Investment Eightfold Path - Part 2

As discussed in the last post, we have simply borrowed the above term from Buddhism to help us think about the eight ways to build wealth. The Noble Eightfold Path is actually super profound and I would urge readers to study it for our own sakes in order to pursue enlightenment someday.

For today, we shall discuss from where we left off in the last post. To recap, we have divided the components of wealth-building as per below and discussed the first four:

1. Active Income
2. Cash, T-bills
3. Pension / CPF
4. Property
5. ETFs
6. Stock Portfolio
7. Top picks for the home run
8. Moonshots

ETFs

Exchange traded funds or ETFs would be the best way for any individual investors to build wealth. The way to do it is also to simply buy regularly. I would suggest every quarter or so, when there is spare cash not needed for daily lifestyle, after paying down mortgage, after investing in T-bills, you would want to put some into risk assets to make more returns, then yes, buy ETFs.

It is always best to start with the S&P500, the largest, most liquidity and most well-known ETF which has generated adequate returns since capitalism began.

Stock Portfolio

Investment professionals do not like to buy ETFs. It is their job to beat the index, i.e. by generating more return than the index. So to buy ETF is to admit that they cannot do their job. Warren Buffett certainly won’t buy the S&P500. So, if Warren can do it, so can I. That’s the thinking. But it’s flawed.

I think the way to do this is actually to have two buckets of capital. One to buy ETFs, the other to create your own stock portfolio to try to beat whatever index you want to beat. I would say 99.9% of all investors should not try this.

It is a lot of work. You need to study a lot of companies better than ChatGPT and the next generation of Generative A.I. and you need monitor these companies closely. Frankly, with all our commitments in life, who has time to do this?

Unless you are really interested, really committed and have that spare resource, time and energy and you think you can beat Generative A.I. to it. Then go for it.

Otherwise, just buy the S&P500 or some other broad base ETF.

Top Picks

Once in a blue moon, we see something that makes a lot of sense. This could be an opportunity of a lifetime where there is a huge valuation arbitrage opportunity. We have done the work, we know the risk reward and it makes sense to make an outsize bet on something.

For readers following this substack, it could be Warner Bros Discovery (WBD). I have studied this stock for years. My model shows more than 100% upside. It could even be more. Some time in the past, Warner Bros was the arch nemesis of Disney. If Disney is worth hundreds of billions, today isn’t WBD way too small at c.USD18bn? If I am wrong, the downside seemed limited, but if I am correct, then all the work done should warrant a bigger bet, to make a difference to the portfolio.

The other relatable example would be Nvidia. Many shrewd investors have identified the name a few years ago. It didn’t even have to be an outsized position. If you had just a bit of Nvidia, would you have made a lot of money today. In Singapore’s context, the name was right under our noses - DBS. Singapore banks had gone up 10x if you have held it since 2003, just 20 odd years ago. DBS’ market cap is SGD100bn today.

Of course, hindsight is 20/20.

Moonshots

We are calling the last section Moonshots but it should be thought of an all-encompassing catch-all to cover every possible remote scenario so that our wealth can be preserved and enhanced. Let’s talk about alternative assets first.

For the rest of the post, please visit 8percentpa.substack.com

Investment Eightfold Path - Part 1

This post is also on 8percentpa.substack.com 

In Buddhism, the Noble Eightfold Path refers to the following:

• Right Understanding
• Right Intent
• Right Speech
• Right Action
• Right Livelihood
• Right Effort
• Right Mindfulness
• Right Concentration

It is is a core and profound teaching providing a practical guide to living. Today we are just borrowing the term to use it for our purpose. The analogy ends with the number (eight) and perhaps how we should have important foundations (i.e. Right Understanding and Intent) before we progress. For those interested and want to learn more about the Noble Eightfold Path, please ask ChatGPT :)

For our investment journey, I have thought long and hard about what would be the several important components of our balance sheets (assets) or types of investments to build wealth over time, in the Singaporean context. The following is what I have come up with, based on my own experience, which I will go through point-by-point in this post and another follow-up post.

1. Active Income
2. Cash, T-bills
3. Pension / CPF
4. Property
5. ETFs
6. Stock portfolio
7. Top picks for the home run
8. Speculative investments / Private equity / Gold / Others

Active Income

Years ago, Robert Kiyosaki wrote a so-called seminal book named Rich Dad, Poor Dad. He introduced the concept of passive income. His message was that we should all aspire to generate passive income, through investment, property etc. Then we didn’t have to work etc etc. It was a big myth. Looking back, I think the book did the world a dis-service. We all have to work. That’s the way it is.

Today I would turn the concept on its head. Passive income can never surpass active income. Take your work seriously. If you don’t like your job, quit and do something else. The active income is the basis of building wealth. Importantly, save up so that you have cash, a big retirement nest egg or pension and property (#2, 3, 4 below).

At a certain point in life, you may acquire the capabilities to not work for someone else. You have achieved the pinnacle in your career and it’s time to slow down. You will still need active income. This is where things get interesting.

The interplay between cash, investments, property can support your transition to do something else. Hopefully this still generates active income which can become supplementary to your investment income which can sustain your lifestyle.

Cash, T-bills

Next we have cash and T-bills, we cannot live without cash in the modern world. While it has no meaning in the animal kingdom, or if you own a farm which can sustain yourself, it is essential for most people today. There are real-world examples of people running out of money and then starving to death. As such, it is important to always have cash. The rule of thumb is 12-18 months worth of liquid cash in case shit happens.

Related to cash is my favourite investment today, which is the first post on my substack. Some of the cash should be invested in T-bills. Singapore 6 month T-bills continue to give 3.4%pa and US ones are even higher. It comes back after six months (effectively you only get 1.7% for 6 months). Honestly, there is no need to do any other investment for most people. Just put all the spare cash (minus what you need for the next 6 months) into T-bills. If you want to remember the one thing from my last 2-3 years of writing, this is it. Buy T-bills. Read this post.

Pension / CPF

In Singapore, almost every worker needs to contribute to the national pension fund which is called CPF. For young readers (ie in your 20s), this is more a pain because you think what is rightfully yours is being locked away. But as you age, the payout day gets closer, then things become really, really relevant.

If you have made the right decisions, you stand to take out a lot at age 55. It could be hundreds of thousands of dollars. Alas, CPF is being used to fund property (the next topic), children’s education and what not. So a significant number of Singaporean cannot hit what is known as the minimum sum which is about SGD200,000. So there was a big backlash that the Singapore Government has cheated us, locked away all these monies. We never see them. We die and it only gets passed on to future generations.

To me it’s a case of mis-concept and not getting all the right information. It is complicated, but it’s all out there. While people called CPF a scam, on the flipside, a guy name Loo Cheng Chuan started the 1M65 movement that utilized the compounding of CPF and grew his money to >SGD1,000,000. Originally, he believed he would get a payout of SGD1,000,000 when he turns 65 (hence 1M65). But he way surpassed his own calculations. He now has way more and he is only in his 50s.

So, think hard about the decisions you need to make with CPF. It can be literally life-changing. Aspire to be like Loo Cheng Chuan.

Property

I have have written one important post about property. In sunny Singapore, we are fortunate to have great leaders who had the foresight to devise a national strategy which allowed 80-90% of Singaporeans to own their homes. So I would presume most readers here would own your own homes.

Your first home is very precious. Don’t trade it.

The second property onwards is then investment. Property provides leverage for individual investors and usually generate positive returns over time. But you could also lose a lot of money if you are not careful. Strive to pay down mortgage fast, then the real investment game begins.

The abovementioned are more like bread and butter of our financials in this lifetime. Please make sure they are secured before you think about anything else. In the next post, we shall discuss the risky stuff. Stay tuned!

TO BE CONTINUED...

Finance Acronyms

After doing this for twenty years, I find it sometimes amazing that we can have so many acronyms. It must also be frustrating and confusing for people not in tuned with them. This is an attempt to put down a non-exhaustive list for everyone since I use them a lot myself and will direct new readers here in the future.

AML = Anti-money laundering

ALM = Asset Liability Management

BRICs = Brazil, Russia, India and China which led the growth in emerging market economies

BS = Balance Sheet

Capex = Capital Expenditure

CF = Cashflow (from CF statement

COGS = Cost of Goods Sold

DE Ratio = Debt-to-Equity Ratio

DM = Developed Markets

DVD = Dividend

EBIT = Earnings before interest and tax

EBITDA = Earnings before interest and tax, depreciation and amortization

EM = Emerging Markets

ESG = Environment, Social and Governance

EV = Enterprise Value

FAANGs = Refers to the Facebook, Apple, Amazon, Netflix and Google but that has now evolved in the Magnificent Seven: Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta and Tesla

FCF = Free Cashflow

FOMO = Fear of Missing Out

FX or Forex = Foreign Exchange

FY = Financial Year or Fiscal Year

GFC = Great Financial Crisis of 2008-2009

GIGO = Garbage In Garbage Out

HHI = Herfindahl-Hirschman Index, common measure of market concentration

IRR = Internal Rate of Return, an important return calculation methodology in the PE world

IV = Intrinsic Value

LIFO = Last In First Out, one of the accounting terms

MOS = Margin of Safety

NAV = Net Asset Value, often used used in conjunction with IRR calculation.

NI = Net Income

OP = Operating Profits which is similar to EBIT

OPEX = Operating Expenses

PBR = Price-to-Book Ratio

PE = Private Equity

PER = Price Earnings Ratio

PL = Profit and Loss Statement

RE = Real Estate

ROE = Return on Equity

ROIC = Return on Invested Capital

SGA = Sales, General and Administrative Expenses

TMT = Tech, Media and Technology, often used to described the 1999-2000 IT bubble, a.k.a. the TMT bubble

That's all for now, but this will be updated as new acronyms come along.

Huat Ah!

Why Do Companies IPO?

This post came from a request from Gerard who recently joined our chatgroup. I thought it was quite an interesting question and a Google search didn't really address the core of it so I thought I could a better job! Hehe! Btw, if you are interesting to join the chatgroup, do whatsapp to +65 8119 6429! Please take a moment to read about the rules also thanks!

For the un-initiated, IPO stands for initial public offering which is the first time a company sells its share to the public so that anyone who has a brokerage account and money can buy the company. In an IPO, the existing owners of the company either sell their shares or they raise new shares diluting their current ownership or both so that there are enough stocks in the market that could be traded. It is usually an important milestone for a company to IPO. It is like a musician cutting an album with a big music label or like an athlete going pro. Something like that.

Facebook's CEO ringing the bell on its 1st trading day

Okay, so why do companies IPO? I believe here are the main reasons, do note that they are by no means exhaustive.

1. To raise money for further expansion.

2. To create public awareness.

3. To ensure better corporate governance.

4. As a directive from higher authorities.

5. To reward early shareholders (usually also employees) by providing an outlet for them to sell.

True value investors usually do not participate in IPOs i.e. they don't subscribe to buying the shares bcos it represents quite a complete opposite of the value philosophy and is another example of the Greater Fool Game. Here's three reasons explaining the details:

1. IPOs create a lot of hype without fundamentals, value investing requires years of data and good analysis to figure out the intrinsic value of the company. There is simply not enough information in the IPO for that kind of analysis.

2. There is information discrepancy during the IPO. The sellers know much more than the buyers and some sellers take advantage to sell lemons to gullible buyers. In value investing parlance, the buyers have no moat vis-a-vis the sellers.

3. In an IPO, buyers are pitched against one another and the brokers and sellers work together to create a bidding situation to their advantage. Prices then move up to the detriment of buyers not unlike auctions where only the highest bidders win. Value investors do not like this.

Having said that, it is statistically possible to make money from IPO in the first few weeks because most sellers want the IPOs to be successful and would price it slightly cheaply. In most cases, there is enough hype and euphoria to make things look good, at least for few weeks. Institutional investors, high net worth individuals and retail investors clamour to get allocation, creating demand to buy and flip these shares. The chart below shows the IPO returns for US in 2017 (likely to be over 3-9 months although it's not stated clearly). 

From the chart, we can tell that average return is positive with the range being -38% to 40% across all sectors. It also shows the signs of the times with consumer staples, one of the best compounders over time, actually underperforming the rest of the sectors. The rage today is all about internet and automation and robots, hence we see them high up there on the chart. However do note that the data could be skewed by just one or two data points. A stellar IPO going up 400% would completely boost a single sector. 

Alas in sunny Singapore, it might not be easy to make money via IPOs. This is because a lot of IPOs are for owners to cash out and hence the stocks falter after IPO, sometimes never returning to IPO price. The classic example being Hutchinson Port Trust, sold by Lee Ka Shing in 2012. The share price since IPO is shown below. An investor during IPO would have lost almost everything. The 6% dividend would not have been able to make up for much. 

Never buy anything from Lee Ka Shing

Over time though (usually 3-5 years), the fundamentals of the company would show after the hype and euphoria during IPO wane. Good companies would compound and poor companies like HPHT falter. So if we can identify great companies with great moats, buying them during IPO and just letting them compound is not a bad idea. Look at Google and Visa! These are two companies with identifiable moats during IPO in recent times.

There are companies that choose not to IPO though. Vitol (oil trader), Cargill (commodities trader), Ikea, Mars, Lego, Koch and the auditors (Deloitte, KPMG). These are well-known companies that are still unlisted. Well, traders sometimes do not want that kind of scrutiny that public companies have to endure while auditors would probably never IPO for the simple reason - who's gonna audit them? Still it is said that sometimes, the money's too good, so why share by selling your company to the public. One of Singapore's largest companies, Tee Yih Jia, founded by our own popiah king Sam Goi is also unlisted.

To put on a trader's hat, the probabilities are skewed towards buying and flipping for quick returns during IPO. Using the first chart, I would postulate that 2/3 of the time we can make money by flipping IPOs i.e. subscribing and then selling out when it goes up. We just have to be mindful we are playing the Greater Fool Game and we don't want to be left without a seat when the music stops.

As a true value investor though, it probably means that most IPOs are probably not worth looking at given the reasons stated above. We definitely do not play Greater Fool Games to benefit from others. But if we can really find gems with moats, then it's worth buying and holding to these compounders for good. 

Huat Ah!

Pay Up for High ROIC! (Part 2)

Do read from the first post.

So does it make sense to pay 20x for 20% ROIC? The answer is YES! In fact, as a rule of thumb in Singapore's investment circle, we should pay one multiple point for 1% of ROIC. So if it's 20% ROIC, we can pay up to 20x and still get a good return. If it's 30% ROIC, then it's 30x. Here's the same table from the previous post showing a 15% ROIC business, let's call it Table 2.

Table 2

So as we can see, at Year 8, even if we value the business at just 10x its earnings per share or EPS, it is worth $30.6, which is more than twice the original price of $15 if we paid 15x for this 15% ROIC business. Now eight years might be a tad too long for most people on this planet, particularly finance people working on Wall Street, or for those of us who can't wait for 2 years for a new iPhone and go for the minor upgrade S version and be disappointed but for true blue value investors, this is the time horizon we are talking about. 

To test the rule of thumb, here's another table (below) showing how long it takes before we double our money using the same assumptions in Table 2. As we can see in the Table 3, testing the original rule of thumb of paying one multiple point for 1% of ROIC, it takes 6 to 8 years to double our money. In fact, if a business can generate sustainable ROIC of 50%, even paying 50x PE, it would only take 5 plus years to double our money. 

Table 3

But how do we know that this 50% ROIC is sustainable? Well, we don't. We can only base in on track record of both the business and its managers. As we discussed before, there are inherently good businesses: consumer related brands, razor-and-blade models, asset light and recurring revenue operations but as businesses grow, incremental return would diminish. For those of us who had scoured businesses across the globe for years, well ROIC of 50% doesn't sustain for too long. 

Hence while in theory it works, in reality, even if we see one or two years of 50% ROIC, it should be safe to assume that ROIC would normalize at some point. Alibaba illustrated this point well. It went public with ROIC at 50-100% which allowed its promoters to justify paying 50-100x for this world's #1 internet stock. ROIC then went on to normalize to around 10-20% today and we saw its share price fell from $100 to a low of $50 before rebounding to $72 today.

Alibaba's ROIC from Gurufocus

More importantly, business managers must stay really focused to reinvest all those earnings for us at higher than normal ROIC (normal means only 8-10% ROIC). Most business managers aren't able to do that. They would see all these cash being churned out and be tempted to use them to buy up low ROIC businesses. It's just too hard to sit there and see the cash pile up for most corporate CEOs. This is why it is way more difficult to find strong capital allocators. Especially so in today's world of short-termism. Even if the CEO did resist doing silly investments, he would be bombarded daily by hedge funds and bankers asking him to spend the money. It would take a zen master to be able to resist the Wall Street vortex of financial sorcery.

Hence, based on experience it is really difficult to find businesses with sustainable ROIC of more than 25%. If that is the case, we have to assume that most businesses would only be able to generate at best high teens ROIC over time. Then going by the rule of thumb, we should then be paying just high teens PE. In the past, I have advocated not buying anything at more than 20x PE. This is one of the criteria of an all-important checklist.

So pay up for high ROIC, but only to a limit - 20x!

Pay Up for High ROIC! (Part 1)

Part 2 is out!

In financial math, high ROIC or return on invested capital can justify almost any PE to buy. This is what this post strives to illustrate. Do read on, it's really important! Promise you won't waste your time. Invested capital simply accounts for all the capital that businesses need: equity and debt. ROE which stands for return on equity, does not take into account of debt. In the financial world, most people talk about ROE but essentially both ROIC and ROE are about how much we can get back by putting in $100.

The genesis of this post comes from:
http://basehitinvesting.com/importance-of-roic-part-4-the-math-of-compounding/

Some businesses are inherently very strong and generates huge cashflows. For every $100 that we put into the business, we could be making $20. That's ROIC of 20%. One example could be the potato chips business. Raw materials are essentially potatoes and packaging materials which cost next to nothing and what matters is the ability to put it into shelves around the world, in the 7-11s, the Tescos and the mom-and-pop stores all across the planet. Well, this, my friends, is the business moat: global distribution networks that takes years, if not decades to build. The world's biggest potato chips maker had shown that ROIC of this business is pretty high. That's Frito Lay or Pepsico, the listed parent entity.

Don't we all love Frito Lay?

For simplicity let's assume that the potato chips firm can generate 20% ROIC (Pepsico does around 15%). We further assume that in Year 1, its earnings per share or EPS is $1. Because of it's ability to return 20%, this $1 will make $0.2 in Year 2 and together with the original ability to make $1, EPS in Year 2 is $1.2. As we can see, this is compounding at work, So Year 3 will be $1.44 and Year 10 EPS is a whopping $6.2. Assuming that we paid $20 for the EPS $1 in Year 1, ie paying up 20x PE, what is our return after 10 years? It's phenomenal! (All this math is in Table 1 below)

The original capital of $20 now generates $6.2 i.e. over 30% return, over the next decade, it will generate more than the original capital in one single year (Year 17 to be exact). If we assume that it trades at 10x PE at Year 10 (which is ridiculously cheap, remember we bought it at 20x PE), the stock will be worth $62 (ie more than double our original purchase price or around 7%pa using our rule of 72. In Year 17, when EPS is $22.2, more than two dollars higher than our purchase price, the same stock should be worth around $222 dollars at 10x PE. So, in a nutshell, what we bought at 20x PE became a ten bagger. Thanks to its ROIC!

Table 1

In Year 20, using the same methodology, the same stock will be worth $383 while generating almost twice the our original capital ($20) in  EPS (of $38) in a single year. This is why we pay up for high ROIC!

Investing is about Swaping Cashflows

If we strip down to the bare basics of investing, it is swapping today's money for tomorrow's cashflows (or future cashflows). So, you buy a stock at $100 today. What you actually want is that the stock can generate more than $100 in terms of future cashflows into perpetuity. The goal of value investing is then to determine how much all these future cashflows is worth today, and pay a lower price (at least 30% lower). So in theory, if you can accurately calculate that the value of all the future cashflows is worth $200 today and you buy the stock for $100. Then you have made a lot of money. Of course that's the hardest part - estimating all the future cashflows.

So, how do we calculate all the future cashflow? The simplest methodology is to apply a multiple. If the co. earns $10 today, give it a reasonable multiple, say 15x - there, you have it. The value of all its future cashflow is $150. Now that's crude right? But essentially that's what the whole finance industry does and that's also what the world's greatest investor, Warren Buffett does. Of course Warren Buffett perfected this art, by buying businesses that have predictable cashflow into perpetuity. Well it's still an art, so by default, it is hard to get it right most of the time. I have also discussed this in detail in the 5 Things You Need to Know about Investing.

Buffett also thinks hard about how to discount future cashflows correctly. Discounting is essentially saying that a dollar in the future should be worth less today as a result of compounding. The methodology is discussed in detail in this post: Faces of PE - DCF. But at the crux of it, the ways and means to value a stock is not different. For those readers yearning for a short cut. the easy way out is to determine a long term average earnings per share (EPS) of a company with a solid business (like Colgate or Swatch or Coke) and then multiple it by 12-18x. For a great business, you can pay up to 18x. For a so-so business, better just pay 12x or less.

That's Warren Buffett, world's greatest investor.

Many things affect whether a stock should be 12x or 15x or 18x. You can find some discussion in the Valuation label. Now once you have determined the right valuation, the right EPS and have gotten the intrinsic value of the stock, you compare it with today's stock price. If the stock price is significantly lower than its intrinsic value (like 30% or lower), then you have got a strong case to buy. That's really putting it in very elementary terms and no guarantee for you to make money. To learn more, do read the rest of the 250+ posts on this blog and you can start with this 1,500 word introduction on Value Investing :) Cheers! 

 Ok, next we talk about something more mind-boggling. If we think in terms of swapping cashflows, then we must also realize that this is a totally different ball game vs buying a stock at $100 and hoping that the price goes up and we sell and make a profit at $120 to a Greater Fool. The mind-boggling way to think about this is that there is no stock market and no daily price after you bought the stock. You are buying an asset at $100. The only return you are assured of is how much this asset will generate down the road ie how much cash will this investment eventually churn out over time, into perpetuity. There is no other buyer who will come quote you a price every day. And you cannot hope to sell at a higher price to a Greater Fool who is willing to pay for it at the higher price. 

That is the way we should invest. Warren Buffett ever so often says that the market can shutdown for 10 years, he doesn't really care. Because essentially he is buying future cashflows. And he doesn't give a damn if nobody is willing to buy his business or give him a quote tomorrow, or one year out, or 10 years out. When he paid $100 for the business he wants, he is already sure he would make money. Because the future cashflows from the business is very likely to be more than the $100 he paid today. So essentially, money is already made when we buy, not when we sell.

 I believe that's the way to invest.

Selecting Unit Trusts

As mentioned in the last post, there are 400 unit trusts in Singapore. How to choose the good ones from this mega-menu? I guess that’s why most people rely on 23 years old sweet young looking financial advisers, who usually does as great a job as a monkey promised bananas. But never fear, there is always help for those who are keen to explore.

Again, we take a look at PhillipCapital since they have one of the best online brokerage systems in town. I tried out their Fund Finder to see what I could get.

The first place to start is at the Advanced Search Criteria. But what if we are not advanced yet? Not to worry, it’s just terminology. It’s easy enough for monkeys so we should be ok. First, select the different asset class, geography and strategy so as to reduce the 400 unit trusts to a fraction so that you can eye-ball them better.

I have alluded to before that unit trusts would make better sense for bonds since ETFs haven’t really come up with a lot of bond ETFs yet. (Well it’s much harder to construct bond indices, and without bond indices you cannot have bond ETFs. So we need to rely on bond unit trusts.) So in the screen shot below, I simply selected “Bond”. Then the 007 logo appeared and I was treated to a 5 min sneak preview of Skyfall, starring Daniel Craig and Cecilia Sue as the bond girl.

Ok, just joking. After selecting Bond and clicking filter, I get to see just the bond unit trusts. Though that’s just the beginning. At the Search Results, you would then have to click on each unit trust to see the details. For me, I drilled into this PIMCO High Yield Bond. (see screen shot below)

The webpage goes down all the way, with general info, dividend info etc. I shall focus on a few key points to think about when selecting a unit trust.

Who is the Fund Manager?

There are 20-30 bond fund managers listed here and for those of us in finance, we see familiar names like Fidelity, PIMCO, Schroder, Templeton and also local ones like UOB, Lion, Fullerton etc. PIMCO is really the stand out brand here, which is why I chose it. As you might know, PIMCO stands for Pacific Investment Management Company and is the world’s largest bond house. Its top management such as Bill Gross and Mohamed El-Erian are also world renowned investors. Real investing gurus! Don’t pray pray.

So the key point here is to really stick with the good names, such as PIMCO, Templeton, Legg Mason. There are others like Fidelity, Aberdeen which are good at equities, traditionally. PIMCO is the only one good at bonds, seriously. Of course, no rules ever work without caveat in the world of investing. So you start by picking the brands, but you still need to drill the performance and other no.s.

But to my dismay, PIMCO is not on promotion, which means you pay full fees. Bo pian lor (We have no choice), go for others like Aberdeen, Legg Mason.

I would say avoid Lion for now, this is a local house that has gone through a lot of issues and still has a lot of issues. Maybe things will change in time.

Sector/Strategy

The other way to cut through the grass is to look at the sector/strategy filter. I would say filter via something like Global, Asia Pacific, Emerging Markets. I tried High Yield but the results were a bit strange (the performance of different funds differed too much). High Yield is a really appealing term in yield hungry Singapore but in the bond world, maybe it means something else. So really, these are just filters. It takes a lot more work to get to the real selection.

Fees

The other criteria that a lot of people will look at would obviously be the fees. As mentioned, PhillipCapital is having a promotion for bond funds and sales charge is zero during the promotion period. So this helps to cut down the fees.

Investment is a product that has no intangible benefits. If you pay 1% to your broker, or financial adviser, you get 1% less return. Over time, this 1% will significantly reduce your total return. This is unlike an LV bag, or Rolex watch, whereby you can pay a lot, benefit a lot of middlemen in the whole food chain and yet still feel good. Bcos there are intangible benefits: mostly just feeling shiok (awesome) that you hold a $8,000 bag or wear a $10,000 watch and can brag about it. Hence make use of the promotion and get a good deal! As mentioned, PIMCO, the best bond house, is not in the promotion, so can only go for others like Aberdeen and Legg Mason.

It also pays to look at the annual fees being charge. Although the sales charge is gone. You still need to pay the asset manager an annual management fee. Usually it adds up to 1% for most bond unit trusts. This cannot be helped. Over time, hopefully management fees will decline as well. So just make sure it is not exorbitantly high.

Performance

The other key factor would be performance. Most people, when shown the chart below, would be happy to buy. Their rationale: if this thing has gone up, then it’s time to join the bandwagon. I would advise against that. Unit trusts invest in assets that move in cycles. It is always better to buy cheap, not at the top of the market.

The important performance no. to look at is the one in the last column: Return/Volatility. Over time this number falls below 1. It is said that even the best investors would only have a ratio of 0.5. Obviously the history is not long enough for this PIMCO fund. Try to look at the 5 year or 10 year track record. If it’s still more than 1, then it means that the fund manager really has skill. Put your money with them!

Price

At the end of the day, we come back to Price. Looking at the chart with the benefit of hindsight, the best time to buy would be Oct last year (2011) when the Europe crisis was full blown. Greece was going bankrupt and everything. But usually, no guts to buy then lah. Phillip advocates this savings plan, ie you just keep buying say every 6 months. $1,000 at a time. But the problem is that the commission on this plan is 2% or more (if I read correctly). Hopefully they come up with a promotion for this too!

It also pays to really just spend time to find out more. (Not too different vs researching on stocks). You talk to other investors who have bought unit trusts before. You read up old reports, old prospectors about the unit trust etc. Just like stocks, sometimes it takes a while to understand to full picture. Esp when we all have full time jobs and can really handle these things parttime.

Nevertheless, personal finance and investing is something really crucial in today’s modern world but yet most people have limited understanding of the workings and how to really make the intermediaries work for us and not vice versa. Phillip/Poems is a good place to start. So go down Raffles City and open an account!

This is a sponsored post.

Unit Trusts’ Price War!

As we were discussing in the last post, unit trusts charges slightly higher fees vs ETFs but it allows retail investors access to other asset classes outside equities.

Last checked there are about 400 unit trusts in Singapore with Asset Under Management (AUM) slightly under $40bn. The unit trust industry as a whole is not growing that much as alluded to before. When the market is not growing, the players need to grab market share in order to survive.

One of the bigger players here is again PhillipCapital. They have a good introductory site for unit trusts for those who are still not familiar.

In the past unit trust charges high fees and doesn’t really value add much since most of the fund managers never fulfill their mandate anyways (which is to beat their benchmark). With the pie shrinking, the players have resorted to lowering fees in order to gain market share. Hence, the fees have been coming down over time. It used to be 5% upfront, now it’s closer to 1-3%.

A couple of years ago, our beloved national paper Straits Times happily announced a Unit Trust Price War was under way when some players cut the fees to 1%. The same article also happily interviewed so-called seasoned investors who invested $300k in unit trusts and who didn’t mind paying when upfront fee was 3-5%. Bcos if the financial adviser gave good advice, it was worth it! Well with that upfront fee amounting to $15k, I hope that he really did receive golden advice. Meanwhile, I give free advice here.

So since then, the industry never looked back, fees are coming down, though still high compared to ETFs at less than 1% but it’s much better than 5%. We don’t even get salary increment of 5% right? How did these guys justify 5% upfront fees in the past? PhillipCapital has probably realized this dilemma for some time. How can fees be so high when investment return is only 5-8%pa over the long term. Even at say 2%, this still represents 25-40% of the annual return that you can get. So they upended the competition to bring fees even lower. Now Phillip charges 0.75% upfront fees and zero platform fees (see table below). Hence you save a lot of money over time. Like close to $2000 over 5 years, according to their calculations.

The table below compares their fees across the competition.

In fact, they are now having a promotion whereby you pay zero upfront fees for certain products. Of course there is still the management fee that each unit trust will charge, usually 1-2%. Sadly that’s still high in my opinion and that’s going to stay. Fund managers and analysts also have families to feed. We can’t expect them to eat their own research reports right?

Besides lower fees, Phillip also has other advantages such as zero cash deposit for investors who intend to buy (other competitors usually require some cash upfront). But if you choose to put cash with Phillip, then it is parked in a money market account that earns interest.

In fact, Phillip goes all out to grab market share.

They even offer this fund transfer service (usually FOC unless it’s StandardChartered or AIG, ie banks that are in trouble with regulators) whereby you can transfer your unit trust bought on other platforms or banks onto Phillip’s platform. And they give you $200 NTUC vouchers!

Last but not least, there is always the powderful online platform. For Unit Trust, you can read updated research published by the funds themselves, have a quick look at the funds information sheet and even screen for the top and worst performing funds. (See screen shot below)

As you can see, for 10 years, there are no funds except for this LionGlobal SGD Money Market. Maybe the history is still too short in Singapore. Or maybe any fund that get into the worst performing 10 year category auto shutdown so as not to lose face. Hopefully those seasoned investors did buy the Indonesia and Thailand funds, that would have made is $15k sales commission worthwhile.

Another interesting point is that this LionGlobal returned 15.66% over 10 years, which is like 1.4% per year. And we don’t know if this is before or after fees. So if the seasoned investor bought into this, his first 3-4 years of return would have been used to pay his financial adviser, who probably looked like Cecilia Sue.

In any case, at 1.4% return per year, you might as well buy Singapore Government Bonds (SGB), that’s risk free. Last checked, over 10 years it also gives 1.4%. Btw you can also buy SGBs over poems too! Well anyways, past performance is not a good indicator of future returns. So pls do not buy the top performing funds. Usually, that won’t work.

Next post, we discuss some tips in selecting unit trusts.

This is a sponsored post

Poems and Unit Trusts

I recently explored Poems in detail and was pleasantly surprised by all the upgrades done to its internet system. I must admit Poems (as in this one www.poems.com.sg, by Phillip Securities) has one of the most powerful internet system for fundamental research. They might also have a good one for technical analysis but I am no expert here.

The current platform allows you to do screens, and access poems research database and look at past 5 year financials for all companies that you can trade on poems, which includes US, UK, ASEAN, HK/China and even Japan markets. Man, this is really powderful. I played with it for a while and concluded that this is probably one account that any serious Singapore investor should setup.

Go down to Raffles City today, they have an office at the Raffles City Tower and get the account done. Well you can actually do online, but they would need to snail mail stuff to you, get signatures and all the crap, so it might be easier to just make a quick trip down and settle stuff once and for all.

Oh and do remember to bring the relevant docs like IC, bank account book, CPF contribution history etc, do check their website for the documents required. It might also be prudent to bring your your PSLE and O Level certificate, a 300 words self-introductory essay, your Facebook photos with at least 3 friends and your next of kin or significant other, just in case. This is Singapore after all. We want to verify everything.

Ok, lets take a look at the system. I always intrigued by the stock screener. So I went in to play a bit. To access the research, all you have to do is to go to the top column, click stocks -> research. Then you can see a whole bunch of cool stuff like MyResearch, Singapore, Regional Market Focus, Dataline, News and at the right end -> Stocks Screener.

Here’s a screen shot:

Sadly I remember the old screener to be slightly better. The new one, you are given dropdown menu to choose. And to my dismay you can’t really get the dividend screen right. Bcos it only allows you to choose 0,5,10,…,50% dividend yield. Now most co. give only from 0-5% dividend yield. So how to sieve out say 3% and above? The answer is cannot… Here we have one of the most dividend hungry nation and our best brokerage house can’t get the dividend screen right. What the… But I believe they will improve this soon. Someone pls feedback.

Well you still can do PE, Debt to Equity and PB screens lor. And you can also screen overseas market.

But the coolest thing on Research is this thing called Dataline. Again to access go via Stocks->Research->Dataline.

Here once you get in, after agreeing that the info you get may not be accurate so pls use at your own risk blah blah, you can basically access the past 5 year historical financials for any companies that you can buy via poems. And you can also access analysts’ estimates and some snapshots of ratios and valuation. Well good enough for something that comes free with just signing up.

Below is a snapshot of F&N’s balance sheet. Amazing right?

So with this one account, you can do a lot of work without pouring through pdfs and paper copies of annual reports. Of course, this step is more for doing quick checks. When you do the deep dive analysis, you still need to read annual reports. Sorry bro, no shortcuts.

Besides the powerful research, I also explored Poems unit trust, or Phillip Unit Trust. For the longest time, I believed that most unit trusts take too high an upfront sales charge. In prehistoric times (ie maybe 10 or more years ago), it was like 5%! And investments only earn you 5-8% return per year… So you just gave 1 yr’s return to the distributor. But things are changing. As in the fees are coming down.

For the un-initiated, a unit trust, also known as a mutual fund, is an investment vehicle that allows retail investors to put money with a professional fund manager to help manage and grow the money. Usually the fund manager will be given a mandate, like to try to beat the S&P500 index, or the STI, or a commodities index.

Ok, for those following this blog long enough, we know that 80% of all fund managers never beat the index. Why put money with them? Just buy the index. That is true. Hence ETFs, or exchange traded funds has ballooned in recent years. ETFs charge much less management fees (usually less than 1%) and no upfront fees and you trade it like a stock. It’s so popular that the amount of money with ETFs would probably eclipse unit trusts within the next decade. Since I was at it, I estimated that the Asset Under Management (AUM) for Singapore ETF is probably around $4-5bn while that of unit trust is at $40-50bn. Yes, 10x difference now, but one is still growing fast while the other is stagnating. Btw, total AUM in Singapore is mind-boggling 1.3 trillion!

Ok, since ETF is so great, why buy unit trust then?

The answer is ETF has less offering for bonds and other asset classes (outside equities). As a normal retail investor, it is virtually impossible to build a bond portfolio by buying bonds yourself, esp in Singapore, where one bond has the face value of $200k. So unless your portfolio is like $10m, and you split $5m for stocks and $5m for bonds, then your bond portfolio can buy 25 bonds. For most of us, we struggle to buy 1 bond :)

So the alternative would be to buy a bond unit trust, which will have bonds of different companies in one offering. Yes, we then have to pay up the 1+% management fee. But in order to build a resilient investment portfolio, that might not be a bad option for now.

Next post, we discuss Phillip’s advantages and offerings of bond unit trusts.

By the way, PhillipCapital is hosting a Value Investing Conference with Mary Buffett attending. Do take a look!

PS: This is a sponsored post.

What constitute an investment?

The way I see it, an investment has to be something that can generate cashflow. Stocks give dividends, bonds give interest and real estate gives rental income. These are real investments.

However in the strange World of Wall Street Craft, anything and everything becomes a feasible investment, an asset class of its own. The recent boom earlier this decade being commodities.

But if you think about it, commodities shouldn't be considered an investment bcos you don't get a cashflow. Holding a ton of copper, or a ton of wheat doesn't give you cashflow. The whole premise is based on prices going up. And when it's based on just prices going up, then it's dangerously close to the idea of the Greater Fool Game. Where you can only make money by selling something that is worth very little, at a higher price, to a greater fool who is willing to buy.

That is why value investors are not interested in price, we are interested in value. Price merely tells us if we can get the asset below its value. If there was no transparent price on the asset, we are happy as long as we have cashflow. But if there is no cashflow, you cannot calculate an intrinsic value of the investment. And in that sense, commodities cannot be classified as an investable asset class. Needless to say, a lot of the newly created asset classes like art, wine, vintage watches and other funny stuff cannot be called investment.

However, if those above mentioned can somehow be construed to generate cashflow, then the story becomes different.

For e.g. if a couple of artworks can be put together at an exhibition hall, and the owner can charge fees for viewers, then we have a cashflow, and the whole business can then be valued. In the same vein, wine is not an investment but the vineyard is. Copper may not be a true investable asset class, but a copper mine or a mining co. is definitely investable.

Similarly, traditional assets that count as investments may not be such if it doesn't generate cashflow. The best examples would be perennial loss making companies. Think Chartered, NOL and the likes.

As the saying goes, cash is king. Well if cash is king, in my opinion, cashflow is then the true master of the universe.

How long term should we be?

The investment horizon that is appropriate for our generation is probably 15-20 yrs, in my opinion. This is bcos we usually have some savings after the age of 30-35 for some real investing as we get married, buy house, have kids etc. And if you think about at what age should you enjoy the fruits of your investment, then it's probably 15-20 yrs later. I mean retirement age may go up to 62 but shouldn't we start thinking about enjoying life in our late 40s, early 50s? No point investing for 40 yrs and then get old and immobile and use the fruits of investment to pay for medical bills right?

Also, we shouldn't forget that even though official retirement may become 62 or it might go up to 65, probably it gets harder and harder to stay employed as our generation hits 45 years old. This is a major social reality/issue and it is already biting at a lot of people. Look around, do you see a lot of your colleagues who are in the 50s or 60s? The career life span is shortening. If you are in your 30s like me, we cannot expect to stay employed until 50.

Say if the investment horizon is only 15 yrs, and intrapolating the no.s on my previous post, the returns probably vary around +3% to +18%. ie if you bought at the peak of the market, you can expect to get 3%pa, which is worse off than leaving money in CPF. And worse still, if you had bought in 2007, it is likely that you might take more than 15 years to break even.

In order to mitigate this undesirable outcome, we must definitely employ a sound investment plan or some form of dollar cost averaging which basically means you put aside some money to buy stocks or bonds or funds every month. This should provide a +ve return after 15 years.

To aim higher, ie achieve an ok return like 8%pa, we must pay attention to market cycles in the macroeconomic sense. Don't buy a whole lot of stocks during the peakish periods and look to buy during doldrums (like now). Of course for true Graham/Buffett style value investing, the valuation takes care of this. You won't be buying stocks at the peak bcos the valuations will say No-No. Graham is famous for using his 10 yr valuation to smooth out earnings peak and trough during cycles. He would say BUY only if stocks are trading well below 10 yr valuations. ie Price/Average EPS over 10 yrs is less than 18x. He also have 6 other criteria to follow. Basically, you can't find stocks meeting most criteria in 2006-2007.

In conclusion, to get an ok return on investment (like 8%pa) over a 15 yr investment horizon, we need to know the macroeconomic trends, don't jump into stocks when everyone is also jumping in, focus A LOT on valuations, esp long-term valuation (not 1-2 yr forward EPS) and keep that margin of safety concept in our heads, and we should be ok.

The power of compound interest

When asked what is mankind's most wonderful invention, Einstein's answer was "compound interest". Guess most people wouldn't want to argue with Einstein, unless you think you can win a Nobel Prize too. But what's so good about compound interest?

For those lao jiao value investors, sorry for writing this simple post which you all would already know and swear by it.

Ok, for those value investors wannabies, this post is gonna change your life. So get ready.

If you buy $10,000 of Singapore govt T-bills (i.e. govt bonds or Treasury bills) today, it earns you 3% interest, bcos of compound interest, it will become roughly $24,000 in 30yrs. Without compound interest, it's just $19,000. That's 55% difference (14 divided 9). If you put it in the bank, it earns 0.025% and becomes $10,700 in 30yrs. You might have as well put it under your pillow.

Now imagine if you can save $10,000 every year to buy T-bills for the next 30 yrs, and they give 3% interest. Do you know how much it will become?

It will be close to $500,000.

If you save $20,000 every year and buy T-bills for the next 30 yrs, you get close to $1,000,000. If you invest and get 5% instead of 3%, you get close to 1.5mn, if you invest as well as an average investor on Earth, i.e. you earn 8%pa, you get $2.5mn. If you invest as well as our hero, Warren Buffett, you get 24%pa and you get *drumrolls* $65mn. That puts you in the top 30 richest Singaporean list.

This is the power of compound interest.

You don't have to do a lot, save enough, earn a good rate of return, and just wait. You will be a millionaire in 30 yrs. Now that seems quite easy right?

So why we don't see millionaires all over Singapore? Well actually they ARE all over Singapore but too bad we are not one of them. There are a few reasons:

1) Discipline: Most pple, after working long and hard for one month will grab their paycheck and spend it on some gadget or some luxury bag worth $7 selling for $700 to reward themselves, including this blogger here. Who has time to think about saving for 30 yrs?

2) Diligence: Putting the money you saved in fixed deposit is not enough. Only when there is some campaign, you get 3% but usually it's only 0-1%. So you have to put them in T-bills and rollover every few months. That's difficult. Imagine spending your precious weekends in banks to rollover these stuff. Now we have POEMs, so pls go open an account today. But still, it's a hassle.

3) Time: Now compound interest works best when the time period is long enough. Warren Buffett took 50 yrs, for the illustration above, you need 30 yrs. Most pple can only have some savings after major cash outflows like wedding, buying a house, having kids etc. So even if you start at 25, you will only become a millionaire at 55.

So that's why it seems easy but it's not. But there people who does this and got there. Their parents started for them when they were like 10 yrs old, and when they are 40, they become millionaires. Well, don't blame your parents, just make sure you try your best to help your children! Hehe.

Is investing a zero-sum game?

This is one question that I would like to answer a long time ago but have always thought I don't have a good answer yet. Nevertheless, I shall attempt to answer that today. Is investing a zero-sum game? I think the answer is both yes and no.

BTW, this post is talking about investing in general, which include fixed deposits, bonds, stocks etc, so not just stock alone, ok hor?

The answer is partly yes, it is a zero-sum game, because whatever you buy, you will have to sell to make a real profit (as in not just paper gain), and whoever bought it from you would be deprived from the amount that you profited. So whatever you gained, he would have "lost" (or failed to gain).

However, we must understand that the world's economy has been growing on average 3-5% p.a. for the past 100 yrs and stocks have grown at roughly 10% p.a. while bonds roughly 5% p.a. So in aggregate, investors would have earned roughly 5-8% (Hence this blog is called 8% p.a., in case you haven't realized), depending on their portfolio mix and also assuming that whatever they invested in did not go bankrupt or go into default. (Actually if they diversify, even if some investments become zero, others would have made up for it. So in aggregate their portfolios will still earn a positive return)

So this is to say, even when you sold your stock at a profit to the next guy, he will not necessarily lose money, because in aggregate, everything will grow, at the very least, with the world economy. He will at least earn 3-5%, if he simply buy government bonds, or 10% if he put everything into stocks.

In other words, the "zero" in the zero-sum is actually 3-5% (which is also roughly the global GDP growth rate) and for stocks, the zero is maybe 8-10%, depending which market you invest in. Hence the "no": as in investing is not a zero-sum game, if someone earns money, it does not mean that someone else is losing money.

To conclude, in the game of investing when you make a realized profit, you deprived someone of that profit but if the next person holds it long enough, he will not lose money, because at the very worse, his investment will grow at the same rate with global economy.

See also The Greater Fool Theory
and Markowitz Portfolio Theory

Investment cannot make you filthy rich, if your last name isn't Buffett

Considering that investment can only make 5-8% on average in the long run, we cannot expect investment to bring home the bacon, can we? Going back to my first post, an average Singaporean earns S$3k per month, assuming that she can save S$1,000 every month, which is very optimistic (i.e. S$60k after 5yrs) and she starts to invest after saving S$60k. She earns 8% of S$60k = S$4.8k per yr, which is S$400 per mth. Well not enough to buy a tap for a certain foundation director some years back, enough to eat, pay off some bills for others. Not exactly a huge amt.

Let's have a bigger example. Consider that a household accumulated savings of S$500k, which probably could be accumulated by some of you, the aspiring readers reading this now, or roughly speaking the top 10% households in Singapore given that their annual household income probably exceeds S$150k, ie this amount can be saved in less than 10 yrs.

So giving this amt the higher return of 8% would give income of S$40k per yr. Now we are getting to something. S$40k could probably pay for most expenses like food, mortgage, utility and phone bills etc. But not the extravagant stuff like a Europe tour, or a nice 1.8L car which today (2012) costs *gasp* a cool S$100k.

So my point is: investment can give you incremental income (S$400 in the first example), if you invest as well as an average investor on Earth. And if your base is big enough, ie S$500k, it can give you some maintenance income, but nothing more. Kid's education, insurance, medical bills and Inflation, the biggest killer - these are things that are not factored in the S$40k maintenance income that we talked about.

And as it is, 8% return every year is quite a high target over long investment horizons of 20-30 years. Very few professional fund managers actually achieve 8%.

So, contrary to what banks, brokers and most financial advisers would advise, investment cannot help you grow your wealth to make you eligible for private banking overnight. Next time you want to gauge the knowledge of the sweet young relationship manager peddling another structured note, ask her what she thinks is a likely return target over 20 years. The answer is 5-8%. If she says anything higher, leave immediately. Well you should still leave even if she got it right since most structured products don't help you make money. Unless she looks like Cecilia or Anne Hathaway :)

Investment cannot make you filthy rich. Over a long period of time, like 30-40 years, it might get you a good retirement nest, if we do things right and get that 5-8%pa over the long run. The easiest way to do that might be simply buying ETFs, or exchange traded funds that allows you to buy whole markets with minimum fees.

To achieve more than that, ie to invest and get 10-20%pa over say 20-30 years, you need to put in a lot of work into analysing macro trends, industries and stocks. It's a full-time job in itself. It might actually work out better to focus on your day job and do it better and get that General Manager position.

However if your last name is Buffett (not Buffet as in-eat-all-you-can type one hor), the story turns out to be quite different. You would have made 25% annual return on your investments for the last 40 years and earned US$30bn. Your "incremental income" on investment would have made you the 2nd richest man on Earth (after a certain Gates who likes to build Windows with security holes) and you will be the only guy in the Top 10 Richest People List that have made your money through investment. Too bad most of us are Lees, or Tans, or Ngs.

See also How much money do you need in a lifetime

and Investment Philosophy and Process