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.

Projection for 2018

My fair weather forecast for 2018 is a net worth gain of about AUD 250k to reach about AUD 2.3 million. It is based on expected salaries and retirement contributions, an increase in spending of 6% and an 8% rate of return on investments.

ASX200 Alpha and Beta

Another new chart:

This is based on regressing my returns in excess of the RBA cash rate on the ASX200 returns in excess of the cash rate using 36 months of data. Clearly there is a negative correlation between alpha and beta. In recent years beta is less than one and alpha greater than one. Alpha was very negative during the financial crisis and there are some wild swings before that. The tech crash also had hugely negative alpha. Looks like I outperform in bull markets and underperform in bear markets but that it isn't all just due to too much leverage.

Annual Report 2017: Graphs

So here is how the last year looks on a graph in the context of everything since 1996:

The blue line is the sum of the other three lines. Medium term balance is liquid assets, the green line is retirement accounts. Both of these and housing equity increased. Markets performed well this year and we saved more.

This graph provides a slightly different view, breaking things down according to savings and profits. I don't break down housing equity into the two components as it's not worth it yet...

Though we are making savings outside of retirement accounts and housing equity - the blue line is rising - the slope is shallower than before we bought a house and had a baby but steeper than last year. So, a lot of this year's increase came from profits. In the long run we have done much better with retirement than with current accounts in terms of profits. Half of our retirement accounts are now made up of profits and half from contributions.

The next graph shows actual monthly non-retirement savings since 1996 and a 12 month moving average:

I have truncated the axis at -$15k - we dissaved $53k in January and $118k in February 2015 as we bought the house. After the big transfer of savings to buy the house, savings recovered, but to a lower level than in recent years. In the past year they have edged back up again to an average of $5k per month, though they are very volatile.

Housing Saving

A new chart - monthly housing saving:

It's mostly mortgage principal payments. Initially, we made our downpayment in two payments over two months. I've truncated the scale at $10,000 - saving in January 2015 was $37k and in February 2015 $115k. The main interesting thing on the graph is the upward trend over time. This reflects the increasing money in our offset account and the resulting lower interest payments. As a result, the part of our mortgage payments that's reducing the principal increases over time. The periodic spikes are the three mortgage payment months - we make a mortgage payment every two weeks. The red line is a 12 month moving average.

Annual Accounts 2017

This is our annual account - the sum of each of the monthly accounts I've posted - in Australian Dollars (one Aussie Dollar is currently 78 US cents - see accounts in USD at the end of this post). First a reminder about how these accounts are laid out: Current account is all non-retirement accounts and housing account income and spending. Then the other two are fairly self-explanatory. But housing spending only includes mortgage interest. Property taxes etc. are included in the current account. There is not a lot of logic to this except the "transfer to housing" is measured using the transfer from our checking account to our mortgage account. Current other income is reported after tax, while investment income is reported pre-tax. Net tax on investment income then gets subtracted from current income as our annual tax refund or extra payment gets included there. Retirement investment income gets reported pre-tax too while retirement contributions are after tax. For retirement accounts, "tax credits" is the imputed tax on investment earnings which is used to compute pre-tax earnings from the actual received amounts. For non-retirement accounts, "tax credits" are actual franking credits received on Australian dividends and the tax withheld on foreign investment income. Both of these are included in the pre-tax earning but are not actually received month to month as cash.... Finally, "core expenditure" for housing is the actual mortgage interest we paid. "expenditure" adds back how much interest we saved by keeping money in our offset account. We include that saved interest in the current account as the earnings of that pile of cash. That virtual earning needs to be spent somewhere to balance the accounts... It is also included in the "transfer to housing". Our actual mortgage payments were less than the number reported by the $8k in saved interest. For current accounts "core expenditure" takes out business expenses that will be refunded by our employers and some one-off expenditures. This year, I think there are none of those one-off expenditures. Oh, "saving" is the difference between "other income" net of transfers to other columns and spending in that column, while "change in net worth" also includes the investment income.

We earned $201k after tax in salary, business related refunds, medical payment refunds, tax refunds etc. We earned (pre-tax including unrealised capital gains) $107k on non-retirement account investments. Both of those numbers were up strongly from last year as Moominmama went back to work and investment markets performed very strongly in the first year of the Trump Administration. Total current after tax income was $308k. Including mortgage interest we spent $101 up 7.5% from last year.

$7.6k of the current investment income was tax credits, which actually was down on last year. Finally, we transferred $50k in mortgage payments (and virtual saved interest) to the housing account. The change in current net worth, was therefore $160k. Looking at just saving from non-investment income, we saved $60k. Both these numbers were up strongly from last year.

The retirement account is a bit simpler. We made $47k in after tax contributions and the value rose by an estimated additional $126k in pre tax returns. $15k was the estimated tax on that and so the increase in net worth was $158k. Taxes are just estimated because all we get to see is the after tax returns. I do this exercise to make retirement and non-retirement returns comparable.

Finally, the housing account. We spent $14k on mortgage interest. We would have paid $23k in mortgage interest if we didn't have an offset account. I estimate our house is worth $2k more than I did last year based on recent sales in our neighbourhood. After counting the transfer of $50k into the housing account housing equity increased $31k of which $27k was due to paying off principal on our mortgage.

In total net worth increased by $350k, $135k of which was saving from non-investment sources. Comparing 2017's accounts with the 2016's, we saved 34% more and net worth increased by 61% more. Total after tax income was almost half a million dollars, up 52% on last year. It is hard to get my head around that number and reconcile it with our fairly modest lifestyle. Of course, most of it was earned in retirement and non-retirement investment accounts and it includes a lot of notional unrealized capital gains. In 2008 we had a net loss of $150k...

Here are the same accounts expressed in US Dollars:

Because of exchange rate movements "non-core" investment earnings don't translate from one set of accounts to the other at a regular exchange rate. The "core investment earnings" takes out that exchange rate movement.

December 2017 Report

The optimistic annual projection was AUD 2 million. We exceeded this, reaching AUD 2.064 million at the end of this month. I'll do an annual report soon.

Here are our monthly accounts (in AUD):

"Current other income" consisted entirely of salaries (after tax) this month and was $13.1k. Spending (not counting our mortgage) was moderat at $6.2k. After deducting the mortgage payment of $4.0k (which includes implicit interest saving due to our offset account - the actual mortgage payment was about $994 less than this), we saved $2.9k on the current account and added $2.2k in housing equity. Retirement contributions were $3.1k. Net saving was, therefore, $8.2k across the board.

The Australian Dollar rose from USD 0.7571 to USD 0.7813. The ASX 200 gained 1.81%, the MSCI World Index gained 1.65%, and the S&P 500 1.11%. All these are total returns including dividends. We gained 1.43% in Australian Dollar terms and 4.67% in US Dollar terms. So, we slightly underperformed the Australian market and strongly outperformed international markets because of the rise in the Australian Dollar against the US Dollar.

The best performer in dollar terms was the Colonial First State Geared Share Fund, gaining $9.2k followed by Colonial First State Developing Companies, which gained $4.5k. Generation Global Share FUnd was the worst performer losing $0.3k because of the fall in the US Dollar against the Australian Dollar. Australian Small Cap stocks was the best performing asset class in percentage terms, gaining 3.54% followed by Commodities at 2.89%. Private equity was the worst performing asset class, but it still gained 0.45%.

As a result of all this, net worth rose AUD 32k to $2.064 million or rose USD 74k to USD 1.613 million.