Sunday, August 20, 2017

It is time to harbour some doubts about the STI ETF.

It is now about the right time to start casting doubt on the STI ETF. At this time, a lot of my fellow bloggers have started to integrate the STI ETF into their primary strategies and it would be useful to consider counter-arguments against using the STI ETF as a primary tool to extract market returns from the SGX counters.

Before I start, active managers have waged a media campaign against ETFs for quite a while now and you can easily find such articles all over the web. When I criticise ETF strategies, I am not suggesting that we regress and begin looking at expensive active management funds again. No sane investor should tolerate high management expenses only to have unit trust managers try to replicate the STI ETF to minimise their career risks.

a) If everyone invests in the STI ETF, the market will fail.

The primary argument against ETFs is that when everyone invests in it to the exclusion of everything else, the market will fail because you can't reward well run companies and punish those which are run badly. This argument is relatively weak because there is currently no risk of everyone investing in ETFs. Even if the risk were to ever happen, we would likely see many smart beta ETFs in the market to ensure that this would never come to pass.

The question has always been whether your performance would be inferior as adoption of the STI ETF ramps up over the next few years.

b) Equal weighting the STI index components leads to better performance.

The STI index is biased towards stocks with a larger capitalisation and the banking sector. Right now the banking sector is dealing with the bad loans from the O&M sector.

In the last event by BigScribe, Teh Hooi Ling reports an annual performance of around 3.5% over 10 years for the STI. I backtested a portfolio that uses equal weights in the STI index and I can report a 1-2% improvement over the STI ETF.

This would have been a great argument to buy STI components in equal proportions directly until I figured out that the minimum size of an investment in Jardine Matheson Holdings is $6,520 USD. The minimum portfolio size you will need to craft an equal weighted STI portfolio is slightly less than $300,000 SGD.

c) Using a sane retail investment strategy can result in superior performance quite easily.

So far in all my backtests, it does not seem to difficult to beat the STI index. Choosing REITS that yield between 6-8% can result in double the performance, so can simply looking out for stocks with a dividend yield above 7%. It also seems that Factor investing, taught my many credible providers like Dr Wealth, can consistently outperform the markets if the horizon is long enough.

Of course sane is not a very objective measure.

For me, sane means that it should begin with a hypothesis about over performance. For example, the idea that cheap stocks outperform, with cheap being  a low P/B ratio or high yields. Then this needs to be backtested. As an added measure, the strategy should remain robust when employed against data from a different market. As a bonus, you should also read up on analysts who specialise in bottom up investing to understand the state of the companies you are investing in.

Overall, the STI ETF remains a much welcomed innovation in the markets. Combined with a Asian Bond ETF, it allows most retail investors to basically put in a market position and then tune out of monitoring the markets. Furthermore, a lot of of financial bloggers welcome this instrument as we conveniently have an answer to any novice who wants to know what is the best way to invest their first $10,000.

But for intermediate investors who can afford more time on investing their money, it's time to start thinking about how we can craft a portfolio which goes beyond the STI ETF in effectiveness.

If we do a good job at that, we might even save the STI ETF strategy from it's own success.

Friday, August 18, 2017

Efficiently Inefficient #5 : General principles of portfolio construction.

This books is really shaping up to be something that is good for novices and the experts.

Today I will talk about six very basic principles of portfolio construction. It is actually quite humbling that my own portfolio does not make the cut for all of these principles.

a) Diversification

The first principle is to diversify your portfolio. This is the only known free lunch in finance. This is best done across asset classes and industries. For folks like me who focus on dividend yields, it is much harder to conform to these principles. I normally look at REITs, business trusts and high yielding equity counters to get the job done. Ideally, you have to throw in annuities and some high yielding bonds into that mix.

b) Have position limits. 

You can have too much of a good thing. Always ensure that no matter how attractive an investment is, it should be limited to a reasonable proportion of your portfolio. 5% is a great number but for me this is more like 15%. This is not too straightforward if you only go for REIT yields because half the SGX would mean investing in only 20 REIT counters, so you have to look at other industries to keep your position limits low.

c) Make larger bets on high conviction trades.

At this stage, you have to deviate from the vanilla ETF strategies and look for high conviction investments and be willing to put more of money in it. Some folks are willing to do this if they like a particular story. For me, I like to use statistical tools to make my decision and generally speaking, the larger the yield, the larger stake I take.

d) Moderate your position by the risk of the underlying investment

The higher the risk of a position, the lower you size it. To balance (c) and (d), I try to reach for higher returns at a lower risk via my back-test, then I employ some leverage so that i can sacrifice a smaller part of my portfolio to take a larger stake in a margin account.

e) Correlations matter

This is violated by me because of the amount of number crunching involved. REITs are generally tied to real estate and move in tandem with real estate trends. Ideally you need to balance out your investments with other countries and industries but this is a mathematical exercise. Correlations also tend towards 1 in a very bearish market making this a very difficult exercise to do properly as a retail investor.

f) Resize positions dynamically.

Once you have all the five principles in action, you would need to react to resize your positions when the risk changes. The simplest expression of this principle is to rebalance your portfolio at regular intervals. This is also very hard to achieve for retail investors who may not have the time and discipline to make this happen.

At this stage, I can only say that I can apply these principles on a best-effort basis. This is something I need to keep in mind if the winds of changes were to affect my legal career.

If I go professional, these principals are possible the bare minimum that I have to adhere to before I start playing with other people's money.

Bonus : Read the Kelly Criterion from an earlier article or Wiki it to understand more about position sizing.

Wednesday, August 16, 2017

New insights from Ramesh s/o Krishnan v AXA Life Insurance Singapore Pte Ltd

Sometimes, a lawsuit sheds such interesting insights on the world of financial planning, it becomes impossible to resist making a small mention of it on this blog.

I will not write about the legal issues raised by this case as I expect a lot of more qualified folks to discuss this negligence case in the next few months.

Just two points before my classes start :

A) Persistency ratios.

The insurance industry tracks this very interesting ratio which tracks the percentage of policies sold by an advisor that are still in force after a certain period of time. So if an agency has a 13 month persistency ratio of 10%, it means that after 13 months, 9 out of 10 policies are no longer in force, consumers have have cancelled those policies within that year. 

Sadly, the industry does not have a standardized mechanism to define what a persistency ratio is and how it should be reported to authorities. If MAS can standardize that all insurance companies should standardise their persistency ratios for Term life, whole life and ILPs for a fixed period like 36 months and make this metric transparent, we would actually have a means of measuring how much regret a consumer is experiencing when buying insurance products.

B) Twisting of policies.

The second insight is the concept of twisting which was also mentioned in the case. Twisting occurs when a financial planner advises a customer to drop an existing policy only to pick up another very similar policy. Twisting occurs to the detriment to the consumer because he or she incurs a sales charge all over again for a new policy.

Naturally, when an agency cultivates an aggressive sales culture, advisors may end up twisting their customer's policies. When done industry wide, persistency ratios will go down.

This case is a fascinating read even though it is tad long at 50+ pages.

Technology can come to the rescue of the hapless consumer of financial products. I imagine a future where MAS or a consortium of companies sets up a blockchain registry that tracks the take-up and put-down of all insurance policies so that citizens can go to a central website to track the persistency rate of the agencies they deal with and the specific products sold by an insurer. 

This would keep agencies and insurers honest. 

In the meantime, readers can try to pep their financial advisors on the persistency ratios of their agencies although I think you are more likely to draw a blank stare in return. 

( If you actually do that, do share your results with me. )

Saturday, August 12, 2017

Efficiently Inefficient #4 : Backtest Noob musings.

There are some murmurings that I am emerging as some sort of back-test guru but that cannot be further from the truth. I am still very much of a noob and have a whole lot more to learn.

Today I will take about some aspects of backtesting that I will need to straighten out to improve some of my own investing strategies.

a) Understanding superior returns

The book explains that there are just two sources of superior returns. First, acceptance of liquidity risk. And second, superior information. Back-testing may refers to obtaining of superior information that compares strategies against each other although some of the counters flagged by a stock screener can lack liquidity. ( Like my frustration of being unable to buy more Global Testing stocks )

b) The problem of trading costs

Bloomberg's backtesting tool should allow us to factor in trading costs. In such a case, monthly rebalancing is costlier than annual rebalancing.

c) Data-mining as a serious form of bias when backtesting the markets

Kyith Ng of Investment Moats asked me privately what would backtesting results be if I changed the order of stock selection in my screens. So instead of choosing the highest dividend yielding stocks and then looking for those with the lowest gearing, I would look for REITs with the lowest gearing and then find the highest yielding stocks in the set. Both backtests will yield different results so one will clearly be superior to the other.

We will always be seduced into backtesting more sophisticated screens to get a higher return or lower risk but we are still operating on one historical dataset and may overfit the data.

d) Need alternative sets of data.

One day to preventing ourselves from data mining would be to test a different set of data with the screens which I have unfortunately not done in any of my talks so far.

We first find a strategy that works in Singapore, for example dividend stocks with sustainable free cash flows. We use a completely different set of data like the US or Japan and we observe to see if we can obtain outperformance in a different market.

This gives us better assurance that our investment ideas are not completely off the wall.


Friday, August 11, 2017

National Day Middle Finger Meditations

It is amazing that a day before National Day, I made an obscure reference to Henry Park and the Law of Attraction responded by giving all of us this courageous kid from Henry Park who took the chance and gave the middle finger to all Singaporeans during National Day. I am sure the poor kid must have been given a hard time by his parents or teachers for what he did.

Before I share with everyone my version of the moral of the story, let me share with everyone a small snippet of my life.

SMU Law Faculty is under new management and it's fair to say that things are certainly getting better for SMU Law Students. For the first time in my life, I sense that SMU is trying to engage with alumni and working really hard to consult with us on making key changes to the syllabus and pedagogical techniques. The alumni responded enthusiastically and I could certainly feel the passion in the seminar room with the new Dean talking directly to us.

But one small observation bothers me.

As I am quite clueless about the legal industry, some JD classmates pointed out to me that the eager folks who came back to help out were the older generations of former Justice Legal Clerks and basically the best of the best that SMU ever produced. If Law School were DC comics - these guys are the New Gods; if Law School were Marvel - they are the Inhumans. They gave well argued points on how legal education can be improved and enhanced and backed it up with industry experience.

[ Side note : Do Law undergrads pay some version of Magic the Gathering that feature prominent lawyers and member of the bench ? Can I tap my Associate and Trainee card to play a Writ of Summons ? Can you tap a tap a Senior Counsel to play a Strike out my Proceedings card ? ]

Then it suddenly hit me.

This is just like a JC reunion. Successful folks will come back to see how everyone else is doing. More ordinary folks will not want to show their face unless they are also into MLM or insurance.

The views represented in alumni feedback sessions, through no fault of anyone, would be overly represented by the folks who had the most positive experience of SMU law school. Why else would you come back?

Law School is awesome when you're kicking ass, but it's worse than eating SAF coconut bun in the 90s when your ass is being kicked.

There may be fewer folks who represented the views of those who might be able to give valuable feedback which makes Law School better for the rest of the 80% of the graduates, such as those :

a) Who tried hard by missed out from getting with a Latin distinction grade by 0.01.
b) Got dumped by bf/gf just before the exams.
c) Who fell sick and had to drop out from the entire semester.
d) Just can't get their writing up to par to meet university standards.
e) Almost had a nervous breakdown from the workload because they have no muggers.
f) Became class pariah and was never willingly invited to form a group with someone else.
g) Who are enraged by some professors who can get tenure in spite of being tardier than a Henry Park primary school student.

Social science research has that same problem. Some research samples are drawn from US universities and run into the bias of being white, industrialised, democratic, highly-educated and rich.

But let's come back to National Day.

If you want a primary school that represents highly successful Singaporeans whether they are parents or students in the future, you will choose to feature a bulge-bracket white-shoe primary school like Henry Park. And then you hope that a successful upper middle-class kids will never give you the middle finger... That hope was dashed last night.

I would like to celebrate the NDP middle finger.

It reminds us that no system is perfect.

It's not even close when everyone is trying their best.

The Changkat Monyet Primary School kids stayed largely at home to watch NDP or may be helping out at their parent's hawker stall. They can't give you the middle finger, but when they get shunted to the Normal(Technical) stream and look forward to a life of constantly being undervalued by society, they might just decide to give a big "fuck you" to the society they live in. The 30% who keep blaming everything on the 70% has a constant middle finger thrown at the rest of Singapore.

But things are looking great.

At least in yesterday's NDP - These folks were represented.

[ Note : I think a bunch of us ordinary mortals were quite committed to future Alumni activities and we've made a pact to attend as many as we can in the future. ]

Tuesday, August 08, 2017

How Singaporeans can be their worse enemy !

Every National Day, I will try to write something to get readers thinking about some important issue they are likely to experience in the future.

Of late, I have been trying to get my daughter into the primary school that is the located closest to our HDB EC. Westspring Primary School has recently been in the news in a good way lately so it is highly sought after by residents in my area. To keep the long story short, we got extremely worried when we had to ballot under Phase 2C but in the end we managed to get a seat in the Primary school of our choice.

While you may want to congratulate me for my good luck, I recently discovered that my own primary school,  Bukit Panjang Primary School, an extremely silly and mediocre place in the 80s (where some of us had to engage in melee with Primary 8E and 8M students) has climbed up the ranks and now positioned at 36th place nationwide. My alma mater is now one of the upper tier primary schools in Singapore.

Not putting my kids into my own primary school was not a straight forward choice. We are confident of the high standard of education in all primary schools in Singapore but have no illusions about the social economic status of classmates my daughter will meet and the lifelong friends she can hope to have when we vary our primary school choices.

In the end, a short commute would save costs and give my daughter more time to sleep. So neighborhood school it is.

The ability of Singaporeans to secure their children in top primary schools through legacy admissions is one of the biggest weaknesses of our meritocracy and belongs to a class of behaviors known as opportunity hoarding.

While it is very convenient to blame the top 1% in wealth and income, a lot of opportunity hoarding is conducted by folks largely by myself  and readers of this blog who belong to the top 20% of the Singapore population.

Yes, we, Singaporeans of the top 20% are the worse enemy of Singaporeans.

The upper 20% has evolved from just buying better toys and game consoles for their children to doing something with time and money that can entrench their kids in the upper crust for life.

Consider this, a neighborhood primary school is often lacking in volunteers. In contrast, in our best primary schools, a presentation on the human body can be made by a medical specialist who wants to volunteer to give a head start to his own child via Phase 2B. A fairy tale can be narrated by someone who is a legal counsel for the same reason. The upper crust volunteers in the best places to get their kids into the same slots that gave them the social networks that played a role in their success. The situation in universities can be worse when rich folks can pay to put their kids in foreign universities and can insure them from bad A level results.

Opportunity hoarding can also be subtle. Some medical guidelines state that babies should be optimally breastfed for 6 months. In Singapore, however,  maternity leave lasts only 4 months. The most powerful couples can afford this luxury for their children because the father is capable enough to hold the fort while the mum finds some way to spend more quality time for their kids. Assortative mating, where the best graduates marry each other, account for 40% of income inequality in many Western societies.

For interested readers who want to know more, how the upper middle class is leaving everyone else in the dust in the US can be found in Richard Reeve's Dream Hoarders, which in my opinion, is a lot worse than what is faced in Singapore.

At the end of the day, I can't change the way I play the game because the future of my own kids are at stake. In fact, I intend to play it to the fullest and bring the financial markets into the picture to boost their chances of succeeding in the future.

So expect no quarter from the top 20% of Singaporeans.

Amazingly, PM Lee, is already on the case putting enhancements to pre-school education as a top priority which is heartwarming.

Our government needs to be a government for all Singaporeans, not just Henry Park Singaporeans.

But we can do more.

I can imagine Singapore mining a new kind of crypto-currency that can be used when wealthier parents volunteer in the neighborhood schools. Mining of the coins is inversely proportional to school popularity and awarded proportionally to volunteers and these coins can then be traded to get their kids into the best primary schools in Singapore. This currency can scale to provide some sort of remuneration to volunteers and do-gooders in our society. I would definitely spend more time giving library talks to get these SamaritanCoins in my wallet.  

That is the least we can do - eliminate the ability of old boys from sending their kids into their own primary schools and create a system to grant incentives to folks who help in schools that need help the most.

This way we can build a better age for our children where our generation's best is yet to be.

Saturday, August 05, 2017

Deep REIT investing insights from Investors Exchange 2017

Sometimes, the good stuff needs to wait until after a seminar is over.

As speakers in BIGSCribe events are also investors, we are also part of the audience when someone else is speaking.

Kenny Loh or Marubozu gave a fantastic presentation on REITs investing and runs a course here. Here are the results of my back-testing to refine my own REIT investing strategy using the insights I learned from Kenny Loh's Three Musketters approach to REIT investing. Paying customers would already have some sort of quick tutorial on what semivariance is from my presentation.

a) Baseline - buying all REITs at one go

If you buy all 41 REITs in equal proportions, your returns would have been 8.5% with a semivariance of 13.67% for the past 10 years. This is our baseline and I recommend that every investor who might not want to go too deep into screening should just buy all the REITS in SGX in equal proportions.

b) Choosing REITs with the highest Yield 

As I have spoken in my own presentation, buying half of the higher yielding universe of REITs can outperform the strategy of buying all the REITs in the SGX universe. Last time I backtested 9.64% with a higher semivariance of 14.25%.

c) Choosing REITs with the lowest Gearing

Kenny spoke about looking for REITs with a lower gearing. I backtest a strategy that buys half of the REITs in SGX with a lowest debt to equity ratio. Once again, I was able to outperform at 9.56% with semivariance of 13.98%.

d) Choosing REITS with the lowest Price to Net Asset Value

Kenny spoke about being careful when looking for REITs with a high net asset value. I backtest a strategy that buys half of the REITs in SGX with a lowest pice to book ratio. This time I underperformed at 7.28% with semivariance of 15.08%.

Attempting to buy a dollar worth of real estate with 99 cents actually backfires on the investor with lower returns and higher risk.

e) Super-duper REIT screening strategy

So thanks to Kenny, there are at least two working strategies. Find REITs with a high yield and low gearing. I combined both screens, searching for the top 50% highest yielding REITs and then within that set, short-listing 50% of those with the lowest gearing.

This time I had a winning strategy in my hands. A final return of 13.16% with a semivariance of 14.49%. It has a fairly high Sharpe ratio of 0.54.  1 in 40 years, you may lose about 16% of your portfolio value, making this something which may be amenable to 200% leverage.

What is the moral of the story ?

When investors get together and mutually present seminars, our insights are silo-ed and we might not be able to extract the maximum benefit if we stick to our own investing approach. Even my 6-8% strategy returned only 10%.

Because I always make sure that I follow up on my learnings from other speakers, the blogosphere can benefit from a much sharper insight that combines the investment ideas of several speakers.

[ Note : The Singapore REITs universe is small, applying a screen to choose a quarter of sticks in the universe will only yield about 8-11 stocks. A diversified investor will need a few different strategies to build a portfolio that can withstand the test of the time. ]

Wednesday, August 02, 2017

Efficiently Inefficient #3 : Alpha shenanigans from Investor Exchange 2017

In today's segment, I'm going to talk about how to incorporate some concepts from hedge fund investing into the talk we just had last week, but first you need to remember what I reported on REIT returns last Saturday.

If you buy all the REITS in the stock market and rebalance your purchases annually for the past 10 years, you would expect to earn about 8.3%. Generous returns by any standard as the STI could barely stretch 5% during that same period of time.

Suppose you then buy 50% of the REIT universe which gives higher yields, you would do 1.15% better or earn a return of 9.45%. It does not take much mathematics to figure out that the lower yielding REITS would return 1.15% less than the average at 7.15%.

A hedge fund manager with a prime broker might be able to structure a bet that allows buying of the top 50% yielding REITs and shorting 50% of the lowest yielding REITs.

This method of investing would yield a really nice 2.3% that does not correlate with the general REIT index. So you can have a market neutral fund that returns 2.3%. This is realistic because Singapore Savers Bonds return about 2.3% risk free.

The industry calls this alpha, which in this example, would be 2.3%.

But the book also mentions this ratio called the Alpha-to-margin ratio.

Some hedge fund managers are given a lot of flexibility from their prime brokers. Suppose the prime broker allows a margin of 20% which allows the hedge fund manager to obtain a leverage ratio of 500%.

The alpha to margin ratio in this case is 2.3% / 20% or 11.5%. This is a 5x magnification of returns.

I bet this is how accredited investors can be told about market neutral returns at such ridiculous.

While it would be fun to create small portfolios like this for individuals, investing in such hedge funds was probably what led to market nightmares like what happened to LTCM. You are using a vacuum cleaner to suck up pennies on the railway while there is an incoming train.

It starts with a simple backtest suggested by an engineering geek which is then followed up generous offers of market leverage from brokers. Sometimes, a market anomaly occurs and low yielding REITs might outperform high yielding REITs for a period of time and KABOOM !

You got a disaster in your hands.