Delevering

I just made a big switch in my Colonial First State superannuation account to reduce risk. Stock markets still look bullish but the Fed shows no sign of stopping raising interest rates, risking an inversion of the yield curve. They have been saying that this time is different and that an inverted yield curve doesn't mean that there will be a recession. But though the sample size is very small, it has been a good predictor in the past. We are not yet at yield curve inversion but it still could make sense to reduce risk. My CFS superannuation account has been invested very aggressively. At the end of September this was the allocation:

CFS Geared Share Fund: 48.9%
CFS Geared Growth Plus: 20.2%
CFS Conservative: 10.2%
Platinum International: 10.2%
CFS Developing Companies: 10.5%

So about 70% was in geared (leveraged) funds. Geared Share Fund is large cap Australian shares. Geared Growth is diversified. The new allocation, which is much closer to our new long-term allocation is:

CFS Geared Share Fund: 15%
CFS Geared Growth Plus: 18%
CFS Conservative: 4%
Platinum International: 23%
CFS Developing Companies: 20%
Generation Global Share: 20%

Both Platinum, which is a hedge fund (long and short global equities) and Generation performed well in the Great Recession. Doing this transaction in a superannuation account is tax free - capital gains tax of 10% is paid on unrealised gains on a continuous basis. There is just the cost of the entry/exit spreads.

I changed the allocation for new investments in Moominmama's CFS account, which is not a superannuation account to only buy the non-geared funds going forward. If things look more bearish, we may yet do a switch there too.

September 2018 Report

The Australian Dollar rose from USD  0.7201 to USD 0.7228. The MSCI World Index rose 0.48% and the S&P 500 rose 0.57%. The ASX 200 fell 1.04%. All these are total returns including dividends. We lost 0.63% in Australian Dollar terms and 0.26% in US Dollar terms. So, we  outperformed the Australian market and underperformed international markets.


The best performing investment in dollar terms was NASDAQ futures gaining AUD 2.6k –  and the worst the CFS Geared Share Fund losing AUD 10.7k. The best performing asset class was private equity, gaining 1.28% followed by commodities (this includes trading), gaining 1.22%. The worst performing asset class was Australian large cap, losing 1.57%.


The following is table of investment performance statistics computed over the last 60 months (extended from 36 months previously) of data:

The first two rows gives the annual rate of return and Sharpe ratio for our investment performance in US dollars and Australian dollars. The other statistics are in comparison to the two indices. Based on beta, compared to the MSCI World Index we seem to be slightly geared, while compared to the Australian index we are less sensitive to market movements. We have a positive alpha compared to the Australian and a negative alpha compared to world markets. We capture more of the up movements and less of the down movements in the Australian market and the reverse in the international markets. The fall in the Australian Dollar over this period explains the poor performance compared to international benchmarks.


This month I made USD 2.5k trading futures. This is the second best result to date and ocurred as the NDX declined for the month. The table * compares my performance to the market and the model:



This month was the sixth month of the futures trading experiment. The first month was the model development phase, and since then I have been trying to get disciplined at trading and further incrementally improving the model. I didn't trade in the first half of the month as I was traveling to Europe and Singapore and the model was short and based on relatively low volatility I thought the profit potential was low. This was a mistake as the model did very well. Then when I got back into trading we were in a corrective phase with the market trading sideways. I traded long NQ short ES for the last few days of the month. The model outperformed the market this month, though its return was not that high. The model is bearish and under-performs when the market is strong and outperforms when the market is weak. It got stopped out a couple of times, which is unusual. As a result the model made 4 trades in 4 days. The second time the model was stopped out, the market ended up on the day and so the stop was too tight. The first time, the stop reduced losses.

What I want to do next on the trading front is write the model's decision algorithm in computer code. At the moment I estimate the indicators I use with an econometric model but I then make decisions manually and record the details in an Excel spreadsheet. It is quite quick to do to make daily decisions in a single market but it is quite hard to do backtesting of different ideas. This will be much easier once we have the decision algorithm coded in the same program as the estimation model. Also, in the long run I plan to automate trading or at least automate data acquisition and decision making for multiple markets. Coding the model in the language of my econometrics program is a first step towards that. Once the model is written in one computer language, converting it to another shouldn't be hard.

I did our tax returns this month. I should get a big refund and Moominmama had to pay a little under AUD 1,000 in extra tax. Otherwise, I am waiting for the probate process to play out before undergoing a big round of financial restructuring.


We made a little bit of 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 funds.

We invest AUD 2k monthly in a set of managed funds, and there are also retirement contributions. Then there are distributions from funds and dividends. Major moves tbis month:

• I redeemed the Janus-Henderson Global Resources Fund, which reduced exposure to ROW stocks.
• I reduced cash and the margin loan in preparation for investing in the Tribeca IPO. As a result our allocation to hedge funds will increase substantially next month. 
• I added to the Yellow Brick Road position which is now about 1% of net worth.

* The statistics at the bottom of the table are based on only 5 months of data and so are not at all reliable yet.
    

Internal Rate of Return and Private Equity

Private equity funds like to report the returns on their investment using the internal rate of return metric. The IRR is the discount rate which results in the net present value of the stream of cashflows from the investment being zero. This article points out that it is only the true compound rate of return if you can reinvest the payouts that you receive over time at the same rate of return (r.o.r.). This is correct. But it then goes on to say that IRR is meaningless if you can't reinvest the distributions at the same r.o.r. I don't think that is right. If the IRR is higher than the r.o.r. that you can invest the distributions at, then your r.o.r. from investing in the private equity investment and reinvesting your distributions is greater than the r.o.r. you'll receive by just investing in your alternative investment (and vice versa). Your actual r.o.r. won't be as high as the IRR but the IRR is still useful for making decisions. The main issue is that you need to deduct the funds fees to get the true IRR. Often they will report that they made a $1 million investment and sold for $2 million and give the IRR without deducting fees. Probably as a back of the envelope calculation you could deduct 1/4 of the stated IRR in these cases and then compare to your alternative r.o.r.

So, for example, in Aura's latest report to investors they reported IRR's to date on two investments of 59.5% and 29.2%. So, yes, these are very good. Of course, those are the investments whose carrying values they are marking up. They report a 21.3% IRR on an investment they are exiting. But then there are others that are just breaking even.

Firetrail IPO

Another hedge fund IPO in the coming month. This one is also managed by Commonwealth Securities and so I could participate via the broker firm offer. It is a market neutral hedge fund that can lever up to 200% of NAV in both the long and short sides. The investment team used to work at Macquarie where they got decent returns (22.1% p.a. from July 2015 to October 2017). I'm not so impressed by their performance this year since starting up on their own:

This is not the sign of a high Sharpe ratio investment – it seems there is a lot of risk in this investment relative to the returns. I think this is a fund that is worth tracking over time and seeing if it settles down and performs better. Based on the above, I don't think the shares will trade above the offer price immediately after the IPO, though that is just a guess.