Investment review: Did my exchange rate idea work out?

Approximately 18 months ago I did a post on the exchange rate opportunity that could be exploited using foreign index funds because the Australian currency was so strong coupled with extremely weak share markets overseas.   I also ran through a very specific example of an investment I had made in the FTSE100 which was to take advantage of the weak pound as well as the weak English share market.

This post will be a review of that idea 18 months down the track, along with an assessment of how I thought about the investment along the way.

So how did it turn out?

As it turns out, this was a rather good investment to make and I have been very pleased with the results.  The chart below shows the performance of the investment over time.

Performance of the index
The blue line is the performance of the index fund (ISF) in pounds.  In the circa 18 months that I owned it the index returned 16.3% plus another ~2% in dividends over that time so approximately 18.3% return over 18 months.  This is annualised return of ~11.8% which I am very happy with in itself.

Performance including the currency effect
However the kicker (and the original point of the investment) was the return benefit that the exchange rate would give when it returned to 'normal' levels.  It has not yet returned to normal levels but it is certainly going in the right direction.  The A$ depreciated by 9.7% against the GBP in the 18 months.  This resulted in a total A$ return on the ISF investment of 27.6% before dividends or ~29.6% after dividends over the 18 months.  This is an annualised return of ~18.8%.

I had no idea that the performance of the UK share market would be strong over that period, the real underlying reason was that the currency gave me protection on the downside and provided significant upside in the event that it returned to normal levels.

...however during the investment period it did not always look so happy!

The chart below shows the return on investment over time.  The red line represents the A$ performance of the investment and the blue line represents the GBP performance of the investment.

For the first few months of the investment, it did not seem to be a great investment.  Indeed the share price was not really going anywhere and the currency movements made me think I had missed the boat at times.  However I had in mind what I thought a fair price for the currency was so I continued to wait and of late, even though the share price has come off significantly in GBP, the fall in the A$ has been so sharp that this has not had a real impact on the A$ return.

So did I sell out of this investment?

Not yet.  I still do not think the Australian dollar is at fair value even though it has fallen significantly.  I think there is a little way to go.  Although I think the same trade is still available, the level of upside is not what it was 18 months ago so I probably will not be throwing more money into this investment strategy.

Was it just a fluke?

Did I just happen to pick the right currency and the right share market?  Was it just a fluke?  I don't think so.  I actually did the same trade with a much larger amount of money into the US market and the returns from that have been even more impressive than the returns I outlined above.  The reason I went through this example in the post is because it is the one I posted about 18 months ago.

Note that this is one of the investments I made that came off.  Next week I'll post about one that continues to cause me significant pain that I posted about several times in the past. I have no problem admitting my losses and it is worth all those who are new to investing to know that you can still get good portfolio returns even when you have a couple of dogs in your portfolio.

As always this is not investment advice.  Just a demonstration of what I have done and make sure you think through your own investments and use qualified advisers if you require it.

You May Also Be Interested In:
Investing in foreign index funds: an exchange rate opportunity
Foreign index funds: An example
Investment strategy: All Posts
Stocks: All Posts

Negative political advertisements about the economy have ALREADY started

I don't often watch television however happened to have very little to do a few days ago and so noticed something I wouldn't have ordinarily noticed.  The negative political advertisements about the economy have ALREADY started.  They have started before a general election has been called and, like most political advertising, is so biased an inaccurate as to be rather misleading.

For all my international readers, this post will be a complaint about the Australian electoral cycle however you may get some benefit when thinking about advertising in your home districts when you go through election cycles.

What sort of advertisements am I talking about?

I tried to find videos on YouTube which illustrated my point but appears that Australians do not bother enough to put their political advertising on YouTube and thankfully our politicians are not yet internet savvy enough to deploy the full gambit of internet advertising.  Alas, that means that I will need to describe for you the type of advertising I am talking about.

The particular advertisement that got to me was one in which the Liberal party pointed out that the Australian government was running up a deficit of $100m a day in 2009/2010 when Kevin Rudd was last leader of the Australian Labor party.   The implication of course being that with him now back in control, if you vote for him he is going to destroy the economy and pile on the national debt again.

It reminded me of an advertisement a few election cycles ago where the basic argument was that you could not trust the opposition party because every time they were in power interest rates rose, thus if you put them in power again, the interest rate that you pay on your home loan will go up again.

This happens at EVERY election cycle.  And both sides of politics play this game with different issues.  I am particularly concerned about economic policy and the Liberal party is typically the one that runs the advertisements about how the Labor party is going to ruin the economy and look at their past record.  The Labor party does it about other issues such as how the Liberal party cronies up the businesses and sticks it to the ordinary Australian worker.

Why do I hate these sort of advertisements?

I am passionately against any sort of advertising that relies on the fact that your electorate is uninformed and which feeds them a simplistic

Why are sector funds so much more expensive than broad based funds?

If you invest in exchange traded index funds (ETFs) at all, you will have noticed that broad based index ETFs (which cover whole markets such as the Australian sharemarket or the US sharemarket) tend to have much lower expense ratios than those exchange traded index funds which cover specific sectors such as utilities, resources or financials.

I only recently started investing in sector ETFs after I saw an opportunity present itself in the resources sector a few months ago.  As I researched the possibilities though, the cost of the sector ETFs, especially in the Australian market really struck me.  Management expense ratio's are incredibly important when it comes to weighting up whether to invest in a particular managed fund (whether exchange traded or not).  In fact, over the long run it has a huge impact on your performance relative to the benchmark you are trying to beat.  The question therefore becomes:

Why do sector specific ETFs cost so much more than index ETFs?

I believe there are several factors which influence the MER for sector funds versus broad based index funds

Can I say upfront, that although I tried to research this I was not able to find any particularly good sources of information out there about why this is the case.  These conclusions are therefore my own. I am happy to be corrected on any of them or for additional reasons to be added.  If you have any suggestions please add them to the comments bar or send me an email and I'll be happy to include them.

I don't think there is any one defining factor which causes the costs for sector index funds to be higher than broad based index funds.  I think it is due to several factors which include:

1. Sector ETFs are typically smaller and so transaction costs are higher as a proportion of funds under management
• There is a significant difference between the

Saving Tip: Out of sight - Out of Mind

As we all know, budgeting and saving are inherently linked.  But as anyone who has tried to stick to a budget knows...things always come out of the blue and although you promised yourself that you should save a certain amount this month it is always less than you imagined.

I have one major tip which should help you improve your savings pattern.  It is a variation on the 'Pay Yourself First' idea that so many self help financial books seem to promote but which I never really got my head around so here it is:

Pay your bills first, put a set amount aside for your monthly spend and the REST gets transferred, ON PAY DAY to a savings account which you don't have easy access to

The key to this is making sure that the cash you are saving is OUT OF SIGHT because if it is, the chances are you wont think about it when you are thinking of spending money.

So...How does it work?

It's quite simple.  You do this

The free market is NOT perfect: Property rights improve efficiencies

As outlined in my last post on this topic - 'The free market is NOT perfect: Knowing Economics 101 is not enough' - I will be doing a series of posts rebutting the claims of free market advocates masquerading as 'libertarians' that we would all be better off if the government was not involved in the free market.  Indeed the only way to create a more efficient society where everyone is better off is if the government stopped getting involved.

These points of view have been gaining momentum in recent times, especially in the United States, although I have noticed more and more people starting to join libertarian type organisations here in Australia as well.  Indeed, in the lead up to an election, these voices tend to get significantly louder.  I will be rebutting many of their claims in the coming weeks - however I am by no means left-leaning in my preferred economic outlook.  I believe that market mechanisms are broadly the most efficient because they most closely play to the human condition.  However I believe that the market is NOT perfect and that regulation and intervention is needed to maximise efficiencies.

If you want a truly free market...give up property rights

Free market advocates and the libertarian strain of these in particular rail against rules, regulations and government intervention in the operations of the markets claiming that all this does is create inefficiencies.

Fine libertarians...if you don't like rules and regulations then the first thing I want you to give up is property rights and see what that does to market efficiency.

Property rights form no part of a true free market economy.  By property rights I mean the right to

• Intellectual property rights including
• Patents
• Trademarks
• Physical property rights

If you truly want a free market

Positive Dilemma: Is it an issue if your property becomes positively geared?

In Australia, one of the biggest benefits of investing in property, or borrowing significantly to invest in any investment class (including shares) is the presence of negative gearing.  That is, you can claim a portion of your losses (your effective tax rate) back against your other earned income.

Although a loss is always a loss negative gearing allows you to

• Supercharge your investment returns by investing less cash and using leverage to maximise the growth in your invested capital
• Have lower holding costs while you wait for capital growth to give you the returns mentioned above

How to investment properties become positively geared?

There are several ways that this can happen without you even noticing it:

1. You have been paying down a little bit of principal every month or have been contributing to an offset account and your interest bill becomes lower than the rent
• This is a really common way for investment properties to become positively geared
• You have managed to save so well and pay down your debt so aggressively that your investment property is now throwing off cash to you each month
2. Interest rates have fallen
• Typically we pay more attention when interest rates are rising because we know that we probably need to contribute a little bit more each month
• However when interest rates are falling most people do not tend to take as much notice
• It is entirely possible for interest rates to fall so much that your property goes from negatively geared to positively geared very quickly
3. The rent you charge goes up
• It is perfectly normal to increase the rent you charge ever year
• Because the incremental amount is so small (i.e. typically $5 - $10 a week) we tend not to notice it on a month to month basis 
• However over a few years it definitely narrows the gap between what you are paying in interest and what you receive from your tenants

Why does this cause a dilemma?

There are several investment books (which I don't like) which bemoan the fact that people are so focused on negative gearing and promote the idea that positively geared properties are ideal because 'they put money in your pocket each month instead of taking it out.  This is only right at a very simplistic level.

However it is not so simple if you think about your whole portfolio, instead if this investment in isolation.  What you should actually think about is: 

What the opportunity cost of having your funds invested in this property versus in another product?  

As I mentioned earlier what negative gearing allows

Emissions Trading Schemes...why would a conservative party oppose it?

If you live in Australia you will know that the Prime Minister, Kevin Rudd, announced that he wanted to move from a carbon tax to an emissions trading scheme (ETS) next year.  What was baffling to me, was the response of the opposition leader, Tony Abbott who is looking (according to the polls) like almost certainly being Australia's next Prime Minister.

I suggest reading this article for a brief overview on the comments made by both parties and I will do a brief overview of why I think Mr Abbott is just playing politics and assuming the Australian voter is exceedingly dumb.

Emissions Trading Schemes internalise negative externalities

Negative externalities are those outcomes of the 'free market' which are bad, however which are generally not taken into account in the price of the good or service being produced.  In the case of energy for example, coal is the cheapest form of fuel in a private sense (i.e. to dig out of the ground and to burn) however there is a social and environmental cost to this which does not get included in the price of coal.  However there is a very real cost to this which is borne by society in terms of environmental effects which need to be fixed / cleaned up by future governments and taxpayers.  This is what is known as an externality.

Note that externalities can be both positive and negative however they both face the same problem in a market economy - the benefits of positive externalities and the costs of negative ones are not included in the price of that product.

The solution to externalities is to try and internalise the cost or benefit in order to reflect the true cost of the product.  This often has to be done via regulation (especially in the case of negative externalities) as profit seeking enterprises are never going to voluntarily give up the lower private cost / higher social cost item.

An emissions trading scheme is a market mechanism to internalise the cost of carbon for those who pollute and it also offers 'credits' for those who do not pollute (e.g. for those who use or create renewable energy).  It is the right-wing, market method of accounting for a cost where the market fails.  A left wing measure would have been to put a tax on the product which