Market Updates For Feb 2012 and Portfolio Adjustments

1) Local market STI increased approximately 11% year to date, 17% from Oct 2011 lows. There were similar returns across regional markets. US markets increase at a lower rate, roughly about 7% YTD.

2) The reasons contributing to the buoyant stock markets have little to do with market fundamentals. It is the consequent of central banks printing money as European Central Bank pledged to lend out 489B EUROS to ease potential credit crunch in Dec 2011. This is as good as providing cheap credit to banks which enable them to lend out more cheaply for investments. This money are flowing to Asia and emerging market regions. Just last week, funds investing in regional equities drew a net inflow of US$430M. This is the 4th straight month of inflows to Asian regions, which explains the 5th straight week of regional equities market appreciation.

3) Aussie dollars appreciated as stock markets rallied. Over the span of 2 months, it has increase more than 4% against SGD and 5.5% against USD.

4) Average turnover of equities are still below last year’s average. There is a noticeable increase in volume, not value. This translates to speculative trading of penny and mid cap companies stocks. An indicator that market may be looking toppish for the short term (3 months-6 months)

5) Borrowing costs continue to appreciate for corporate loans. This is a peculiar phenomenon. Notice that although banks are able to borrow cheaply from their central banks, they are charging high premiums on the interest lent out to companies, driving up returns on bond yields and returns. One local unlisted company have even issued out 8% PA (non investment grade), 3 year corporate bond.

6) The rationale is simple. World central banks provide cheap liquidity to their local banks. Instead of lending out to companies, they lent it out to governments instead. This way, they do not need to set aside the regulated reserve requirements as government bonds are considered their capital. What happens if government defaults then? The scenario though unlikely may result in foreign banks run.

7) The Baltic Dry Index as of last week has fallen to its lowest in 25 years. This index is a leading indicator of world trading activities, which means lower anticipated demand for raw materials.

8) Conclusion: There could be possible downside risk, given that markets have rallied so strongly over the past 1.5 months. Greece coalition government is under pressure from its own people and Euro zone leaders on their debts. There is small break through lately but with debt refinancing due in March, all eyes are on their ability to repay their current debt obligations. Nobody is able to forecast market’s reaction to Greece default as no EURO Zone member has defaulted.

9) What am I looking at to invest? I have taken profit on a number of equity positions and embarking on exciting leverage financing. I will pledge my shares for a cheap OD line (1.3% P.A.), purchase a 3 year SGD corporate bond and leverage on the same bond to purchase another one. This would increase my yield of $250,000 to 6.5% P.A, assuming interest rates remain low. This investment is at the final stage as my OD line is up, I just need to select the safe bond to leverage upon. My outlay will be approximately $150,000 in cash and $350,000 in borrowings. This would enhance my entire portfolio to $500,000 in fixed income, $230,000 in equities and $50,000 in cash. I will write more about this when the bonds are purchased. Margin call concerns will also be addressed.

Common Law Is The Law For Common Man 法证先锋3 Translation

Cantonese dramas are the best form of entertainment. It virtually costs nothing as it can be downloaded on the net, provide excellent subject knowledge of law and specialised fields. I took awhile to translate the above, impressed by the efforts made by the script/research writer. The below translation begins at 1:05

Pro Sir: Common law is the law for common man. Common law is the fundamentals of all Hong Kong laws. The model for common law is to accept the objectivity of rules. This refers to the unspoken rules agreed by the majority which dictates habits, truth and false, right and wrong. This forms the fundamentals of common law.

The motive behind an action is accepted is not solely due to my judgment but derived from the fundamentals of common law. It reflects the same motive behind the same action of the majority.

The accused forcefully inserted the pill bottle into the deceased mouth. The motive behind the action was to force the deceased to swallow ketamine pills within the bottle.

Lawyer: Your honour, the witness’s illustration has already been dislodged from the specialization of a forensic scientist.

Pro Sir: My professional judgment must definitely be base on the fundamentals of common law. Thus my court statement is not dislodged from my profession.

Judge: Expert witness, you may continue.

Pro Sir: Thus when you brought the bottle to your mouth with a swallowing action, the whole set of actions under normal circumstances would led one to believed that the bottle is filled with water or other forms of liquid. Thus a normal person would then be driven to display a drinking action.

Of course, a person would also would pick up an empty bottle and pretend to drink. This is because he is acting. He is an actor. The motive behind your actions is to create a perfectly logical scenario. In reality, your account is an unconceivable illusion which is a blatant attempt to overthrow the whole truth.

From your perspective, to overrule my judgment, your motive is reasonable. But I need to emphasize, the legal judgment I made is based on the fundamentals of common law. The accused forcefully inserted a bottle full of ketamine pills into the deceased’s mouth have led to her death.

This is definitely a correct judgment, closest to the truth.

Why I worry about retirement

Many close friends who read my blog often label me as a salty man. This has a negative connotation because in Hokkien context, it is “kiam” or scrooge in western terms. However, when I explained my rationale to them, suddenly they realize they either be prepared to work past 55 or be better off being more salty.

In today’s competitive workplace, there are not many people who are willing to work past 55 years old, even if they are ABLE to. Perhaps it is due to the increased pace of life and work pressure, many people just find it too stressful to cope mentally and physically beyond 55 years old.

The problem is exacerbated when the same group has ailing parents, growing kids and mortgages to repay monthly.

Life becomes much more stressful, simply because they need to work or they die (from debts and poverty).

In a nutshell, most people don’t retire at 55 simply because they cannot afford to do so, not because they choose not to.

Let’s work some simple figures here. Most Singaporean men with degrees start work at 25 years old. If they aim to retire at 55 years old, they have 30 years of working life. Assuming a life expectancy of 85 years old, they have another 30 years of income-less life to sustain after retirement.

This effectively means for every day we (men) work, we need to set aside funds for both the day we work and another day we do not work for the next 30 years.

And for the savings we put aside, we need to grow it at least at the prevailing 5.7% inflation rate in order to sustain the same kind of life style when we retire.

CPF only grows 2.5% PA, which is grossly not enough to cover inflation. Even if it is enough, most likely it is depleted to purchase HDBs which easily cost $500,000 at today’s prices.

Let’s assume again a modest lifestyle of $2,000 per month for a single at age 55. This works out to be $2,000 x 30 years = $720,000 cash balances in today’s dollars to sustain a modest life style. The amount will balloon to $900,000 if the single requires $2,500 a month for the next 30 years.

If we factor a conservative 4% inflation, today’s $720,000 will be worth $2.34M (future value) in 30 years time.

The same 4% inflation will make $900,000 today’s dollars worth $2.92M.

For people lost in reading, it simply means that you need $2.92M in 30 years time to buy something worth $900,000 today if inflation is 4%.

In order to enjoy the same modest lifestyle of between $2,000 to $2,500 per month, the individual who retires at 55 needs to set aside between $2.34M-$2.92M for him to call it quits at age 55, 30 years later.

This is not factoring if the individual lives beyond 85 and whether he can invest his retirement funds at the prevailing inflation rates. If he is unable to do so, he probably needs to sell off his house in order to exchange for food.

Most Singaporeans who buy houses today stretch their loans to 35 years. This means that a 30 year old couple will need to service their loans till they reach age 65 before they finally own their homes.

There are no prizes to guess why government is stretching the retirement age.

Some other observations I made as follows:

(1) Most singles out there probably spend more than $2500 a month, even if they just earn this much.

(2) Most people at age 55 now do not have $720,000 to $900,000 to lead a worry free life up to age 85. What makes you think we can achieve the equivalent amount in future value 30 years later?

(3) Medical costs and inflation rates are not at 4% only.

(4) You need to earn a minimum of $5,000 a month, save $2,500 a month and invest this sum at prevailing inflation of at least 5% consistently for the next 30 years in order to retire at 55.

(5) The sums required may increase 1.5x to 2x if you have a partner. If you have kids, you need to pray that they give u some allowance if you have not achieve the required by age 55

(6) You cannot afford to be retrenched or your retirement age stretches even further.

(7) You cannot depend on CPF for retirement if you have bought a house.

In my workplace, I do see many people earning high 4 figure salaries but have not much savings. They take for granted that health, wealth and career path will always be smooth sailing.

Let’s not be pessimistic about life but admit the fact that we can’t afford to retire if we are not prepared for it.

And I am not kiam, just getting prepared. :)

Update on Historical Volatility of SPH and STI ETF

With regards to my earlier post on volatility, yes the calculation was a bit off but it has no material impact on my comparision. But anyhow, for folks interested in the volatility of SPH and STI, I have taken monthly returns from 2008 Jan to 2011 Sept. Calculation was based on excel. The results are quite similar, SPH and STI has a correlation of 86.5%; Annualized volatility of SPH was 22.28%, STI (ETF) was 25.15%.

Unfortunately, volatility does not tell you whether it is upside volatility or downside volatility. It also assumes the same weightage of volatility throughout every month, which is not accurate. It also does not factor in dividends that affects price movement much more on certain days.

Compared to Schroders Singapore Trust, the average 3 year volatility was 23.7%, which is higher than benchmark. As for the returns, it returned 18% over 3 years.

Assuming one bought SPH at 2008 1st Sept at price of $3.98, dividend yield for 3 years would have been 19.85%.

Assuming one bought STI ETF at 2008 1st Sept at price of $2.45, dividend yield for 3 years would have been 5.78%.

At 1st Sept 2011 SPH price of $3.73, total return for the same investor would be 13.57%.

At 1st Sept 2011 STI ETF price of $2.92, total return for the same investor would be capital gain of 19.2% + dividend of 5.78% = 25%

It is likely that actively managed funds under performed ETFs due to higher management and brokerage costs.

This post will convince most people to diversify into ETFs and stop holding large single stock holdings, which includes me!!!!

A little comparison with a single stock and unit trust

Most of my friends who bought Unit Trust didn’t really make money. I personally considered that a weird phenomenon as most of them held their holdings for more than 3 years and are still in the red. Compared to me, most of my holdings are held in single undiversified companies that gave me decent returns. Today I make a comparison with 2 random funds and my largest single stock holdings, SPH.

I will compare the risk and return during the past 4 years.

I am using 2 funds which most of my friends invested during the height of the crisis. They are First State (FS) Asian Growth and First State (FS) Regional China.

During the peak of their price in end Oct 2007, FS Asian Growth peaked at 1.93, FS Regional China peaked at 2.35.

Today I checked their prices; they are at 1.73 and 2.0021 respectively. This is to say an investor who invested at the peak of the fund prices would still be suffering a loss of 10.4% for FS Asian Growth and 14.8% for FS Regional China.

There were no dividends for the above 2 funds.

What was the price for SPH in 30 Oct 2007? It was 4.58. The latest closing price was 3.84. The same investor who bought SPH at the point when the above funds peaked will be suffering a loss of 16.2%, before dividends. What were SPH dividends during the last 4 years?

Assume the investor bought SPH in Oct 2007 and held it till today, his dividends would be as follows:

2007: 19 cents (not accounting for May 1H dividends)

2008: 27 cents

2009: 25 cents

2010: 27 cents

2011: 7 cents (1H only)

Total dividends: $1.05

Thus the same investor who bought SPH at the peak of the fund prices would have recouped his capital and made a modest gain of 6.8%. This is not considering he would have gained interest on his dividends.

Many readers would point to the fallacy of my argument. What if the investor bought SPH at the peak of 4.72 in 10^th Dec 2007 (just before it goes dividend XD)?

His cost of purchase after accounting for the dividends would still be at $3.67, his profit would still be at 4.6%.

Again academia would argue it is not fair to compare a single stock to mutual funds. I could have taken much higher excessive risk to achieve better returns. Let’s calculate it on the basis of risk adjusted returns.

In order to simplify my calculation, risk free rate is assumed to be zero and volatility is calculated based on peak to trough deviation from mean, 3 years average.

FS Asian Growth: 3 year high 1.85, 3 year low 0.93. Average 1.39, 33% volatility

FS Regional China: 3 year high 2.17, 3 year low 1.02. Average 1.595, 36% volatility

SPH: 3 year high 4.72, 3 year low 2.35. Average 3.535, 33.5% volatility

Volatility is assumed to be deviation from the average price. Though not accepted by many academia, it is a rough way to get risk adjusted returns for comparison purposes.

Thus the Sharpe ratio, which gives us the excess return for every unit of risk taken are as follows:

FS Asian Growth: -0.32 (negative returns for every unit of risk taken)

FS Regional China: -0.45 (higher level of negative returns for every unit of risk taken)

SPH: 0.13 (positive Sharpe ratio that states that every unit of risk taken yields 0.13 unit of excess returns)

Some observations, disclaimers and fallacies in my little research report:

Unit trust sales charge and brokerage charges are assumed to be zero.

This is not to discourage the purchase of Unit Trust. I personally have FS regional China in my portfolio as well. This is just to compare (unfairly) SPH with two of my best performing Unit Trusts in my portfolio.

Volatility calculated though consistent is not correct. Sharpe ratio is a function of volatility and different fund house calculate volatility differently, perhaps to their advantage. Some may take minute/day/weekly/monthly/yearly volatility ratios to generate their financial ratios. I use my in house SBC volatility calculation, easy to understand and meaningful for comparison.

As long as returns are negative over the given period, Sharpe ratio will be negative. Most funds give negative sharpe ratio over 3-5 years period anyway.

The fact is I am still holding every single share of SPH I bought in 2007 and some were added, off loaded along the way. Dividends reinvested in other counters gave pretty decent returns during the crisis where REITS were near the bottom.

If I have used some of my worst performing stock eg Hong Leong Finance or DBS (fortunately both less than 20k investment), the above funds will be doing much better.

If I have used Aberdeen Pacific equity for my comparison, SPH would have fared much poorer.

Fact is, SPH did give better risk adjusted returns over most funds available in Singapore.

Diversification does not provide you better returns or lesser risk than a single stock, at least in the above case study.

I still prefer my current way of investment style. Income concentrated with dividends reinvested in different counters for more income. It has buffered a lot of my losses and added a lot more thrill and returns in my investment journey.

I would still be investing in Unit Trust mainly using CPF funds. I will still actively look out for dividend blue chips to grow my income to a day that I do not need to work for a living.

And my apologies for keeping my faithful readers the long wait for a single post.

Busy with work lah!

Hyflux Preference Shares

This post is slightly overdue as interested parties would most likely subscribed to it. Currently I see a lot of interest in it with books closed for subscription closed that very morning when it was launched in my workplace.

In fact I did carry around the Hyflux advertisements and ask some of my aunties in my office to subscribe to it. The 6% cummulative dividends and 8% step up (2018 if not recalled) is a compelling reason to subscribe.

However, do take note that the preference shares are not rated and most probably only Singaporeans are familiar with Hyflux. It is unlikely to have fund houses buying large quantities as it has no credit rating and fund managers cannot overide the mandate of having non investment grade preference shares/bonds in their portfolios.

This may result in poor liquidity.

It is extremely rare for non financial companies to issue preference shares as it is a tool used mainly by banks to shore up their capital adequacy ratios. The other non bank that issued preference shares I know of is Cheung Kong Holdings.

If the size is increased to $400M, Hyflux will have an additional war chest of $400M, a hefty sum relative to its $1.8B market cap.

Wait, why does Hyflx need so much money suddenly? Not considering Hyflux would have to repay $24M (6% of $400M) every year to preference shareholders which is more than 30% of its 2009 net profit ($75M).

Are there any dividends left for ordinary shareholders?

With interest rates being all time low, is there a reason why Hyflux has to resort to expensive financing?

Is there a problem with Middle East Investments? Middle East contributed the bulk of revenue in recent years, over taking China as it largest revenue contribution region in 2009.

According to SGX announcement in April 15th 2011, one of the directors sold all his stake in Hyflux.

Have you applied for it?

Patriotic to own a Beemer

One of my classmates bought a BMW recently. I know she earns about $10,000 a month and technically speaking, she is buying a car that cost roughly twice her annual salary. There is nothing wrong to enjoy the finer things in life though it means she is also patriotic as well.

Why patriotic?

In Singapore to own a car, you will be paying a huge load of tax to the government. Take my classmate’s BMW, she has paid the following to the government:

Open Market Value (OMV)= $58,000

Thus Additional Registration Fee (ARF) will cost 100% of OMV =$ 58,000

Excise Duty: 20% OMV= $11,600

Registration Fee: $140

Certificate of Entitlement= $45,000 (few months ago)

GST: OMV x 7% (approximate) = $ 4,000

Total tax payable to government coffers: $118,740

The total cost of her car was about $210,000 then, which means the gross profit margin for the car dealer was 43.4%.

In order to own her dream car, she has to contribute in excess of $100,000 to nation building, I have respect for that.

Good thing is that she only took a 1 year loan and has only a couple of months to fully pay up her car. As for me, it will be unlikely that I will ever own a BMW, probably the furthest I would go is a Toyota Camry.

My rationale is simple. Consider a $200,000 lump sum investment to grow on a compounded basis of 10% (1.1^10), this initial sum would grow to $518k after 10 years. The opportunity cost of $318k means that she might have to work another additional 3 years to fund her retirement. Coupled with her 2 years salary to purchase the car at the onset, she potentially could have retired 5 years earlier.

Yup, 10 % PA might not seem realistic. But if one has the investment horizon and purchase some China Equity fund, we should be looking around this level of returns. China will be overtaking America as largest economy in my lifetime, according to most analysts.

Well, to each his/her own. I prefer to retire earlier and spend my days reading, writing and travelling when I am still able. As for owning a nice car, I think I will hitch a ride when I meet up with her in school instead.

Life is tough, retire early. That’s for me.