September 2008 Report

I'm still waiting for one final piece of data for the October report, so in the meantime here is the much-delayed September report. This report will be pretty short as I'm no longer comparing results against annual goals and there'll be more detail in the October report. Also, these results are so bad I don't really want to analyse them too much!

Both September and October's results are heavily influenced by the decline in the Australian Dollar that took place in this period. This has the effect of reducing both our expenses and non-investment income in US Dollar terms and making investment returns in USD terms much worse than in Australian Dollar terms.

Income and Expenditure



Expenditure was $2,996 ($A3,674). Non-investment income of $3,618 ($A4,436) mainly consisted of Snork Maiden's salary. Retirement contributions were $539. Total investment losses were $71,412, which is a record loss. $11,648 of this was due to the fall in the AUD. In AUD terms we lost $A64,651 with a positive $8,641 contributed by the rise in the USD. The currency neutral loss is worse than the estimate of October's loss.

Investment returns are reported pre-tax. Australian retirement account earnings are taxed at 15% (10% for long-term capital gains). A fall in the value of the account reduces the tax liability and so the actual account value falls by less than our estimated pre-tax investment returns on the account. Reduction in the tax liability on these accounts kicked in $2,756 to the change in net worth.

Net Worth

Net worth fell by $67,496 to $324,821 or in Australian Dollar terms by $A59,849 to $398,358. At month's end retirement accounts stood at $172,541 and non-retirement accounts at $152,280 ($A211,603 and $A186,755).

Investment Performance



Investment return in US Dollars was -18.2% vs. a 7.59% loss in the MSCI (Gross) All Country World Index, which I use as my overall benchmark and a 8.91% loss in the S&P 500 total return index. Returns in Australian Dollars and currency neutral terms were -14.11% and -15.23% respectively. My previous worst return was in September 2002 when the loss was 17.96% (17.13% in AUD terms).

So far this year we have lost 29.47%, while the MSCI has lost 21.04%. We are still beating the market over 5 years and 10 years in USD terms but trailing in all the more recent timeframes.

Asset Allocation

Allocation was 49% in "passive alpha", 63% in "beta", 1% was allocated to trading, 8% to industrial stocks, 4% to liquidity, 4% to other assets and we were borrowing 29%. Due to the use of leveraged funds, our actual exposure to stocks was 128% of net worth. Leverage declined due to the restructuring following the margin call from CommSec. In August we were borrowing 36 cents for each dollar in equity; we are now borrowing 29 cents. Taking into account leveraged funds borrowing declined from 89 cents to 82 cents per dollar of equity. Looking at asset classes:



We halved exposure to bonds but kept stock exposure as a fraction of gross assets constant. I've also included a tentative long-term allocation for the first time. We're not going to move our allocation towards these targets in the short-term, but they indicate where we'd like to be a few years from now. I've allocated 10% to each of bonds, hedge funds, private equity, commodities, and real estate, which is totally arbitary. We would like to have about half of total assets in these categories as against about 30% now. But I really don't know if 5% or 10% is say the appropriate allocation to private equity given the limited options available to retail investors. I am pretty sure though that more real estate and managed futures would be good.

There is a bit more science behind the equity allocations. The Australian equity exposure is double the foreign exposure. The allocation to large cap vs. small cap reflects the 78% of Australian market capitalization in the ASX 200 stocks. The breakdown between US and rest of the world stocks reflects that 50% of world market capitalization is in the US.

Anyway, in the next few years I plan to scale back exposure to large cap Australian stocks and increase exposure to real estate, bonds, and commodities if and when global stock markets recover. I'd also like to get overall leverage down to about 30% or so.

At the end of September currency exposures were roughly 54% Australian Dollar, 24% US Dollar, and 22% Other and Global.

Reinvesting Distributions

A couple of years ago, I stopped automatically reinvesting the distributions from my Colonial First State Managed Funds. It turns out it was a good idea not to reinvest the distributions when the stock market was near its highs. Unfortunately I didn't always just pay down debt with the money... Anyway, times have changed and I am now switching back to the automatic reinvestment option. I doubt these funds will have much in the way of distributions in the near future anyway, but whatever it is it'll get reinvested at what are relatively low prices. I'm not switching the distribution payout method on Snork Maiden's account as it is very straightforward to make the reinvestment online ourselves and when we do we can rebalance the account. Reinvesting in the funds in my margin account though requires faxing or mailing in a form to CommSec, which is a hassle.

Berkshire Hathaway

After yesterday's massive rally boosted the value of my account, today I had the buying power to buy back Berkshire Hathaway at a cheaper price. So not everything is bad. And the stock has even gone up since I bought at the beginning of the session. I also added $A1,000 to Snork Maiden's Colonial First State account allocating more to funds that have declined so as to rebalance the account.

Performance of Commodity Trading Advisors

An interesting paper on managed futures funds, otherwise known as "Commodity Trading Advisors":

"Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors"

They argue that the after-fees performance of the average fund is hardly higher than U.S. government bond returns and that no skill is shown on average by CTAs. The latter isn't a surprising result, the former may be a bit surprising. But maybe not when you find that annual fees averaged 4 1/2 percent!

On the other hand some managed futures funds have very good track records and can provide diversification benefits. The question is will their outperformance persist? If it does then it will have been worthwhile to research the better funds to invest in.

Warning Signs

They really like warning signs in Hong Kong. This one seemed kind of apt:



They especially like warning signs inside taxis:



We counted around 22 stickers inside each back door.

Pictures of Food in China

Revanche asked for some food pictures from our trip to China, so here are some pictures of food and related things. These are freshwater crabs, which are popular in Tianjin:



Their claws are furry even after being cooked. There are huge barrels of live ones scampering around in supermarkets.

Here is the table at Snork Maiden's parent's at lunch on the day we left for Beijing:



Note both cold and warm dishes. Bread on the lower right. In this part of China people eat at least as much bread as noodles and rice (and sweet potatoes and corncobs are also popular). I can't remember what the top right dish is. The middle top dishes are some kind of vegetable with tofu and some extremely cooked very crispy fish. Generally, Chinese cook fish too much for my taste. Top left is a piece of very tasty green radish. Bottom middle includes some white bambooy stuff, some dark fungus and some green vegetable. All cold.

This is a dish at a small local Sichuan restaurant in Beijing a block from our hotel:



The red things are peppers the brown chicken. You don't eat the peppers luckily, just pick the chicken out :) Lunch came to RMB45 for the two of us with about three dishes and probably a beer or tea.

This is a very large more expensive restaurant a few kilometres from our hotel on the same street:



In this kind of place the menu is likely to feature pictures and English in addition to of course Chinese. So you can order stuff by pointing if you don't speak Chinese. Luckily I had a Chinese speaker with me :) Yeah it's called "Golden Tripod Attic". A chain apparently as there is another one between the Yonghegong Temple and Ditan Park.

This guy was a decoration in a Yunnan restaurant near Houhai in Beijing:



The menu features some interesting fungus recipes and stuff cooked in banana leaves.

Some kind of noodle soup in a cheap noodle place in Hong Kong:



Prices in cheaper places in Hong Kong match mid-level prices in Bejing and are still half the price of restaurant prices in Australia.

This isn't very clear but it's supposed to be a dessert made of soy milk, rice, and gingko fruit:



It cost about HKD 15 in a small dessert only restaurant. Cheaper places in HK have no English on their menus just like in Beijing. The only English the first taxi driver we encountered in Hong Kong seemed to know was "safety belt". He only understood our address when we showed it to him written down. The level of English knowledge is a bit higher than in Beijing but far far below Singapore. Snork Maiden fluctuated between trying to talk to people in Mandarin and in English (They speak Cantonese in Hong Kong with Mandarin as first foreign language and English as second foreign language in the public schools). At this restaurant in Kowloon:



I said to her: "Now imagine you were in Thailand and trying to get your food :)" At least she could read the menu and there were some pictures on the menuboard you can see in the background. But we were served one wrong dish and our rice didn't show up and we weren't sure it was coming. Of course, it is usual to eat rice late in the meal so maybe that's what they were thinking. Between Mandarin and Cantonese we weren't sure what was going on. You can also see the woman in pink in the background cooking at the store entrance. Umm here's a pile of some kind of clams or something:



Round the corner from that place was a dessert restaurant where moom tried this:



The black on the bottom is glutinous rice, the white, coconut milk based stuff, and the yellow mango. The menu had English and pictures (a chain). One dessert had "mango in mango juice with extra mango"! There were also some very odd things including desserts with "harsmar".

These are live crabs for sale in Hong Kong:



It looks very cruel to me.

Snork Maiden was very happy to learn that there is Ben and Jerry's ice cream in Hong Kong:



We don't have any in Australia unfortunately. On a finance note, that banknote was issued by HSBC, not the monetary authority. We also saw Standard Chartered and Bank of China notes. Only HKD 10 notes seemed to be government issued. The only other place I've actually seen that is Scotland.

We spent most of our second full day in Hong Kong on a trip to Lamma Island. These are fishfarms in the harbor at Sok Kwu Wan:



And here are the restaurants lining the main street:



Fish hanging up to dry maybe?



And here is a fish not totally destroyed by Chinese cooking methods :P



This is what we ate - they often post lists like this on the table and the waiter ticks things off as they are delivered:



All I can read of that is "beautiful", "sky", "water", and "cow". Now that's puzzling :P Here you can see the fishtanks in the restaurant:



Some contain quite peculiar creatures like mantis shrimps:



And to finish off the meal here is a fingerbowl:



I don't know why the water is colored. It looks like Russian tea.

Damage Control

That's all that is on my financial agenda at the moment. I just sold four stocks to meet another margin call. A couple at minor losses and two at big losses. Three were "industrial stocks" and I'm planning to have none of those in the long-run. And the other was my remaining share of Berkshire Hathaway B. This way at least I get to pick what to sell rather than have the broker pick.

China

We got back from China this morning. We left Australia on 1st October. Seems like much longer. We were in Tianjin, Beijing, and Hong Kong as well as the special development zone north of Tanggu on the coast east of Tianjin and the Great Wall at Badaling as well as a reforestation/carbon sequestration project in that area. Also had a glimpse of the rural areas between Beijing and Tianjin. In Hong Kong we stayed on Hong Kong Island and also visited Lamma Island and Kowloon. We had a mix of experiences in each city from the very touristy to the very untouristy - visiting homes in each city, shopping, travelling on public transport as well as taxis etc., meeting friends, relatives (in Tianjin and Beijing), colleagues (Beijing) and other local development/environment professionals (Tanggu, Badaling). Sightseeing in each location - foreign tourists are usually outnumbered by 100 to 1 roughly by Chinese tourists from all over the country in the PRC - observing the domestic tourists (and pilgrims at temples) can be as interesting as looking at the site in question. Yeah, and there was a lot of eating including home cooking in Tianjin, various banquets (in Tianjin and kind of in Tanggu), small local eating places, grocery shopping in smaller and larger stores and street markets, and western and Chinese fast food outlets. Moom was working on his Chinese. Snork Maiden attended a conference in Beijing she helped arrange. There was also a lot of shopping for clothes, tea, gifts, and even a pair of glasses - you don't need to be able to read either Latin or Chinese characters to do an eye test in China. Maybe I'll put up some pictures when we have them sorted out. Let me know what you'd like to see.

Update

As you can see, I removed all the goals from the sidebar. We are so far from them there is little point in tracking them. When I went into the market earlier in the year when it was down 20% in the US and 25% in Australia, I figured there might be 10% downside from there and I was prepared to handle it. Now the market is down 40% from the peak, so I miscalculated. At this point we are very battered by the market but can still survive. I'll report on September together with October. It's going to be interesting after the second severe bear market in a decade whether a lot of the proponents of indexing into stocks, and mostly US stocks change their tune. I know that I will be a lot more cautious in investing in the future after being mauled twice by bear markets. I'm not going to go to the opposite extreme of what I've been doing though, rather making sure I am diversified and not using much leverage.

I also removed the word "trader" from my profile. It's time to get back to my previous career and investing patiently for the long-term. Some people can be highly successful traders. I'm not one of them.

Hold to Maturity Value

During the U.S. Bailout debate Bernanke introduced the buzzphrase "hold to maturity value". The argument is that mortgage backed securities currently trade for irrationally low prices in the markets given the likely cash received if the security was held to maturity. In other words, some loans will default but not as many as implied by current prices. One of the purposes of the "bailout" is to push up the prices of these securities closer to their intrinsic values in order to help keep financial institutions from becoming insolvent.

Many of the closed end funds I own trade at similarly irrationally low prices in the markets:



As you can see, some of the discounts to net asset value are more than 50%. I wondered what effect accounting for all these closed end funds would have on my net worth. As the table shows, using NAVs instead of current share prices would value these funds at $A147,000 instead of $A102,000 adding $A45,000 or about 10% to net worth.

I expect that eventually when the financial crisis diminishes these funds will trade nearer to their NAVs as they have in the past. In most cases I expect NAV to also rise though in the case of NCT it will probably fall. Its NAV is given by valuing both its assets and liabilities at current market prices for mortgage related securities and its liabilities are poorer quality than its assets.

Asian and U.S. Financial Crises

As the U.S. seems to be reaching consensus on the next stage in addressing its financial crisis I thought about another financial crisis ten to eleven years ago. The Asian financial crisis of 1997-1998 had somewhat similar causes and symptoms as the current American crisis. The main difference was the role of dollar denominated foreign loans which suddenly became much harder to repay after currencies such as the Thai Baht were devalued. The IMF response, which was much criticized at the time, was diametrically opposed to the U.S. response to its own crisis that we are seeing develop now. The IMF urged governments to cut budgets, raise interest rates, let banks fail, privatize state companies and to introduce a host of other structural reform and austerity measures that at best were irrelevant and at worst exacerbated the crisis. As a result Indonesia's GDP fell 13.5% in 1998 and deep recessions occurred in all the most affected countries.

At the time I really couldn't understand the IMF's response. It seemed that they were simply applying the same policies that they had applied, to hyperinflation in Latin America to a totally different situation. It seemed to me they only had one set of tricks they knew.

Looking at the U.S. (appropriately) doing the exact opposite of what the IMF prescribed in the Asian crisis, I don't know if we should be more angry or amused.

Failure to Communicate

March of the Unemployed in Perth, Western Australia in 1931

The financial crisis and its possible solution have been very poorly explained to the American people. As a result, people think that the proposed solution is about saving financial services firms in order to prop up the stock market. When the issue is actually about arresting the spiral down into a Depression due to collapsing credit and money markets. And those of us in the rest of the world would also suffer the impact due to the interconnectedness of financial markets. For example, Australian banks get a large percentage of their financing for loans in Australia from foreign investors. Less than half comes from Australian depositors.

I'm not criticizing Boston Gal, it's just that she states the common perception very clearly, whereas most Americans just seem to be angry. I think the contribution of the Democrats in Congress will result in a much improved program, though noone really knows if it will work all the same. Other countries such as Sweden and Israel have effectively nationalized their banking systems after such crises before eventually reprivatizing them. The details of each case were different though. I think a combination of what is currently planned combined with a Swedish type program would be the most efficient use of public money based on what I understand.

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.