A speculative twist for boring investors

PORTFOLIO POINT: Channelling some of your funds into more speculative areas can pay off, but boring and patient investing should be your core strategy.

A prize for responsibly investing the bulk of your savings in an age or situation appropriate, diversified multi-asset portfolio is the opportunity for you to take a few speculative positions from time to time with a small allocation of funds.

While there is never a shortage of ideas to speculate in, there probably isn’t a good framework for doing so, which I’ll try to lay out here.

In the recent Eureka Congress I shared the ingredients of a resilient portfolio, balancing the often competing needs to grow with protecting your wealth and lifestyle, as shown below.

Once custom built to your specifications, your default position should be to limit tinkering with this, and even to keep it in balance, as investments go down and up in price.

While this might sound boring, it might pay to remember the words of George Soros, who said “If investing is entertaining, if you're having fun, you’re probably not making any money. Good investing is boring”. Some also believe that activity is rewarded in finance. However the reward may belong to someone else, according to Warren Buffett, as he thinks “The stockmarket is designed to transfer money from the active to the patient.”

Having established that “investing” is a boring and patient activity, we can still entertain the idea of “speculating” with a small amount of surplus capital, provided you:

• Limit your speculative position to about 5%-20% of your investment capital and never “bet” more than you could afford to lose.
• Don’t have this target amount of capital “invested” every day as it is highly unlikely opportunities are always available. When you don’t see opportunity, hold uninvested funds in cash or in your core portfolio.  
• Benchmark your returns and periodically check whether the effort after transaction fees and taxes was worth it. Note the lazy investor’s way of benchmarking is to include a small holding of an Australian share index fund you can compare returns with.
• Provided it is allowable by your SMSF investment policy (and your wife or husband), consider speculating in your lowest or nil taxed entity as speculative gains are generally taxed without discount.
• Don’t use borrowed money. Even long-term geared investment strategies only have a three out of four chance of success held over 10 years.
• Limit your losses (consider stop losses) and while you should let your winners run, remember no one ever went broke taking profits

There are many different ways of speculating in today’s market and here are some ideas which you may wish to explore:

Have a small speculative share portfolio

Unlike for your core equity allocation, a speculative share portfolio can be a random assembly of shares you think are oversold or ready to accelerate. They can be in one or multiple sectors. They can be small or large. They need not be blue chip and even dividend paying. Borrowing from the famed US mutual fund investor Peter Lynch, they could be companies you have bought products and services from and liked what they do and their queues of customers.

For instance, I had a great experience selling a car on carsales.com.au and so I bought their shares (CRZ), and reminded myself to avoid Fairfax where I would have earlier advertised. That said, you could speculate now that Fairfax is a bargain if pay walls are around the corner and newspapers don’t need to print and deliver papers any longer. If you pick six winning shares out of 10 right, you are doing well.   

Another caution is that many companies in growth industries, especially start ups, make bad investments as they are often ravenous consumers of your capital and often expensive. For instance the market capitalisation of the 72 stocks in the ACT Australian CleanTech Index are now worth $6 billion, or 56% less than the $16 billion they were worth in July 2007. While the numbers aren’t as bad, investors in agricultural stocks betting on food scarcity have not been well fed – but perhaps they will be if and when the Australian dollar falls.

Bet on a falling Australian dollar

It’s hard not to have a view on currency. At the moment I consider the Australian dollar a “Steven Bradbury currency”, having benefitted from other’s collapse. Like most, I doubt our high dollar is sustainable but I struggle with knowing when it might revert. I can even see it go higher in the meantime. If you think you know, then you could:

Reduce your currency hedging on your international equity investments (recalling having some helps you earn extra income. Increase your mix of unhedged international shares at the expense of Australian shares including perhaps safer defensive stocks in consumer staples (for example, health care and telecommunications).

Buy US dollars at the bank or via an ETF, but don’t expect any interest. Buy overseas property including US or European property, and perhaps funded with 2%-3% local interest rate borrowings should you be one of the few those banks will lend to.

Note, as most of these assets offer you about half the yield you get in Australia, then you need the dollar to fall about 3 cents every year to break even on your holding cost. The exception to this is Australian residential property, which yields about half as much as overseas property. Investors at the moment are arguably speculators as they need capital growth to justify holding – which over the long term they should expect to get equal to wage inflation. Note, speculating in Australian property is hard in today’s market, especially given enormous transaction costs in buying and selling. No risk of high frequency trading there.

Momentum investing

The mysterious art of charting and commodity trading advisers like Wingate and MAN rely on the phenomena of momentum. Momentum investors believe stocks that have large increases in price will continue to gain, and vice versa for declining shares. Indeed, Chicago money manager Richard Driehaus, considered the father of momentum investing, takes exception with the old adage of buying low and selling high. He believes instead “far more money is made buying high and selling at even higher prices”. The origins of momentum investing are in behavioural psychology and include “investor herding” and “confirmation bias”.

While it is not clear that this strategy will work long enough in the current “risk-on” and “risk-off” market, you could try applying it by buying the Australian share index as you see it accelerate, or the new inverse Bear ETF to profit when it falls away.

Gold

Buying gold or precious metals is not investing, it’s speculating. Since gold and the like pay you no income, and even cost you money to hold it, you instead are speculating that someone will pay you more money for it one day than you did. Gold miners are also pretty stingy dividend payers, so while this is not exactly true, it’s close. Had you bought gold in the last 12 months you most likely have made no or lost money. Many have written in the Eureka Report about how to take a gold position including in physicals, certificates, ETFs and miners. Note you can buy gold through both US$ and A$ ASX-listed ETFs, with the latter actually paying you a small income from currency hedging, which maybe you could stretch to say you’re actually investing in gold. It is fair to say some also buy gold as insurance against financial system catastrophe and are willing to pay the 5% or so annual income opportunity cost for doing so.

Climate catastrophes

While not available to retail investors, at least one Australian super fund is speculating on the weather and other major disasters. Catastrophe bonds pay a regular income to investors for the privilege of handing over capital in the event of major disasters. This is a great way for reinsurers to limit their risk and is a securitised version of the famous Lloyds of London insurance syndicates and “Names”, many of which went bankrupt.

Speculating in sharemarket catastrophes

In gloomy economic periods, the entire sharemarket, or certainly subsets of it, make for value buying. At the moment billions of dollars are sitting on the sharemarket sidelines opting out of reasonable tax-effective income, settling instead for the security of deposits – which at least in Australia are above inflation.

Millions of Australian investors are thus speculating that there will be another major market downturn. Half are determined to invest at the bottom and the other half won’t invest, ironically, until the sharemarket proves itself by rising reliably past 5,000.

If we do see shock falls (which won’t be a shock) then your speculative sidelined capital will need to find its way quickly out of cash (and locked in termed deposits) and into shares, and out of high-quality government bonds and into beaten up hybrid income securities, out of big companies and into small ones, and out of expensive high-yielding, defensive stocks (discussed earlier), and back into cyclicals, banks and resources.

American Jesse Livermore is regarded as one of the most successful speculators/traders famous for shorting the stockmarket in 1929. He made and lost his fortune many times, and sadly he ended it all with a gun in a Manhattan hotel room. Read here for some of his timeless tips based on human psychology.

If all this sounds too hard then don’t worry, you don’t need to be a speculator to build and enjoy financial security. You can stay a boring investor. If on the other you believe you can out-pick and out-time the market, just don’t put at risk your financial security doing so.

Doug Turek is mostly a boring risk-averse strategic investor and is principal advisor of Professional Wealth. Investments and strategies discussed here are for illustration only and do not constitute a recommendation.