Bond funds??

I was reading an online magazine and a financial advisor from a reputable company suggested a bond fund portfolio for risk averse people. He claims that it has low risk and by having bond funds, one can invest in global fixed income and withdraw a portion of it from the bond fund periodically, funding one’s retirement.

Well, even though I am about to have exams in less than a week’s time, I can’t help but to write something to kick the joker’s ass.

I have compiled, as much as possible the SGD returns of bond funds, available to the DIY investor from fundsupermart. The below data are correct as at June 22^nd, 2009.

Returns tabulated using the data of bid to offer returns to account for sales charges. Returns tabulated are also compounded. Example, if I invest $100 in Fund A and it gives me a 3 year compounded return of -2%, I will have $94.11 at the end of 3 years.

I have tried to compile the funds that are named like fixed income instruments. I could have inevitably missed many other bond funds. Apologies on that.

AIGIF SINGAPORE BOND FUND

Bid to offer returns:

3 years: -0.7%

5 years: 1.8%

ABN AMRO STAR EUROPE BOND

Bid to offer returns

3 years: -1.6%

5 years: -0.9%

DBS ASIA BOND FUND SGD (CL A) (only up to 3 years data)

Bid to offer returns:

3 years: -3.9%

5 years: NA

UOB UNITED INTERNATIONAL BOND FD

Bid to offer returns:

3 years: -2%

5 years: -0.1%

PIMCO HIGH YIELD BOND USD

Bid to offer returns:

3 years: -7.5%

5 years: -3.2%

SGAM TOTAL RETURN BOND S$

Bid to offer returns:

3 years: -3.7%

5 years: -2.2%

DBS SHENTON DYNAMIC BOND

Bid to offer returns:

3 years: -6%

5 years: -4%

FIDELITY INTL BOND A-SGD (only have 2 years of record)

Bid to offer returns:

1 year: -9.5%

2 years: -6.1%

FIDELITY US HY USD

Bid to offer returns:

3 years: -5.1%

5 years: -0.7%

ING RF EM MKTS DEBT HC EUR (only 4 years of record)

Bid to offer returns:

3 years: -3.3%

4 years: -0.9%

As one can see, most if not all of the bond funds returns are in the red!!

In Finance 101, we know that bonds are definitely part of the stock portfolio to lower the overall beta and risk of the portfolio. However, bond funds are altogether a different animal. There are a lot of expenses, upfront and inherent costs that erodes away investors’ value. The recent 3 years should theoretically be a bull market for bond funds, as equities tanked (they are inversely related, theoretically). Why is it that they are performing poorly as well? Are fund managers acting on the best interests of the investors? Are they imposing too hefty expense ratio or incurring unnecessary transactional fees that are ultimately borne by investors? We do not know.

If I were to invest in bonds, it will be truly bonds that pay me a fixed coupon rate and redeemable upon maturity. Not bond funds that pay me nothing and return me less than my principal!

Just for information sake, a bond is a debt issued by a company and pays a fixed amount (coupon) which will be redeemable at par value(price which was originally sold) by the company upon maturity. The maturity date can be 1 year to 100 years, depending on the financing needs of the company. It can be traded at the secondary (bond) market.

Ok, I hope I sound more convincing than the joker financial advisor. Who is employing me for financial advice now? Kidding!

Marriage: A risky business

Lately I came to know a few friends from different social circles getting married. I am not sure if you call it pre marriage jitters, but 2 different couples who have already bought HDB houses are already having 2nd, 3rd thoughts about that person they want to marry.

One couple was together for 6 years, and the reason for getting married is because they have already known each other for 6 years and time is running short! The guy in the relationship really hates to receive SMS and calls from his fiancée, often trying to avoid her whenever possible. Breakups have been tried and failed due to pressure from the fiancée’s whole family, he was time and again held hostage emotionally by them.

As for the other couple, they rushed into a marriage less than 1 year of their relationship as they were keen to receive the 40k CPF housing grant by buying a resale HDB. Both are unwilling to go through the marriage now, but the house had been bought, banquet booked, bridal shoots taken and renovation paid. All by installments. There is little they could do but carry on with the mistake. And by the way, they no longer talk anymore, even over dinner.

Needless to say, we can foresee that they might not live happily ever after upon marriage.

Risk: Considering sunk costs

“It will be a waste if we don’t get married after being together for so long” is not a good reason to get married. Even if we were to analyze the issue from finance perspective, knowing each other for years is actually a “sunk cost” which should not be considered when making cost benefit decision. (Sunk costs are costs that cannot be recovered once they have been incurred. However sunk costs greatly affect actors' decisions, because humans are inherently loss aversive and thus normally act irrationally when making economic decisions. )

Actually marriage is a cost benefit decision between 2 persons. We should be choosing the person we love that would provide the biggest benefit and lowest cost to us in FUTURE. In order words, we want to maximize returns and minimize risk. Hence, “sunk costs” like knowing each other for years, already spent a lot of money on him/her, already bought the house etc should never be considered for marriage decision making, if you are a rational person.

We should rather, be concern about opportunity costs. If I forgo this girl (or project) and I invest time and money in another girl (or project), what is the projected benefits (cashflows) from the new selection? Is the net present value or internal rate of return higher? It depends on your expectations (discount rate) though!

Unfortunately, for marriage, the payback period for the investment is often minimum 40 years. Hence, it is a risky investment!

Risk: Non diversifiable risk

The other reason to consider marriage as a high risk activity is because of its non diversifiable nature. I can only choose one spouse and live with it. I cannot marry many (for non muslims) and spread my (their) eggs over few baskets. Hence, it is of paramount importance to choose the correct one! Even if one may argue that you can choose the best wife from many girlfriends (though not ethical), choosing the correct girlfriend may not turn out to be the correct wife, mother (for you children) and daughter-in-law.

Just like business climate, tax policies and consumers’ taste change rapidly; your spouse will also change. The same spouse today may not be the same one 10 years later. You will need to discount and adjust your expectations accordingly, which may be painful and difficult experience.

Risk: Unfavourable historical returns

Look around yourselves. Are there happier married couples or happier singles? What is the percentage of divorce and broken families? Again, from current statistics and “historical perspectives”, most people are better off single, which again points to the risky nature of marriage!

So if you are considering to get married, do think carefully! Do not get married for the wrong reasons!

After all, life can only be understood backwards; but it must be lived forwards.

What is the yield on housing investment (2)?

Supposed Mr. Tan does not invest in an apartment. Instead, he invest his downpayment of $124,000 and 2 years worth housing installment of $66, 0192 into a diversified portfolio of stocks, with an investment horizon of 20 years. I am assuming here that he has prudently set aside about $190,000 before purchasing the apartment.

In the earlier example, Mr. Tan obtained a gain of $1,193,807 at the end of 20 years. Hence, to be equally wealthy at the end of 20 years, what is the return of his stocks portfolio he must achieve (compounded annually) before he can be indifferent in purchasing the property or investing in the portfolio of stocks?

Using a financial calculator, (PV= $190,000, N=20, FV= 1,383,807), the required return of the portfolio is 10.44%.

Hence, if Mr. Tan is not confident that his stock portfolio can give a return of 10.44% annually, he will be much better off if he invests in the property and earn 3.33% return annually.

In fact, even if Mr. Tan can only sell his property for $700,000 at the end of 20 years, his stock portfolio must return an annualized gain of 6.93% for him to be equally well off.

The above (and below) example shows why it is so much “easier” to earn a higher quantum of monetary gain in the property market, compared to buying securities. Property is also physical and hence emotionally more “logical” (adage of everyone needs a roof over their heads) investment for most people. It is less prone to nasty shocks like your property losing 50% of value in a month, compared to commodities. Worse case scenario, you can stay in it but you cannot live on stocks!

The 2 examples are not to determine a better investment asset but rather to show the difference of return between 2 different asset classes. Properties being leveraged product will return a lower return on percentage terms but higher returns on absolute monetary terms.

In this case, it pays to be in debt!

I do not include buying stocks on margin as the interest rates are exorbitant and people do not buy stocks on margin for 20 years.

If you are Mr. Tan with $190,000 on hand, which would you choose? Apartment or stocks?

For myself, I am on a lookout for a freehold property of about 800-1000 sq feet in the prime district near a MRT station selling for $650,000. I believe that the property market will have some more way to go down till 2011 as large waves of TOP apartments will flood the market then, bringing down the rental and price of private apartments.

Hopefully I can be as rich as Mr. Tan in 22 years time!

What is the yield on housing investment?

Singaporeans are obsessed with housing as an investment. Considering the large number of people scrambling to buy a house even during such times are telling signs that you can know nothing about equities, forex, commodities and derivatives, but you can never miss out on properties.

“Land is scarce, so property is a sure win bet here” are one of the main reasons why the HDB auntie next door and the lawyer opposite are saving hard to fund their next property.

I rarely hear people asking how much they will be yielding on their housing investment if you buy and rent for 20 years.

Many are simply just interested in the absolute gain. The absolute monetary gain (if any), is likely to be large as housing like derivatives are leveraged products!

Before I comment further, let’s do some maths here to see if it is really worth our while to buy a 2nd property for investment.

Assumptions:

35 year old Mr. Tan just bought a new 99 year leasehold, 1000 square feet property beside Kovan MRT station, for $620,000 that will TOP in June 2011.

He intends to rent it out in 2011 and has started paying the monthly installment of his home yesterday (2009 May).

He intends to hold the property for 20 years (till 2029), before selling it away. Note that the property will have a remaining lease of 77 years when he sells it away in 20 years.

His has opted a 3% fixed interest rate for a 20 year loan, at 80% cost of the property which is $496,000.

He will need to pay $2,750.80 monthly to the bank for 240 months. Total amount paid is $660,193. Hence, the property actually costs Mr. Tan $124,000 (20% downpayment) + $660,193 (interest and principal payments) = $784,193.

He estimates that he will collect an annual rent of $30,000 per year (4.8% yield based on $620,000), after factoring all expenses, including property tax (10% of rent), repairs, fittings and furnishing, maintenance fees (estimated to be $300 monthly), and property agent fees of the apartment. (Take note that your tenant do not need to pay the monthly maintenance fees as they are part of the rent. You need to fork it out for them!)

Mr. Tan is making conservative estimate that for the first 10 years, net rental income will be $30,000 per year. The next 8 years (since rent only starts coming in on 2011), net rental income will be $40,000 (net of expenses) yearly. He is conservative because he is aware that there are times his property might not have tenants (like during sars and now) and if he needs to renovate the house, there will also be no rental income for 1-2 months. Besides, when his property is 15 years old, he might not be able to rent it out at a premium as there may be more and newer apartments around his neighbourhood for rent, depressing his rental. The rental will be used to pay for his monthly installment to the bank as Mr. Tan’s CPF is currently used to service his HDB flat. Total rental income from the Kovan apartment is estimated to be $620,000 for the 20 years of investment.

Effectively, Mr. Tan got his Kovan apartment for “free” after renting out for 18 years! Sounds good! His payback period for this investment is 20 years.

Mr. Tan feels that it is reasonable to assume that his $620,000 property will appreciate at 4% per year when he bought it this month. Hence at the end of 20 years, he will be able to sell it for $1,358,000.

What is the annual yield of Mr. Tan’s investment after 20 years?

Answer:

Total cost: $784,193

Total gain: $620,000 (rental income)+$1,358,000= $ 1,978,000

Net gain: $1,193,807

Annual yield (using financial calculator, N=20, PV= 620,000, FV= 1,978,000)= 3.33%

I know my assumptions are not perfect. The rent collected over the years could be higher, the property being sold at 2019 could be much lower. However given the information I have at hand, I do feel that my assumptions and projections are rather realistic.

Personally I feel that buying a property in Singapore for investment shouldn’t be a long term affair, and Mr. Tan should sell his property if there are offers of $720,000 in 2011. His yield will be roughly 7% per year if he can sell it at that price.

On top of that, Mr. Tan has to handle tenants complains, difficult tenants, chase them for rents, handle repairs and renovation, be at mercy of disappearing tenants, be saddled with a large mortgage loan and be afraid to change his job for fear of lower pay and possible underperformance which might lead to retrenchment. That’s stressful!

All that for 3.33%?

However, on the other hand, Mr. Tan can retire comfortably after selling his Kovan property in 2019. With a large sum at hand, he can invest $1m in large companies’ preference shares yielding 4.5% (rather ironic) per year with semi annual payments. He will earn $45,000 yearly and together with his CPF monthly payouts, retirement life should be a breeze for him.

Life will be easy for him after that.

Not that bad afterall!

Well, so if you really want to invest in that property, make sure you can get it at a bargain price, so that your yield on both rental and capital appreciation can be much higher, even if you have to hold it for the long term.

Most importantly, do your sums right! :0)

Temasek sells BOA stake, loss estimated to be US$ 4.28b

Just read online that Temasek has sold its 13.7b percent BOA stake during 1Q 09.

Reuters cited a source briefed on the deal saying that the shares were sold for between US$2.53 and US$14.81 in the first quarter.

Based on a Reuters calculation which assumed an average price of US$8.67, Temasek may have suffered a loss of about US$4.26 billion.

SIGH

I thought the banks bought in were supposed to be for long term? 2007 till now is barely 2 years, "long term" is defined like this?

SIGH

They better have a good reason to realise the loss at the worst possible time. US$4.26b is not a small sum, considering Temasek can even buy 100% of SPH for S$4.26b.

SIGH

Portfolio balancing is definitely not the best reason to sell. More news on this will definitely follow.

Enjoy “free” Funds Transfer at 9%

I am sure you have come across like a million times those fund transfer “promotions” offers where you just need to pay a “low” 3%-5% processing fee and enjoy 12-24 months of interest free installments.

Let’s do some maths with the help of financial calculator to see if it is really worth it.

Consider a $1,000 loan with a 5% upfront processing fee, payable in 12 installments. How much annual interest are you paying?

Installment for the loan is $1000/12= $83.33/month

Number of payments is 12

Present value of loan is $1000-$50 (processing fees)= $950

Effectively, it means that you borrow $950 but have to pay $83.33 per month for 12 months.

Using a financial calculator, the interest rate is 0.7981% per month, or 9.58% per year.

No prizes to guess why you get to enjoy “free” gifts when you sign up with a minimum $5,000 loan.

The next time some telemarketer calls you to sign up the fund transfer offer, ask them for the effective annual interest rate. At least you get to feel smart (FOC) after putting down the phone!

The same calculation method can be used on buying a car.

Consider a $50,000 car loan with a 2.5% interest rate, payable in 60 equal monthly installments. What is the annual interest rate you are paying?

Total payment to be made is ($50,000x2.5% interest per year)x 5 years +$50,000 original loan =$56,250

Installment for the loan is $56250/60= $937.50/month

Number of payments is 60 (5 years)

Present value of loan is $50,000

Using a financial calculator, the interest rate is 0.3946% per month, or 4.73% per year.

In other words, if you put in $50,000 today into an account bearing 4.73% interest a year and withdraw $937.50 monthly, you will exhaust this account completely in 60 months time, earning a net interest of $6,250.

Ok, somebody tell me why is my e-saver still earning 0.4% per month?!!

When facts are false

"There are three kinds of lies: lies, damned lies, and statistics." The statement refers to the persuasive power of numbers, the use of statistics to bolster weak arguments, and the tendency of people to disparage statistics that do not support their positions.

Statistics is a powerful to induce people to make wrong decisions based on numbers.

Consider the following statement: “Attempting to move in and out of the market can be a costly affair, particularly because a significant portion of the market’s gains over time have tended to come in concentrated periods. Looking back at the performance of the S&P 500 since 1980, an investor who missed out on only the five best performing days in the market would have ended up with a portfolio worth roughly 26% less than one that had been fully invested throughout the period.

Further, missing just 30 of the best performing days for the market since 1980 would have reduced the value of a portfolio by about 73%, compared to one that remained fully invested.”

Source: MARE: Market Analysis, Research and Education, Oct 16, 2008. “Stock market, exit at your own risk”

There is nothing wrong with the statement. All the above stated are known facts. However, it gives people the false impression that you will definitely lose out if you exit the market “prematurely” upon investing and you only miss out the 5 or 30 best performing days but got hit by all the worst days, which is unlikely. Basically, it condemns market timing and embraces long time investment.

Consider the market turmoil last year, if you had exited or cut your losses in Jan 08, you would have missed the 40% downturn. You would probably miss the 20% recent rally, but you will still be better off!

The notion that statistics lie is common knowledge, but we should also be mindful that the motivation behind each statistics evidence is to induce people to make certain decisions. Consider the following fictional examples:

There is an epidemic in Singapore. 10,000 people are infected and on the verge of death. A new drug is available. If you choose to administer the drug, you will save 5000 people. If you do not use the drug, 5000 people will die. What will you do?

There is an epidemic in Singapore. 10,000 people are infected and on the verge of death. A new drug is available. If you choose to administer the drug, 5,000 people will die. Will you administer the drug?

You should be indifferent on both choices. However, the above simple example shows that the way numbers are phrased and presented will induce different emotions (thus choices), formation of different perspectives and possibly even different investment or life philosophies.

I once had an IFA agent who used to service my insurance polices and investment, 2 years back. The first thing he did when he met me was to scrutinize my then present polices and lament on how poor protection I had, how irresponsible my past insurance agents were.

He gave me his blog address to show his superb knowledge on finance and his “many” testimonials of satisfied customers. Eventually, when I invested with him, he disappeared and when I asked him difficult questions, requested financial transactions, he even scolded me (without my name) in his blog and classify me as one of the “clients from hell”.

Eventually, I fired him and sold off all my holdings for his poor and tardy after sales service in 3 months. Today, he is still doing extremely well, possibly earning in excess of $150k per annum. (When I met him, he was earning $120k per year!) Well, he made use of statistics to help him earned a good reputation. Uploading positive testimonials of satisfied clients (minus the complains component); bragging on how accurate his prediction on market was by linking his past posts when 50% of his predictions were wrong; portraying an upright image on himself by thrashing tie insurance agents etc.

All the above are just another form of manipulation of numbers and facts to induce people to make favourable decisions, to erm the “owners” of statistical evidence.

So the next time people show you numbers to prove a point, take it with a pinch, opps, I mean with a bucket of salt!