The Problem with HVST (Betashares Australian Dividend Harvester Fund)

For probably two years now I have been buying up the Betashares Australian Dividend Harvester Fund (HVST), which is a exchange traded managed fund listed on the ASX. The appeal of this fund is that it pays a very high dividend yield (about 10% to 14%) and pays this dividend monthly. The monthly dividend payment normally gets paid into my bank account in the middle of the month, and every payment is roughly the same. Hence HVST makes living off dividends very easy. This is why I have accumulated over $100k worth of HVST.

However, it is becoming increasingly clear that there are many flaws with this fund, the main one being that it has not performed well in the last few year compared to the ASX 200.

HVST vs ASX 200 from 2014 to 2017
HVST has significantly underperformed the ASX 200 over the last few years (chart from CommSec).

That being said, I am not criticizing the fund or Betashares. I was well aware that the dividend harvesting technique employed by the firm would result in less upside when markets were going up. This is a result of the fund manager buying high dividend paying stock just before dividends are paid and then selling the stock after the dividend is paid. As stock prices normally go down after dividend payment (as the company’s value goes down in line with its reduction in cash) then naturally a dividend harvesting technique would result in lower capital gains.

Something else surprising is that during downturns in the ASX 200, HVST also went down considerably as well, which makes me question the firm’s risk management overlay employed. According to the article Managing risk: the toxic combination of market downturns and withdrawals in retirement on the Betashares Blog:

One way to help manage sequencing risk is to apply a dynamic risk exposure strategy, which seeks to reduce downside market risk…. BetaShares combined its expertise with Milliman to launch the BetaShares Australian Dividend Harvester Fund (managed fund) last November. The fund invests in large-cap Australian shares with the objective of delivering franked income that is at least double the yield of the Australian broad sharemarket while reducing volatility and managing downside risk.

Based on this description, I was hoping that the fund’s risk management overlay would reduce downside movements, but the chart of the performance of HVST against XJO shows that when XJO turns downwards, HVST goes down by as much. When XJO goes up, HVST tends not to go up much if at all, which results in HVST falling by about 20% over the last few years while XJO has managed to increase in value by a modest 5% during the same time period.

As I said, this does not mean I will not continue to invest in this fund. The regular and high monthly dividend payments are extremely convenient, and any capital losses made by the fund over time, in my opinion, can be compensated for by investing in ETFs in riskier sectors e.g. investing in tech stocks, emerging market, or small caps or even by investing in internally leveraged ETFs such as GEAR. For example, if you invest half your money in HVST and half in GEAR, you get the convenience of monthly regular dividends from HVST and any capital loss is compensated for with your investment in GEAR which should magnify upside market moves. Note that a limitation of the half HVST and half GEAR strategy is that when the market goes down, GEAR will go down significantly as well. Furthermore, another problem with both GEAR and HVST is that they have management expense ratios that are significantly higher than broad-based index ETFs mostly from Vanguard or iShares. Both HVST and GEAR have management expense ratios of 0.80 percent whereas Vanguard’s VAS is 0.14 percent and iShares’s IVV is 0.04 percent.

Nevertheless, I do recommend many products from Betashares. One ETF that I am interested in from Betashares is their new sustainable ETF called the Betashares Global Sustainability Leaders ETF (ETHI). I normally buy ETFs in batches of $10k to $25k at a time, so I intend to buy a batch of ETHI and write a blog post about it later. I have mostly positive views about Betashares as they provide a great deal of innovative ETFs.

Update 18 June 2017: The poor price performance of HVST is explained in the Betashares blog article Capital vs. Total Return: How to correctly assess your Fund’s performance. If performance includes income as well as franking credits, the gross performance of HVST looks more favourable.

Agricultural Commodities Bottoming? ASX: QAG

The prices of agricultural commodities such as sugar, wheat, and soybeans have been falling for some time now. This can be seen in the performance of the QAG ETF.

For a number of months now I have been thinking that these commodities cannot go down forever. If this were the case, soybeans, sugar, etc would eventually be free. Could this be a buying opportunity?

QAG ASX price from 2012 to 2017
Source: Google

Property vs Margin Loan vs Internally Geared Funds

I have mentioned in a previous post that I don’t like to buy a house. Instead, from experience, I find that it’s best to invest in ETFs. The reason is because ETFs give you flexibility to invest in what you want. If you buy a house as an investment, you are leveraging into one house, and although the general property market may behave one way it’s very hard to know how your house will perform individually. For example, the house price indexes from the Australian Bureau of Statistics averages out results for a number of different houses. If, say, you have a house in Sydney and Sydney house prices went up 5% this does not mean your house specifically went up 5% but that houses in general in Sydney went up 5%.

Furthermore, if you buy a house to live in, you have nothing but debt (unless you buy a house outright without a mortgage, but this is rare). You have a mortgage that you must pay monthly and any benefit from the investment is in the form of capital gains, which you cannot access until you sell the house. You cannot see capital gains, and you cannot access capital gains. Capital gains are invisible and, if there is suddenly a recession, all your capital gain that may have taken you decades to accumulate may disappear in a matter of weeks or months.

Capital gains do not provide the same sort of comfort that cold hard cash income provides. If you have a house, this problem can easily be fixed if you turn your house into an investment property and rent it out, but even if you had an investment property, the performance of an investment property just doesn’t compare to ETFs, in my opinion. Unless you really know how to pick good property, residential property in general has low yields, and after you pay property management fees, taxes, house repair and maintenance, etc, you don’t end up with much, especially not when compared to ETFs that have been engineered to seek out and pay high dividends.

Property is not a good investment. From my experience with residential property, once you buy a property, suddenly everyone wants money from you and everyone sends in their bills. Once you buy property, you need to pay bank fees, mortgage interest, lawyer fees (for conveyancing), real estate agent commissions, taxes (stamp duty and land tax), and property manager fees. Once something goes wrong in your house (e.g. the shower breaks) you need to get a repairman in to fix it, and he send you a bill as well.

Investing in high-dividend paying ETFs is completely different. You use an online broker (e.g. CommSec) to buy ETFs listed on a stock exchange, and then you sit back and watch money flow into your bank account. That’s it.

What about leverage?

One of the benefits of property is leverage. Because you borrow money from the bank, you have more assets exposed to the market, which means potentially higher gains. However, leverage works both ways. If the asset price does not go up enough to compensate you for the interest expense, you will lose money, and when you are leveraged, you will lose a lot of money.

That being said, leverage is a legitimate strategy if you want to accept higher risk to get higher returns. You are effectively moving up the efficient frontier.

Leverage is easy to achieve using ETFs. There are two options: (1) invest in leveraged ETF (e.g. the Betashares Gear Australian Equity Fund (ASX: GEAR)) or (2) apply for a margin loan to borrow money from the bank to buy stocks or ETFs.

Based on the modelling I have done, all these options (property, margin loan, and leveraged ETFs) have somewhat similar returns, so it doesn’t matter which you do so long as you feel comfortable with the risk you are taking. However, that being said, I think that out of these three choices, property is the worst because once you sign up to borrow money from the bank, you have a monthly mortgage that you must pay. You basically have a noose around your neck. If you don’t pay it, the bank will sell your house, and you will incur substantial transaction costs. When you have a margin loan, many people will try to scare you about the dreaded so-called “margin call” but this I think is overblown. The bank will only step in to induce a margin call when your debt levels are high relative to the value of your assets (they look at your loan-to-value ratio or LVR). They do this because, if you have a high LVR, the risk you are taking is too high, and the bank will get worried that the size of your debt will be too high relative to the size of your assets, which means you may owe the bank money that you may not pay. As part of their risk management, banks will monitor your LVR and intervene to lower your LVR if you raise it too much. This applies not only with stocks but also with property.

Banks will intervene to lower your LVR if you have not been paying your mortgage. If you miss a mortgage payment or two, the bank may allow it because your LVR will not be too high, but if it goes on for too long and your debt levels start to rise too much, the bank will intervene to sell your property. Therefore, regardless of whether you have a property or a margin loan, the bank will still intervene if the LVR is too high. So long as you keep watch of your LVR and make sure it is not too high, you will be fine.

When managing your LVR, the problem with property is that you have zero control over your portfolio. Once you buy your house, there’s littel you can do to affect the volatility of the asset. You have zero control. However, if you own a portfolio of shares or ETFs, you can control how much volatility there is in the portfolio by buying specific listed assets. Managing volatility is important to managing your LVR because volatility affects the value of the portfolio, which of course impacts the denominator in the LVR. If you use a margin loan to leverage, say, into the Chinese stock market (e.g. the iShares China Large-Cap ETF (ASX: IZZ)) then the risk you face (and therefore the probability of a margin call) will be much higher than if, say, you invest in stable assets such as global infrastructure (e.g. via the AMP Capital Global Infrastructure Securities Fund (ASX: GLIN)).

There is a much easier way of leveraging that involves zero risk of a margin call, and this is by investing in internally geared funds. With internally geared funds, you don’t borrow. Rather, you take your money and invest it in the fund. The fund manager collects your money (as well as money from other investors) and uses this to borrow money from the bank in order to invest in stocks. Because debt is handled by the fund manager (rather than you yourself), you don’t owe anyone anything ever. Betashares currently offer two listed internally geared ETFs: GEAR, which leverages into Australian stocks; and GGUS, which leverages into US stocks.

According to the Betashares website, the fund is “‘internally geared’, meaning all gearing obligations are met by the Fund, such that there are no possibilities of margin calls for investors.”

Gearing via an internally geared ETF, in my opinion, is the optimal strategy unless you want to borrow money yourself so you can claim the interest expense as a tax deduction. However, that being said, if you borrow money yourself, because you are only one man (or woman), you will typically pay between 4 to 6 per cent at current rates, but if you invest in a leveraged ETF, the fund manager is responsible for borrowing, and the fund manager has access to low institutional interest rates (supposedly around 3%) thanks to its buying power. You are therefore able to gain even greater leverage with internally leveraged ETFs.

Conclusion 

I used to be very much against gearing because I strongly believe that debt is slavery, but now I accept that gearing can be a legitimate strategy so long as you have robust downside protection. I believe that no matter what you do (when investing and in life in general), it’s good to take risk because more risk provides greater return, but risk must be managed. It is okay to take risk so long as you have a safety net or a fallback plan if everything goes wrong.

Advice to Millennials: Don’t Buy a House

Where I live in Australia, most people are obsessive about property investment. There is an assumption that you must buy a house otherwise you will fail financially. As a millennial who doesn’t own a home, people always ask me when I will plan to buy a house or whether I have made any progress in saving up for a deposit on a house. People are either pressuring me to buy a house or to get married.

My response is that I will never ever buy a house. There is simply no need to buy a house when there are investments available that are far better. For example, BetaShares (a brilliant organization, in my opinion) has recently issued the BetaShares Global Banks ETF. This ETF tracks an index that invests in big multinational too-big-to-fail banks. The top 10 holdings are disclosed on the BetaShares website and is reproduced below:

top 10 holdings of BNKS as at 29 July 2016

Investing money in large too-big-to-fail banks, in my opinion, is a wise strategy. For years now, Australians have only had access to Australian banks on the ASX via ETFs such as QFN and MVB. Banks are an excellent investment because typically they pay very high dividends.

The more dividend income you have, the more freedom you have in your life. Dividend income is true passive income because you don’t have to do anything to earn it. Even if you own property and rent it out, you must still find tenants, fix broken showers, and unless you own the property outright you have to slave away at work in order to meet monthly mortgage repayments. Then you pay outrageous taxes such as stamp duty, and every year you must pay bills and council rates, as well as land tax. If you own the BetaShares global bank ETF, you pay virtually nothing other than a minuscule 0.47% management fee. You can literally sit back, relax, do nothing, and watch the dividends enter your bank account.

When you own property, you typically need to borrow money from a bank. If you’re borrowing money from a bank, you’re not generating dividends. Rather, you’re paying for someone else’s dividend income. If you borrow money from a bank, you make the bank rich, which effectively means you’re making bank shareholders rich.

What happens if there is a GFC 2 and bank shares collapse?

This is a fair argument. One could make a strong argument that the financial system is more precarious now than ever. However, even if we are nearing a massive recession (which I suspect we are), I don’t think that is a reason to not invest in bank stocks (or stocks in general) because we don’t know when the bubble will pop, and bubbles can perpetuate for decades or centuries.

When I see a bubble forming, I rush in to buy, adding fuel to the fire. That is not irrational.

~George Soros

Furthermore, if you own a property and the global economy collapses, how will owning a house help you? Property prices can go down just like stock prices can go down.

One of the benefits of owning bank stocks is that, even if these banks fail, many of them are too big to fail. They are so integrated into the economy that in the event of an economic crisis they can hold society as hostage and demand ransom (or bailout money) from the government. The government will typically give money to these banks, either from existing funds or from simply by printing new money to hand to the banks. Once banks receive bailout money, they can use it to repair their balance sheet, and stock prices should go back up again.

Below is a passage from the Financial Systems Inquiry report in Australia:

Global history records governments of all political persuasions using taxpayer funds to support distressed institutions. As undesirable as it may be to put taxpayer funds at risk to support financial institutions, in the midst of a crisis it is often the fastest and most certain option to stabilise the system and avoid widespread economic damage.

Investors can rationally surmise that the government is likely to rescue systemically important institutions if no other options exist, as their collapse would cause the most damage to the financial system and broader economy. This leads to a belief that some institutions are too-big-to-fail — that they receive an implicit government guarantee.

http://fsi.gov.au/publications/interim-report/05-stability/too-big-to-fail/

In a world characterized by wage slavery, big banks are basically the apparatuses of wage slavery. Whips and chains have been replaced with mortgages and credit cards, and banks are the institutions responsible for distributing these instruments of oppression to the masses in order to enslave them.

If the big banks are in trouble, the entire system of wage slavery is under threat, and for this reason I don’t think the government will allow the banks to collapse. They might make one bank fail just to make an example of them (e.g. Bear Stearns) but if you buy a broad-based index fund, you’ll be investing in the entire banking sector, so it’s not a problem.

How can you live without a house?

Of course you need to live somewhere. Shelter is a necessity. However, shelter is not expensive. I currently live with my parents and pay some of their bills. Other people can easily lower costs by sharing a house with others. They can rent (or even buy) a place and then rent out spare rooms. I recommend buying or renting a place far away from the city in order to get the cheapest price or rent possible and then simply use public transport to travel into the city if you need to work.

Living with others can be problematic because it can be difficult to get along with other people, but there are easy ways to fix this problem. Try to find people who are kind and who will not cause drama. Also try not to interact with people you live with too much. Personally I am always out of the house, either at work or at the local library. If I am at home I usually stay in my room. I have food cooked for me, but even if there is no food, I have a large supply of Australian Soylent (Aussielent Body) that I can drink should I need to eat. This ensures I never have to bother with cooking or cleaning, and arguments over who should clean the dishes are common when people share accommodation.

Personally, with food technology so advanced nowadays, cooking and cleaning are quaint, archaic and useless activities that must be eliminated from your life. People are always trying to tempt me into a life of slavery by telling me that I must get married because I need a woman to cook for me, but Soylent has now made the housewife’s cooking skills completely redundant.

Conclusion

You don’t have to buy a house. Live with your parents or find good housemates, and then keep interactions with them minimal to prevent drama.

Drug dealers have a saying: “Don’t get high off your own supply.” In other words, drugs dealers make money off their customers’ drug addiction, but if a drug dealer were to consume his own product, it will be to his detriment because the strength of his business depends on the weakness of his customers. The same applies to banking. Everyone in society is addicted to debt. The “drug dealers” who supply this debt to the masses are banks, and anyone smart enough can become a drug dealer by buying bank stocks or bank ETFs, but as a drug dealer you should not “get high off your own supply,” that is, you should be very cautious about going into debt.

The goal of my life is to produce passive income mainly from dividends. This ensures I can obtain income without working, which gives me freedom. I am not dependent on anyone. Even though I live with my mother, I rarely speak to her as I’m out of the house all the time, and even if she wants me out of the house, I can easily rent a small one-bedroom apartment paid for with dividend income. Most people move out of their parents’ home, buy a house, and drown in mortgage debt, which makes them slaves to their managers. Because I live off dividends, I am not dependent on my work. I don’t need a job. If I get fired or even if I dislike my work, I can simply find a different job that I enjoy or I may even fly off to Chiang Mai where US$1000 per month ensures you live like a king, and in Chiang Mai I can spend all my time in coworking spaces where I can work on whatever I want that I am passionate about regardless of whether it makes money or not since I don’t need income to live since I live off dividends. None of this would be possible if I had a massive mortgage over my head that forced me every month to pay a large chunk of my income to the bank so that other people can collect their dividend payments. I’d rather be on the receiving end of a dividend payment.

Typically when someone has a large mortgage over their head, they have more than a mortgage. A house has associated costs such as electricity and gas bills as well as taxes, and people who are desperate to buy a house in order to keep up with the Joneses are usually trying to show off in other ways as well, so they will likely have expensive furniture, massive kitchens, refrigerators, huge couches, and expensive TVs. People always put me down for being a minimalist. Some do it with more subtlety than others, but people always try to put me down for not owning a house or having expensive furniture or having a trophy wife or multiple children in elite private schools. I am usually very honest nowadays. I tell them I am trying to have more freedom in my life so I can do what I want, and I tell them I am trying to build up dividend income. This usually comes as a complete surprise to most people because most people have been conditioned by society to buy things and to go into debt. All the money they earn is eaten up either by debt or by lifestyle expenses whereas all the salary income I earn is invested. My savings rate is 100 percent, and I subsist off dividends of approx $30k per year. I do not live a hand-to-mouth existence. I am not fed with money obtained from my own labor. I am fed with money obtained by other people’s labor. My hands don’t feed me. Other people’s hands feed me.

Living off dividends and escaping slavery is not about showing off, in my opinion. I have no need to show off to people because I am quite detached from people. As such, other people’s opinions don’t matter because I am not close to them. Most people must care about what others think because they’re forced to be around them due to circumstances, and if they’re stuck with these people, they need to get along with them, which means these other people must have a good opinion of you.

But I don’t need to be around anyone. I am not dependent on anyone for anything. I am completely independent. I am not afraid of bullies. Bullies can bully me, but because I live off dividends, I can use dividend income to block them from my life. I don’t need to suck up to anyone because, unlike salary income, dividend income doesn’t impose upon you an obligation to keep someone happy. I am no one’s slave.

But from my position of freedom, I am a witness to all the manipulation, deceit, propaganda, slavery, and oppression in this world, and I personally cannot be willfully ignorant of it. I cannot close my eyes and pretend that atrocity does not exist in this world.

Doing something about it is the difference I can make. I can spread the word and help vulnerable beings escape from oppression. That is my purpose in life: to be free myself and to help others be free as well.

Can we change the world? No, but hell, we can all try.

~Rupert Murdoch

There is nothing in life more important than freedom. Even if you don’t want freedom, being free will give you the freedom to not be free. Better to be free and have the choice of being a slave or not rather than be a slave and have no freedom to be free.