Windfall profit on RBS early wind-up of ETSBRK

Having previously bought US shares directly via Comsec, I had been unhappy with the costs (an annual fee from the US broker that was holding the stock certificates, plus a hefty fee for each international trade due to both Comsec and their US agent charging a large fee). So when I wanted to invest in Berkshire Hathaway in 2011 I decided the ETS (Exchange Traded Security) issued by RBS (Royal Bank of Scotland) on the ASX was the way to go. I bought 113 ETSBRK at a price of A$75.19 (total cost $8,496.47 + $10 payment transfer fee). RBS recently had a special meeting to seek to have unit holders pass a resolution to close down the various RBS ETS offerings early (the normal termination date was May 2021), as they have never been very popular and obviously were a significant cost to RBS to maintain - RBS decided to cease their equity derivatives business in 2014. In order to get the unit holders to agree to the early termination date RBS proposed a 25% premium to the normal pricing for these units. The resolution was passed on 2 May, and yesterday I received a nice cheque from RBS for the sale of my 113 ETSBRK for $27,223.79. This represents a very nice profit (capital gain) of $18,712.32, or a return of 220% over five years.

To mitigate some of the capital gains tax implications I've decided to fix $75,000 of my Comsec margin loan balance for 12 months at 6.49% (the current variable loan interest rate is 7.13%), which will allow me to claim a tax deduction for the $4,867.50 prepaid interest this financial year.

Subscribe to Enough Wealth. Copyright 2006-2016

Adding to my share portfolio - AFI and ARG

I decided to buy some listed investment company (LIC) shares today. I bought 5,000 shares of Australian Foundation Investments at $7.26 $5.642 (total cost with brokerage: $28,185.73) and 4,000 shares of Argo Investments at $5.642 $7.26 (total cost $29,036.75). The share purchase was funded using my Comsec margin loan, currently costing 7.13% pa interest, and I transferred $20,000 from my St George portfolio loan account (costing 4.99% pa interest) which will reduce the amount funded using my margin loan to $37,222.48. Annual tax deductible interest cost for this investment will therefore be around $3,651.96 (or an average interest rate of 6.382% pa), The AFI shares paid a dividend of 23 cps in 2015, and the ARG shares paid a dividend of 29.5 cps in 2015, the the annual dividend from the investment will be around $2,330, leaving a net negative cashflow (and net reduction in taxable income) of $1,322 or so, plus some franking credits (a tax credit available to Australian investors for the company tax paid on dividends from Australian companies, based on the amount of company tax paid).

In the long term (ie. when I retire in 10-15 years time) the 'plan' is to sell off these shares for more than they cost, making a capital gain (which would be taxed at half my marginal tax rate at that time), hopefully more than the cumulative cost of the net cost of holding these investments.

AFI had a total return (dividends and share price appreciation) of 8.4% pa over the past 5 year period, and ARG had a total return of 9.0% pa over the past 5 years. The ten year average annual total return figures are a lot less impressive, but as that period include the impact of the GFC I expect the next 10-15 years average annual total return to be more like the past five year period than the past ten year period. Only time will tell.

Subscribe to Enough Wealth. Copyright 2006-2016

A Belated attempt to KISS

When the markets were booming it seemed to make sense having three separate margin loan accounts, plus other broker accounts for training US stocks, options and CFDs with Commsec. Post-GFC the principle of KISS (Keep It Simple, Stupid!) has a lot going for it. So I continue to slowly rationalise my stock and fund portfolio...

Today I sold off my holding of IANG [IAG FINANCE (NZ) LTD] as I'd made a reasonable gain and there were little prospects of further price appreciation with the stock trading around $104 for what is basically a company debenture with a face value of $100. Although the yield is fairly attractive it didn't make sense to keep owning this stock when I'm paying almost 10% margin interest. I also put in an order to sell off the last of my direct US share investments (220 shares of Microsoft), as the potential gains aren't worth the paperwork hassles and account keeping fees of having a US trading account through Commsec. As soon as the trade settles and I transfer the balance of the account back to Australia I close this account down. Again, the dividends flowing from this stock were negligible, so I'm better off using the proceeds to reduce my Australian margin loan balances a bit. I'll also sell of the two varieties of Westfield stock (that resulted from the recent Westfield demerger). I'd also like to get rid of the tiny tranche of AEJ [ALINTA ENERGY GROUP] shares I ended up holding when one of the Babcock & Brown funds was wound up, but the cost of the share trade would be more than the proceeds! So I'll have to wait until I get an offer for some free stock trades from Commsec.

After this pruning is finished, my stock and fund investment portfolio (outside of superannuation) will be:

The total value is around $450,000 which will be about the same as the total outstanding loan amounts (including the $235,000 HELOC used to fund some of the investments that have 0% margin value). As the overall interest rate is about 8%, the total return (dividends plus any capital gains) isn't likely to produce much net return. At best, it produces a modest tax benefit by deferring current income tax (as the amount by which the tax deductible margin loan interest exceeds the dividend income is deductible against my salary income) and creating a long-term capital gain tax liability, with long-term capital gains being taxed at half my marginal income tax rate. The potential benefits hardly outweigh the amount of complication added to my tax returns, so as soon as the OMIP and Macquarie equinox funds reach their maturity date (when their capital guarantees kick in and I can get my initial investment back!) I'll use the proceeds to pay off some of the margin loans rather than reinvest.

Subscribe to Enough Wealth. Copyright 2006-2011

CDF wind-up payment arrived

As announced last month, the wind-up of the Commonwealth Diversified Share Fund (CDF) was completed yesterday, with payment of $1.0387 per share made to all remaining shareholders. I'm glad that I borrowed some money to meet the margin call that resulted from Comsec Margin Lending reducing the margin value of this share to 0% on 17 May, otherwise I would have only received around $0.96 per share selling the shares on-market during late May.

By maintaining my shareholding until the termination date (1 June) and getting paid out the full NAV on 18 June, I received an extra 8% or so - around $5,136 - compared with having the shares sold out by Comsec in late May to meet the margin call.

Some smart operators made a killing by buying up CDF shares in late May. For example, Weiss Capital made around $200,000 by buying CDF shares for around $0.96 in the last two weeks of May and receiving $1.0387 per share yesterday. 8% ROI in one month with minimal risk is a pretty canny investment. If I'd had spare cash I would have bought some CDF shares as well.

I am less impressed that CBA also became a substantial shareholder during late May. Their share transactions notification shows a lot of buying and selling by Value Nominees (ie. Comsec Margin Lending) which I suspect was mostly due to Comsec cutting the Margin Lending Value of CDF shares from 70% to 0% on 17 May. However, CBA ended up with a net increase in CDF shares of around 2.5m shares, which also gave them a nice profit when the fund was wound up. Perhaps I should ask ASIC to look into the behaviour of CBA Bank, Comsec and CDF Fund regarding possible conflict of interest issues regarding these related parties and their clients/shareholders?

Subscribe to Enough Wealth. Copyright 2006-2008

A margin call from Comsec Margin Lending

As feared, the wind-up of the Commonwealth Diversified Share Fund has resulted in me getting a margin call on my Comsec margin lending account. I had expected it might happen when the CDF shares ceased trading on 18 May, and had phoned the Comsec help desk about this last week. They didn't call me back as they had promised, and yesterday they changed the margin value of CDF shares from 70% to 0% without any warning, resulting in a $30,000 margin call.

I managed to get through to Comsec this morning (after being on hold for ten minutes) and they confirmed that I had to meet the $30,000 margin call by 2pm or they *could* sell off some of my shares, although they couldn't even confirm which of my share holdings would sold (apparently it is "random" - although I find that hard to believe). I don't want to sell my CDF shares as they are trading very thinly and at a 10% discount to NAV since the announcement of the fund termination. I also don't have the required amount of cash sitting in my credit union savings account so I had to hunt around for a quick solution.

I initially thought I could take advantage of the 6.9% balance transfer offer Citibank sent me last week, but the funds transfer into my margin loan account could take up to five business days, so it wouldn't prevent Comsec selling off my shares. Instead I had to redraw $30,000 from our home loan account and transfer it into my St George Portfolio loan account, from where I could BPay the funds to Comsec. It took another two phone calls to Comsec to get the BPay details to make the payment, and then to provide them with the St George BPay receipt number to prove that I had met the margin call before 2pm.

I then applied for a Citibank Redicredit $50,000 balance transfer into my St George portfolio loan account. When the funds arrive I'll repay the $30,000 into our home loan account (after checking there are no excess repayment penalties on that account), and the remaining $20,000 will reduce my Portfolio Loan balance. I'll keep those funds available for future investments.

When the CDF fund pays out the realised NAV amount to unit holders on 18 June I'll use the money to pay off the Citibank Redicredit debt. As I'll only be using the Citibank loan for about four weeks, the interest cost will end up being around 0.53% of the total amount borrowed. That is a lot less than the 10% NAV discount if I sold the CDF shares. Of course that calculation ignores any gain or loss in NAV from now until the fund termination date of 1 June.

Since both Commonwealth Diversified Share Fund and Comsec Margin Lending are owned by Commonwealth Bank, I'm extremely unimpressed by the level of customer service provided by Comsec. Providing me with the information I requested last week, or at least providing some advance notice that CDF margin value was going to be changed to 0% on 11/5, should have been the minimum level of customer support.

Subscribe to Enough Wealth. Copyright 2006-2008

Sell Low, Buy High?

Last week I decided to sell off around half the stocks remaining in my Comsec and Leveraged Equities margin lending accounts. They were mostly smaller companies in which I had small positions, adding up to around 25% of the value of the stocks in my geared equities portfolio (I haven't sold off any of my managed fund investments yet). The proceeds for the LE sales will sit in the linked Cash Management account until the end of June, when my fixed-rate loan period ends. At that time the total margin loan amount for this account will drop from around $170K to around $70K. The extra cash will reduce the margin utilisation from 98% back down to around 93%, and as the cash value will remain constant, any further market declines shouldn't generate a margin call on this account. The stocks sold off from the Comsec account reduced the net loan amount, as the proceeds generate a negative variable loan amount which partially offsets the fixed loan amount (interest pre-paid until June). I probably should do the paperwork to setup a cash management account linked to the Comsec margin loan account, as otherwise I don't get any interest for the negative variable loan debt.



The stocks that I sold were the ones that would be most affected by a recession in Australia - entertainment stocks, retailers, one steel maker and a construction company - so it may be just as well to off-load them now. Of course, it would have been much, much better to liquidate my Leveraged Equities account back in 2007 when I was seriously thinking about reducing my margin lending accounts and investing via my SMSF instead.

Overall, my 20-year experiment with gearing has been a disaster. As happened last time (in the 90s), the use of gearing has meant that I am unable to buy into the market at the bottom (indeed, I'm again being forced to sell stocks when the market is down). I had thought that this time around my gearing was reasonably conservative (only using 50%-60% LVR, rather than the maximum 80% as the market rose), but the 2008-9 bear market has exceeded my "worst case" scenarios of the usual 20%-40% drop during a bear market. When the market does eventually start to rise again, I won't be maintaining the current 90%+ LVR levels by increasing my borrowings, so even if the market regained it's previous peak my equity wouldn't fully recover.

The scope of my stock losses during the 'Great Recession' shows that my strategy of keeping gearing levels at around 60% LVR during bull markets and then simply holding on and riding out a "typical" 20%-30% bear market was flawed. It didn't have a contingency for a severe recession (well, it did in the form of my Index Put options, but letting them expire in Dec 07 negated that strategy). So I'm working on a revised strategy that will employ dynamic asset allocation to reduce my gearing levels during future bear markets. The trick is to get the timing of such reallocations correct. Many pundits say that 'timing the market' is impossible (assuming random walk/efficient market theory holds), and that examples of successful timing can be attributed to luck.

A book I read a few years ago suggested selling off stocks that had broken their up-trends and dropped by 10%, thereby limiting losses during bear markets, could produce superior returns to simple 'buy and hold' strategy. I'm trying to adapt that theory to help avoid losing too much in any future severe bear markets. My current model is to sell off my geared stock portfolio when the 60-day moving average closing price falls more than 10% below the high attained since the last 'buy' signal. The 'buy' signal (to initially invest, or to reinvest after exiting the market) would arise when the market index daily close had risen 10% above the low reached since the previous 'sell' signal, and stayed there for at least 5 consecutive days. So far back-testing with daily data for the All Ords since 1984 suggests that using these signals to time strategic asset reallocations would have moved you out of the market relatively early in a bear market phase (and without too many false sell signals), and got you back into the market when it had bottomed out. The model did fail with the current 'Great Recession', as it signalled a 'buy' in May 2008 (when the market appeared to have bottomed out), only to signal another 'sell' in June after the market had continued to slide. But mostly using the model to time exits and reentries into the market would have restricted losses during bear markets to around 20%, which would have produced superior returns to 'buy and hold' in about 75% of bear markets. Overall it would have improved my ROI considerably since I started investing in stocks in the early 80s. I could tweak the parameters of this model to eliminate the false 'sell' signal in 2008, but optimising for historic data doesn't mean the model would perform any better in future periods. Keeping models as simple as possible, and retaining some common sense justification for what the parameters are, is usually more likely to result in a reliable model.



If the market doesn't drop too much further I'll retain my remaining current direct stock investments, and aim to slowly pay off my margin loan balances over time. I'll also keep our future superannuation contributions sitting in cash until 'the model' gives a buy signal - currently that would be the All Ords Index closing above 3422 for five days in a row. I may then start to use some leverage within our Self-Managed Superannuation Fund investments - either via buying Comsec CFDs for the market index (if there's a suitable CFD available), or else by investing in a geared stock fund such as the one run by Colonial First State (providing the fees aren't too high). Otherwise I'll just start moving the accumulated cash into the Vanguard High Growth Index Fund.

Subscribe to Enough Wealth. Copyright 2006-2008

A whiff of panic in the air

Today the Australian government announced a second economic stimulus package of A$42 billion on the same day that the Reserve Bank slashed official interest rates by another 100 basis points (1%) to a 50-year low of 3.25%. It appears that the full impact of the GFC on our local economy is finally being admitted by the government, with an element of panic as a technical recession seems unavoidable and the steps taken in 2009 woefully ineffective. The series of interest rate cuts in the past six months is unprecedented. Most charts though underplay just how dramatic the fall has been, choosing to use simple bar charts showing the series of rises and cuts as if they were evenly spaced:



In reality, plotting the changes against time shows that the controversial interest rate rise during the last election campaign was "one too many", and after making jsut one unusually large cut in March 2008, the RBA held fire for a long while, probably expecting the single cut would be enough "shock therapy" to insulate Australia from the impacts of the sub-prime crisis. It was only in Sep/Oct last year that the magnitude of the GFC became apparent, with the drop in economic growth rate in China showing that Australia couldn't hope to avoid being affected.



So far I've tried to keep my stock portfolio as intact as possible, only selling the minimum necessary to avoid getting a margin call. But looking at the stock market and interest rates over the past 5 or 10 years it doesn't look like we're going to see a recovery any time soon. However, I'm too stubborn to give up on my long-term "buy and hold" strategy and high-risk asset allocation. So I think I'll still hang in there in the expectation that the Australian economy does start to recover in the second half of 2009, and that the stock market recovery leads the economy by the usual 6 months or so. However, if the stock market continue to fall I'll be forced to sell off stocks fairly rapidly to settle my margin loans. In the worst case I could end up with no direct stock investments, no margin loans, but a $250,000 HELOC debt (my St George "portfolio loan") offset by only $50,000 or so value in unlisted funds (such as Ord Minett OM-IP) and agribusiness investments. Those investments don't mature for several more years, and the unlisted funds only have a price guarantee if held to maturity. If that happened I probably wouldn't be in a position to reinvest in stocks when the market eventually recovers, so I'd be unable to recover my losses even in the market reached new highs at some time in the future. C'est la vie.

Subscribe to Enough Wealth. Copyright 2006-2008

Stock Market Storm Sinks Life Savings

A brief report in the SMH outlines the horrendous impact of the bad investment advice dished out by Storm Financial, who advised many retirees to borrow against their mortgage-free homes in order to use margin loans to invest large sums in the stock market at the tail end of the bull market. While the self-serving (fee generating) "advice" provided by Storm seems completely inappropriate for many of their clients circumstances and actual risk tolerance, I'm sure that many of the investors rendered bankrupt have mostly themselves to blame. It's easy to cry "foul" and engage the lawyers when the market has plunged 40% or more and wiped out your investment portfolio, leaving you with massive loans secured against you home. But I suspect that a lot of these people were only too happy to sign off on dodgy loan applications (some with overstated income figures) and skim-read the fine print of the terms and conditions, when their "financial plan" projected massive gains if the market had returned another year of two of double digit performance. Those who play with fire get burnt - the tricky bit will be sorting out those Storm clients who eagerly grabbed the match box and lit their matches knowing the risks, and those "babes in the woods" would were handed a box of "safety matches" and told that there was nothing to fear.

It's interesting to compare how a Storm client who invested at the market peak in late 2007 would have fared if the market had gone up 15% in 2008, rather than dropping 45%:

Assume: Retiree/investor borrows 50% ($500,000) against mortgage-free home valued at $1,000,000, interest 8% ($40,000 pa interest)
Pays Storm 7% up-front fee on funds invested (ie. leaves $465,000 "capital" to invest after $35,000 in fees up front)
Invests in a stock portfolio using max 70% gearing, interest 10% (capitalised)
Dividend rate 3%
Margin loan amount = $1,085,000 (total invested in market = $1.55m)

If market had gone up 15%, at end of 2008 situation would be:
Debt: $500,000 (home loan) + $1.085m (margin loan) + $108,500 (interest) = $1.6935m
Int paid: $40,000 (home loan int only payments)
Income: $46,500 (dividends)
Cash flow: $6,500 "tax free" income (due to tax deduction for capitalised margin loan interest)
Portfolio value: $1.7825m (15% rise)
Unrealised capital gain: $89,000

I doubt that any of Storm Financial clients would have been complaining in that situation!

In reality, a 45% market plunge occurred, with losses only being realised in late 2008 when portfolios were liquidated to meet margin calls (where clients tapped into their remaining home equity to borrow to meet earlier margin calls - say up to the maximum 80% LVR for owner occupied home loans):

Debt: $800,000 (home loan) + $1.085m (margin loan) +$108,500 (interest) = $1.9935m
Int paid: $52,000 (home loan int only payments, assuming extra $300,000 borrowed during 2008)
Income: $46,500 (dividends)
Cash flow: -$5,500
Portfolio value: $852,500 (45% drop)
Debt remaining after portfolio liquidated: $1.9935m - $0.8525m = $1.141m

Since this is slightly more than the family home is worth, bankruptcy results!

The worst part of the advice provided by Storm (aside from the investment strategy not matching the clients real risk tolerance or level of understanding) appears to have been to continue borrowing against other assets (the family home or other real estate) in order to meet margin calls while the market dropped during 2008. If the investors had simply liquidated their stock portfolio to meet margin calls as they arose, they would have ended up taking a big loss, but not being bankrupted and losing the family home. However, it was all too easy in March 2008 to imagine that the market had bottomed out after a "normal" 20%-30% correction, and try to hang in there, rather than turn paper losses into real ones.

I wonder if there are any Storm clients who started investing in 2003 and liquidated their portfolios in late 2007 when Storm began their IPO process? They're probably sitting on their yachts sipping champagne.

Meanwhile, it will be interesting to see how the court cases against Storm Financial and the banks turn out. (Not to mention ASIC's role in all this)

Subscribe to Enough Wealth. Copyright 2006-2008

Bailing rapidly, but the boat is still sinking

The Australian market followed the US lead and dropped another 4.5% today. It's now declined by more than 50% in the past year, dropping to levels last seen 4.5 years ago. Although my three margin lending accounts hadn't quite gone into the "buffer" zone (100%-105% margin utilisation), it was time to bite the bullet and start selling some of my stocks. From my Comsec account I sold my ASX shares (around $8K worth). They have dropped by a similar amount to the overall market (around 50%), but I doubt that they will recover as much as other stocks when things start to improve. The current bear market will have scared a lot of "mum and dad" investors and day traders out of the stock market for quite a while, which will impact on ASX trading volumes and profitability for years to come.

Recent Trades:
Sell ASX .20 Nov 2008 ..200 @ $29.734 
Buy. IANG 18 Nov 2008 ...90 @ $77.000 
Sell LDW .17 Nov 2008 1,350 @ .$2.500 
Sell BBW .17 Nov 2008 1,782 @ .$0.820 
Sell THG .17 Nov 2008 4,000 @ .$0.580 

Out of my Leveraged Equities account I sold off the rather large block of Telstra (TLS) shares I had built up from the T1 float and the T3 float (I fortunately didn't buy into the T2 tranche as it was way overpriced). That will realise around $40K which will improve my overall margin utilisation in that account (since the margin value of the TLS shares was around $32K). I also took the opportunity to sell off $1,000 worth of miscellaneous Babcock and Brown infrastructure trust stocks, which I'd wound up with after a takeover:

Trades:
Sell BBI ...Babcock & Brown Infr 25/11/2008 ...222 $0.04 .....-$8.21 
Sell BBP ...Babcock&Brown Power 25/11/2008 ...197 $0.04 .....-$6.90 
Sell BBW ...Babcock & Brown Wind 25/11/2008 .1,241 $0.77 ...-$889.57 
Sell BEPPA .Bbi Eps Limited .....25/11/2008 ...472 $0.10 ....-$47.67 
Sell TLS ...Telstra Corp .......25/11/2008 10,200 $3.98 -$40,149.44 

After the market drop and these stock sales my accounts margin utilisation currently stands as follows:

Comsec Margin Lending
...Loan:................ $107,752.98
...Portfolio Value:..... $197,079.95
...Margin Value:........ $110,578.33
...Margin Utilisation:........ 97.44%

Leveraged Equities 
...Loan:................ $170,473.54 
...Portfolio Value:..... $178,075.27
...Margin Value:........ $138,921.53
...Pending sale proceeds: $41,101.79
...Margin Utilisation:........ 93.13%

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My margin loan accounts are both in "the buffer"

The Australian stock market fell another 107 points (-2.7%) today - it was the third consecutive day of losses and helped push the market down 2.5% for the week. It is also the lowest close since November 23, 2004. My two biggest margin loan accounts, with Commsec and Leveraged Equities, both got flagged as being in the "buffer" today. This means that my loan balances are above 100% of the margin value (around 70% of the market value) of my stock portfolio. If the margin utilisation gets above 105% I'll get a margin call, which would mean doing something to bring the loan balance back down to less than 100% of the margin valuation of my portfolio. I transferred $10,000 cash from my savings account into each of the margin loan accounts today, which should prevent me getting a margin call on Monday. I'm still hopeful that we're close to finding the "bottom" of this current bear market - it's already much more severe than most bear markets, and Australian p/e ratios are getting absurdly low. Also profits will undoubtedly drop significantly this financial year due to a global recession, the Australian economy is still expect to achieve positive growth. On that basis the market would appear to be in a panic and oversold, simply echoing the plunging stock markets in the US and Europe, where the economies are likely to plunge into a severe recession this year.

If the Australian market continues to drop next week I'll have to start selling off my stock portfolios to meet margin calls - I'm rapidly running out of cash to inject into these accounts!

Subscribe to Enough Wealth. Copyright 2006-2008

Comsec Margin Lending Customer Service dives along with the market

Big Banks are often accused of treating their customers with contempt when chasing profits. Comsec Margin Lending just provided a fresh example of this. When I logged in to my margin loan account this morning to check how close I am to getting a margin call, I noticed this new notice appearing on the "welcome" page:

"Loan Summary:

If you trigger a margin call that is below $5,000, please expect an SMS text message as notification of that margin call. Failure to act on this SMS notice will result in a sell down of a portion of your portfolio to cover the appropriate margin call obligation.

It is your responsibility to provide us with your latest contact details. Failure to do so may result in you not receiving notification of a margin call. To update your contact details, simply click on ‘Profile’ under the ‘Quick Links’ section on the top left of the website."

In other words, since they don't have my mobile phone number on record (and it's often turned off anyhow), I may not get contacted before they start liquidating my investments to meet a margin call!

In contrast, I have a very small CFD trading account with CityIndex that I opened with just $100 (and got another $500 added to the account by CityIndex for opening an account after attending their seminar). I had created a portfolio of ten Australian stock CFDs in that account, and the market crash of the past two weeks saw it get a couple of margin calls, then get liquidated (I owe them just over $100 now to settle the account). However. even though the account was for a Small amount, and the margin call was only $100 or so, I received several liquidation warnings from CityIndex via email AND I received a phone call from a real human being to warn me that I had a margin call to meet to avoid my positions being liquidated.

Compared to that, the customer service at Comsec is really poor.

Subscribe to Enough Wealth. Copyright 2006-2008