Towards 2008

So that's it for 2007, we have come to an end. Taking stock, this is a very good year, a very bullish year in fact. STI continue to set new record to nearly 4,000 points. This is something we never seen before. During previous decades, the highest point STI can go was just slightly above 2,500. But today, we make history again and again. However, in July 2007, US subprime problem triggered a correction and subsequently, market became very volatile. We have, unfortunately, to live with it even in 2008. And in case you asked how I fare this year in stock investment, I did quite well. My uncompounded absolute returns is above 20%. This is simply using the money I won over the initial investment. Existing portfolio gain/loss is not considered. My portfolio actually suffers a 8% losses when SGX closed for the year. Even if we use "holding periods return" to measure, my gain is still well above 10%.

I wish to take this opportunity to wish all my friends and readers Happy New Year, good health and "show us the money!!!".

Seven Traits Of Great Investors

My all time favourite analyst, BT senior correspondence, CFA Charterholder Ms Teh Hooi Ling wrote another good article analysing traits of investment gurus. The article is so good that I ready have to paste it wholesale on my blog to share with you. In her article, Ms Teh listed down seven traits of greater investors which I share the same opinion. I had either previously in my article or through discussion with friends, highlighted about the same thing. For those who know me or had followed my blog should know what I mean. Quickly, I’ll summarise these seven traits and input my remarks.

1) Overcome greed and fear. I learned this from Warren Buffett and have emphasised over and over again in my blog.

2) Passion for investment. I often have friends/colleagues asking me why I am not tired of reading and analyzing stock (almost) everyday. Why I never breakdown? My answer is simply – by asking back “why didn’t you breakdown when you watch World Cup every midnight and then reporting to work in the morning?”

3) We must learn from our mistakes and make sure that we do not make the same mistake again. I didn’t emphasise this but I thought that is rather commonsense!

4) Commonsense is the least common human attribute. I pick up this quote from my ACCA lecturer Mr. Fred Keer, a very knowledgeable lecturer. And I use it many times in my blog. Let me illustrate how I use commonsense. A few years ago, there was a hot stock dealing with mobile phone repair. The company kept reporting profit growth and the share price kept moving up. I posted questions to my coursemate – “how come that company can continue to report profit growth when its trade (mobile phone repair) is simple and can be easily duplicated or has no barriers to entry? How come it can earn lucrative margin when it is purely an outsource company? Why didn’t its major client (Nokia) squeeze its margin?” My questions were basically a result of commonsense. What happen to the company later? I leave it to you to find out (or you can write to me for answer).

5) Believe in your study, analysis and philosophy. Do not compromise your principle. Do not follow the crowd. They always make mistake.

6) Good in math will not make you a successful investor. In every book written on Warren Buffet, you will find large portion on qualitative analysis.

7) And the most important one, which has always been a topic of discussion – can Warren Buffet be duplicated? I discussed it with my CFA coursemates before and we concluded that it couldn’t be duplicated. You can learn everything about ratio analysis, options, Black-scholes model, forward and futures etc. But there is one thing that you cannot learn – GUT FEEL.

Enjoy the article.

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Business Times - 17 Nov 2007

Reading this won't make you great

Mark Sellers, founder of a Chicago-based hedge fund, argues that the best investors are born with particular psychological traits that others can never learn

By TEH HOOI LING
SENIOR CORRESPONDENT

WHAT makes someone a great investor? It's something you have to be born with, said Mark Sellers, founder and managing member of Sellers Capital LLC, a long/short equity hedge fund based in Chicago.

Apparently, it's not about your IQ, the education you've had, the books you've read, or the experience you've accumulated. 'If it's experience, then all the great money managers would have their best years in their 60s and 70s and 80s, and we know that's not true,' he said in a speech to a class of Harvard MBA students.

Intelligence and learning are obviously necessary too, and are sources of competitive advantage for an investor, but there are structural assets some possess that cannot be copied or learnt by others. 'They have to do with psychology and psychology is hard wired into your brain. It's part of you. You can't do much to change it even if you read a lot of books on the subject,' said Mr Sellers.

He said that there are seven traits great investors share that are true sources of advantage because they cannot be learned. You are either born with them or you aren't.

The seven traits are:

One, the ability to buy stocks while others are panicking, and the ability to sell at a time when other investors are euphoric. 'Everyone thinks they can do this, but then when October 19, 1987, comes around and the market is crashing all around you, almost no one has the stomach to buy,' Mr Sellers said.

'When the year 1999 comes around and the market is going up almost every day, you can't bring yourself to sell, because if you do, you may fall behind your peers.

'The vast majority of the people who manage money have MBAs and high IQs and have read a lot of books. By late 1999, all these people knew with great certainty that stocks were overvalued, and yet they couldn't bring themselves to take money off the table because of the 'institutional imperative', as Buffett calls it.'

Two, the great investor has to be obsessive about playing the game and wanting to win. 'These people don't just enjoy investing; they live it. They wake up in the morning and the first thing they think about, while they're still half asleep, is a stock they have been researching, or one of the stocks they are thinking about selling, or what the greatest risk to their portfolio is and how they're going to neutralise that risk.

'They often have a hard time with personal relationships because, though they may truly enjoy other people, they don't always give them much time. Their head is always in the clouds, dreaming about stocks. Unfortunately, you can't learn to be obsessive about something. You either are, or you aren't. And if you aren't, you can't be the next Bruce Berkowitz.'

(Berkowitz was a managing director of Smith Barney and set up his fund Fairholme Capital Management in 1999. Since inception, Fairholme Fund has returned 18.7 per cent annually on average.)

The third trait of a great investor is the willingness to learn from past mistakes. 'The thing that is so hard for people and what sets some investors apart is an intense desire to learn from their own mistakes so they can avoid repeating them. Most people would much rather just move on and ignore the dumb things they've done in the past.

'I believe the term for this is 'repression'. But if you ignore mistakes without fully analysing them, you will undoubtedly make a similar mistake later in your career. And in fact, even if you do analyse them it's tough to avoid repeating the same mistakes.'

A fourth trait is an inherent sense of risk based on common sense. 'Most people know the story of Long Term Capital Management, where a team of 60 or 70 PhDs with sophisticated risk models failed to realise what, in retrospect, seemed obvious: they were dramatically overleveraged. They never stepped back and said to themselves, 'Hey, even though the computer says this is OK, does it really make sense in real life?'

'The ability to do this is not as prevalent among human beings as you might think. I believe the greatest risk control is common sense, but people fall into the habit of sleeping well at night because the computer says they should. They ignore common sense, a mistake I see repeated over and over in the investment world.'

Five, great investors have confidence in their own convictions and stick with them, even when facing criticism. 'Buffett never get into the dotcom mania, though he was being criticised publicly for ignoring technology stocks. He stuck to his guns when everyone else was abandoning the value investing ship and Barron's was publishing a picture of him on the cover with the headline 'What's Wrong, Warren?'. Of course, it worked out brilliantly for him and made Barron's look like a perfect contrary indicator.'

Mr Sellers said that he is amazed at how little conviction most investors have in the stocks they buy. 'Instead of putting 20 per cent of their portfolio into a stock, as the Kelly Formula might say to do, they'll put 2 per cent into it. Mathematically, using the Kelly Formula, it can be shown that a 2 per cent position is the equivalent of betting on a stock which has only a 51 per cent chance of going up, and a 49 per cent chance of going down. Why would you waste your time even making that bet?'

The Kelly Formula arose from the work of John Kelly at AT&T's Bell Labs in 1956. His original formulas dealt with the signal noise of long-distance telephone transmission. It was then adapted to calculate the optimal amount to bet on something in order to maximise the growth of one's money over the long term.

Six, it is important to have both sides of your brain working, not just the left side - the side that's good at maths and organisation. 'In business school, I met a lot of people who were incredibly smart. But those who were majoring in finance couldn't write worth a damn and had a hard time coming up with inventive ways to look at a problem,' said Mr Sellers.

'I was a little shocked at this. I later learned that some really smart people have only one side of their brains working, and that is enough to do very well in the world but not enough to be an entrepreneurial investor who thinks differently from the masses.

'On the other hand, if the right side of your brain is dominant, you probably loathe math and therefore you don't often find these people in the world of finance to begin with.'

So finance people tend to be very left-brain oriented - and Mr Sellers said that that is a problem. A great investor needs to have both sides turned on, he said. 'As an investor, you need to perform calculations and have a logical investment thesis. This is your left brain working. But you also need to be able to do things such as judging a management team from subtle cues they give off.

'You need to be able to step back and take a big picture view of certain situations rather than analysing them to death. You need to have a sense of humour and humility and common sense. And most important, I believe you need to be a good writer.'

He cited Warren Buffett as one of the best writers ever in the business world. 'It's not a coincidence that he's also one of the best investors of all time. If you can't write clearly, it is my opinion that you don't think very clearly,' Mr Sellers said.

And finally the most important, and rarest, trait of all: the ability to live through volatility without changing your investment thought process.

This, said Mr Sellers, is almost impossible for most people to do; when the chips are down they have a terrible time not selling their stocks at a loss. They have a really hard time getting themselves to average down or to put any money into stocks at all when the market is going down.

'People don't like short-term pain even if it would result in better long-term results, he said. Very few investors can handle the volatility required for high portfolio returns. They equate short-term volatility with risk.

'This is irrational; risk means that if you are wrong about a bet you make, you lose money. A swing up or down over a relatively short time period is not a loss and therefore not risk, unless you are prone to panicking at the bottom and locking in the loss.

'But most people just can't see it that way; their brains won't let them. Their panic instinct steps in and shuts down the normal brain function.'

得不到, 已失去

Economic Forecast - US Recession

I decided to publish analysts' economic forecast (just an excerpt) frequently on my blog so as to increase awareness, to help us to monitor the situation and to make adjustment along the way. My advise to all - be defensive. Keep more cash or cash equivalent. For those who are still bullish, all the best and good luck.

=========================

Business Times - 22 Dec 2007
SUB-PRIME WORRIES

Defaults to pick up next year on US recession risk: S&P

(NEW YORK) US corporate defaults will increase next year as the worst housing slump in 16 years threatens to send the world's largest economy into recession, according to Standard & Poor's (S&P).

The rating assessor expects high-yield, high-risk borrowers in the US to default on 3.4 per cent of their bonds outstanding by November, from a record low of almost one per cent, New York-based Diane Vazza, head of global fixed income research group said in a report dated on Thursday. Defaults will rise more noticeably in the later half of next year and in 2009.

'Our projections are based on a decidedly gloomy economic outlook for 2008, underpinned by expectations that the world's largest economy will falter on the cliff of recession,' Ms Vazza said in the report.

'The housing decline will have its biggest impact during this period, and orders data suggest slower capital spending. A serious risk confronts the US consumer, as households feel the pinch of lower home prices and higher energy costs.'

High-yield bonds are rated below Baa3 by Moody's and BBB- by Standard & Poor's.

The 15 largest US homebuilders have lost 56 per cent of their market value this year as home prices declined for the first time since the Great Depression, according to the National Association of Realtors in Chicago.

Finding The Cheese Or Focus On The Present?

Source Of Passive Income – Publishing Books

I trust that most of you would be familiar with Robert Kiyosaki’s “Rich Dad Poor Dad”. It is really a good book imparting knowledge on financial freedom. In fact, I first came to know and understand the term “passive income” from his book. From his cashflow quadrant, anything that give rise to constant stream of income without much time on it is a passive income. Writing and selling books is also a source of passive income. I had many friends who read a lot, frequently, but sometime indiscriminately helping the author to be rich. Should we be selective in buying books? The answer is definitely yes unless you have nothing better to do. To read a book, you must first spend money on it, and then spend time on it and finally a storage space. And every time when you pay for a book, you are helping the author to collect passive income; you are helping him to be rich!

No offence to those who write and sell books. But my point is that you shouldn’t buy a book for sake of buying it. For example, if you already know about investment, then no point keep buying more since they are about the same (change the soup but not the ingredients). Am I here to discourage you from reading? Definitely not! I am here to advise you to be selective and don’t help others to gain passive income unless that person really deserve the reward. Let me share with you how two books change my life. It’s a big joke of my life. While the author is certainly rich, I am still that poor. But I promise there is good lesson to earn.

The First Encounter – The Cheese

In 2002, I completed my ACCA (accounting) study. I was then an army regular earning very decent and stable income. I used to own a car then. As with most of my comrades, our promotion was quite smooth and prompt. It was a secured job (but not anymore today). However, like many others, we were not contented then. Many took up higher study and left after graduation – for green pastures. I too hope to be a professional accountant earning high income. Then someone recommended me to read a book titled “Who Moved My Cheese”. I can’t remember exactly the content now but it is about accepting change. It talks about rat in a maze enjoying its cheese but what if it finish that cheese? So one should move out to look for other cheese outside the maze, or something like that. Anyway, the moral of the story is to accept change and to take the challenge.

Back then; the SAF adopted a new system to retain qualified servicemen. They call it the Premium Plan. Only those who met certain criteria will be offered a lifetime career. In early 2002, I was offered and I accepted it. But after reading the book, and with encouragement from a few friends and colleagues, together with my newly acquired qualification, I tendered my resignation. I decided to find my cheese outside.

The Struggle

I left the service in 2003 in the midst of recession. The job market was tight and I was unable to join any accounting firm and became jobless for 9 months. Finally I join another company doing operational work. My accounting qualification was wasted. But I didn’t give up. I continued to search for my chance, took up higher study (again), tried to go into business with a friend but there was no result. While most of my ACCA coursemates were holding very senior appointments earning exceptionally high income, I am not even an Executive. I remember one coursemate got the post of Dy GM for Natsteel’s China business. And my operational job just ensures that my certificate will be useless and I’ll never climb.

When I was disheartened, my ex-manager gave me a book and insisted that I must read it. I didn’t read it immediately as I was not that keen initially. But when I read it, my mind opens up again. This book is Adman Khoo’s “Master Your Mind, Design Your Destiny”. The whole book was about having positive mindset to help you to overcome problems and to excel. I changed my mindset and it did make a different. That is a very good book.

The Present

Last week, my current boss lends me a book to read. The book titled “The Present”. Guess what? The same author who wrote “Who Moved My Cheese” wrote the book. Bascially, the book is about appreciating present and find ways to work it out no matter how discouraging it is. Let me quote a para in page 42 of the book:

“Focus on what is happening at the moment. Appreciate what is right about the situation, and build on it.”

Did you find something odd here? Five years ago, the author's book encouraged me to find my cheese outside - to change. But now, the book wants to me appreciate presence; appreciate what I have now!!! I was shocked and insulted. If not because of my boss, I would have torn the book into pieces. While the author continues to earn passive income, and I am one of the donors, his book got me into trouble (indirectly)!!!

What Have I learned?

We receive tonnes of information and advises from many sources – friends, colleagues, books, internet, pastors etc. But to make right decision, in my opinion, the very first thing that a person need is MATURITY and PATIENCE. I mean we just can’t always simply adopt new concepts other people shared indiscriminately. The intention may be good but may not be suitable for every reader. There is never right or wrong answer in each of these concepts. I am sure every book has its good purpose and will definitely benefit some readers but not all.

Do I blame the book? No, I made the decision and I shall bear the consequence. Certainly I am not that mature at that point in time (five years ago) and was rather impatient. Do I regret moving out (of SAF) to search for new cheese? Yes, to some extend but no point looking back. And what’s the lesson I learned so far?

1) Be selective in buying self-enrichment books. Do not help others to earn a passive income unnecessarily unless it justified. If you invest (pay) in a book, you must expect a POSITIVE RETURN, tangibly or intangibly.

2) When acquired new knowledge/teaching/concept, stay calm and think it over and over again. Consult some friends or seniors. Be patient.

3) Accept the fact that even if you apply a concept closely, it doesn’t mean that you will definitely get the same result. For some yes but not all. E.g. the author shares with you his secret to become millionaire. Do not expect that you will also become a millionaire if you apply exactly. Get real!

The Future

To be continue......if there is any.......

Is Koh Brothers Undervalued?

Clarification And Reminder

Firstly, to all my readers, I must emphasise here that although I am gloomy on the global economy, I had never, ever advise any friend to damp all equity immediately. We must be very clear here that we can only monitor the situation and make minor adjustments along the way until concrete evident emerged. For example, currently I feel that US economy is shaky or to put it correctly, uncertain, I will hold my stocks and limit any further investment regardless of the price movement. Some of my friends told me that it is stocks are cheap after correction and we may average down. The question is that it can be even cheaper. So how you define “low” in the first place? But of course if you are trading, then that is a different story.

Before global economy really goes into recession, there are definitely growth stories in certain industries or companies. Many of us know that this year, oil and oil-related companies are giving out 6 months bonuses to their employees. The US economy may be uncertain, but that does not change the fact that oil-rig providers like Keppel currently has more than $1 billion oil rig contracts on hand keeping their employees busy for next few years. What else do we have besides oil?

Koh Brothers – Under-priced

Another lucrative, billion-dollar project is the Integrated Resort. This is nothing new to Singaporeans. The whole IR project is expected to cost some $5 billions (can’t remember is in US$ or S$). As of 21 Dec 2007, as far as I know, the casino construction contract has yet to be awarded. So who will be awarded has always been my question. Discounting foreign conglomerates, locally, only those with substantial size (manpower, finance) and with good track records stands a chance. And in my opinion, the following companies may stand a chance especially if they join hand:

- Lam Chang
- Koh Brothers
- Ho Bee
- Lian Beng

Among these four companies, one of them, in my opinion, is mis-priced – Koh Brothers. As at 21 Dec 2007, Koh Brothers’ share was last done at $0.38. This price, in my opinion, is undervalued. The following points are my justification:

1) In a Business Times report dated 5 July 2007 (titled - Heeton expects bonanza from prime project), analyst assessed that Koh Brothers’ JV project with Heeton (The Lumos) would fetch Koh Brother approximately $0.24 a share net profit from the sale of the condo. The following is an excerpt of the article:

“Property group Heeton Holdings could recoup its entire initial investment in its exclusive The Lumos condo by selling just two penthouses and a few mid-sized units during this weekend's pre-invitation launch.

The company is confident that over a third of the 53 units at the prime Leonie Hill site will be snapped up at this Saturday's 'by-invitation-only' event for special guests.

'We have not issued any price list,' said Danny Low Yee Khim, the Sesdaq-listed company's executive director and chief financial controller. 'But I expect property agents will have indicative prices benchmarked against neighbouring properties in the vicinity. Some are apparently coming with blank cheques from their invited clients.'

Key among these 'neighbouring properties' is SC Global's Marq On Paterson Hill, which set a new record last week when a unit was sold for $5,100 per square foot (psf). And all 21 apartments in the first phase of that 66-unit luxury development - just down the road from Lumos - have been taken up at an average selling price of $4,137 psf.

Market watchers reckon units at The Lumos could fetch well over $3,000 psf. At this price, Heeton and Koh Bros (each has a 50 per cent stake in the project) stand to make some $220 million - or $110 million each - in profit.

This works out to about 50 cents per share for Heeton, and 24 cents per share for Koh Brothers.

The two firms bought the site - previously Hilton Towers - in April 2006 for $79.2 million, or about $880 psf per plot ratio, including a development charge of about $3.9 million. Coupled with construction cost, the total cost is said to be well under $1,200 psf…..”

2) In Jun 2007, Koh Brothers announced that it has formed a consortium with a few big players including Heeton and acquired prime freehold site at Newton road.

3) In Nov 2007, Koh Brother announced that it has acquired freehold sites at prime Bukit Timah road and another one at Changi road.

4) In Dec 2007, Koh Brothers was awarded a project from MOE for the construction of River Valley High school and hostel.

The Integrated Resort (Casino in Singapore) Contract

In my opinion, current price of $0.38 a share is under-priced with existing contracts plus those newly awarded particularly The Lumos condo. Assuming that the analysts are correct, at $0.38 a share, you are actually paying $0.14 for Koh Brother’s business. Let’s not drift too far away from my most interested topic – the IR project. Among the four companies that has the potential of tendering and carry the IR project, I chose Koh Brothers. Ok, may be I should say I bet that Koh Brothers might get it and since I believe that its price is undervalued, I had a safety margin.

In Dec 2007, Koh Brothers announced that it has formed a JV with Lian Beng to tender for the casino tower. Its share price surged to a high of $0.49 but subsequently retreated to $0.38. I hold on to it. I wanted to continue the game until I see the last card.

Koh Brothers 1H2007

In Koh Brothers’ interim report, gross profit grew by 42% to $14 million. However, property revaluation caused Koh Brothers’ interim profit to jump 2,225% to $30 million. As such, I am expecting better performance and more good news especially with existing and new projects awarded. I will do detail analysis of Koh Brothers financial report separately.

In my opinion, Koh Brothers’ current price of $0.38 is cheap. And I am not even talking about IR project here. The IR project will be a great catalyst. Therefore, I don’t think investors are not paying a lot for $0.38 a share and thus offering good safety margin. How much is the safety margin I don’t know. And don’t ask me what’s my expected price of Koh Brothers. This is because I don’t know and I never set price target; never in any of my article. At $0.38 a share, I call a buy on Koh Brothers.

The Selling Strategy

When To Sell?

If you read a book written by some experts covering buying strategies but never touched on selling strategy, your learning are not complete. A good investment gurus will definitely tells you (or teach you) on the importance of selling strategy. Yes, when to sell is just as important as when to buy. I am not an expert and certainly not a guru. But through years of reading and investment experience, I had developed my very own selling rules. So this is my own “when to sell” criteria:

1. When you need money. This should be self-explanatory. The first rule of investment is when you have spare cash that is not needed in the near future. If this assumption does not hold anymore, you should not invest; at least not in stocks.

2. When a counter has been heavily speculated, price surge aggressively not supported by any news. This is a common phenomenon whereby speculators switch their attention to a counter and trade aggressively. And usually you will see that particular company answering to the SGX’s queries with “we do not know any circumstances that could explain high trading volume”. Basically there is no change in the company’s fundamental. In this case, you should sell high and wait for Ms. Market to cool down. You can re-purchase again when the price retreated to a sensible level.

3. When the fundamental of the company you bought changed. This is really from the teaching of Warren Buffett. As a value investor, you invest in a company certainly due to a value in that company and that the price does not fully reflect that value. That’s why you buy its shares. But if the fundamental of that company changed, depending on the situation, usually you have to get out of the company ASAP. If Coca Cola no longer sell coke but hard disk, you got to get out immediately. A good example in Singapore context would be education provider – Informatics. For many years, Informatics enjoys reasonable growth and was well covered by analysts. It was investors’ favourite stock until the expose of its accounting scandal. The education provider’s brand was seriously damaged and student intake fell drastically. One of the mechanics in my company asked for my opinion in terms of investment and education (for his daughter) in this company. Objectively, I advised him to avoid this company whether it is for investment or education. The company’s brand name was the key reason for buying it. If the company losses its brand name, then you should sell immediately.

4. When the economy is on the downturn. If the generally economic, or the global economy is on the downturn (or recession), you must run like hell. With certain exception, if the economy is entering into a recession, you must make sure that you are one of the first to get out. I’ll discuss more on this point later.

5. When existing price fully valued a company. This means that the price reflects the value of a company. The obvious question would be what’s the value of a company, how to measure it. Well this is not easy and can be very academic. Generally people use discounting cashflow on dividends, free cashflow and other formula to assess a company’s value for whatever remaining life, today. This requires prediction of a company’s future growth and performance. It is a highly difficult task with many assumptions and even two analysts using the same formula may produce different answers. So usually I use other easy method that kill lesser brain cells. For example, I use PE ratio to determine if the company is over-priced. Another situation would be when you buy a company because of a catalyst, and when the price adjusted for that catalyst, generally you can sell it.

When The Economy Is On The Downturn

This is a more interesting topic and I like to talk more about it. My approach to investment is always to look at the generally economy, local and global. We like to invest long-term but not that kind like Warren Buffett because we are a bunch of poor little retail investors. So we must look at the business cycle. When the business cycle is on the recovery to its peak, generally, you will make money in most of the companies you purchased. Think about it again. You are sure to make money by mid-2007 if you buy in almost any company listed in SGX in 2005. You don’t need any analytical skill but just throw your dart on the list of listed companies. Even laggard stocks like the construction companies that hardly move until 2006, can create miracle. Most of them surged aggressively from end 2006 to mid-2007 ensuring that your average uncompounded annual returns is about 30% (I don’t have statistics here).

Now the same rule applies. If the economy is on the downturn, in the mid term, your portfolio will surfer a loss. Although a small group of companies can still outperform (I will cover in another write-up), the problem is that can you spot these and only these companies? Are you that good and lucky. I am afraid most of the time we are not. That is why if the economy is on the downturn, you really must run away from the equity.

“So what’s your opinion on the global economy now?”

Since November this year, or after the exposure of US subprime problem, I had been quite pessimistic about the generally economy. Together with rising oil prices, and that US is one of the highest consumers of oil; I think we have more bad news. It is extremely difficult to predict the future economy but if you ask me to place a bet with all my savings, I will bet that the US economy is on the downturn. This is simply the logic of probability. There is just more bad news than good ones. And we all know that if US economy goes down, she will drag everyone down especially Singapore (being an export country to mainly US and Europe). So if my assessment is true, which we will know very soon, then we are heading to a downturn or to put it clearly, a recession. When will that take place? God knows! But this is my assessment:

We had just passed the peak (or the tip) of the business cycle!

Conclusion

If you have been following my blog, you should recall that I mentioned that the stock market is a leading indicator of the economic movement. Yet it is highly difficult to predict the global economy. But we have to try. Based on what we know to-date, I am definitely not bullish. I believe that we had just crossed the peak and we must be prepared – for the worst. I had advised my friends to start looking at bonds which I had covered extensively in my blog. I don’t mean that you should damp everything away today and switch all your money to bonds. But certainly you should start getting defensive on equity and study the bond market. I am afraid that one of my selling rules has emerged. And I write this blog today to mark my analysis so that my judgment may be judged in the future.

STI Movement Nov 2007

The Days After Tomorrow

On 27 Nov, I returned to my office after a long weekend. If not because of the series of unfortunate events, I should be at Boracay Island now. But actually all my friends and colleagues were supportive instead of been sarcastic. I went out with ex-army friends during the weekend. He told me that, after reading my blog on “My Worst Holiday”, he would have make the same decision if he is in that situation. In my office, a few colleagues encouraged me that my friend in Manila would understand the agony I gone through; reconciliation would not be an issue.

And yesterday, TV Mobile on SBS bus reported that Typhoon Mitag killed 22 Filipinos. But if what Joshua told me is true, he will not be affected. According to him, Boracay Island is surrounded by islands thus having similar strategic location like Singapore. Based on the original schedule, we should be spending three days (26 – 28 Nov) in Boracay Island.

This evening, while I was on my way back home, the TV Mobile in SBS bus reported another shocking news – the army stormed a Manila hotel held by the rebels. Now this is really upsetting. The bad news from this country just keeps coming up none-stop. According to our original schedule, we should have leave Boracay Island on 28 Nov and spend two days at Sonya’s Garden. So I hope that Joshua and his family didn’t head back to Manila. But even if they did, most probably they are staying in another hotel not occupied by any rebels.

I actually thought of calling Joshua but I knew that he does not turn on his mobile phone during his holiday. Besides, I really don’t know what to say if I call him. This is because I might be perceived to be sarcastic because my instinct is, in a way, quite correct. I had emphasized many time that I don’t have the peace for this trip. In any case, I serious don’t think that anything could happen to Joshua and his family. This is because he is very familiar with The Philippines and he knows how to get help from our embassy if there is a need. We have a friend currently working in our embassy in Manila.

As for me, with this experience, I am not sure if I would ever visit Philippines unless the government is able to establish political stability. Notwithstanding the probability of future visit to Philippines, I still need to prepare a thousand dollar cheque for the damages when Joshua returns from his holiday. The damages can only be alleviated if he is able to change his hotel room. And I hope for the best.

Monkey-See-Monkey-Do Strategy

Follow The Experts

Does following experts blindly yield lucrative returns, or even beat the index? I remember some time last year (or the year before), there was article in the Business Times reporting that local investors enjoy high returns by simply following behind Temasek Holding's investment actions. According to the report, whenever Temasek invested in a listed company, you just follow, no question asked. At the end you still make relatively high returns (I don’t have the figure with me, need to find that article). Some of you may be able to recall such article.

So is monkey-see-monkey-do strategy works? In my opinion, it definitely will as long as:

1) You do not speculate
2) You follow, even blindly but the correct experts

Point 1) above is important because if you speculates and try to follow blindly, in my opinion, you will end up contributing to the “experts” you followed. But for value investment, which takes time to yield the expected result, it’s ok if you follow the right experts.

On 17 Nov 2007, there was a wonderful article on the Business Times further reinforce that monkey-see-monkey-do strategy does work – if you follow Mr Warren Buffett. When Warren Buffett bought PetroChina in 2003, my course mates and myself were aware of it and wanted to follow him. So what’s stopping me?

1) After Warren Buffett’s investment in PetroChina, its share price surged a bit….I was unhappy about it.
2) To buy Hong Kong stock, which I am not really familiar with, I will incur custodian fees. I don’t really like the additional cost especially when I am not buying large quantity.

Unfortunately, I was wrong. Warren Buffett makes big bucks from PetroChina. And if I followed blindly behind him, I am sure I will also make that kind of money. So we can use monkey-see-monkey-do strategy but do intelligently; at least follow the right experts.

The following is an excerpt of the article in Business Times. Enjoy.


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Business Times - 17 Nov 2007

Even a monkey can get 24% with this investment formula

Investors could beat the S&P 500 just by imitating Warren Buffett's trades

(NEW YORK) Buying whatever billionaire Warren Buffett bought, often months after his share purchases, delivered twice the return of the Standard & Poor's 500 Index during the past three decades.

Investors would have earned an annual return of 24.6 per cent by buying the same stocks as Mr Buffett after he disclosed his holdings in regulatory filings, sometimes four months later, according to a soon-to-be-released study by Gerald Martin of American University in Washington and John Puthenpurackal of the University of Nevada, Las Vegas.

The S&P 500 rose 12.8 per cent a year in the same period.

'A monkey would have beaten the pants off the S&P 500 by following Warren's buying and selling,' said Mohnish Pabrai, who manages US$600 million at Pabrai Investment Funds in Irvine, California.

Mr Pabrai and a friend paid US$650,100 this year in an annual charity auction to lunch with the 77-year-old Buffett.

Mr Buffett's stock picks outperformed his Omaha, Nebraska-based Berkshire Hathaway Inc from 2002 to 2006 when Berkshire shares advanced at a yearly rate of 7.8 per cent.

By comparison, Berkshire holding USG Corp, the biggest maker of gypsum wallboard in North America, increased about 1,140 per cent and PetroChina Co, China's largest oil producer, soared eight-fold.

Mr Buffett built Berkshire Hathaway during the past four decades into a US$200 billion company with businesses ranging from ice cream and bricks to insurance and corporate jet leasing.

Berkshire had US$77.9 billion invested in stocks at the end of September, according to a filing with the US Securities and Exchange Commission.

The company's shares closed on Thursday at US$135,300, the highest price on the New York Stock Exchange.

My Worst Holiday

Today, I am going to share my worst holiday, something unrelated to investment management. I jot it down here partly to apologise to my best friend Joshua and his wife Lessie for the most unfortunate event. The damage was severe.

At The Beginning

Somewhere in mid-2007, during an old-buddies gathering, one of my “brothers”, Joshua, revealed that he and his family will be going to Manila In Nov for visits and holiday. Joshua was previously posted to Manila and spent a few years there. So he is very familiar with the country. Instantly I expressed my interest since I had been deprived of distant travel for couple of years. Another brother also expressed his interest. A few months later, this brother decided not join us as his wife just gave birth to a baby. But I was determined to go according to plan. In Oct, I visited Joshua new home to discuss on itinerary. The plan was as follow:

Duration – 14 days (24 Nov to 7 Dec 2007)
Place to visit – Boracay Island, Sonya's Garden and Manila City
Initial budget - S$2,000

But Joshua and his family will flew off a few days earlier for visiting purposes. And they will pick me up at the airport upon my arrival. As safety was always my first concern, I choose to fly on SIA instead of any other airline especially budget airline. While budget airline cost less than S$200, SQ will cost me S$650. But I accept it. This is the first time I am flying alone and I am set to go.

During The Last Month

In early Nov, local news reported a bomb blast in Manila. I was shocked and disappointed although I already knew The Philippines’ always has security issue especially at the southern part. But I still take the courage to ignore it. The reason was because they don’t get bomb blast everyday and everywhere. With proper safety measures, it should be fine. For example, avoid loitering around hotel lobby or shopping mall entrance. Anyway, since Joshua is not worry at all, there is no reason I should. In fact, I go around joking with colleagues that if a bomb hit me, then it is God’s will – if it is my time, it is my time!!!

I visited Joshua again to do my budget. I am an analyst, I am a finance guy and I never believe in “no plan is best plan”. However, when we sat down to do the figures, I was shocked to discover that I have to up my budget to S$3,000 - S$4,000 mainly due to long period of hotel stay. Spending more than S$3,000 in The Philippines will make me a laughingstock. I might as well go to Australia or even Japan. But Joshua assured me that, although I need to up my budget, S$3,000 is guaranteed to be sufficient. So I booked my air-ticket while Joshua booked all hotel accommodations at various locations.

The Day Before Tomorrow

On 22 Nov night, I packed my luggage and I am all ready. I checked in my flight through the internet before I sleep. On 23 Nov morning, I was having breakfast with colleagues and they broke the news to me – there was another bomb blast at southern part and Typhoon Mitag is expected to land during the weekend!!!!!!!!! All these were report the night before (I did not watch TV).

You cannot imagine the shock on my face. I had stayed positive even with previous hiccups. But now, this is really too much to bear. Around 0830hrs, my colleagues forwarded to me the news report in the office. According to the report:

- The typhoon is coming and the soldiers are evacuating hundreds of thousands of people who live around the danger zone.
- Typhoon speed estimated 100km/h, almost speed of our cars along PIE.
- Arroyo is leaving Singapore ahead of schedule to prepare for the typhoon.
- Last year Nov, the typhoon killed thousands people.

On reading this news, I could not function properly in my office (luckily my boss understand). Quickly I send SMS to Joshua who is already in Manila with his family. There was no response after two SMS and I started asking for advice – colleagues, some friends at MINDEF. There are basically two schools of thought:

1) “If all along you do not have the peace, and together with this news, you should trust your instinct and following your feeling. After all, your life worth more than S$2,000 (air-ticket plus hotel) and sometime, you have to believe in your gut feel.”

2) “There should not be a problem since your friend is already there. Otherwise he would have called you. In any case, Philippines is big. Just go and don’t think so much. If it is really your time, it will happen no matter where you are.”

I started calling Joshua but could not get through the line. The anxiety inside is about to kill me. The feeling is that I am not going for holiday; I am preparing myself for a war. I called SIA and was told, luckily, that I can refund my ticket with S$75 admin charges. But I should make my decision one day before departure. Since my departure time is 0945hrs the following day, that means I need to make a decision in one hour time. There was still no respond from Joshua, and there are two schools of thought, I almost breakdown.

Critical Decision At 1000hrs 23 Nov 2007

A critical decision is urgently needed. I was forced to assess/analyse alone.

1) The typhoon is worst than bomb blast. While bomb blast is random and occasional, typhoon is not. Nobody expected Tsunami to be that devastating. Assumption is the mother of XXXX.

2) Chances for typhoon to disappear suddenly should be remote especially when we are at the end of the year. I assessed that it will not disappear suddenly.

3) The visit to Boracay Island is most probably impossible. I think the island is facing South China Sea. We need to take an internal flight first and then to cross to the island by boat. Both these mode of transports are dangerous with typhoon. Even if we somehow get to the island, it is almost 100% impossible for any sea activities like diving or jet skiing. I assessed that the most important destination – Boracay Island is out.

4) Under such poor weather condition, I assessed that terrorist has no plan for any homemade bomb.

5) Assuming that Typhoon Mitag really spend its holiday with us, then the most likely outcome is that we may be grounded in Manila hotel for 14 days.

I could not wait for Joshua’s respond anymore but to perform damage control. At around 1000 hrs, I called SIA to request cancellation of flight and asked for a refund. And it was done. Then I cancelled all my annual leave and re-applied by spreading them into different days. I have leave balances that I must clear by end of this year or else it will be forfeited.

2nd Chances?

I don’t believe that this is happening to me. I still try to call Joshua but there was no response. At 1230hrs when I was going for lunch (actually no mood to eat), I send another SMS and this time, Joshua called back! He was shocked of the outcome like he missed the whole part of 2nd World War. Joshua swears that he did not receive any SMS or missed call from me in the morning until a minute ago. He assured me again and again that it is a sunny day there right now. He said that The Philippines is very big and the typhoon does not cover the whole country. He assured that the trip will be relaxing and enjoying and even if I still wish to head back early, he will send me off and covers the remaining hotel expenses. He wanted me to undo everything!!!!!

This is really madness! To undo everything, I got to get my boss involved (cancel the new leave application and re-apply again) and SIA involved (try to revive the air ticket again with possible admin charges). But this is not the most important question. The most important question is after all these worries which actually started with the first bomb blast, is it an indication that I should not go against “HIS” will? And if I go against HIS will, I may have to pay for it…. with my life? Why I just couldn't reach Joshua in the morning before I was forced to make a decision alone? One thing for sure, I have no peace! Joshua sends a few more SMS to calm me down but was not successful. I also called SIA to check whether it is possible to undo everything. The SIA girl replied that she need to check since my request in the morning has been processed. I told her don’t bother as I am still “unconscious”.

Everything was in a shit mess! I decided to get last word of advise from wise man - my boss. He was very accommodative in terms of undoing all my leaves application especially with that kind of assurance from someone (Joshua) I trust. But he wanted me to make a decision based on this question:

“If tonight the news report the typhoon get worst and perhaps there are casualties, would you change your mind again? Or whether there is any possible chance that you may change your mind again? If you do this too many times, it’s really not going to be a nice things to do”

At the same time, with excellent service, SIA staff knew that I am hesitating and called me to offer their help. According to them, although they are processing my refund, they can stop it but I must make a final decision ASAP. By tomorrow morning if there is no decision, then I have pay a penalty fee. I promised to call back ASAP.

The Last Hour

I gave myself another half an hour to calm down and think through. There are only two options:

1) Let my friend and his family down and reconcile when they are back together with thousand dollars cheque for damages.

2) Undo everything and to go with the fear in my heart. I will incur full budgeted costs and… hopefully I return alive.

I chose option 1).

I called SIA again to confirm my refund request and apologise for the trouble I created. I confirm with my boss that I will not re-apply my leave again. And then I send the most difficult SMS in my life; to tell my friend that I had thrown in my towel and I will not retract. Then my boss called me in to do my year-end appraisal. This is the first time I am so quiet, inactive and kept looking at the table while doing the appraisal. I believe he understands.

In the evening on my way home, Lessie SMS me that she still hope that I can join them. But now there is no chance I will retract. It is ok to make one mistake but not two. If I continue to be indecisive, I will only create more problems and that my boss may be disappointed with me. I apologise again and commit to pay for the damages if they are unable to change the hotel room.

Lesson Learnt

I established new criteria for any subsequent holiday:

1) Never to go for holiday between November – January.
2) Never plan for long holiday like 14-days in regional countries unless I am going to Europe.

-

My worst holiday.....sigh.... I didn't even get the chance to board my plane.

Warren Buffett's Teaching - Goes Beyond Stock Investment

Value Investment – It’s True Value

If anyone asked me the best book I ever read, that would be “Essay of Warren Buffett”. I read this book somewhere in 2002 which totally changed my approach and strategy in investment management. The book covers Warren Buffett’s approach in investment analysis and some technical concepts. But if you only read the book and never put it into practice, you gained nothing. You must put it into practice. And this is always the problem with many people; they read self-enrichment books like any storybooks such as Lord of the Rings.

Last year, one of my colleagues was complaining about our job (again) and that he says that likes to read books. Out of curiosity, I asked him if he have read Robert Kiyosaki’s “Rich Dad, Poor Dad”? He couldn’t remember initially, but finally recalled. I continued to ask him for his comment on the book, and whether the book changed his life in any way? He replied “ok lah, it’s a good book, nothing much lor”. I smile and changed the subject. That was an expected but disappointed answer. He read the book like any storybooks – no wonder it took him sometime to recall.

Whenever I lent a self-enrichment book to a friend or colleague, I always tell them beforehand not to read it like a storybook. Instead they are to understand it, appreciate it and try to relate it to their current situation. Buying self-enrichment book is an investment; we should expect a return from it. If you need a storybook, go to library and borrow for free.

Impact Of Reading Essay Of Warren Buffett

After I read Essay of Warren Buffett, I immediately put it into practice. I totally change my approach and strategy in stock investment. I start to analyse company’s annual report and evaluate those figures vigorously. I also use Warren Buffett mindset to question certain figures and corporate announcements. For example, many companies frequently announce to market that it has plans to do this and that. Or that it believes that it can sustain growth by certain percent. Or it targets to maintain certain profit margin or market share etc. But after applying Warren Buffett’s approach, I always disregard this kind of empty promises. On the newspaper, you can also find many analysts writing reports on companies and like to use motherhood statements such as company so and so is expected to clinch so much contracts, or expected to benefit from industrial growth, or pursuing active for mergers and acquisitions etc. I will throw this kind of report immediately into the dustbin.

So what have I actually learnt from Warren Buffett? A few months ago when I attended a seminar conducted by a land banking company, I use exactly the same mindset/approach when I asked critical questions to evaluate its business (you can find it in my archive). If you invest in anything, check for its real (or intrinsic) value. Check the facts and double checks again. The word “expecting” or “target” has zero value. But “signed million-dollar contract" has good value. Also when we study a company’s fundamental, focus on company’s cashflow and not on items that can easily be manipulated. What else have I learnt? I also learnt to overcome greed and fear. If you think that this is pure commonsense and going to rebuke me, don’t! I can show you tonnes of examples on how people got cheated or loss lots of money because of greed and fear. I was once one of them. Commonsense.... my ACCA lecturer used to say that “commonsense is the least common human attributes”.

So Warren Buffett’s teachings not only make me a winner in stock investment but also equipped me with the skill to evaluate any investment objectively. Everyday, there are someone in another part of the world coming up with new investment scheme to “make money”. Some may be genuine while others are scams. I like to ask all readers of my blog, how do you:

1) Differentiate between a genuine investment and scam?

2) For genuine investment, how do you evaluate its risk and return?

If you are hoping that in this article I am going to share the answer with you, you are going to be disappointed. It is not that I am stingy in my sharing, but that this is a huge topic. I can only share with you my experience for a start. To be that good in the above two points, you must keep reading, learning and practicing.

My Approach To Sunshine Empire’s Scheme

I had previously shared my experience on Sunshine Empire in my blog. I never jump to any conclusion; I never allege that it is a scam. But based on what I learnt from Warren Buffett, I am able to evaluate the scheme objectively (point 2 above). Last Saturday, I went back to office to finish a report for Monday. One of my colleagues was working on shift then. She came to me and then suddenly we talked about Sunshine Empire again. It’s a hot topic now. She asked for my opinion. The following is what I shared with her:

1) I discovered that many retail investor, aunties and uncles are seriously lacking of fundamental knowledge in investment evaluation. I am talking about really simple knowledge.

2) If you want to invest in any scheme or products, you must first understand how it generates the income and whether it is sustainable. Preferably, we want to see growth of course.

3) You should never be convinced by PowerPoint slides, pictures or video clips on company's assets and finance. You must obtain assurance by somebody trustworthy which, in an unfortunate event, you can hold him/her responsible if there is negligence or fault. This “somebody” must be qualified and independent. For example, it must be a lawyer, external auditor, independent property evaluator etc. This qualified professional must sign on his report and you must see (and even obtain a copy) of such black and white. Preferably, get a copy of Sunshine Empire’s annual report together with the external auditor’s report.

4) We must be satisfied with all the questions on risk before even talking about return, regardless of the rate. I meant what’s the point of talking about return if you cannot ascertain or manage risk? If risk is not an issue so long the return is very high, then a casino would probably solve everything. There is a chance to earn 100% return in every minute if risk is not an issue! Sunshine Empire certainly cannot provide such return.

5) I told her to first overcome greed if she wants to protect herself forever from all tempting schemes. Of course that does not means that we should become so timid that we place all our savings with the bank. With higher expected inflation next year, you may even incur a loss (in value of money) even if you save your money in fixed deposit.

6) Do not succumb to hard sales tactical. There is no such nonsense as “this opportunity comes only once in a lifetime and valid only for three days” etc. Anyone making this statement, give him/her 50 cents to buy a kite – to fly.

My colleague continues to ask me if there are better investments that come with low risk but reasonable return, at least higher than the inflation rate. I shared with her a few products such as bonds which I had covered intensively in my blog.

So is my approach to Sunshine Empire’s scheme correct? If you read The New Paper on Sunday (18 Nov), page 12 – 13 gives some updates.

1) The press check with the relevant authority in Taishung, Taiwan, found that Sunshine Empire’s affiliate Emcom is not in partnership for the wireless broadband business. Emcom has never contacted them on this project.

2) Malacca theme park. The paper reported that Malacca City Council did not receive any such proposal.

Lacking Basic Knowledge In Investment Evaluation

So I found many aunties and uncles (and sometimes young men) seriously lacks very basic skills in investment evaluation. And I am not talking about reading annual report or legal document. I am talking about not knowing how to “get the facts correct”. And they actually believe that someone is there to help them to reach financial freedom. I asked one of the Sunshine Empire’s partners on why would the founder wants to share such lucrative returns? He could have borrow from the bank cheaply and keep all the remaining. I mean if their investment yield approximately 10% returns a month, the founder could have borrowed from the bank at less then 10% cost a year! The answer given to me was “the company wants to share wealth with commoners instead of bankers”!

I didn’t know Jesus walks the earth again! If anyone can believe such statement, he/she is not naïve – he/she is stupid at an unbelievable level. Perhaps I should start a course on basic investment evaluation.

Speculation - Are You An Expert?

I missed an interesting article in Business Times (1 Nov 2007). I noticed that article and after reading it, I find it a very good article to bring reality to the naïve. All my friends who had sought my advice or had learnt investment from me know my very first rule – I never gamble. It’s not that I never but after I understand the truth from warren Buffett, I strongly protest against stock speculation. No doubt occasionally, I still buy lottery but it is a mere $15 per bet for $1 million and that’s it. There is no repercussion and my maximum lost is a fixed $15 (about 2 x MacDonald meals).

Recently one of my friends called me up and asked me questions on trading. What happened was I recommended him to buy China Sunshine Chemical and then when there was alight movement in the price, his colleague advised him to contra off and locked in profit. Then he can buy back at cheap price again and do the same thing again. I replied that I know what game his colleague is playing, but I am not interested. I told him that if he speculates, he is on his own and I will not assist him in any way. He has to make a choice. No doubt that recent poor market sentiment has caused many stock prices to retreat, but my comment/principal will never change. In fact, I also have friends who tried to invent some methods to correlate it with the stock market, i.e. a secret to success. May we can also use the tide to predict stock market, or the temperature at noon, or the number of adverts on the obituary. All these voodoo tricks, I am not interested.

I like to specially highlight a para in the article. It is something I always warn opportunists or people who try to find luck in stock market, that ANYTHING can happen.

“….There's always a first time for everything, even a default of 'safe' government bonds.”


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Business Times - 01 Nov 2007

Even the experts can get it so badly wrong

History is replete with heavy trading losses that were all too easily incurred

By LARRY WEE
SENIOR CORRESPONDENT

Within less than a fortnight, two Singapore shipbuilders have announced massive currency trading losses. How and why these losses were incurred will surface only after investigations have been conducted.

However, history is replete with financial case studies of how heavy trading losses can be all too easily be incurred by individuals or corporations. In early 1995, we discovered that Barings trader Nick Leeson had blown a US$1.4 billion hole trading in financial futures on Simex here in Singapore. Three years later, in 1998, veteran traders and Nobel prize winners at the US-based Long Term Capital Management (LTCM) suffered losses of more than US$3 billion in the short space of nine months because of heavily leveraged trades. In 2004, China Aviation Oil blew more than half a billion US dollars on oil derivatives trading.

And just this week, we have discovered that even blue-chip investment banking giants like Merrill Lynch and UBS are continuing to report multi-billion dollar losses from complex mortgage-related debt portfolios that have become nigh impossible to unravel.

How do such trading losses - and we stress we are not talking about SembMarine and Labroy here - pile up? Here are some clues to consider.

Leverage is a two-edged sword. Making bets based on only a fraction of the underlying sums transacted is attractive because profits are correspondingly magnified - but then so are the losses. In the case of blue-chip US hedge fund LTCM, their convergence trades were basically bets that too-large price differentials between different types of bonds should become smaller over time - something which they backed with state-of-the-art trading models which studied historical price movements.

Between 1994 and 1998, LTCM reportedly leveraged US$5 billion in client capital into US$125 billion worth of borrowings, and outstanding swap positions worth more than US$1 trillion in nominal value.

Murphy's Law. 'Anything that can go wrong, will - at the worst possible moment.' In the case of LTCM, the fallout from the Russian debt default of August 1998 shrank their capital from more than US$4 billion at the start of 1998 to just US$600 million by September that same year.

Nick Leeson had to throw in the towel when already bad losses on his large Nikkei futures contracts skyrocketed following a massive earthquake in Japan in January 1995 and forced the Japanese stock market into free-fall.

This time around, one fear which refuses to go away out there is that the sub-prime debt crisis could spiral further out of control - forcing another panicky flight to quality.

Double or nothing usually means you end up with nothing. Every veteran trader knows that he must squeeze the most money out of his good bets but keep loss limits tight on those that go awry.

But human nature often finds people cashing in too quickly on the good stuff but massaging losses for far too long - in the hope that they will come right someday, somehow. In the case of Barings and China Aviation, history tells us that record-sized positions - and therefore record losses - were accumulated because of a desperate effort to average down the cost of what was to become awfully wrong (and highly leveraged) bets about the direction of the Nikkei and oil prices respectively.

Here's a simple example. Let's say that about one year ago, your banker persuaded you to buy US$100,000 at S$1.60 because it could enhance the yield on your fixed deposit by at least 2 per cent. Then, as the US dollar fell, he encouraged you to buy more to average down your cost. Let's say that you bought another US$100,000 at S$1.55 and again at S$1.50.

By July 2007, you own US$300,000 at an average of S$1.55. In August this year, the US dollar rebounded to S$1.54. Had you sold out then, you would have reduced your total currency loss to S$3,000 - which is more than offset by the extra US$6,000 in interest earnings from your US$300,000 deposit.

If however, you had chosen to hold on until now - hoping for an even stronger US dollar rebound - the currency losses would have swelled to S$30,000 as the US dollar has now fallen to S$1.45.

Admission is free, you pay to get out. As banks from Goldman Sachs to UBS have found out to their detriment, it is all too easy to find rocket scientists who will happily structure complicated financial products - whether based on derivatives or housing loans - which offer superior yields. And the longer the tenure, the more you stand to make.

But here's the problem. When you discover, as they have, that nobody is willing to fund those fancy CDO (collateralised debt obligation) structures, or buy them back from you when you need to sell them, then you are also stuck with losses for a nerve-wrackingly long time. Worse, the structure can be so complicated that you are not even sure how much they are worth at a given point in time, or how to unravel them without paying a hefty penalty.

Illiquid can too quickly become insolvent. Buying an asset at tempting yields is all too easy. But any corporate treasurer worth his salt will also want to find out how easily he can dispose of the asset. LTCM could not find any buyers for their less than desirable bonds when Russia's declared moratorium on US$13.5 billion of its Treasury issues caused a nervous flight to quality in fixed income markets.

The other important lesson from LTCM to take home here is that historical evidence must be taken with a pinch of salt. There's always a first time for everything, even a default of 'safe' government bonds.

It is not known whether some of these problems, so painfully experienced elsewhere, also touched SembCorp Marine and Labroy Marine. But these firms' shareholders will want to know how they could have allowed themselves to get so deeply embroiled in foreign exchange speculation when their core business is the building of oil rigs.

Investment Strategy - Surviving The Economic Downturn (Final)

In Part I of this topic, I mentioned that generally, investment in bonds should come with capital protection. This is because in any worst-case scenario, you will get back your capital at par value. But company can fold up especially in bad times. If you invest in a bond directly, you will know its characteristics including risk. But if you buy bond funds, you got to be careful. The fund brochure may use big words such as “secure”, “capital protection” etc. But you should really read the fine print usually right at the bottom. It will say something like “the fund may incur losses if any borrower defaulted or “capital protection is only guaranteed assuming no default” etc. The reason is because fund manager may buy corporate bonds which come with higher risk. And if one of the companies default on its obligation, your bond fund will suffer and the price will fall. Of course if the bond fund's policy statement clearly states that the fund only invest in “AAA” investment grade bonds (especially government bonds), then the comfort of “capital protection” will be much higher.

So what will happen if a company (the borrower) defaulted or fold up? If the company defaulted, the trustee will demand the money back immediately. This may cause the bank and all other borrowers to do the same so as to protect their interest. Then the company’s fate may become a self-fulfilled prophecy due to cashflow problems.

What if the company fold up? The good news is that bondholders are the first “claimer” when the company liquidates. The company’s remaining assets will be sold off, cash realised will be use to pay back the bank and bondholders first. These lenders are on top of the list.

So Is That All?

Unfortunately, no! So we know that the best time to buy bond is when interest rate is high, when the business cycle is around the peak, when there are enough evidence to believe that the bull run is unsustainable. The biggest problem is – how do you define “high”? How do you know if a downturn is coming? How do you know that US will ignite a recession in 2008? Didn’t George Soros predicts a recession this year? How about asking the economists? Well, if the economists is that good, how come he/she is still earning employment income? By the way, I thought only God knows the future? Imagine if I followed some analysts’ prediction and dispose off all my shares last year, I’ll be crying now. This year, global stock markets are bullish setting one record after another even in the midst of rising oil price and US subprime woes. If you ask if I have any clue, I have no clue. Yes, the best thing anyone including any expert can do is only to analyse, assess and to come up with his/her BEST GUESS.

My recommendation is this:

1) Do your homework, make your best guess. Nobody knows who is correct. People only comment on the result. When a decision is proven to be wrong, then everyone will start saying that “you should do this or that because of this and that”! It’s human.

2) If you want to shun away from volatile equity market especially if you seriously believe that the bull is coming to an end, start switching to fixed income instrument. You may not need to do it instantly like disposing all your shares in a day. You can do it gradually by reducing your equity portfolio's size.

3) If you want to invest in fixed income instrument, avoid one with currency risk. And buy investment-grade local bonds (or bond funds).

4) If you buy SGS, you can either buy the existing ones or newly-issued bonds. Personally, I will advise you not to select bonds with very long maturity period such as ten years. Find one that is you are comfortable with the yield and maturity period, say three or five years. If you don’t want to go through this pain, then pay for a fund manager.

5) Assuming that your analysis is correct, you had protected your loots. You shall wait for the dust to settle. When that day comes, i.e. business cycle on recovery again, if your bonds expired, you will get back your capital. Otherwise you can sell it in the open market and get your capital gain. You have huge amount of cash and is ready for another upswing of the business cycle. And the story continues.

Conclusion

So here we come to an end on my sharing of long-term winning strategy in good times and in bad times. Lastly, in case you’ve forgotten the ultimate objective of all these efforts in investment, I need to remain you again. The ultimate objective is not to buy a bigger house or car. Buying bigger car is one “xxxxx” things to do. No offence to anyone but if you read books from successful investment gurus or wealth creation experts, you will know what I mean. Early gratification is unwise. The ultimate objective is for comfortable retirement or even early retirement (as in the case of Robert Kiyosaki) where you never worry about sufficient savings till the day you meet your Maker; where you can continue with the lifestyle you used to have with your wife. If we can survive through a few business cycles successfully, this will not be just a dream.

Investment Strategy - Surviving The Economic Downturn (Part III)

Determination Of Bond Price

Before we continue, if you just want to buy bond, you can skip this session. You don’t really need to know how bond price is determined especially if you buy bond fund. The fund manager is paid to get some brain cells killed. But if you like to know more, then this session is important. Everyone knows how the price of a stock is determined – supply and demand. But for bond, it is not by supply and demand. It is purely mathematical. Firstly, for newly issued bonds, every unit will be priced at $1,000. Note that price of bonds are quote based on par value of $100. This is different from equity fund; just accept it. After a bond is issued, the price will change. To know how we determine existing bond’s price, let’s go through the elements that will affect bond price:

- Time (or maturity period)
- Coupon rate
- Future value (par value at redemption)
- Current interest rate or yield

I won’t go through the definition again. If you look at these elements carefully, you will realised that only the yield will change from time to time. The maturity period (or the remaining life), the coupon rate and future value cannot change. Therefore, only yield will change thus directly affecting the price. Or only the price can change and it will directly affect the yield. Their fate is intertwined. With a financial calculator (or using a web-based bond calculator), if you increase the yield, the price will fall and vice versa. This is the inverse relationship between bond price and yield (or current interest rate). Like I say, it is purely mathematical. Play around with the calculation and you will understand.

Inverse Relationship Between Market Interest Rate And Bond Price

You MUST remember this by hard even if you don’t understand - the inverse relationship between bond price and market interest rate. When interest rate goes up, bond price fall; when interest rate comes down, bonds price rise. So if the government (e.g. US’s Fred) increase their interest rate, the banks will follow and existing bond price will drop and vice versa. Again this is purely mathematical. No tricks and not by supply and demand. We can prove this easily with a financial calculator. But even without a calculator, we can also understand it with our common sense. Firstly, when the government announce an increase in interest rate, you wouldn’t buy existing bond, i.e. those that are already issued and available in the open market. Why? This is because the new bonds will be issued with comparatively higher coupon rates following the government’s new interest rate direction. Remember that I say the coupon rate of a bond is fixed? Thus you have no incentive to buy existing bonds with comparatively lower coupon rate. As such, these existing bond prices’ will fall and adjusted immediately such that the yield equals to current interest rate, generally speaking. Thereafter, you are indifferent to whether you should buy the newly issued bonds or existing bonds since they all gives you about the same yield. I repeat again – the YIELD should be your ultimate focus.

“Hey, I am an artist; I have no clue what you are talking about!”

Then forget about the above explanation and just remember the relationship by hard! We are going to use this knowledge to set our investment horizon; our strategy. Please take note that I am not talking about timing the market (buy in December and sell in January) but setting investment horizon. Let's say the economy just recovers from recession, interest rates are generally low. In the process of recovery to full-blown bull market, the government will increase the interest rate gradually. Imagine you bought a 10-year bond before economic recovery, say in 2003 and your initial intention was to hold it until maturity. Then you witnessed strong economic recovery and a few interest rate hikes. And everyone is making tonnes of money from equity. You gave up and decided to sell your bond before its maturity but you need to sell at a capital loss.

Let’s see how much you have learnt. My first one million dollar question:

Q. When is the best time to buy bond?
A. …….. Don’t know.

At the peak of a business cycle! The economy is bullish and interest rate is high. Everyone knows that what goes up must come down. It’s a matter of time. So if you believe that the bull run is over and recession may start in 2008, now is the best time to get out of equity and switch to bonds. When global economy really goes into recession for next few years, interest rate will fall. Governments will cut rates to boost business investment. And what happen when interest rate fall? Your bond price will goes up and you have two easy options:

1) Continue to hold and earn your higher coupon.

2) Sell it in the market for capital gain.

To formulate strategy, understanding this relationship is very important. If you don’t understand then remember by hard.

In The Event Of Default

I mentioned previously that the borrower must deliver its promise “without fail”. Although the borrower guarantees to pay you back on maturity date, it does not mean that Bonds are risk-free. What if the company fold up along the way? If you really want to play safe, you can lend to the government instead. Since the corporate bonds (or commonly known as debentures) carries a higher risk compare to the government bonds (on apple-to-apple basis), its coupon rate tends to be higher, all else remains constant. Let me illustrate this with an excerpt from an article “Corporate bonds risky on two counts” in Business Times during recent recession.

“SOME investors have been tempted into investment-grade corporate bonds this year because yields have been relatively attractive compared to money market returns. But events in the past few months have illustrated the risk of these investments. US and European bank and corporate bonds have been downgraded. Ford Motor's benchmark bond, which has been regarded as investment grade, is another example of the risks involved. Just over a week ago, Ford's ten-year bond maturing in 2011 was priced on a yield of 9.25 per cent. This was a spread of 565 basis points, or 5.65 percentage points, above 10-year US Treasury bonds, which were yielding 3.6 per cent. Such a spread is generally allocated to high-risk bonds. "

Business Times - 21 Oct 2002
Archived Hock Lock

To be continue…..

Investment Strategy - Surviving The Economic Downturn (Part II)

Bond’s Credit Rating

Like movies in Singapore, bonds are also rated. There are high-risk bonds (like RA movie, risky for youth) and low risk bonds (like PG movie). As usual high-risk high gains and low risk low gain; you know the rule. The higher-risk bond naturally comes with higher coupon so as to compensate investors for assuming additional risk and vice versa. Currently, there are credit-rating agencies that businesses and investors frequently used. They are Standard & Poor's, Moody's and Fitch. Just to give you an idea on these agencies rating system:

1) Standard & Poor's

Investment Grade:

AAA : the best quality companies, reliable and stable
AA : quality companies, a bit higher risk than AAA
A : economic situation can affect finance
BBB : medium class companies, which are satisfactory at the moment

Non-Investment Grade (also known as junk bonds):

BB : more prone to changes in the economy
B : financial situation varies noticeably
CCC : currently vulnerable and dependent on favourable economic conditions to meet its commitments
CC : highly vulnerable, very speculative bonds
C : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
CI : past due on interest
R : under regulatory supervision due to its financial situation
SD : has selectively defaulted on some obligations
D : has defaulted on obligations and S&P believes that it will generally default on most or all obligations
NR : not rated

2) Moody's

Investment grade:

Aaa : highest quality, with minimal credit risk.
Aa1, Aa2, Aa3 : high quality and are subject to very low credit risk.
A1, A2, A3 : upper-medium grade and are subject to low credit risk.
Baa1, Baa2, Baa3 : subject to moderate credit risk. They are considered medium-grade and as such may possess certain speculative characteristics.

Speculative grade:

Ba1, Ba2, Ba3 : speculative elements and are subject to substantial credit risk.
B1, B2, B3 : speculative and are subject to high credit risk.
Caa1, Caa2, Caa3 : poor standing and are subject to very high credit risk.
Ca : highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
C : lowest rated class of bonds and are typically in default, with little prospect for recovery of principal or interest.

3) Fitch

Investment Grade:

AAA : the best quality companies, reliable and stable
AA : quality companies, a bit higher risk than AAA
A : economic situation can affect finance
BBB : medium class companies, which are satisfactory at the moment

Non-Investment Grade (also known as junk bonds):

BB : more prone to changes in the economy
B : financial situation varies noticeably
CCC : currently vulnerable and dependent on favourable economic conditions to meet its commitments
CC : highly vulnerable, very speculative bonds
C : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
D : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations
NR : not publicly rated

Obviously, triple A bonds are the most reliable. Bonds issued by Singapore Government are rated “AAA”. Do I memorise all these agencies rating system? Of course not! Not even for my examination…. crazy. But my lecture taught me a short-cut method to differentiate between investment grade bond and junk bond. If you are risk averse, then avoid any bond where you can’t find even one cap-locked “A” on the rating. In this case, you are sure to avoid junk bond. A junk bond is also known as a "high-yield bond" or "speculative bond". These bonds have higher credit risk are usually purchased for speculative purposes. Junk bonds typically offer interest rates three to four percentage points higher than safer government issues.

How to Invest In Bonds

You can invest in bond by placing your money with a fund manager and let him invest for you…. at a small commission of course. In this case, you are buying a bond fund, or commonly known as fixed income fund. As a bond fund does not require active trading, the expense ratio is generally low as compared to equity funds. With the pool of money, the fund manager will invest in many bonds. The advantages:

1) If you have no time for this, let the fund manager do it for you.

2) You lack the expertise so let the experts to do it for you.

3) Bond fund allows you to diversify your risk, i.e. risk is spread across.

4) If you intend to invest for a very long time especially if you’re at retirement age, it’s better that the fund manager do it for you. In this case, you don’t have to keep buying bonds when existing one expires. Also you won’t have a problem with the re-investment assumption of the bond yield. This is a bit technical; you can skip it.

Alternatively, you can buy bond directly from a company or the government. In Singapore context, our government-issued bond is known as the Singapore Government Securities (SGS). If you buy a bond directly, your investment will come to an end at the maturity date stated on the paper. If you invest through a fund manager, all else remains constant, it will be there for as long as possible. Note that for all my subsequent sharing and illustrations, I will assume that you buy the bond directly instead of buying a bond fund.

You can invest in any kinds of bonds through Fundsupermart.com. There are other distributors such as banks but since I am more familiar with Fundsupermart.com, I’ll use them for illustration purposes (“free marketing”). I had an investment account with Fundsupermart.com but I don’t have any financial interest in that fund distribution company. Assuming that you want to buy SGS, from Fundsupermart.com, you will find the following list of SGS:

Firstly, please focus on the yield. The yield takes into account current selling price and the coupon. Pick one which you are comfortable. Of course if you pick the highest yield (3.12%), that bond has another 19.34 years before it matures. This is because the longer the maturity period, the higher the yield and vice versa. So assuming that you want a bond with around five years maturity and click on “NX03100Z”, the following details will appear.

Now stay focus. The fact sheet will show the bond’s remaining life; it’s annual coupon and yield. The coupon rate is the interest that you will actually receive calculated based on 2.25% x par value (in multiples of $1,000 per unit). Par value; not market value (bond price can move up and down). So for every unit you bought, you will receive $22.5 every year. The yield tells you your actual rate of returns because yield takes into account your purchase price. In this case, the current indicative price is $98.5. So every unit will cost you $985 - that is below the par value of $1,000! And you know that you will receive $1,000 back at maturity. That is why your actual rate of returns (the yield) is higher than the coupon rate. Make sense?

“Hey I am a doctor and I still don’t understand what you are talking about!”

In that case, just look at the yield and maturity period. Pick one bond that you are comfortable with the yield and maturity. Still cannot? Get yourself a fund manager..



To be continue…….