Saturday 3 August 2013

Behind Every Successful Bear Market Recovery is A Cash-Like Instrument

29 July 2013 marks the end of the OCBC 5.1% Non-Cumulative Preference Share (NCPS). I had held this stock steadfastly since its inception 5 years ago, only liquidating it partially to raise cash for the equities and REITs during the Global Financial Crisis (GFC) in Oct 08. I seldom think about this stock, but now that it is gone, I'm beginning to remember its importance to my portfolio and investment strategy. This blog post is dedicated to this stock which has served me so well in the past 5 years.

Firstly, to understand its importance to my investment strategy, you have to understand that I have an equity-centric investment strategy. This means that I think of asset allocation primarily as between equities and non-equities. As to what the non-equities should comprise is a second-order question, so long as I can liquidate the non-equities when the equities portion calls for it (see the post on Have a Plan for a brief description of this investment strategy). Ironically, the most important part of this equity-centric investment strategy is not the equities portion, but the non-equities portion. When there is a bear market, most shares will decline, almost independent of which shares you bought. At this time, you'll wish to have a cash pile to invest in equities at now much lower prices. The ability to raise cash from the non-equities portion then becomes key, without which you are basically at the mercy of the market. To be a good cash-like instrument, it must be able to raise cash quickly and at minimal loss. If cash cannot be raised when needed or at an unacceptably large loss, it would jeopardise the opportunity to buy low and sell high subsequently. While cash is the most obvious choice, it suffers from the ravages of inflation, which for the last 5 years, was at an unusually high level. On the other hand, OCBC 5.1% NCPS (and its elder sibling, OCBC 4.5% NCPS, before its inception) paid a 5.1% dividend semi-annually, which was just able to keep up with inflation that averaged 4% a year from 2008 till 2012. It was also a very stable stock, exhibiting very little volatility and correlation with the stock market. Its biggest one-day decline was around 2.5% every 6 months, on the days it went ex-dividend. So, OCBC 5.1% NCPS became the key cash-like instrument of the non-equities portion.

Was it able to perform its role as a cash reservoir for the equities portion when the time called for it? There was only one time in the last 5 years when it was called into action, which was during the GFC. Unexpectedly, due to the financial nature of the GFC, it fell by as much as 17% at the depth of the crisis in Oct 08. I sold half my holdings at 8% loss in that month to invest in REITs and shares, which fell by even more. So, despite losing money in selling it, I more than made up for it with the subsequent rise in REITs. In the one instance when it was called for, it has performed its role admirably, even though it did not quite fulfil the criterion of minimal loss.

While the NCPS was the non-equities of choice, it was not the only non-equities instrument I had. Prior to the GFC, I had presumed that REITs and Business Trusts (BTs) would only record small losses during a bear market and could still be liquidated to support the equities. To my horror, the REITs and BTs fell by as much as the equities. Most of the BTs never recovered and ended up as major losses. As for the REITs, they had fallen so much that it did not make sense to liquidate them. In fact, they were competing for cash with almost 1-for-1 rights issues at near 40% discounts to the prevailing market prices (which had already fallen off steeply)! You never knew which ones in your portfolio would be the next ones offering a rights issue. So, you had to reserve some cash to cater for the REITs' rights issues at a time when the equities portion were also screaming for cash injections. From this perspective, OCBC 5.1% NCPS performed really well among the non-equities as a cash reservoir.

The second key role the NCPS played was in preventing a major loss in other high-yield instruments. Around the time of its inception, the minibonds were quite popular with their handsome dividends. I was also tempted by their dividends and the role they could play as a cash reservoir. However, considering that firstly, the NCPS' dividend was comparable to that of the minibonds; secondly, the NCPS' share price could be observed directly; and thirdly, the NCPS could be sold and settled in 3 working days, the idea to invest in the minibonds was abandoned.

Was there any other areas that the OCBC 5.1% NCPS contributed? It and its 4.5% sibling showed that a market pricing discrepancy could continue for a very long time. In the post on Preference Shares, I had explained that because of the 12% difference in their dividends, the 5.1% NCPS should be priced about 12% higher than its 4.5% sibling. But the market only priced in a 4% difference (after accounting for a difference in the timing of the dividends). Throughout the 5 years of its existence, this discrepancy wasn't corrected.

To conclude, OCBC 5.1% NCPS was truly boring stuff. But it saved my portfolio and allowed my equity-centric investment strategy to withstand the market test of a lifetime. Thank you so much. If there were any regrets, it would be that I had seldom appreciated its importance and that it is no longer around.

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  1. Have you considered OCBC OCC 5.1% ?

    1. Hi Cory,

      Yes, I've considered OCC 5.1%. The reason why I didn't invest in this preference share is because its dividend rate will reset from 5.1% to 3-mth S'pore Swap Offer Rate (SOR) + 2.5% in Sep 2018. While we won't know what the SOR will be in 2018, the dividend rate is likely to drop below 5.1%. My take is when the dividend rate is reset, the share price will also drop. So, it can't fully preserve the capital.

      (The) Boring Investor