETF's that follow this strategy are ALFA and GURU. But both have horrible performance with negative alpha of of -5% and -7%, which is rather ironic. Does this strategy no longer work?

Cracking Horse-Racing, the Lottery, and the Stockmarket?

Articles about Bill Benter who "cracked" gambling on horse-racing by using a model to predict which horses would win and Eddie Tipton who cracked the state lottery, illegally. I'm testing whether I've cracked the stock market :) So far, so good this month, but it is early days.  

P.S.
More on quant betting on horse-racing. Model remains long stocks (NDX and SPX) and switches to long oil for Monday. Yes, I added a model for predicting oil, so far I only did very quick trades in oil.

P.P.S.
More on Zeljko Ranogajec.

Fear of Missing Out versus Loss Aversion

The key to sleeping better in Australia while trading in the US markets seems paradoxically to be using wider stop losses rather than tighter stop losses. With a tighter stop, I am concerned that the market will hit the stop and then bounce back up strongly, which is what would have happened last night except I stayed up and adjusted the stop. This is the fear of missing out - crystallizing a loss and then missing the upside. I need to be more accepting of the possibility of large losses to allow the possibility of gains. I actually seem to have less aversion to losses if they aren't tied to then missing out on gains. FOMO seems to beat loss aversion. This is because my trading model has a high win rate. Traders with techniques that have a small edge or no edge have to make sure that wins are bigger than losses - letting winners run and cutting losses. They need the asymmetry to make money. I don't.

April 2018 Report

A very active month financially. The Australian stock market rebounded quite strongly and now looks pretty bullish to me. I also started trading futures again, which so far had the opposite effect on the results for the month :)

The Australian Dollar fell from USD 0.7680 to USD 0.7540. The MSCI World Index rose 1.08%, and the S&P 500 0.38%. The ASX 200 rose 3.92%. All these are total returns including dividends. We gained 2.86% in Australian Dollar terms and 0.98% in US Dollar terms. So, we underperformed the Australian market and to a small degree the international markets but outperformed the U.S. market.

The best performing investment in dollar terms was CFS Geared Share Fund up AUD17k. The worst performer in dollar terms was IPE, down AUD3k. My holding is now quite large (more than 1% of the value of the company - it's a very low value company) and the price is quite erratic. The best performing asset class was large cap Australian stocks, which gained 2.84%. The worst performing asset class was private equity, losing 2.04%, the only asset class to lose money this month.

A new item that I am reporting from this month is trading income. This includes trading in futures and options etc and interest on cash dedicated to trading. It doesn't include any trading done on fundamental grounds. This month I lost money - USD1,987 - which isn't surprising as I was experimenting with different models and approaches and learning to trade more confidently. I pretty much reversed that on the first day of this month, but anything could happen. Less than 3% of net worth is dedicated to trading at this point, which mainly means a deposit of Australian and US dollars used as margin for derivatives. The plan for this month is to consistently trade one futures contract according to the trades that the model provides, while learning about entering trades more optimally and setting stops or using options as hedges (much wider hedges than I was using last month).

We made a bit more progress towards the new long-run asset allocation:

Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged mutual funds. I have reduced the allocation to cash, because assuming I will be trading, there will always be plenty of cash in the trading account plus the ability to borrow, though the latter can be reduced in a financial crisis. Commodities now includes managed futures, trading, and gold.

The "improvement" in allocation, came partly due to market movements and partly due to investment activity. We invest AUD 2000 monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. During the month, I also:

• Invested in a venture capital fund.
• Bought more IPE (private equity) at below net asset value.
• Sold out of Leucadia National (LUK) and bought more 3i (III.L, private equity) and China  Fund (CHN).
• Bought more units in the Winton Global Alpha fund (managed futures - in the commodities category).
• Transferred cash into my trading account and did a lot of trading of futures and options while developing my trading model.

As a result the allocation to private equity and commodities increased quite a bit.

New Model Rule

The model was still short yesterday based on the forward forecast.  But Facebook's earnings release pushed the market up and I lost money. So, now I will check the model in real time as well before putting on trades. Also, today's decision based purely on forecasts would have been to stay short like yesterday's. But yesterday the actual observed indicator signalled a buy. So, now we add a rule that if the actual observed signal yesterday was a buy that over-rides a forecast....

Now Amazon released their earnings an the market is up in after hours again.... I put on my first full size futures order with a 1% stop buying the E_Mini S&P. Now this is the real test of the model...

Sophisticated Investor

I got an e-mail about an Australian venture capital fund and decided to follow it up. The information the fund sent me looked very interesting, but it is limited to wholesale and sophisticated investors. In order to be classified as a wholesale investor you must have individually (not with your spouse) AUD 2.5 million in net assets or AUD 250k in gross income. I don't qualify individually on this basis, though we jointly would qualify on the second criterion and in the near future I will qualify on the first criterion. So, I told the fund salesperson that and they sent me a questionaire to see if I qualify as a sophisticated investor who understands the risks involved. I just sent the form back. If they qualify me I will invest in the fund and disclose more information here. Overall, I plan to invest 5% in private equity and it makes sense to allocate half of that to venture capital and half to buyout etc. IPE and OCP cover the later stage private equity in the portfolio 2.5% roughly equals the fund's minimum investment requirement, so that is what I will invest, if approved. Interestingly, early stage venture capital investments are tax free in Australia. That also means, of course, that you can't claim losses against your income tax.

In other news, I redesigned a trading algorithm from the bottom up on 2018 data, using the same forecasting model. It has a bit lower return and larger drawdowns, but all the rules make theoretical sense and it sticks to the model predictions rather than reversing direction if stopped out. In fact, it only uses a stop when initiating a new direction - this is to guard against the new signal being noise - the stop is removed after the direction is confirmed. After that I would just use hedges. Next, I need to backtest it for 2017 and 2007. I think 2007 is analogous to 2018, while 2017 is very different - a constantly uptrending market.

The model is currently short, but I am not trading it without backtesting and also there is higher risk entering a move already underway, as the model is unlikely to time the exact optimal turning point to reverse direction.

P.S. 25 April
I backtested the model for the second half of 2017. Results are not as good as year to date in 2018 but they are much better than the model I was using at that time when the fake stops are removed from the model. The main issue is that my model tends to underperform the market in strongly trending markets as it keeps looking for opportunities to go short. We can compensate for this by trading 2/3 the model and 1/3 just long the index. This means that when we go long we use 3 times the position we use when we go shorter. This results in a more consistently rising equity curve. Increasing position size when going in the direction of the established trend definitely makes sense.

P.S. 27 April
They accepted me as a sophisticated investor.

Backtesting Failed

I backtested the model for 2017 and some periods in 2006-8 and it either makes no money (2017) or matches the market. So, this needs a fundamental rethink to get a more robust model. For the moment I will step away from live trading and observe what happens and when I have more time have a look again and developing a robust framework. I also saw that some of what I put in spreadsheets from 2006-08 is not realistic regarding how stops work, and so exaggerates the performance of the model. The current model was stopped out very very often in that period as the index was often both up and down more than 1% in a day. It could only work with hedges rather than hard stops.

Improved Model

The "Gold Model" was stopped out twice in a row on Thursday and Friday when the market was more than 1% down and it was long. So I now took another of my old models that uses a different approach entirely but only gives rare signals. Those signals over-ride the "Gold Model" signals. The combination enhances return. It would have been short Thursday and long Friday. It signals short for Monday. In simulation, it's average win is 1.3% a day and average loss 0.36% with a 62% probability of winning.  The Sharpe ratio is 0.52. This is only based on data since January 1st. Trading 1 NQ contract the biggest drawdown since January 1st is USD 3852.

I ended up USD 200 down on the month in trading at the end of Friday after being USD 700 up on Wednesday. Plan is to switch to trading NQ contracts with a stop loss next week. I am a bit wary of taking the signal from the new model for my first larger trades and so maybe will wait till Tuesday.

I made decision trees in Powerpoint for using the model in each of the 4 possible states where yesterday's trade was: long, short, long but stopped out, and short but stopped out. There is then no discretion over putting on trades. Here is one of the four decision trees, to give you an idea:

Collared Trading Has a Low Expected Value

I did a proper analysis of trading futures with an options collar. The win and loss probabilities are the same as trading with a stop loss. But the average win is reduced from 1.26% to 0.73% and the average loss from -0.65% to -0.53%. As a result the expected value of each day's trade goes down from 0.57% to 0.28%. And that's with perfect execution of the hedges and entry point so that the hedge is costless and the upside and the futures entry point is exactly in the middle of the interval between the hedges. Usually the hedge costs something, maybe 0.1% and the entry point isn't perfect. Together this probably reduces the expected value to a 0.1% gain or so. Some slippage in entry point on the futures plus stop tactic doesn't have such a big effect on the expected value. Maybe reducing it to 0.5%.

Given this, I have no choice but to bit the bullet and trade futures with a stop loss instead of a hedge and accept the relatively larger dollar value of losses when stopped out, as would have happened today trading NQ.

Why is Trading Stocks So Expensive in Australia?

Commonwealth Securities Charges 0.1% and Interactive Brokers 0.08% for Australian stock trades. That means that to trade AUD 170k of stock you would pay AUD 136 with IB. But to trade an S&P 500 futures contract costs USD 2.05 at IB. For U.S. stocks IB charge 0.5 cents per share so trading the same value of the SPY ETF costs USD 2.50.

These high prices aren't unique to Australia. IB charges around 0.1% to trade shares in most countries apart from the U.S. and Canada. On the other hand they charge AUD 1-6.5 per contract for Australian futures. So, maybe the question, should be why U.S. and Canadian shares are so cheap to trade.

Anyway, the high prices definitely discourages day-trading of Australian shares.

Long Futures Collar Trade

I put on my first collared futures trade. The idea was to sell a call 5 points above my long futures entry point and buy a put 5 points below. But my futures entry was at 2676.25 instead of 2675 and and the call was 1.5 points less than the put. So my potential upside is only $112.50 not counting fees and my potential downside is $387.50. As the model has a 71% win rate, the expected value is -$32.50 :( It's probably worse than that because the futures gapped up over the weekend reducing the potential upside. Oh well, the expected "tuition fee" is not so big. The screenshot shows the current state of play. Down.

P.S. 17 April
I "managed" the trade a bit and the futures were just below 2680 when the options expired. So I had a naked futures position, which I then sold at 2680.25. Overall, I made about USD 200 on the trade. I have now put another trade on. Long futures at 2681.5, sold a 2690 call for 7.25 and bought a 2675 put for 9.25. Maximum upside is USD 325 and maximum downside is USD 425 not counting commissions, which are small. Expected value is about USD 100. The spread between the two options today is 15 points, up from 10 points yesterday. The idea is to gradually widen the points spread as I am comfortable with it, eventually buying the put 25 points below the futures entry price, which is equivalent to a 1% stop. Yeah, the model is still long, the market is "overbought" and trending up according to the model.

ASX 200 and MSCI All World Total Returns

The Australia share price index - the ASX 200 - has not performed well since 2007. The current level is below its peak. However, when you add in both dividends and franking credits, it has almost doubled since the peak. Since 1996 it has returned twice as much as the MSCI in Australian Dollar terms, though since the crisis the two have had about the same gain, tripling from the low.

The Gold Model

I have now managed to reconstruct something similar to the old model I tried to trade a decade ago. It is a mixture of trend following when the markets are trending and predicting the direction to trade in when markets are more choppy. It follows a clear set of rules with no real discretion. Using those rules since January 1st this year would have returned 51% with a Sharpe ratio of 0.58. The model wins 71% of the time with an average daily win of 1.15%. The maximum loss is 1% as set by the stop. When I optimize a portfolio of the various methods I have come up with to maximize the Sharpe ratio of the portfolio the solution says to put 90% in this strategy and to actually short one of the other strategies! At the moment the model is long, which is good, as I have a long calls position still on from Friday. I think I will rename the new version of the old model the "gold model" :)

By the way, if you can borrow, maximizing the Sharpe ratio makes much more sense than maximizing return. You then get the smoothest time path of returns, which you can lever up if you want taking into account the size of likely drawdowns.

Friday Update

I finally exited Leucadia National after they announced they are converting into an investment bank and will sell some of their private equity assets and change their name to Jefferies. It has been one of my worst investments losing just under USD 4k (there have been some far worse ones though...). I got in too late just as the financial crisis was getting underway and the company never recovered. Previously, it had an excellent track record and was referred to as a mini Berkshire Hathaway. I bought some more shares in 3i instead, which has been a good investment.

I have been doing more work on improving my trading model and more on trying to trade it. The options I am willing to buy - i.e. the maximum loss is bearable - have too much time decay and so the market can go up and I end up not making money. I about broke even over the week due to this and various stupid things I continued to do. I stayed up last night trading the market, though that is not something I should do. The market was beginning to go up after initially falling and I decided for some reason that shorting put options on expiration day would be a good idea. I shorted a 2650 Friday 13th S&P put and bought a 2625 Friday 13th S&P put. This exposed me to a maximum USD 1300 loss. Of course, the market immediately turned around and started going down. As it reached 2650 I sold short a futures contract as a delta hedge. Then the market bounced and hit the stop I had subsequently put in place at 2650. And then it went back down again... In the end, I actually ended up about USD 20 on the trade :) But it was quite nerve-wracking. I don't know how ERN sells lots of put options all the time without trying to determine market direction or "buy reinsurance" to make it an options spread.

Next week I am thinking to experiment with futures contracts with options collars to limit both the upside and downside. Using options you can have a much tighter effective stop and not worry about the market coming down, hitting the stop, and then going up again. The downside is that the upside has to be limited or the cost of the put option (or call if short the futures) is too much. So, you sell a call (or a put) to defray the cost. I think for a reasonable net cost it's possible to have a little more upside than downside, though as the model does have an edge it's not strictly necessary to have more potential upside than downside. I am thinking of buying a put 10 points (E-Mini S&P) below the entry price into the futures contract and selling a call 20 points above. The maximum downside is then something like 13 points (USD 650) and the maximum upside 17 points (USD 850). Another downside is that if the market is flat, you lose 3 points (USD 150).

The only issue is if both options are out of the money at expiration I will have a naked futures position without a stop at the end of that day's session. I guess if the market hasn't moved in a decisive manner up to that point then maybe it won't suddenly, but I need to be up in time to put on a new options position.

The model is neutral for Monday. The different predictors point in different directions.

Another idea I had is that it is easy to adjust the ASX200 index for franking credits. S&P have a franking credit adjusted index but it only goes back to 2011 and has some weird features, like only reinvesting the dividends once a year. If you get the monthly values of the total return or accumulation index - which includes dividends but not franking credits and the price index which is without dividends, you can calculate the monthly dividend yield. The dividend yield can then be grossed up for franking - this will exaggerate franking a bit as some companies pay unfranked dividends. The return including franking credits matches the MSCI World Index gross total return since the financial crisis in 2009 very well:

My performance is also given pre-tax includes estimated franking credits. A major reason why I am lagging the index is presumably management fees.... You can see though that my returns about match the ASX in the last five years, despite the drag of management fees. This is by investing more in funds that do generate alpha. The black line is a simulation for the "target portfolio".

Exited First Model Based Trade

The futures market started crashing when the People's Daily said that Xi Jinping's comments on openness to trade did not apply to the US. I exited my trade when the S&P 500 was down 1% on the day, based on a 1% stop loss. I made USD 245 on the trade, which was roughly equivalent to 1/3 of an S&P 500 futures contract. So it's about 1/2% on the underlying stock. I was up about USD 650 at the close of Tuesday's regular market.

I am continuing to fine tune my model strategy. It's different to how I traded a decade ago but following similar principles. When I deem the market is overbought I remain long (with a 1% stop) unless one model says that we will exit the overbought situation. Another indicator shows when we enter overbought. The mirror image applies to oversold - remain short with a stop. When neither overbought or oversold, I use the average of 4 predictors. This combination, if executed perfectly would have returned 37% since January 1st. It would have returned far less in the generally bullish market in 2017.

Despite this, I have some further research ideas to test out to see if they can provide a more theoretically satisfying signal. One of the 4 signals in the composite makes no sense whatsoever, but it has done really well since the beginning of this year.

The inverted head and shoulders formation still remains in play unless the market falls below the right hand shoulder:

Notice the higher volume on the left shoulder than the right, which is a classic sign of a head and shoulders formation. The alignment of the recent highs perfectly along the white line is also a classic sign. P.S. 12 April Long again for 0.75 cents slippage.

More Trading Model Research

Even with all my old notes it is hard to reconstruct the trading rules I was using a decade ago. I have put that on the "back burner" while developing new approaches. I realised that I can actually make predictions on the level of the index. My model predicts the change in an indicator. I can solve for the index level that will generate that level given some assumptions. If there is little change in the index it's best not to trade. If a big move is predicted it is worth trading. The tests I've done so far are good, though it needs systematic backtesting. Using this approach the NASDAQ 100 index is projected to rise to 6555 on Monday up from 6433. That is a big move up. This will set up the price action of the last two weeks to be a "head and shoulders bottom". Based on that there should be a new uptrend over the next couple of weeks or so. Of course, my model can only project one day at a time. As this hasn't been extensively backtested yet, I think I will sell a put spread that limits my potential losses to less than a 1% stop loss on a futures contract would.

P.S. 9 April
After looking at my options (pun intended) I decided instead to buy a call option. Specifically a June 2018, ES-Mini 2800 call. This is an option on the ES-Mini futures contract. This option has currently a delta of about 0.16 - for a 1 point move in the futures contract it moves about 0.16 points. So, it is equivalent to going long USD 22k of stock instead of USD 130k. Also, the most I can lose is the USD 500 that the contract cost. The likely loss if I am wrong is more like half of that or about 1% of the implicit position. So, this is like a built in stop loss.* Because the option expires in a couple of months, the time decay shouldn't be too bad, but I will need to investigate further whether longer-dated options make more sense.

I just found it impossible to find a risk-return trade off that I liked with selling put spreads. The net amount of premium I would have received was just too great relative to the potential loss.

* This is particularly attractive for holding a position over the weekend when a stop can't be activated. The CME Globex market trades 24/5 not 24/7. Not that I'm planning to hold this position that long, but for future reference.

Reviving Old Trading Models

I dug into my computer files and updated the trading models I last used 10 years ago. One of them which is fairly simple flashed a strong warning sign at the January high in the market. It does tend to have false positives where it is fooled by a very strong trend into thinking that that is a top in the market, but this time the market actually did fall of course after the warning. This is a very negative signal. There was a minor buy signal at the recent low about a week back but there are typical several buy signals on the way down in bear markets. I had been looking for signs of a recession before taking de-risking action in a big way on our portfolio - for example, an inversion of the yield curve. There hasn't been any sign of a recession. But Trump's trade war and the Fed's unwinding of its inflated balance sheet are having a negative effect on the market.

I have another much more complex model that attempts to forecast the day ahead direction of the market - despite what standard investment theory says, that the stock market is a random walk and can't be predicted this is actually possible to some degree with some insight from econometrics into how to turn it into a predictable problem. I updated the model using the last ten years of data and reoptimized the parameters - they hardly changed. That is a good sign. However, though I have all the past predictions and the trade directions I decided on based on them, I can't remember how I used the model to actually choose market direction. Unless I can find something I wrote about that, I'll have to reverse engineer that from scratch.

P.S.
I found a folder of handwritten research notes on my trading model from 2006-8 in my home office. This should help a lot.

P.P.S.
I predict the US will go into recession in 2019. In 2007 the stock market peaked in Summer-Fall but the recession didn't really get started till Bear-Stearns failed in March 2008. In 1999-2000 the stockmarket peaked in March 2000 but the recession didn't really get going till September 11, 2001.

Types of Trading

There are lots of types of trading. Some of the important strategies are the following:

1. Market-making: A market maker profits from the bid-ask spread in the market, selling at the ask and buying at the bid. This is very apparent in options markets where there is usually a big bid-ask spread. They can hedge their "delta" risk by buying or shorting the underlying security - for example for futures options they can buy and sell futures contracts. For individual stocks - if they are trading a diversified basket they can again hedge using futures contracts (or ETFs). It is possible for individual investors to make markets in small and illiquid stocks - ie. selling at the ask and buying at the bid, but it is a very slow process waiting for people to trade with you.

2. Arbitrage: This exploits pricing anomalies, for example between futures contracts and ETFs for the same underlying index. Short one and buy the other. Occasionally, there are big arbitrage opportunities such as the famous Palm case.

3. Mean reversion: These are generalizations of arbitrage. For example, buying closed end funds (listed investment company in Australian) when they are selling below net asset value and shorting them when they are above. I've done this quite a lot with Platinum Capital (PMC.AX - just selling when above NAV - but actually there is a CFD you could use to short the stock). This is arbitrage between the value of the portfolio and the price of the fund. Statistical arbitrage is a market-neutral mean reversion trade where stocks that have risen in value are shorted and those that have fallen are bought. It was pioneered by Ed Thorp.

4. Selling option premium: This relies on the time decay of options. Most options expire worthless and risk aversion means that buyers should pay in net to reduce their risk. So option sellers should on average win. Again, delta risk could be hedged away in theory. The simplest case is covered calls where the trader buys a stock and sell a call - though actual delta hedging is a lot more complex than that.

5. Information trading: Here the trader knows information that they think will move the security. For example, recently I bought shares in IPE because Mercantile did. I assumed correctly that their analysis must have shown that the underlying portfolio was worth more than the stock price. This is a kind of mean reversion/arbitrage of course and is could also be seen as investing. Even after the company released news of the sale of Threatmetrix to Elsevier, the price didn't immediately move to the new higher NAV.

6. News trading: Here the information is not yet known but a trade is placed to take advantage of it. For example, if I know that Apple Computer will release their earnings but I don't have a hypothesis of which way it will move the stock, I could buy both calls and put options in the hope that a big move will make one increase by more than the other decreases. This seems pretty close to gambling - option prices should take into account the size of likely moves, so you are gambling that the move will be bigger than the market thinks.

7. Trend following/momentum trading: This is what most people think of as trading. The trader tries to take advantage of market momentum. This is the approach taken by many managed futures funds. Much online trading advice is based on this.

8. Hedging: These traders trade to hedge their investment or business positions. For example, an airline buying oil futures contracts to guarantee their future price of oil or an option buyer hedging an investment portfolio. The latter might also sell options to fund the hedging puts.

What have I missed? This paper has an interesting discussion of types of traders.

First Futures Trades Since 2008

I transferred some money from my Australian bank account to Interactive Brokers to do some practice trades. I haven't traded futures since 2008 and so just want to get used to doing trades again. I did 2 very quick daytrades, shorting the E-Mini S&P. The first trade I got out where I got in and so I lost $4.10 the cost of commissions. On the next trade I made 1 point or $50, so I made $46.90 net. I was very nervous while doing the trades even though I am trading with a stop that is transmitted at the same time as my order and is only one point above my sell price, so the most I can lose is $50.  The contract value is $130k (about my pretax annual salary :)), so short selling that much stock does make me feel nervous despite the stop. I've just got to get used to this again as I am thinking of doing more systematic trading again and doing it properly this time. When I traded before, I had lots of winning trades but my winning amounts were small relative to my losing amounts. If I can fix that I could trade profitably.

March 2018 Report

The first of the new style reports. A second losing month, but thanks to (listed) private equity investments, we beat the ASX200 index.

The Australian Dollar fell from USD 0.7794 to USD 0.7680. The MSCI World Index fell 2.15%, and the S&P 500 2.54%. The ASX 200 lost 3.77%. All these are total returns including dividends. We lost 1.20% in Australian Dollar terms and 2.64% in US Dollar terms. So, we outperformed the Australian market and underperformed international markets.

The best performing investment in dollar terms was IPE.AX, a listed private equity fund, which gained AUD 9.8k in the continuing rise after the acquisition of Threatmetrix by Elsevier. I sold my holding in IPE prior to the stock going ex dividend, as I didn't want an AUD 11k income tax bill. I then bought back even more shares than before as MVT.AX were recently still acquiring shares.

The worst performer in dollar terms was not surprisingly CFS Geared Share Fund, down $18.6k. The best performing asset class was private equity, which gained 7.12%. The only other asset class with gains was hedge funds, up 0.57%. The worst performing asset class was large cap Australian stocks down 3.01%.

We made a little progress towards the new long-run asset allocation:

Total leverage includes borrowing inside leveraged (geared) mutual (managed) funds. The allocation is according to total assets including the true exposure in leveraged mutual funds. The "improvement" in allocation, came partly due to market movements and partly due to investment activity. We invest AUD 2000 monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. During the month, I also:

• Sold out of Clime Capital (CAM.AX)
• Bought a small amount of Oceania Capital Partners (OCP.AX, listed private equity)
• Did the trading in IPE.AX
• Bought more units in the Winton Global Alpha fund (managed futures - in the commodities category)

Over time we've been reducing our exposure to large cap Australian stocks since the post financial crisis high:

New Era in Moomin Valley

In a few months we will reach "financial independence" - our annual spending will be feasible with a little less than a 3% p.a. withdrawal rate. About 60% of this was due to our own efforts working, saving, and investing over the last 24 years and 40% from inheritance. I never depended on receiving the inheritance, which is why I saved so hard. Because I knew finding an academic job could be very hard when my initial short-term contracts ended, I saved up to 50% a year at times. This allowed me to live for a year in 2001-2 without working for pay, traveling around the world looking for work. Similarly, when we moved to Australia, I could experiment with trading in the financial markets while exploring alternatives.

On the other hand, I think I was willing to take more risk based on the probability that we would receive a substantial amount. In the case of the financial crisis in 2008-9, I took on too much risk. The pressure of trying to make a living from trading with a small amount of capital combined with the volatility of the financial crisis was too much and I decided to stage an academic career comeback, which has been very successful.

The other half of the financial independence equation in the blogging community is usually "retire early". I don't have any plan to do that any time soon. I like the research side of my work and I have my teaching etc organized so that going forward it shouldn't be too hard - I only need to teach during one half of the year for now. As things are at the moment, it would be hard to find a better job than this. So, it doesn't make any sense to sacrifice my salary. I am actually exploring a potential career move to another bigger city. That job would have more admin and maybe no teaching. Introspection tells me that I wouldn't like to retire currently.  On the other hand, Moominmama is pretty frustrated with her work at the moment and so now has options to take a break and consider alternatives.

On the other hand, our spending is growing by more than the rate of inflation and I expect that to continue. So the current 3% withdrawal rate would become more than a 3% rate over time unless investment returns are very good, which does not seem likely. Continuing to earn some money does sound good in those circumstances.

Is continuing to work limiting our location choices? At the moment, I don't think there is another location that we would both agree on and which would make practical sense. We have to consider education opportunities for little Moomin. So, moving to a small town in Australia does not sound like a good move from that perspective. The nice parts (with good education) of the two biggest Australian cities are extremely expensive and would take us out of the financial independence zone. We definitely would never move to Moominmama's home country (she doesn't even want to visit at the moment). Moominmama is not enthusiastic about moving to either of my home countries. One is too cold and dark as far as she is concerned (Northern Europe) and the other too foreign and dangerous (Middle East). That leaves Southern Europe as a sensible or feasible alternative, but I don't think we want Moomin to grow up speaking Spanish or French? I think it would be hard for Moominmama to learn those languages too, though not difficult for me. So, continuing to work is not stopping us from making a move to another location that we could or would want to make.

So, for now not much will change, but this blog will change. I plan to stop reporting actual earning, spending, and net worth figures. Going forward, all numbers will be in percentage terms only. When the vast majority of our net worth was the result of our own work and effort I was happy to report those numbers, and reporting, even though it is mostly anonymously, helped keep us on track. But now that so much of our net worth has not come from our own efforts and we don't have the goal of achieving financial independence anymore, I don't want to report the numbers any more. On the other hand, I'm not going to erase the existing blog.

Our long term goal now is to pass on at least as much wealth in real terms to the next generation as we received from the previous one. My parents also inherited more than 2/3 of their eventual net worth, though they also saved and worked hard to build up wealth in earlier years. They eventually passed on what they inherited.

Perth Mint

The Perth Mint (Western Australian government corporation) looks like the best way to invest in gold. There are no fees for trading or storage for Australian and NZ residents for accounts greater than AUD 50k, though there are fees to trade online. This is assuming that you only want to have an interest in a pool of gold rather than own specific gold bars. Alternatively they have an ETF trading on the ASX with a management fee of 0.15% p.a. (PMGOLD.AX). This is lower than IAU or GLD.

Other alternatives are to actually hold physical gold in a bank vault or trade gold futures. The problem with futures is if the price of gold does go up, you will have to pay short-term capital gains taxes continuously as the contracts expire (and buy and sell contracts every few months). And I don't really like the idea of getting delivered a bunch of gold bars, taking them to the bank, and then paying storage fees.

Gold has historically been a reasonable hedge aganst inflation but only in the very long run. It is actually more useful as an asset that is negatively correlated with the stock market and useful as an emergency fund in a stock market crash.

Target Portfolio

Following up on my previous post where I tested the performance of an idealized portfolio, here are some more ideas about an actual implementation. In total, 50% would be allocated to stocks, half of that Australian and half of that international. A fifth (maybe more) of the Australian category would be allocated to small cap stocks. Of the remaining 20% portfolio allocation half would go into unhedged funds/stocks and 10% into hedge fund type funds, probably mostly listed hedge funds, such as Cadence Capital (CDM.AX). Of the 25% in international stocks, half would go into hedge funds, primarily Platinum Capital (PMC.AX), which pays franked dividends. Then 25% is allocated to managed futures, probably mostly Winton Global Alpha Fund. This should mostly be held in a superannuation account for tax reasons – pay 15% tax on distributions instead of 47%. That means I am going to need a self-managed superannuation fund.

5% is allocated to gold. This would be held in a taxable account as it doesn't pay dividends. On the other hand, the long-term capital gains rate in superannuation accounts is 10% (and zero after going into pension mode) and my current long-term capital gains rate is 23.5%. If Labor get into power, which is likely, and implement their program, which is less likely, that will rise, though in retirement I expect my marginal tax rate will fall back into the 32.5% bracket but with Medicare tax and Labor's proposal, I would still be paying more than 25% for long-term capital gains. So it makes sense to get more money into superannuation, which is zero taxed in pension mode for the first $1.6 million for each partner. I plan to initially invest about $900k in the SMSF. This will come from rolling over my superannuation fund now at Colonial First State and adding $300k - you can invest 3 years of contributions at once - for each of Moominmama and myself.

The remaining 20% is allocated roughly equally to (mostly direct - i.e. not listed) real estate, bonds, private equity, and cash. Then the whole thing is levered up a bit, with the overall exposure adjusted for market conditions. I expect that debt will be roughly equal to the value of our house ($840k).

To summarize, this is the asset allocation (not including our house):

We are quite a long way from that - in particular very overweight long Australian shares and underweight hedge funds, managed futures, and gold.

Safe Withdrawal Rates

Interesting simulations of safe withdrawal rates over longer time horizons by ERN. The lowest withdrawal rate simulated is 3% p.a. Ed Thorp states that 2% is actually the safe capital preserving withdrawal rate. Our current spending is about 2.75% of estimated total net worth including the inherited money. But I expect our spending to continue to increase faster than inflation for a long time to come.

Art and Net Worth

On one of the many documents we've been sorting through my mother estimated her and my father's net worth in 1995. The number she came up with is equivalent to about USD 1 million today (£350k at the time). But she estimated that an inherited artwork* they owned was worth £20k (USD 56k today). The next year the artwork sold at auction for... £750k (USD 2.1 million). Another letter from my father to his brother in 1954 stated that the art had been valued at USD 880 or around USD 8500 today.

*The art consisted of panels like on this cabinet, but not the cabinet itself:

Sorting Things Out

We're sorting through everything in the apartment - first finding things specifically identified in the will to be given to various people. Mostly jewellery and silverware. But also a stamp collection, which I am supposed to get. We found most of them, but not all. Searching through boxes of documents - recycling a lot of routine financial statements and reserving others for further study. There are files and boxes of letters from the early 20th Century and even greeting cards from the 19th Century. Old books, some family books with names in, others that my mother saved from destruction. We are sorting books into ones we are interested in and others to probably give away. We decided to sell the apartment within a year - if we sell in less than 18 months our mother's previous tax status will apply and we won't need to pay capital gains tax. The apartment will need a lot of work to put it into saleable condition. But there is plenty of demand. My brother keeps getting asked if he is going to rent it out. But like me, he is not keen on owning physical assets directly....

My Mother

This weekend I am traveling to the other side of the world to visit the "home country", though it's not the country I grew up in.

Just over three weeks ago my mother died. She had dementia for several years. When I visited in December, things didn't look good, but she went through a few more cycles of getting a little better and then worse again. Still when the news came it was a shock, though it was so long expected. Maybe partly just finally hearing the bad news. I had decided beforehand not to rush to the other side of the world, right away. The custom there is to hold the funeral on the same day if possible. So, I would miss the funeral or hold everyone up. It seemed better to try to go on with life somewhat normally for a little while than inconvenience everyone here to sit on a plane and in airports on my own for two days each way. Now I am going for the ceremony when the gravestone is "set".

I am also going to work with my brother on sorting all the legal and financial stuff out. Things are actually quite well organized, especially as my brother and I managed all my mother's finance and care etc in the last few years, but there are still some uncertainties. My brother will have to handle most of the organizational details. The main  thing I have been involved with so far is paying the termination payment for the care worker who looked after my mother in the last 7 years. Her devoted work meant that my mother could continue to live at home and did not move to a nursing home or hospital. My brother and I shared in making the payment, which includes paying out her nominal superannuation savings - there aren't real accounts for foreign workers superannuation it seems. We transferred the money to her daughter in her home country. My mother's bank accounts are all frozen now until the probate is sorted out, so we have to take care of all these expenses. Luckily we have the means to handle this kind of thing - my share of this payment was equivalent to a few months salary for me - easily.

Out of IPE

I sold my 700,000 shares of IPE.AX on Friday and today at 13.5 cents each. This was after the company announced that due to a potential performance fee the net tangible assets of the fund were likely 13.8 cents a share. They will pay out next month a 7 cent per share distribution that is about half unfranked dividend and half capital return. If I had kept my shares I would have got a $A49k distribution with about $A11k of tax payable on it this year. By selling now and taking a capital gain, because I still have accumulated capital losses, the income tax is effectively deferred to a future year - by bringing forward the date I will have to pay capital gains taxes again. This probably doesn't make strict financial sense as I "threw away" about $2,000 to avoid paying $11,000 in tax this year rather than a year or two later, which implies a high discount rate. On the other hand, it's quite likely that the fund will have other expenses etc before we would get a final distribution from the fund.

On the other hand, Mercantile (MVT.AX) - Ron Brierley's firm - are still buying. They probably won't have the same tax consideration that I do and they must see some upside in the shares still. It will, therefore, be worth having another look at this stock again after the ex dividend day later this month.

Lifetime profits over the ten years I've been invested in IPE, starting with just 6,000 shares have been about $A31k with $A20k in gains since the beginning of this year.

I also recently sold out of Clime Capital (CAM.AX). Their performance has been subpar in recent years. Instead, I have increased my holding in Cadence Capital (CDM.AX).

Dividend Reinvestment Policy

If a company offers shares at a discount to the market price through a dividend reinvestment plan then I participate in the plan. Not participating seems like not getting part of the return on investment. We own shares in two companies that offer a discount – Platinum Capital (PMC.AX) and Cadence Capital (CDM.AX). But if a company or fund doesn't offer a discount, currently I'm not participating. We did this to help build up the money in our offset account, but it seems to make sense in the longer term to provide cash for rebalancing and new investments without paying fees to sell shares or increasing margin borrowing. There is one exception to this rule, which is the Winton Global Alpha Fund. But I am trying to increase the allocation to managed futures and so it doesn't make sense to withdraw money from the fund.

Optimal Portfolios

I have been doing some experimentation with designing optimal portfolios, something which I last looked at in 2011. I have the monthy rates of return on various asset classes going back to 1996. These include international shares (MSCI World Index, gross) both hedged into Australian Dollars and not. Australian shares (ASX 200 accumulation), Managed Futures (a mix of Man AHL and Winton), direct real estate (a particular US fund as a proxy), hedge funds (HFRI index), the bond market (again I'm using a fund as a proxy), Australian Dollar cash, and gold in Australian dollars. You can use the solver in Excel to find the allocation that monthly rebalanced gives the highest Sharpe Ratio. This optimal portfolio varies over time but generally it doesn't like hedge funds and allocates about 10-20% to gold, and 20-40% to managed futures. Because future performance won't necessarily be the same as past performance (particularly a worry for managed futures) and because managed futures, in particular, are not tax effective – they pay most income out subject to marginal tax rates – I wouldn't allocate according to a particular optimization. A target portfolio gets near the optimal performance while being more diversified and a bit more tax effective:

This graph shows the performance of various assets and a "target portfolio":

Here the target portfolio is 25% international shares (half hedged into Australian dollar and half not), 25% Australian shares, 25% managed futures, and then 5% in each of real estate, bonds, cash, gold, and hedge funds. Then the whole thing is geared up a bit with borrowing. It performs pretty nicely over various historical periods.

Here we have a close up of performance since the financial crisis:

I've managed to match the performance of the Australian index but have lagged behind the MSCI World Index. It matches the performance of the MSCI but has a smoother path. The next graph shows ten year rolling returns:

Here we see that such a portfolio clearly dominates in the long-run over regular stock indices or my own performance, which has not been good over a ten year period recently. The graph also shows how the performance of the Australian stock market has declined. It had very high ten year  returns prior to the crisis, but now has lower returns than international shares over the last ten years.

I have been moving in the direction of the optimal portfolio by diversifying out of Australian shares and buying managed futures, but it has been too slow so far. In the last few months I have been buying $A10k of managed futures each month. I also allocated more to international investments when I reinvested my CFS superannuation fund in their wholesale funds.

February 2018 Monthly Report

After eight months of gains comes a losing month. Here are our monthly accounts (in AUD):

"Current other income" which is mostly salaries (after tax) was $12.3k. Spending (not counting our mortgage) was a little on the high at $8.6k. But spending was elevated by $2.7k I paid for a plane ticket to "the other side of the world" - more about that soon. After deducting the mortgage payment of $4.1k (which includes implicit interest saving due to our offset account - the actual mortgage payment was $910 less than this), we dissaved $0.4k on the current account and added $2.2k in housing equity. Retirement contributions were $2.9k. Net saving was, therefore, $4.7k across the board.

The Australian Dollar fell from USD 0.7794. The MSCI World Index fell 4.16%, and the S&P 500 3.69%. But the ASX 200 gained 0.36%, the All these are total returns including dividends. We lost 0.43% in Australian Dollar terms and 3.92% in US Dollar terms. So, we underperformed the Australian market and outperformed international markets.

The best performing investment in dollar terms was CFS Geared Share Fund, which gained
$3.3k. The worst performer was the Winton Global Alpha Fund, down $4.5k. I am assuming that the market plunge was too sudden for them to change direction. The best performing asset class was hedge funds, up 0.44% and the worst commodities down 4.48%

As a result of all this, net worth fell AUD 3k to $2.156 million or USD 64k to USD 1.681 million.

Rising Local House Prices

The graph shows the percentage premium over the original sales price (when the development was originally marketed) of freestanding houses sold in our development since we bought. Ours is the first datapoint. The most recent sale at auction yesterday establishes a new record premium. The regression model I fitted to the data predicts a price for our house that almost exactly matches my recent upgrade of the value. I use two regressors – the original sale price and the date of the new sale. Premia are higher on the houses that originally had lower sales prices i.e. the smaller houses.

Long Term Investing Trends

The Australian Dollar tends to be high relative to the American Dollar during economic booms and low during economic crises. The recent low point in 2015-16 is related to a fall in commodity prices and slowdown in the World economy, especially in China. I think China probably slowed down by much more than the government admitted. During 2015 US stock markets went sideways or declined. The Australian market started 2015 optimistically but then had a steep fall:

There is now a lot of talk of renewed growth in the World Economy. On the other hand, US interest rates are rising as the Federal Reserve tries to reduce its balance sheet and with the Fed not buying US government bonds, but the US Treasury trying to issue even more after Trump's tax cut, the Treasury will need to offer higher interest rates, which makes government bonds an unattractive investment as rising yields implying falling prices for existing bonds. That is likely to both have negative effects on growth in the short run and make Australian Dollars less attractive in terms of interest yields. So, I'm a bit skeptical about the Australian Dollar rising strongly from here.

The US stock market is also very highly valued based on corporate earnings over the previous 10 years (Shiller's measure of stock market valuation, CAPE):

Historically, that has meant negative returns in the US market going forward. On the other hand, it is possible that something has changed and the risk premium for stocks has declined so that the stock market won't return to PE's as low as in past bear markets. It's unlikely that inflation would get as high as it did in the 1970s, which both raised the required rate of return and compressed growth profit. CAPE in Australia was 18.4 at the end of January, which is much more reasonable.

The best indicator of an oncoming recession is the yield curve. If short-run interest rates are higher than long-run interest rates, usually a recession follows. There is no sign of that at the moment in the US:

January 2018 Report

We gained for the eighth straight month in a row as US stock markets went parabolic, the Australian Dollar rose, and one of our private equity investments made a big gain.

Here are our monthly accounts (in AUD):

"Current other income" consisted entirely of salaries (after tax) this month and was $17.8k. It's higher than usual because I finally got my tax refund from last year of $2.6k. Spending (not counting our mortgage) was a little on the high side at $7.8k. After deducting the mortgage payment of $4.1k (which includes implicit interest saving due to our offset account - the actual mortgage payment was about $874 less than this), we saved $6.1k on the current account and added $2.2k in housing equity. Retirement contributions were $2.9k. Net saving was, therefore, $11.1k across the board.

The Australian Dollar rose from USD 0.7813 to USD 0.8077. The ASX 200 lost 0.45%, the MSCI World Index gained 5.66%, and the S&P 500 5.73%. All these are total returns including dividends. We gained 1.11% in Australian Dollar terms and 4.53% in US Dollar terms. So, we outperformed the Australian market and underperformed international markets.

The best performer in dollar terms was IPE.AX, which is a listed private equity fund of funds, gaining $8.7k. One of their funds made a deal to sell Threatmetrix to the former Reed Elsevier group, now known as RELX. The stock, which had been languishing at around 9.9 AU cents rose to 12 cents. Management estimates that if all goes well the net value of the stock has risen to 14 cents. I have bought some more shares at 11.5 cents since the deal was announced. Is this what Ron Brierley knew when he bought into IPE? I am at around 470,000 shares and hoping to buy more as the position is only 3% of net worth :) Early in the month I sold out of Platinum Capital (PMC.AX) at prices of $2.09-$2.15 and then recently when the price fell I bought back in at $1.96-2.00. I also reopened a position in Oceania Capital Partners (OCP.AX), another private equity investment. So far, my latest trade is down. Yes, it was the worst performing investment this month, down $2.7k.

The second best performer this month was Winton Global Alpha Fund, a managed futures fund, which gained $2.8k. I'm planning to increase my holdings in it too as a hedge against equity downside. Currently, the position is $110k after investing an extra $10k. Yeah, that's only 5% of net worth. Despite the craziness of the stock market rise in the US, there isn't a strong case for a big correction. The yield curve isn't yet near inverting, the world economy seems to be doing well, and Oscar Carboni is bullish for the year :)

Private equity was the best performing asset class, up 9.6%. All asset classes gained. Australian large cap stocks gained the least at 0.1%.

House prices rose here 8.4% for the year. Given this strong rise, I have raised the value of our house adjusting the September and December 2017 accounts. The carrying value is now $840k.

As a result of all this, net worth rose AUD 30k to $2.158 million or rose USD 81k to USD 1.743 million.