Friday, April 3, 2015

Stocks bubble?

Finnish Financial Supervisory Authority (Finanssivalvonta) warned recently that "financial sector participants must refrain from excessive risk taking in their search for yield. We should also be prepared for a bursting of a possible asset price bubble.".

This fueled the ongoing "stocks are in bubble" discussion in the media.

Well, I'm not going to start guessing near term directions of stock market. Instead, I think people too easily use the word "bubble". Many of us participated in the turn-of-the-millenium IT bubble so we know what a bubble looks like.

There are crazy valuations out there, but stock market overall is not in the bubble. US and European stock prices have gone up over last few years considerably.

On the other hand, we are in an environment where there really is no "sure" inflation protection available. Central banks in US and Europe have slashed the interest rates to near zero if not negative (according to some news stories even individuals might get loan with negative interest rate!).

In that kind of environment stocks that yield 3-6% look good and it's only natural money flows to higher yielding asset classes.

According to data that I have available (via Valuatum), the median yield expectation for 2015 for Finnish stocks is 3,5%. This means half yield more than this.

There are stocks where price-per-earnings (P/E) ratios are clearly too high (for me P/E beyond 20 is expensive unless company is growing and that is expected to continue). Median P/E estimate for Finnish stocks in 2015 is 16,5. Meaning half of them are below that.

My conclusion is that many stocks have rallied probably too high, but the market overall is not in a bubble.

Corrections might happen, though, even big ones.
For long term investors like me they only provide opportunities to buy more those stocks that are still reasonable priced.

Sunday, March 8, 2015

Why to avoid costs (and tracking error)

Actively managed stock funds charge yearly fees of 1-3%. Some take management fees north of 4%.

In addition to costs that are typically disclosed to investors (as "total expense ratio" or "management fees" or "entry/exit cost" etc.) there are other costs such as transaction costs that are not typically disclosed to investors.

All costs produce tracking difference.

We assume 0,48% as tracking difference for our "benchmark investment" (which simulates passive ETFs). Total cumulative gain of the benchmark investment (net of taxes) between 2009-2014 was 100,3%.

To illustrate how small differences in tracking difference turn into significant difference over the 6 year period, I recalculated the benchmark investment performance with tracking differences between 0,48% and 4%.

The result is that every 0,5% increase of tracking error makes the cumulative gain roughly 5-6% smaller. The relationship between increase of cost and decrease of cumulative gain isn't linear, but at least with such a short period of time (6 years), it is quite close to linear.

For example, 4% tracking difference drops the cumulative gains to just 60,30% (40% less than with 0,48% tracking difference). Even increasing tracking difference with just 0,52% (i.e. to 1%) drops cumulative gains significantly (to 93,90% - 6,4% less than with benchmark investment).

Many actively managed funds lose to their benchmark index even more than what their management fees etc. take away, which makes the situation even worse.

In long run, it's not the profits alone that matter - also cost of holding matters a great deal!

Thursday, February 12, 2015

5 years blogging

I wrote my first blog post on 12th of February 2010 - exactly 5 years ago.
Since then my blog has got over 60,000 pageviews.

When looking back to what I have written I find some things odd. For example, I have written lots about gold even though that has never been major part of our portfolio. Same goes for mining companies.

Most of my investments to mining sector have proven to be if not mistakes then not as profitable as most of my other investments. That is truly a hard sector - but for some reason - continies to be a fascinating one for me.

Early on, I made quite a lot of changes to portfolio. Later I have slowed down rate of change a lot. I think there are three reasons for this. Five years ago, I had more time to follow the market and this lead to more activity. Secondly, when I had to justify changes in the blog, I started to be more critical towards acting on new ideas and towards change in general. Finally, there are now many excellent companies in the portfolio with good long term prospects and it simply is hard to find better ones. Changes make even less sense to positions that have accumulated significant capital gains.

Opposed to what many other people does. I keep the winners (keep the gains accumulating without taxman eating into those) and ditch the loosers (even at loss).

Over the years, the number of my blog posts per year have decreased. This year, I plan to turn around the trend and write more posts than last year ;-)

I went initially for direct invetment into many companies in developing markets. Most of those came out as problematic positions. Either because of the company selection itself or because of taxation of dividends out of those companies in Finland. The biggest lesson that I learnt from those investments is that for inverstor like me, passive ETFs are the best vehicle to get market exposure outside of markets that are familiar.

Some things have been not changed.

I consider still Warren Buffett's annual letters and other materials as some of the best investment advice one can find. I have not always followed his advice and most of the time this has lead to mistakes.

There has also been one crisis after another over these 5 years
- aftermath of US crisis,
- then Euro debt crisis,
- then Greece,
- then Ukraine
- then again Greece...
- (and likely forgot something in above list)

Still, our porfolio has done very well over the years.

So far, almost pure stocks portfolio has paid off - big time compared to stocks/bonds/cash portfolio alternatives.

Let's see what the future brings.

Wednesday, January 7, 2015

Portfolio performance 2009-2014

It's time to compare the performance of our portfolio in the year 2014 against passive index investing.
Our "benchmark investment" is an imaginary passive ETF that closely tracks the performance of MSCI all country world (ACWI) index in euros.

In 2012 we significantly underperformed, in 2013 we significantly overperformed and last year we lost a bit to the benchmark. Overall, we are a bit ahead in terms of performance.

Our performance during 2009-2014 has been as follows:

I have made changes to how "benchmark investment" is calculated and this reflects in performance of all the years (in case you compare to my previous "portfolio performace" articles). Over the years I have also corrected some minor errors in the spreadsheets.

Our portfolio has been more defensive (less risky) and less volatile than the ACWI index. Therefore, it has underperformed in bull market and overperformed in bear market - except for 2013 where our big turnaround bet to Nokia paid off and we also got above market gains from Western Digital and UPM.

During 2014 it looked like we may beat our benchmark by wide margin. Especially our U.S picks from the IT sector delivered above average gains (Western Digital, Intel, Microsoft, Cisco Systems) and overall things were progressing very nicely - until last quarter.

Euro declined from 1,3791 to 1,2141 U.S. dollars (-11,96%) during 2014. Our portfolio is much more tilted to Europe and Eurozone than the ACWI index where U.S dollar exposure is currently 52% (source: XTF). This was likely the most serious headwind for us in 2014. Also, our oil sector positions - especially Fred Olsen Energy - did very badly in the latter part of 2014. Mining sector wasn't doing that good either.

Generally, our european positions - outside of the sectors that did very badly - didn't help the race by producing above average gains - apart from Orion. However, most of our european positions pay out above average dividends compared to what ACWI index funds pay out. Long term that will matter and limits the downside risks.

 Our benchmark index 2009-2014 (based on MSCI All Country World Index; Net; Euros)

I have not calculated our performance during 2007-2008 because we were off the market. During that time and also before that our benchmark index would have been different because the investment objective was different and risk level was much lower.

About the "benchmark investment"

I have chosen to construct my own imaginary benchmark index fund out of MSCI ACWI index instead of choosing one particular index fund that tracks the index. The main reason for this is that I would never invest all our money in any particular fund. I would rather choose several funds managed by several companies that as a whole would track the index close enough. My estimate for average cost level for the benchmark investment is 15EUR + 0.5% per transaction and 0,48% tracking difference per year. The latter is estimated to be 1,6 times Total Expsense Ratio that in turn is estimated to be 0,30%.

Also, I am taking into account paid taxes. The ones that we have paid for real and the ones we would have paid if we would just buy and hold the benchmark investment instead. In Finland, gains of ETFs and stocks are treated the same. There is, however, difference in how payouts are treated. Tax rate for dividends from stocks is lower. That is actually one reason, why we have much more direct investments to stocks than money parked in passive ETFs. Over time, even small differences matter a great deal.

To take into account taxes that would have been paid by us, our benchmark investment gets penalty of 0,60% per year. This is assuming that in reality it would pay out roughly 2% yearly dividend which would be taxed at 30% in Finland before we could invest money back into the fund.

The index data itself is available via MSCI Barra web site as excel-file at least at the time of writing this post. I use a version of ACWI index which has large and mid cap companies in it. I use it with the following parameters:
- EUR (as in euros)
- Daily (as in daily quotations of the index)
- “Net” (as in “With Net Dividends” that takes into account taxes that an insitutional investor or fund would have to pay to various countries where they have holdings)

The benchmark investment is always fully invested into the passive index. Starting balance was invested at end of 2008 to the index. By dividing the money with the value of the index, you get “shares in index”.

About calculating the yearly returns

The yearly return of the index and the "benchmark investment" will be different if more money is added into the brokerage accounts during the year. To take that into account, the yearly returns are calculated as [balance at end of year N] - [(balance at end of year N-1) + (additions to brokerage accounts during the year N)] / [(balance at end of year N-1) + (additions to brokerage accounts during the year N)]

Background materials:

For the changes done this time around, I actually browsed through quite a bit of materials. Best are linked here.

About MSCI index calculation methodology

About tracking difference and "hidden costs" that are not explained by Total Expense Ratio (TER):

Thursday, January 1, 2015

Portfolio update: Allocations and Top 5 positions

Happy New Year 2015 !!

At the beginnig of each year I have two tasks to complete regarding investments: document our portfolio allocation and compare how we did last year against our bechmark.

The latter requires quite many excel drills so I will start with the easier one.
Our portfolio is currently allocated as follows:

Stocks 97,8%
Gold 2,1%
Cash 0,1%

No bonds.
I simply substitute bonds with quality dividend payers in our portfolio.

Geographical Allocation (stocks):

Europe 55,8%
North America 33,2%
Emerging markets 11,0%

Actually, place of incorporation is pretty meaningless for most corporations we have invested in. Most operate and sell globally.

Sector Allocation (stocks):

Information Technology 43,6%
Other 20,2%
Oil & Gas Production 9,3%
Health Care 8,1%
Communication Service Providers 7,3%
Low Emission Power Generation 7,0%
Mining & Exploration 4,5%

Top 5 positions:

Company/ETF (sector) allocation%

Western Digital (IT) 10,0%
Siili Solutions (IT) 8,2%
Nokia (IT) 7,2%
UPM (Other) 6,4%
Intel (IT) 5,9%

20,8% of all stock positions are done via ETFs.
None of those positions made it to top 5 this year.