... so logically it's time for another. Ignore the misleading headline - my time machine is broken and I'm not reviewing the whole of 2018 just yet, only the tax year that just completed.
As last years post says I'm a semi retired forty something who lives mostly off my investment income, and also runs a fully automated futures trading system. Last year I said I was putting the finishing touches to my second book on investing; that came out in October (I won't incur the wrath of the mods by posting a link to it, but you can find it if you wish via my blog). I've also been doing some consulting and part time university lecturing; with book royalties this means that my dividend income was nicely padded out this year. The other interesting event this year was the arrival of a modest inheritance.
Overall performance and income sustainability
Our household net worth is up 4.2% this year; however if I factor out the inheritance gain there would actually be a 1.0% fall. As usual I ignore any potential house price inflation in these figures.
Excluding housing equity entirely overall the total return of my investment portfolio was 0.6% of which 4.1% was dividends [gross of tax, of which more later] balanced against investment losses of 3.5%. An appropriate benchmark is the Vanguard 60:40 fund which did a little better, earning 1.3%. Equity only investors will scoff at these figures; but this is the downside of a relatively safe portfolio. Much more detail on performance later.
Rather than looking at net worth, with all the tiresome business of excluding inheritances and trying to account for tax, it's probably better to think about income sustainability in terms of margins of safety. Let 100 be our total post tax income from all sources this year. Then:
Household expenditure excluding mortgages: 54.7
........ with mortgage interest: 70.0
........ with mortgage interest & repayment: 80.5
Income from dividends outside of tax shelters, net of tax: 54.6
Income from all dividends: 80.3
Income from all dividends, plus book royalties (net of tax): 88.1
Income from all dividends, royalties, consultancy and part time employment (net of tax): 100.0
There are numerous interpretations from these figures, which when presented this way I call 'the waterfall'. For example we could almost live off our taxable dividends once the mortgage is out of the way (it's currently in a long fixed rate period so I'm not even thinking about possible early repayment). Including all dividends our mortgage interest is easily covered, but our repayments aren't quite so we might have to dip slightly into capital to repay the mortgage (which wouldn't actually affect our net worth). However the additional income we're currently receiving means we are generating surplus cash, which can be reinvested.
Last year I said: (my)... goal is to cover all my spending from all dividends (regardless of status, and after paying any relevant tax), including both mortgage interest and repayments. That way if the book royalties dry up and the part time job is no longer amicable then all will still be well. ... this is comfortably exceeded with a 7% margin of safety (in other words if dividend income was £100K [not the real number], then after covering all expenses including the mortgage we would have £7K left).
Using the same comparison the current margin of safety this year is -0.3%. The main problem here is that our dividend income is around 10% lower than last year. This could be due to fewer special dividends, or portfolio re-allocation away from high yielding UK stocks to lower yielding ETFs. I'm relatively relaxed due to the personal circumstances we are in that we can easily absorb this dividend fall. Still it's a warning signal for anyone who is relying on an HYP portfolio as their sole source of income.
I took some independent financial advice this year. This is something I've talked about before, but the idea is to get an annual 'check-up', partly as a sense check but also to ensure that if something happened to me that my family would have someone who could be trusted to give them some guidance. In fact the service provided was 'guidance' rather than 'advice', the former being much cheaper (since, as someone who knows vaguely what they are doing and isn't interested in extreme tax avoidance, I don't really need expensive advice).
The most relevant part of the guidance I received implied that I should make the maximum possible contribution to my SIPP, something I hadn't considered doing without employer matching, but when I re-ran the numbers myself it made sense. Of course dividends don't count as income for this purpose, so this basically consists of everything I've earned as 'real' income. I've only really missed one year of contributions, as in the previous two tax years I didn't earn any 'real' income, so I could only have put the nominal minimum amount in. From a few hours of university lecturing I've also acquired my first DB pension (the controversial https://www.uss.co.uk/ scheme), which is an interesting novelty.
I also decided to split the contents of one large brokerage account and open an account with another provider; as the concentration risk was too high. Now we have no more than 25% of our net work with any single firm. The slight increase in annual account fees is worth the additional peace of mind.
My investment portfolio is more complicated than most, and there are various ways it can be sliced and diced. For this post I will use the following categories; the figures shown are the contribution of each category to my total investment performance:
a) UK equities +3.3%
b) ETFs -2.0%
c) Long only investments (consisting of a plus b) +1.3%
d) Systematic futures trading -0.7%
e) Equity hedge +0%
An explanation of d and e; my futures trading account is funded with a lump of equity (both buy and hold, and ETF) and some cash. To avoid equity returns “polluting” that account I hold a hedge against the equity exposure (also in futures). This makes the returns of that account a combination of two hedge fund strategies - “managed futures” and “equity neutral”. However I think the categories above are easier to understand.
Most of this portfolio is now held inside ISAs and SIPPs, and traded using a systematic (but not automatic) set of rules which I explained in my last post:
The logic behind my equity selection is explained here http://boards.fool.co.uk/time-to-join-the-party-13313278.aspx. I've since tweaked this during the year, to enforce more sector diversification. The change is that any stock that is sold should be replaced with a stock in the same MSCI [industry] sector.
I said most, there are also a couple of legacy stocks which are held outside tax wrappers, and on which my position is outsized. However I've been gradually selling these down as CGT allowances allow.
At the start of the year my UK stock portfolio looked like this:
Where STOB and ICP are the legacy stocks where my holding is too large. I sold about a third of my STOB holding; withdrawing the value and putting it into my ETF portfolio to reduce my UK equity exposure (which used to be 100% of my portfolio and is now much lower - see the discussion later). The other trades were all mechanical, where I sold after a 30% fall off the stocks high watermark. IBST replaced KIE, GOOG was a substitute for MARS, and BP replaced PFC.
The portfolio now looks like this:
In terms of performance I made around 5.8% of the starting value in dividends, and earned another 12% in capital growth. However since I withdrew some funds this slightly understates the real performance of the portfolio. As any fool knows we need to use the IRR function to calculate the true performance; this comes in at 18.3%. I like to benchmark this against a cheap as chips FTSE 100 ETF, and there is a favourable comparison as that had an IRR of 2.2%.
Total return figures by stock are interesting (simple return, not IRR):
Naturally I lost money in the three stocks that were sold after hitting their stop losses; otherwise some excellent performance.
I plan to continue reducing my overweight positions in ICP and STOB; at this point my total UK equity exposure will probably be at a level I'm comfortable with (see further discussion later).
I take all my non UK equity, and all my bond, exposure through ETFs (I also own some Gold and commercial property funds). Throughout the year I traded for a few reasons: CGT optimisation (which meant selling to realise tax losses, using the proceeds to fund ISAs and SIPPs, and then repurchasing), rebalancing from bonds to equities (discussed further below under risk), and making additional investments using funds from selling UK equities, from my inheritance and from excess income.
It doesn't make sense to look at my ETF portfolio performance or risk exposure in isolation; we need to combine it with UK equities which I'll do next.
Long only investment portfolio
Lumping together my ETFs and UK equities is sensible; I target my risk allocation looking at both of these together.
Performance was middling; earning around 4.4% in dividends and losing 3.1% in capital value for a total return of 1.3% and an identical figure for IRR. The benchmark, a cheap Vanguard 60:40 fund, also came in at 1.3%.
Systematic futures trading and equity hedge
There were small losses in this part of the portfolio; my equity hedge was flat (although slightly up if I include the value of assets it is hedging against; remember these are already accounted for in the long only part of the portfolio), and I lost about 4.7% on my futures portfolio (as a proportion of notional capital held). The latter is roughly in line with industry benchmarks.
For those who are interested there is more detail in this post on my blog: https://qoppac.blogspot.co.uk/2018/04/trading-performance-year-four.html.
Total investment return
My total return on all my investments, including cash held for futures margin and the resulting p&l on that, came in at 0.6%. Vanguard 60:40 seems an appropriate benchmark (since if I wasn't trading futures I could throw all my cash into that fund), this came in ahead at 1.3%. So like last year a slight underperformance on the benchmark.
My investment portfolio asset allocation at the end of the year stood at 25.1% in bonds, 65.3% in equities, 6.4% in cash and 3.3% in other (Gold and commercial property).
In risk weighted terms the allocation to less risky bonds is lower: 13.1%; with 59.4% in equities, 24.5% in futures trading and 2.9% in other. These should be compared to my strategic allocations: 22% bonds, 50% equities and 28% in futures trading and other. Or in a nice table:
Asset Strategic Start of year Current
Bonds 22% 17.1% 13.1%
Equity 50% 53.8% 59.4%
Futures 25% 26.0% 24.5%
Other 3% 3.0% 2.9%
The lower weight to bonds is dictated by a mechanical model based on their very poor 12 month relative momentum versus equities: global equity indices are up about 16% for the 12 months of this report, versus bonds being down 2%.
Regionally my exposures are (each row adding up to 100% of each asset class):
Asset Asia EM Euro UK US Other
Bonds 0.0% 25.7% 27.8% 4.4% 33.7% 8.4%
Equity 13.5% 27.4% 20.5% 28.8% 9.3% 0.5%
And for comparison last years figures (after I did my annual rebalancing, something I've already done with the current figures shown):
Asset Asia EM Euro UK US Global
Bonds 0.0% 27.3% 21.0% 19.2% 27.0% 5.5%
Equity 14.8% 20.6% 19.9% 37.8% 6.7% 0.1%
This has been another slightly sub-par year; but I'm still intensely relaxed about the stability of my wealth (to misquote Peter Mandelson). Of course I would have done much better if my time machine had been working, as I'd have just bought Bitcoin at the start of the year: but I'd also be much less relaxed!