Blessed by the Potato

Asset allocation refers to how you split up your assets (i.e., money). To me, it’s an easy concept, but to others less so. Here’s an analogy to StarCraft I was going over with Netbug the other night:

Bonds/fixed income. This is your defensive stuff. The marines in your bunker aren’t going to get a whole lot of kills through the game, but they’re going to keep you protected. Even in an all-out assault, the enemy has to blow through the bunker before they can even touch the marines. It’s not a glamorous job, but it’s always wise to have a few marines on guard duty. As you get nearer the end game, and protecting what you’ve got becomes more important than getting more, it’s wise to shift more of your assets into defensive roles.

Equities. This is where your growth comes from. The expeditionary forces you send out to secure more expansion points. In the long run, you’ll expect to take a few lucrative vespene geysers with these forces, but any individual one could get surrounded and wiped out. Best to diversify by trying a few different expansion locations, rather than putting all your eggs into one basket. Early on, you’ll probably want to put most of your forces into these growth areas, since even if they do get wiped out you’ll have time on your side to make it back. Later on though you’re going to want to shift your focus away from growing more, and back to protecting what you’ve managed to grab.

Which brings us to rebalancing: if you have a good run of luck with your risky growth stuff, it may be wise to use some of those newfound resources to beef up your defense. Vice-versa, after a nasty market decline decimates your equity expansion task force, you’ll probably want to take a few goons off defense to bring you back up to your target allocation. Turtling up after a small setback on the expansion front is not the way to go in investing.

Your last category of asset allocation is what you’ve got in the bank. This mineral stockpile can be easily and quickly spent to buy what you need in the moment, and is an important buffer for your finances. But, it’s not earning anything for you sitting there, so you want to figure out what margin of safety you need (3 months of expenses is a good rule of thumb, or in SC terms, enough to get each of your production buildings going with one unit in the queue if you need to switch directions), and get the rest out there on the field working for you.

My picks look even worse over the last 3 months.

HBU is up, but I had shorted it (-23.6%)
FRE-W was doing ok for a while there, then in June the political risk reared its head, and the government decided to delist the shares, sending it spiralling down (-65%)
IM reversed its gains to be basically flat (-7%)
AONE is down even more (-59%)

If my math is right, these picks are down 38.6% overall since the beginning of the contest, putting me squarely in last place (note that my real-life investments are not this risky and have not been as terrible!)

Remember that this is a game with a set end-date so looking for value is not necessarily the way to go — often a shoot-the-moon approach works well in these kind of games. So bear that in mind, and don’t consider any of these as recommendations for you to actually buy!

Sold my BRK.B today. Not that I don’t like Berkshire, I think it’s a great long-term hold, but I needed to raise some cash and it has been defying the downturn of the last few weeks so it looked like the least under-valued thing to sell. Plus, when I bought it in January, it had been underperforming the S&P500 for a few months; now, it’s been outperforming by an even wider spread than I had anticipated. Plus, the Canadian dollar’s down almost 2% today, making selling something in USD slightly more attractive (though my effective transaction costs on selling US equities is 3-4X higher than the effective commissions on Canadian stocks due to the hefty exchange fees TD charges).

Sorry Warren, it’s nothing personal, and I’ll probably be an owner again in the future…

Diet was terrible again this week, and I felt pretty ill and headachy on a few days — the humidity outside seemed to put me right on my ass, just couldn’t breathe out there. Nonetheless, I did get two good long bike rides in for the week, and feel pretty good about that. I gained weight though, which is bad bad bad, so I’ll have to get better about the diet next week!

I ballparked the magnitude of the oil spill at about 50k barrels per day a while ago, choosing to believe the image analysis guys (and taking something of the midpoint of their estimates). The media kept reporting smaller numbers (and early on the reported estimates were, to my eyeballing and logic, way low). Last week though I started hearing 60k barrels per day as a new estimate in the news, and cost estimates above my $50B started appearing. I thought after my first post on the matter that I might have been pessimistic assuming the well gets capped in early August. Now I’m wondering if I might have been too optimistic! The stock is already well below my “attractive” price…

Of course, it’s hard to take the plunge on BP when some of my other calls have gone so badly. RIM released results today which looked ok to me (and to TD’s analyst), but the stock was hammered by the market, down over 10% today (and down almost 20% from where I bought it). It’s trading at about a 12X P/E now — the territory of stodgy retailers and banks, not low-debt, growing tech stars like RIM! I just can’t wrap my head around why the market isn’t more positive on RIM — their slice of the pie is undeniably getting smaller thanks to Apple and Google, but the smartphone pie keeps getting bigger (heck, now even I have a crackberry). Their EPS is growing, and should continue to grow for years to come. I think what they need to do is start issuing a dividend, since it doesn’t look like they need all the cash they’re generating for growth anymore.

I own some Freddie Mac (preferreds), even though at the time I bought it, I figured the odds were good that political risk would sink it. Yet I couldn’t resist a little nibble since if the government managed not to kill it, the payoff would be huge. So it’s only a very small portion of my portfolio. It now looks like political risk is indeed rearing its ugly head, as the government overseer has announced that FRE will be delisted from the NYSE. This is a strange move since on such a huge company, the listing fees can’t really save them all that much, and Freddie wasn’t at risk of being delisted anyway (just the opposite, Russell was about to add them back to the Russell 2000 index). Internet chatboard speculation is that this is the first step to the government canceling the private ownership of the GSEs. I can’t really refute that, since the government has definitely taken a different stance on the bailout of the GSEs than of the banks. The bailout money for Freddie comes with a 10% interest rate attached, which is rather punitive to begin with (AFAIK, the naughty banks that more directly helped cause the credit crisis woes got interest-free loans, or money for common equity). The government is also making them keep cash reserves on hand, and reserve loan losses in advance — which costs them 10% — which is ludicrous in my view, since the idea of capital reserves goes out the window once you’re already under government conservatorship.

One scenario I’ve held out hope for is rather than waiting for the company to turn around and conservatorship to end, for the government to tender for the preferreds at a discount. While they are not currently paying dividends on the junior preferreds, in theory that capital costs them ~5%. The government could have Freddie offer to buy back the preferreds at say 25 cents on the dollar, and even at the 10% rate that they’re charging Freddie, it would still end up being a cheaper source of capital for them (and a massive return for speculators like me who bought the preferreds at something closer to 5 cents on the dollar — today they’re closer to 1 cent on the dollar).

If you do decide to take a gamble on Freddie Mac, please do read John Hempton of Bronte Capital’s (long) series of blog posts explaining why he thinks they can be worth something down the road if given the chance to recover (I just bobbed my head and hummed along to his analysis). And note that the political risk means that the most likely scenario is that these things go to zero. They’re basically lottery tickets, so don’t spend more on them than you would at the casino or other gamble — it’s not a sound investment for your retirement!

Finally, on the indexed side of my portfolio (which I don’t talk about too much since it’s purposefully boring — remember, boring is often good in investing!) I saw that the Euro has gone down relative to the Canadian dollar recently (~10%). For my international portion of my indexed portfolio I originally chose the “currency neutral” version of TD’s e-series fund, not really knowing the differences or hidden costs of hedging. Fortunately, that has worked out for me, as that currency hedge helped prevent the international fund from going down quite as much. I’ve taken advantage of that and switched over to the plain C$ version.

On the TFSA SNAFU, Ottawa has decided to be lenient, and all the people who couldn’t figure out this relatively simple tax-shelter will be given leniency for over-contributions in 2009. You still have to respond to your letter from the CRA though, it’s not automatic! The deadline for responding though has been pushed back to August.

I don’t know what to make of all this fuss.

Supposedly, there are a lot of people out there that mishandled their TFSA accounts, ended up contributing more than the $5000 allowed in 2009, and are now being assessed the 1% per month penalty. This has lead to much wringing of hands and wailing over the fees (especially since if you opted for a savings account, you made 1% per year in interest on your over-contribution).

On the one hand, it was the first year of the TFSA, and people over-contributing to savings accounts with paltry interest were clearly doing so out of ignorance and not trying to out-earn the penalties, so perhaps there could be some leniency in the penalties assessed.

On the other hand, it’s not that complicated an account. The contribution room was $5000 for everybody — the RRSP has a similar over-contribution penalty, but people seem to be able to track their contributions for that (and there everyone’s contribution room is different!).

Indeed, before each of my blog posts on the TFSA I summed up the new account in just seventy words, which covered both the limit and the having to wait a year part:

“You can contribute money to it ($5000 per year) to grow tax-free until you feel like taking it out. While the banks might charge a fee to withdraw, there’s no tax penalty (unlike an RRSP), and you can recontribute any withdrawals in later years so you don’t lose the tax shelter space (again, unlike RRSPs) so it’s a great account not only for retirement, but also for medium/long-term savings goals.”

Other blogs and newspaper articles had similar summaries all throughout the introduction, I don’t know how people aren’t getting this.

At least the fuss over the penalties should give the issues prominence in the media so in the future, people will get it!