(The) Boring Investor: Investment Planning

Showing posts with label Investment Planning. Show all posts

Sunday, 20 December 2020

Possibly The Worst Time to Invest – 6 Years On

This year's blog post on the same series comes out later than usual, as I wanted to see how the rest of 2020 would pan out for my passive portfolios. In fact, my plain vanilla passive portfolio has just past the 7-year mark while my spicy passive portfolio is 5.5 years old. You can read more about them in The Passive Portfolio and The Anti-Fragile Portfolios.

In Mar this year, the unrealised profits of my 2 passive portfolios dropped by nearly half. Prior to Mar, my plain vanilla portfolio had an unrealised profit of 57.7% since inception while my spicy portfolio had unrealised profit of 54.8%. Almost half of that profit accumulated painstakingly over 5-6 years vapourised in just 1 month! Is that it, the crash that I had been waiting for in the past 5-6 years? Would stock prices revisit the lows during the Global Financial Crisis in 2007-2009? Looking back at the lost profits in Mar, I wondered if I should have rebalanced and locked in some of the profits in Feb while the Dow Jones Industrial Average reached a new high (yet again, for the past 6 years).

No, stocks did not go into an unrelenting free fall. 5 months later, by Aug, the value of the 2 passive portfolios recovered to their highs in Feb. This time round, I carefully considered whether I should rebalance out of the equity funds into fixed income funds. But the rules that I set for rebalancing at the start of the portfolios had not been reached. The rules call for rebalancing whenever allocation to the equity portion reaches either 62% or 78% (i.e. +/-8% margin from the initial allocation of 70% to equities and 30% to fixed income). Equity allocation for the plain vanilla portfolio reached only 73% while that for the spicy portfolio reached only 77%, just a tad shy of the rebalancing trigger. In the end, I decided to stick to my original rules and not rebalance.

The portfolios dipped slightly in Oct, but recovered after the US presidential elections in early Nov. To-date, the 2 portfolios have reached new highs. Unrealised profit on the plain vanilla portfolio is 65.2%, while that of the spicy portfolio is 62.6%. I am glad that I had not tinkered with my rebalancing rules when the portfolios recovered to their Feb highs in Aug. To-date, neither portfolio has reached the rebalancing threshold, with equity allocation for the plain vanilla portfolio at 74% and that for the spicy portfolio at 77%.

COVID-19 is a major public health crisis, with significant economic impact on many sectors such as aviation, hospitality, tourism, retail, etc. Stock markets sold off sharply in Mar, but thanks to the massive fiscal and monetary responses from governments around the world, stock markets have recovered from their steep declines in Mar to post new highs. We are still not out of the woods yet, as vaccination from COVID-19 would take many months to complete, and there are reports of mutation of the COVID-19 virus. Nevertheless, this episode shows that we should not stop investing because we are worried of market crashes, so long as there are good defence mechanisms in the portfolios to manage them.

See related blog posts:

Sunday, 18 August 2019

Possibly The Worst Time to Invest – 5 Years On

US-China trade wars, Hong Kong protests, US yield curve inversion, etc. You probably would be thinking now is a bad time to invest. I had the same feelings 5.5 years ago in Dec 2013, when the Dow Jones Industrial Average was then near an all-time high and interest rates near an all-time low. You can read more about it in Possibly The Worst Time to Invest. Nevertheless, I still went ahead to initiate a plain vanilla passive portfolio comprising 70% in global equities and 30% in global bonds. In 2015, I also added a more spicy passive portfolio comprising 70% in US equities and 30% in Asian bonds.

Each year, I would blog about whether that decision in Dec 2013 turned out to be correct or not. Each year, the blog post would say the passive portfolios were up and there is inherent defence mechanism to manage the fearsome stock market crashes through portfolio rebalancing. These once-a-year blog posts on this series almost sound like a broken record.

This year, the plain vanilla portfolio is up by 39.5% since inception 5.5 years ago, while the spicy portfolio is up by 34.7% since inception 4 years ago. You can read about last year's figures in Possibly The Worst Time to Invest – 4 Years On.

Each year, there are bound to be events that worry us and stop us from investing. But each year, the stock market would somehow manage to shrug off the worrisome events and continue its upwards march, reaching new highs which previously seemed unimaginable along the way. A couple of years later, would you still remember the events that stopped you from investing? Do you still remember the taper tantrum in 2013, the threat of Grexit and yuan devaluation in 2015, the shock Brexit vote and US presidential election in 2016? Some of these events have faded from memory, and some people might wonder what was the fuss that stopped anyone from investing in 2013/ 2015/ 2016, etc. But when these events were playing out, the mood was cautious and the stock markets were falling. A couple of years from now, would most people still remember the US-China trade wars, Hong Kong protests and US yield curve inversion that are causing the stock markets to drop currently?

There will be a time when the stock market crash really arrives. But no one can predict reliably when it will arrive. The best way to deal with it is not to stop investing, but to have a good defence mechanism in place while investing.

See related blog posts:

Sunday, 27 May 2018

Possibly The Worst Time to Invest – 4 Years On

This once-a-year post probably sounds like a broken record, but 4 years after I thought it was a bad time to invest (due to record high Dow Jones Industrial Average and record low interest rates then), the DJIA has not crashed yet, despite a series of corrections along the way, with the most recent one in Feb. I have 2 passive portfolios invested in index funds and adopting the portfolio rebalancing strategy. The plain vanilla portfolio has 70% in global equities and 30% in global bonds since Dec 2013, while the spicy portfolio has 70% in US equities and 30% in Asian bonds progressively built up over 2015.

To-date, the plain vanilla portfolio is up by 31.4% while the spicy portfolio is up by 24.2% since they were started approximately 4.5 years and 2.5 years ago. Needlessly to say, had I worried about the high stock prices and low interest rates back then and not started the 2 portfolios, I would not be sitting on such paper gains.

I am tempted to allocate more money from my active investments to the 2 passive portfolios, considering that all it takes is to monitor occasionally whether the relative allocation between the equities and bonds has moved significantly away from the initial allocation of 70% stocks and 30% bonds and rebalance them when it happens. In contrast, active investment requires a lot of hard work. I need to read the financial statements and annual reports, attend Annual General Meetings, understand pricing strategy and competitors' activities, etc. to understand how well the business is doing. Just take a look at M1, a stock that I blogged about recently. I spent no less than 6 posts (and another 3 posts on its competitors) to describe the various aspects of M1. Even then, there are probably still a lot of areas about M1 that I do not understand. Furthermore, the size of my M1 position is only 1/3 that of the 2 passive portfolios!

So, would I be worried if I were to invest more into the 2 passive portfolios and the crash finally happens? Obviously, I would be quite upset if it were to happen, but I would attribute it more to bad timing. One way to mitigate this risk is to spread out the investment, similar to what I did when I initiated the spicy portfolio. The plain vanilla portfolio was a lump-sum investment in Dec 2013, but the spicy portfolio was built up over 12 months in 2015. Furthermore, the rebalancing strategy will ensure that if stocks were to crash significantly, the bonds would be sold to buy more of the now cheaper stocks. There is inherent defence mechanism in the portfolio rebalancing strategy.

This time next year, I am not sure if I will be happy or upset over my 2 passive portfolios (which depends on whether the crash happens or not), but likely, it will be business as usual.

See related blog posts:

Sunday, 11 February 2018

Are There Stocks That Can Withstand A Crash Better?

Stocks tanked this week. When I was mulling over whether I should move 22% of my money into 1 stock, Global Logistic Properties (GLP), in Nov 2015, I wondered what would happen if the stock market were to crash. Are there stocks that could better survive a market crash of the same magnitude as the 1997 Asian Financial Crisis or the 2007 Global Financial Crisis? In the end, I reasoned that there are 2 categories of stocks that could withstand a crash better than others: undervalued (or at least not overvalued) growth stocks and dividend stocks.

Growth stocks are stocks of companies that are growing over the long term. If a company could grow over a long period of time, it is a matter of time before the company doubles or triples its earnings and/or book value. Hence, even if a severe market crash were to happen and wipe off 50% of the stock price, the stock price at the bottom of the crash would not be too far off the price that you bought, since the earnings or book value would have doubled. As an example, GLP managed to grow its book value from USD1.33 in 2011 to USD1.78 in 2016, representing an annual growth rate of 6.0%. At this growth rate, it will double its book value in 11.9 years. If a crash were to happen 11.9 years later and cut the prevailing Price-to-Book (P/B) ratio by 50%, I still would not have lost money. Thus, it was with this thinking that I decided to take the risk of moving 22% of my money into GLP.

Having said the above, there are a few important things to note. Firstly, the company must be growing over the long term. It is no use if the growth is limited to a few years only. The company would not be able to grow its way out of a severe stock market crash. Secondly, the holding period must be long enough. As the example above shows, it will take 11.9 years for GLP to double its book value, assuming it can maintain the growth rate at 6.0%. If the stock were to crash the day after I bought it, I would be losing a lot of money. Thirdly, the growth stock must not be overvalued in the first place. Using P/B valuation as a example, if the average historical P/B ratio is 2.0 but the stock is purchased at 3 times book value and the stock falls to half of the average historical P/B ratio (i.e. 1 times book value), it will take more than 11.9 years to grow its way out of the crash.

There are other psychological benefits of investing in a growth company in a market crash. Even though the stock price might be declining, if you know that the management is doing a good job growing the company, you will feel assured and not sell the stock in a panic during the crash. This is very important in countering the fear that most investors feel when the market crashes.

Having undervalued growth stocks is relying on the company management to get out of trouble. If you do not have a company with good management, you will need to rely on yourself. This means bargain hunting at the depth of the market crash, which requires additional capital beyond what you have already invested. This additional capital can come from either (1) your salary, (2) war chest, or (3) accumulated dividends. The first 2 methods do not need further explanation. For the third method, you just save the dividends collected from the stock during good times and re-invest them when the market crashes. For example, if the stock pays 4% dividend yield and the stock crashes to half its original price, you will need to collect and re-invest 12.5 years of dividends to maintain the value of your investment in the stock. Obviously, the higher the dividend yield, the less number of years of dividends you need to accumulate.

Similar to the growth stock approach, there are a few important factors to note. Firstly, the dividends should be fairly constant in good times and bad times. There are stocks that have high dividend payout ratios but volatile earnings. The dividends they pay are equally volatile and contribute to the volatility in stock prices. In contrast, a stock with fairly constant dividends behaves like a bond and reduces the volatility of its stock price. The lower the stock price goes, the higher is the dividend yield, which would attract other investors to buy into the stock. See What Can We Learn About Stocks From Bonds for more information. Secondly, the stock should not be overvalued in the first place. The more overvalued it is, the lower its dividend yield is, the more number of years of dividends you need to accumulate.

What about other stocks? Can they withstand a market crash equally well? Undervalued stocks will fall less, since they are already undervalued compared to other stocks. However, for an undervalued stock to rise to its intrinsic value, it will take many years and likely requires a catalyst. For cyclic stocks, in all likelihood, the industry downturn will coincide with the stock market crash and you end up with a double whammy -- low earnings, dividends and limited interest from investors.

Thus, before you invest in a stock, have a plan to decide what you would do with it in case the market crashes. It will save you from panic. Good luck!

See related blog posts:

Monday, 23 October 2017

The IQ, EQ and AQ in Investing

To be successful in investing, it takes more than just having a high Intelligence Quotient (IQ). As Warren Buffett said, "Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ." Besides IQ, Emotional Quotient (EQ) and Adversity Quotient (AQ) also play important roles in determining the outcome of our investments.

Intelligence Quotient (IQ)

IQ is about the ability to rationalise our investments. It involves setting up a framework to determine asset allocation, risk management, stock selection, stock valuation, buying and selling rules, etc. If you are an active investor who picks stocks or unit trusts, IQ is at work most frequently in the last 3 activities. Nevertheless, being able to spot a good investment is important, but not sufficient, as we shall see in the section on EQ later.

It is also not necessary for an investor to have high IQ to be successful. If an investor recognises his limitations in picking stocks, he could become a passive investor and buy a basket of market indices and still be able to reap good results. See All I Want Is To Invest Wisely for more info.

Emotional Quotient (EQ)

EQ is about the ability to control our emotions from running wild and interfering with our investment rationale. Examples are: not being influenced by peers or market rumours, not getting too excited when we spot a good investment and buy beyond our means or position limits, not chasing the stock as it goes above our target buy price for fear of missing out, not losing our nerves as the stock keeps on rising or falling, etc. Essentially, it is about making sure that we do not do something stupid that we might later regret had we thought through more comprehensively. If we have the IQ to spot a good investment but do not have the EQ to hold on to it until its full potential is realised, our competency as investors will be diminished.

Personally, EQ is my weakest link. There have been countless examples where I get too excited, chase a stock or sell too early. I also have loss aversion bias, which means that I sell my winning stocks too early and hold on to my losing stocks. In addition, I have phobia about financial crises, having gone through both the Asian Financial Crisis and the Global Financial Crisis. EQ is the area I have to work on if I wish to improve my investment results.

Having said the above, the good news is that EQ can be managed to some extent using IQ. For example, by setting rules on stock valuation, position limits, target prices, etc. and following them strictly, emotions of fear and greed can be managed to some extent. See Have a Plan for more info.

Adversity Quotient (AQ)

AQ is about the ability to survive difficult times, such as at the depth of a market crash. Do you give up and sell out, or do you rationally look at the situation and identify potential silver linings among the dark clouds and act accordingly? In a way, AQ is related to EQ, but there are some differences with EQ. The emotions that I associate with EQ are greed and fear, while the emotion that I associate with AQ is despair. They are different emotions and some people can handle one emotion better than another. For me, I can handle actual losses (both realised and unrealised) much better than the fear of losses. A case in point is my Oil & Gas (O&G) portfolio. Although the unrealised losses are heavy, they have not seriously dented my confidence in managing them. I am still taking steps to turn them around.

Conclusion

To be a really good investor, you not only must have high IQ, but also high EQ and AQ. I am still trying to improve in these 3 areas.

See related blog posts:

Sunday, 13 August 2017

No Need to Maximise Profits with Cash of Last Resort

CPF funds are my cash of last resort in investing. I have quite a good record of investing my CPF funds. However, that statement would be incomplete, because majority of the time, the funds are parked in bank preference shares and collecting regular dividends that pay higher than CPF Ordinary Account's interest rate of 2.5%. On equity investments, there were only 2 occasions when CPF funds were deployed. The first was during the market doldrums during 2000-2003, when I ran out of cash for investments and had to rely on my CPF funds. The second was to buy more of Global Logistic Properties (GLP) than what was allowed for in my cash portfolio (see What is My Target Price? for more info).

Since CPF funds are my cash of last resort, the overriding principle is safety rather than maximising profits. Hence, majority of the time, they were parked in bank preference shares rather than being invested in equities. Furthermore, on the 2 occasions when they were invested in equities, they were not held until profits were maximised. On the first occasion, CPF funds were invested in STI ETF when the STI was at 1,316 points in Feb 2003 and sold when the STI reached 2,169 points in Mar 2005 for a 66% gain. The STI went on to hit a high of 3,876 points in Oct 2007. The reason for selling STI ETF early was because by early 2004, the stock market had recovered from the doldrums and my cash portfolio had turned a profit. There was no longer any need to use CPF funds for equities investment. Hence, they were returned to CPF.

On the second occasion, I bought GLP at $1.985 in Nov 2016 on rumours that a Chinese consortium was interested to buy GLP. Last month, GLP announced that it had selected the Chinese consortium as the preferred bidder, which offered to privatise it at $3.38. I sold the GLP shares bought with CPF funds at $3.22, even though there is another $0.16 to gain if they were held until completion of the privatisation, which has to be completed by 14 Apr next year (unless extended). The gain is 62%. In my opinion, the job is done. There is no need to further expose the CPF funds to unnecessary risks to get the remaining gains. They can be returned to CPF until the situation calls for them again.

When you have a cash of last resort, the important thing is to keep them safe and have them ready when you need them. There is no need to expose them to unnecessary risks for longer than is required.

See related blog posts:

Sunday, 30 April 2017

Globalisation, Technology and the Home Bias

I have both active and passive investments in my cash account. The active investments are in local equities while the passive investments are in global/US equities. Part of the reasons is because I understand that passive investments, especially using index funds, can lead to better performance over active investments. In recent years, I have come to realise that there is another important reason for having passive investments that are invested globally. It is the increasing disadvantage of the home bias in the face of globalisation and technology.

Since my active investments are in local equities, I am highly susceptible to the home bias. Home bias means that an investor invests only in companies operating in his home country due to familiarity with local companies and regulations. Literature shows that home bias results in lower performance as the investor gives up the opportunities of investing in better managed companies overseas. With globalisation and technology, the disadvantage posed by home bias is increasing.

Let us use Yellow Pages as an example to illustrate the increasing impact of globalisation and technology on home bias. Before the rise of internet search engines, whenever consumers wish to search for a particular good or service, they had to refer to either word-of-mouth or Yellow Pages. Yellow Pages thus could do well as it had a monopoly on the directory of goods and services in the country. Each country has its own version of Yellow Pages, with some doing better than others due to different environments. While investors who invest only in their country's Yellow Pages might not have reaped the maximum benefits from investing in the best run companies globally, they could still do relatively well. Before globalisation and technology, home bias leads to relative underperformance, but it is still not serious.

Enter the internet search engines. With internet search engines, consumers no longer need to refer to the local Yellow Pages to find goods and services. They can search on the internet instead. Companies also respond by advertising their goods and services on the internet instead of Yellow Pages. There is also a network effect at work. The more companies a particular search engine covers, the more consumers use that search engine. And the more consumers use that search engine, the more companies advertise on that search engine. This gives rise to just a few dominant search engines in every country. The 3 dominant search engines in the world are Google, Bing and Yahoo, which all reside in US. Thus, with the march of technology and globalisation, local Yellow Pages in every country suffer declining revenue from a business that used to be very stable. Investors who invest in their country's own Yellow Pages suffer as well. Home bias, in the face of globalisation and technology, can be serious.

Although I used Yellow Pages as an example, it is by no means the only company facing increasing challenges from globalisation and technology. SPH's newspapers are facing declining readership due to internet news sites, ComfortDelgro's taxi business is under threat from Uber, hotel business trusts like CDLHT, FrasersHT, FarEastHT, etc. are facing competition from Airbnb. The list goes on and on. The examples above show that big, local companies are not spared from the competition. Not only that, the competitors threatening the local companies are all based overseas. Investors who invest only in local companies are likely to see declining dividends and share prices.

In conclusion, before globalisation and technology, home bias is a small price to pay for the familiarity with local companies and regulations. But with the relentless march of globalisation and technology, the price of home bias is more and more singnificant. It looks like I have to allocate more money to my passive investments, which are invested in global/US equity funds.

See related blog posts:

Sunday, 23 April 2017

Possibly The Worst Time to Invest – 3 Years On

This is an annual blog series that I started 3 years ago to document the worries about investing at the wrong time, which would bring losses and headaches. The blog series track the performance of 2 passive portfolios invested in index funds using the portfolio rebalancing strategy. Both portfolios comprise of 70% allocation in stocks and 30% in bonds. The plain vanilla portfolio invests in global equities and global bonds while the spicy portfolio invests in US equities and Asian bonds. The first portfolio was started in Dec 2013, while the second one was funded progressively over 2015.

In the first post in 2014, I mentioned worries about the Dow Jones Industrial Average (DJIA) nearing its all-time high (then) and US Federal Reserve planning to raise interest rates from an all-time low. In the second post in 2015, I mentioned that the same worries persisted, with DJIA touching yet new highs and interest rates moving up in anticipation of Fed's interest rate increase. Not only that, new risks emerged with oil price crashing by more than 50%, China's growth slowing down and the threat of Grexit. Yet, despite all these worries, the plain vanilla portfolio went up by 12% since its inception.

In the third post last year, I mentioned that worries about market declines actually materialised, with major declines in Aug 2015 and Jan 2016. The decline in Jan 2016 was especially severe, with stock markets around the world crashing. At mid Feb 2016, the plain vanilla portfolio was down by 0.7% since inception while the spicy portfolio lost 7.0%. Yet, by the time I wrote the annual post in Apr 2016, both portfolios had bounced back strongly. The plain vanilla portfolio was up by 8.5% while the spicy portfolio gained 0.6% since inception.

With each passing year, more and more risks materialised. Jun 2016 saw Britons voting for Brexit while Nov 2016 saw US citizens voting for Donald Trump as president. Both outcomes were unexpected and led to sharp falls in the stock markets around the world. Yet, barely days later (or hours in the case of the US presidential election), stock markets had recovered fully from their initial falls. Not only that, stock markets went on to scale new heights on optimism that President Trump's fiscal policies would spur faster growth in the US and world economies. Currently, the plain vanilla portfolio is up by 21.6% while the spicy portfolio is up by 13.7% over their respective holding periods of about 3.5 years and 1.5 years.

Personally, I still worry a lot about risks, which I wrote about in a couple of posts last year, such as What Have We Got After 8 Years of Easy Money?, Making America Great Again and Its Impact to Asia, Another Year That Ends with 7, etc. This pessimism is reflected in my active investments. Over the past 1 year, I have been taking some money off the table. Some of the risk management related divestments include Venture at $8.38, Valuetronics (partial) at $0.50, Global Logistic Properties (partial) at $1.81 and a couple of speculative shares (see Meet The Minions). Nonetheless, there are new investments, but these are in more defensive stocks such as dividend stocks, beaten-down stocks and even Gold.

In fact, I was quite tempted to tinker with the 2 passive portfolios given the strong views about the market. But I decided not to do anything about them. Had I rebalanced or withdrawn money from the 2 passive portfolios, they would not have achieved the returns mentioned above. They have built-in defence mechanisms to manage market crashes through portfolio rebalancing if the stock/ bond allocation were to deviate from the original allocation by a pre-defined amount. For these 2 portfolios, I will continue to stick to the pre-defined strategy even if the markets were to crash.

In conclusion, it is difficult to predict where the markets are heading. If you have a well-defined defence mechanism in place, just let the portfolios continue their work.

See related blog posts:

Sunday, 9 April 2017

Breaking My Valuation & Position Limits

It is official! I have broken my valuation limits on buying & selling stocks and position limits on individual stocks! Previously, I mentioned in What is My Target Price? that I have valuation limits of 1.8 to 2.0 times book value for buying stocks and 3.5 to 4.0 times book value for selling them. In Jan this year, I had broken these rules with the purchase of M1 at 4.7 times book value and Singtel at 2.5 times book value!

Also broken were my position limits on individual stocks. I have an initial position limit of $15K to $20K on each stock, depending on what type of stocks they were. These limits could be doubled to $30K to $40K if I need to average down on the stocks. The position limits were first broken in Nov 2015 with the purchase of Global Logistic Properties (GLP). Initially, I thought this would be the exception rather than the rule, considering the long-term growth prospects of GLP. However, after I invested in M1 and Singtel beyond the initial position limits, it is confirmed that the position limits have been broken.

What caused the change in my valuation and position limits? To understand the reasons for the change, you need to understand why the valuation and position limits were put there in the first place. For a very long time, I have been using quantitative methods to analyse and value stocks, looking at only earnings, dividends, cashflows, debts, book value, etc. This approach has served me well in the past, but there are times when this approach turned up value traps whose share price keeps on declining. Thus, it makes sense to have valuation limits to ensure that I do not overpay for stocks identified using this approach and position limits to ensure that whatever mistakes I make do not become so large that I cannot recover from them. Quantitative limits on valuation and position size go hand in hand with quantitative methods.

It is also important to realise that quantitative methods have some underlying assumptions -- either (1) the stock will close the gap between price and intrinsic value, (2) the stock will recover to its past earnings and price (mean reversion), or (3) the stock will continue to generate good earnings and dividends (extrapolation). Sometimes these assumptions do not hold. Some stocks just do not recover in earnings and price after a decline, such as the few Oil & Gas stocks that have gone into judicial management. Other stocks are unable to sustain the good earnings and dividends, such as Starhub and M1. The problem with quantitative methods is that you cannot tell whether the assumptions will hold or not until the results are announced. By that time, it is probably too late to sell the stocks. Valuation and position limits make a lot of sense when you cannot see what is ahead.

Over the past 2 years, I have been gradually moving away from quantitative analysis into qualitative analysis, looking at issues such as business strategies, competitive environment, corporate governance, etc. This approach has the advantage of providing a glimpse into where the business is heading instead of extrapolating from past performance. Thus, if the business looks good, I could take up positions ahead of the market. Conversely, if the business looks bad, I could sell in advance. Valuation and position limits are less useful if you can see accurately what is ahead.

Furthermore, SGX is a small market. There are very few stocks in some industries such as banks, telcos, shipping, etc. But the amount of work necessary to analyse the industry is independent of the number of listed companies in that industry. For example, I wrote 8 posts on the telco industry but there are only 3 telco stocks, out of which I selected 2 for purchase. If I could only invest $15K on each stock, it really does not do justice to the amount of efforts put in. Position limits become constraints when there are limited number of stocks in a particular industry. Thus, my position limits were officially broken with the purchase of M1 and Singtel in Jan.

Having said the above, I have not fully discarded the valuation and position limits. There are dividend stocks that I purchase using the quantitative methods. For these stocks which I have no insights or time to analyse deeply, valuation and position limits will continue to be in place.

Will breaking the valuation and position limits lead me to make mistakes that I cannot recover from? I certainly hope they would not. I will still need to improve my skills at seeing the future prospects of the companies.

See related blog posts:

Sunday, 16 October 2016

What is My Target Price?

A reader asked me what was my target price for a particular stock in one of my blog posts. I was stumped for a while, and realised that I do not really have a target price for my stocks! I do have valuation limits on what price I could buy or sell a stock, but they are not the same as target prices. Let me elaborate further on the buy side and sell side separately.

Buy Side

Having a target buy price suggests that there is a particular stock that you like to buy but is waiting for the price to fall to the right level. To prevent myself from overpaying for stocks, the maximum price I would pay for a stock is 1.8 to 2.0 times the book value of the stock. It looks like a target price, but it is actually a stock selection criterion. All stocks that fail the criterion would not be considered for purchase. The Price/Book (P/B) criterion works the same way as the Debt/Equity criterion. The stocks either pass or fail the criteria; it is not quite the same as waiting for the price to fall to the right level. The litmus test of whether the P/B threshold is a target price is to consider what happens when the price falls to that level. Nothing happens, until the next review. If, in the next review, the stock is still below the P/B threshold, it would be considered for purchase, assuming it passes all other criteria. Thus, it is possible that the stock is bought at a P/B ratio lower than 1.8 to 2.0.

There are also stocks that I wait on the sidelines before buying. However, I am not waiting for the right price, but the right moment. Take for example, Keppel Corp, which I am interested to average down. Based on my assessment, Keppel Corp has not seen the worst of the Oil & Gas winter yet. Thus, if it revisits its low of $4.64 reached earlier this year, I would not be keen to buy the stock. On the other hand, if visibility improves on its business environment 2 years later but the stock then rises to $6, I would be interested to buy at the higher price. The main reason is to wait for the price to reflect fully the business conditions as well as assess whether the company is able to recover fully. All these take time. I view Keppel Corp as a long-term investment, thus it is much more important to understand the business conditions fully than to buy at a low price.

Sell Side

Having a target sell price means that you are waiting for the price of a stock to rise to a particular level before selling. It also means that if the price does not reach the target level, the stock would not be sold. Similar to the buy side, I have valuation limits on when I must sell a stock, no matter how much I like it. The P/B ratio for selling is 3.5 to 4.0 times. However, it does not constrain me from selling even if the stock does not reach the P/B threshold when the need to sell arises. In fact, rarely has a stock in my portfolio reached the P/B threshold mentioned above. Typical reasons for selling include changes in business fundamentals, triggering of trailing stops, or simply risk management.

Having said the above, I have loss aversion bias. There are some stocks that I regretted buying and no longer wish to hold on to them, but the price has dropped below my cost price. For these stocks, I am usually reluctant to sell at a lower price. Thus, the original cost price becomes a target price for selling these stocks. Nevertheless, if the loss is manageable and there are overriding concerns, e.g. changes in business fundamentals or risk management purposes, the stock would generally be sold at a loss. Just last week, I wrote that I had a 19% concentration in Global Logistic Properties but would be happy to reduce the concentration to 15% if the price recovers to my cost price. This is loss aversion bias at work. On reflection, I realised that the position limit on this stock is 20%, which means that I only have a 1% headroom for averaging down if the need arises. I sold 3% at a loss this week. The same goes for the growth stocks in my portfolio which were at the position limit.

Conclusion

Generally, I do not have target prices for buying stocks. On the sell side, I do have target prices for stocks that I no longer wish to hold and are under-water but not for stocks that are above-water. I think it is more correct to say that I have loss aversion bias rather than have target prices for selling stocks. So, the next time someone asks me what is my target price for a particular stock, I will be more confident in replying that I have no target prices.

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Sunday, 24 April 2016

Possibly The Worst Time to Invest – 2 Years On

About 2 years ago, I blogged about setting up a passive portfolio of 70% stocks and 30% bonds and wondered if it could be the worst time to invest. I updated the status of the portfolio a year later in Possibly The Worst Time to Invest – A Year On. In fact, I believe that nothing should stop us from investing and I initiated a second, more spicy passive portfolio last year. You can read more about it in The Anti-Fragile Portfolios. In the 13 months since the last post, the stock market underwent 2 major turbulences, first in Aug last year and second in Jan this year. It seemed to prove that last year was indeed a bad time to invest. Yet, the 2 passive portfolios, which were designed to rebalance themselves whenever the asset allocation exceeds the target allocation by 8%, soundly slept through both turbulences, blissfully ignorant of the upheavals in the financial markets.

This is not to say the portfolios did not suffer any losses. In Jan this year, when stock markets all over the world fell precipitously, the original passive portfolio suffered a loss of 0.7%. The spicy portfolio, true to its name, lost 7.0%. The stock allocation for the original passive portfolio roughly fell from 71.1% to 67.4%. However, the swing was too small to trigger any rebalancing. Currently, stock markets have recovered and so have both portfolios. The original and spicy portfolios currently return 8.5% and 0.6% respectively over their holding periods. After investing for nearly 2.5 years and 0.5 years respectively, the returns are nothing to shout about. However, considering the financial market upheavals in Jan when there were talks of crises in China, European banks, US credit markets, etc., the portfolios have performed admirably. Even my own actively managed portfolio went into a state of panic, as shown in I Don't Know Where The Market Is Heading, But I Should Know Where I Stand.

Moving forward, I am not particularly confident about the stock market and have been increasing the war chest for my active portfolio. However, I am not pulling any money out of the 2 passive portfolios. Their have in-built defence mechanism which was proven during the market crisis in Jan. While I do not hope to see another market crisis that leads to rebalancing of the portfolios, I am confident that these 2 portfolios will do well in the long-term even if a rebalancing is triggered.

In fact, passive investing in index funds is like buying an air ticket to your financial destination. There is no doubt that there will be mid-air turbulence from time to time. When that happens, do you head straight for the emergency exit and parachute to safety? Although you could save yourself from further turbulence if you do that, you will end up in nowhere and could only watch fellow passengers who sat through the entire flight land safely in their financial destinations. There is no way to avoid mid-air turbulence, but you could choose the type of aircraft you sit in and the pilot who will steer the aircraft. Index funds, which invest in some of the largest companies that make up the stock market indices, are among the most sturdy aircraft available. Passive investing strategies, whether it is Dollar Cost Averaging or portfolio rebalancing, are like flying on auto-pilot, which removes most of the errors associated with human pilots. Combined, passive investing in index funds is like flying on Boeing 777 on auto-pilot. No doubt, there will still be mid-air turbulence, but you can sleep soundly knowing that you are in good hands. You just have to tighten your seat belt and have faith that you have chosen the best aircraft and pilot that will bring you to your financial destination safely.

If you think flying on Boeing 777 on auto-pilot is not safe enough, compare that to the alternative of flying on a 2-seater propeller plane with me as the pilot. You will get a lot of excitement on this flight. For example, in Jan this year, you will hear passenger announcements that we are running out of fuel (i.e. war chest) and need to off-load some cargoes (i.e. sell stocks)! Thus, when you compare the alternatives, flying on Boeing 777 on auto-pilot seems the much better choice. You might ask, if this is the better choice, why do I still choose to fly on my own? I am been participating in the stock market for the past 30 years and will not totally switch to passive investing. It is like a driver who has been driving all his life; he will not easily switch to public transport, even though public transport may be more efficient.

How will the stock market and the 2 passive portfolios perform in the next 12 months? Let us wait and see.

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Sunday, 7 February 2016

For A Better Tomorrow

These are difficult times for investors. Even for me who have gone through several bear markets, I have felt the stress. However, it is times like these that we learn how to be better investors, building up our strengths in emotional control, investment strategies and stock-picking skills. Bear markets are very good at exposing our mistakes, and learning from mistakes is one of the most effective ways of learning the art of investing.

One key area of stress in my portfolio comes from a concentration in Global Logistic Properties (GLP), which was initiated barely 3 months ago in November. It was my first attempt in concentration. As things turn out, it is not the best of times to learn how to concentrate. At the start, a mere 3% daily fluctuation in the stock price is enough to make me worry about the outsized position. In fact, this 3% daily fluctuation can cause more concern than a 30% paper loss in a diversified collection of oil & gas stocks whose collective size in the portfolio is nearly equal to that in GLP. I told myself if I ever wanted to be a successful business investor, I must learn how to ignore this daily fluctuation and the stock price. It is certainly not easy. So far, the paper loss on GLP is approximately 20%. The training will go on.

So, do not be despair by the current difficult times. They are there so that we can learn to become better investors. It is like the young butterfly which is struggling to emerge from the cocoon. The struggle might seem overwhelming at times, but it is through that struggle that the butterfly finds the strength to soar to greater heights!

It is the eve of Chinese New Year and the time to put the stock market aside and celebrate the joyous occasion with your loved ones. I wish all readers a Happy and Prosperous Chinese New Year! 祝大家新年快乐，万事如意!

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Sunday, 31 January 2016

Prudence is the Name of the Game

Today is the last day of January. After the stock market rout this month, it is time to take stock of the current portfolio allocation and articulate the game plan for the rest of the year.

Entering January, I had moved about 25% from cash/ fixed income into equities to bet on US Federal Reserve's interest rate rise. Also included in the move was a tactical bet on the January effect. As things stand, this move turned out to be wrong. A review of my portfolio shows there are 3 areas of stress, namely, a collection of oil & gas (O&G) stocks, a 15% concentration in Global Logistic Properties (GLP) and stocks in general. The current war chest level stands around 37%. The past 3 weekends were spent analysing what is happening to China, O&G stocks, GLP, potential bargain hunting opportunities and the adequacy of the war chest.

China remains the most important risk and currently, there is no clarity on how things will eventually turn out. Rather than assume the worst and sell stocks, the decision is to keep good stocks, trim unnecessary ones and maintain an appropriate level of war chest to manage the fallout in the event of the worst case happening. As part of the scenario planning, the war chest is allocated to the various areas of stress in the portfolio.

On O&G stocks, there seems to be some light at the end of the tunnel (hopefully it is not the headlight from an oncoming train) with the recent recovery in oil prices. Even so, O&G stocks are unlikely to recover by themselves to their original purchase prices. Additional capital is needed to bail them out. Approximately 5% of the war chest is reserved for this purpose.

GLP is fundamentally sound. Its risks stem mainly from the external environments in which it operates, i.e. China and Brazil, which make up 63% of its total net asset value. Ignoring the China factor, it should be able to recover on its own without needing additional capital. Nevertheless, it might be dragged down further by China's woes and 5% of the war chest is reserved for it.

For general bargain hunting in the event of further market declines, approximately 10% of the war chest is allocated to it. On top of that, there is a need for a psychological cushion of about 15% to tide through the depth of any potential stock market crisis. Summing up all the allocations, that works out to be about 35%, which is very close to the current level of 37%. That means that the current war chest is sufficient to manage any potential crisis, but there is no room for further errors. At current stock market levels, any stock purchase must be accompanied by a corresponding sale of existing stocks. It is from this perspective that I view the current bargains that have emerged in the stock market.

Currently, banks and telcos have dropped to attractive levels. However, both sectors carry risks that I do not have the capacity to manage. For banks, the main risks are China's slowdown dragging down the global and regional economies which banks have exposure to and a glut in the local property market. Let us leave the China factor aside, since it is not clear how it will pan out. As for the local property market, it is quite clear that there is an oversupply in properties, a slowdown in the rental market due to the tightening of foreign labour and rising interest rates. If the local economy slows down further, it could add strains to the banks' balance sheets, which already have to grapple with a prolonged slump in shipping and a sharp decline in O&G and other commodities. Although attractive, I will have to leave it to other people to make money from the banks.

As for the telcos, the risk is the possible entry of a fourth telco. My experience as a consumer suggests that the existing telcos have not been competing as fiercely as before, as I seem to be paying more on my mobile phone and cable broadband bills in recent years. On the other hand, the entry of MyRepublic in the fibre broadband market has caused prices to drop significantly. So, competition from the fourth telco is a major risk. Since I have never invested in telcos and enjoyed their handsome dividends and steady capital appreciation before, I prefer not to join them in the potential decline now.

This post summarises my investment plan for 2016. China remains a key risk, and until clarity is established on this issue, I will have to be prudent in my bargain hunting.

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Sunday, 17 January 2016

Confidence Can Only Be Built From Within

When the stock market drops, do you search the internet to find out what is happening? I do occasionally. It is OK if you just need to find out the reasons, but if you are searching for reassurances that it will not drop further, then it can be quite futile. When you read a negative opinion, you will be worried about your investments and search for more opinions, hoping to find one that will refute the previous opinion. However, even if you find one such opinion, you will still not feel assured and continue to search for more confirmation. The end result is you will end up very tired from all those searching and still feel just as unassured as when you started. Even if all the opinions you found are reassuring, the moment the stock market drops further, all your new-found confidence will be shattered. Confidence cannot be acquired from outside, it can only be built from within.

The reason why you will still feel unassured after reading all available opinions on the internet is because these opinions do not belong to you. You might agree with the opinions, but without going through the thought process of deriving these opinions, the confidence you have with them is only as strong as the next stock market movement. The correctness of these opinions is judged by the outcome (i.e. stock market movement) rather than the strength of the facts and arguments. On the other hand, if the opinion were derived by you based on available facts, the correctness of this opinion is judged not only by the outcome, but by the strength of the facts and arguments. Even when the outcome is unfavourable, you can re-run the thought process again, taking in new facts that you had omitted or just emerged, and re-evaluate that opinion. You will have much more confidence in the opinion that you derived.

There is another important thing you need to know about the stock market. It is often said that the stock market reflects all available information. We should assess what kind of information does the stock market really reflect. Consider stock recommendations from stock brokers. Even though everyone has access to the same facts, different stock analysts will come up with different price targets. Based on their own price targets relative to the current stock market price, they will then recommend to buy, hold or sell the stock in question. When investors follow up on these recommendations to buy or sell in the stock market, they are transferring the opinions of their stock analysts into the stock market. Even for investors who do not rely on stock recommendations from analysts, there is an analyst within all of us who will perform the same activities. Thus, the stock market actions that we see are really reflections of different opinions from thousands of stock market participants rather than indisputable facts which nobody would disagree.

If the stock market were to reflect indisputable facts, I would say that the stock market is always right. But if the stock market merely reflects opinions, and we know that opinions can be right or wrong not matter how strongly expressed, it means that the stock market is not always right! History has shown that the stock market can deviate from economic fundamentals from time to time, which is why we have stories such as Mr Market and timeless wisdom from investment legends to ignore the stock market. In essence, the stock market is again some other people's opinions expressed in the form of price quotations. Do you still want to treat the stock market as the indisputable truth and be extremely concerned over what level the stock market closes everyday?

If the stock market were to reflect the opinions of all investors, it might still serve as a good reference. However, it is not. You probably know of people who think the stock market is undervalued but have no money to buy further. Their opinions are not reflected in the stock market. In fact, the stock market only reflects the opinions of a very small minority of investors. Take for example, Singtel, which had the highest transaction value on Friday. A total of 31.0M shares changed hands. This was the result of 6,263 trades conducted. Assuming 2 investors per trade (i.e. a buyer and a seller), the closing price of Singtel at $3.56 reflects the aggregate opinions of 12,526 investors (plus an undisclosed number of investors who placed orders in the queue but were not successful and another undisclosed number of investors were watching on the sidelines). Contrast this with the 298,709 shareholders of Singtel (again, plus an undisclosed number of interested investors who are not shareholders) and you will see that the stock market really only reflects the opinions of a very small minority of interested investors. You might want to read The Stock Market is a Voting Machine for more information.

So really, to find the assurance that you need, you need to ignore other people's opinions, especially that of the stock market. That is not to say that you should not read other people's opinions, but it should be to identify the facts that they use to derive their opinions and analyse those facts and form your own conclusion. You might still agree with those opinions eventually, but because you have gone through your own independent and rigorous analysis, the confidence you have with that opinion is much stronger and not affected by what the stock market does next.

Not only do you need to form your own opinions about the stock market, you need to form your own opinions about individual stocks that you hold as well as your overall asset allocation and adjust them according to your opinions. Only then can you achieve the assurance that you need face whatever the stock market throws at you.

Finally, if you truly understand the essence of what I am trying to explain in this post, then you will also realise that you should ignore all that I say in this blog, because these are solely my opinions! You will have to come up with your own opinions and conclusions.

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Sunday, 10 January 2016

I Don't Know Where The Market Is Heading, But I Should Know Where I Stand

In all my years of experience in the stock market, I never had to deal with a stock market crash in the first week of the trading year. I usually make a tactical bet on the January effect, especially this year as the US Federal Reserve had just made its first interest rate move. This means that I am overexposed to the stock market just as the crash came. The slew of economic news also sent me back to the drawing board to make sense of what is happening and going to happen.

Despite spending an inordinate amount of time on Friday and Saturday trying to figure out what is happening, I still have not reached a conclusion. I almost wanted to stop blogging this week to continue to figure it out. On the other hand, I had a much easier time figuring out the amount of war chest I should keep now and when I should deploy it and by how much. This current state of jittery is both due to the new economic news that I had not considered previously as well as a recent dislocation in my investment plan as I adjust to the loss of a bank's preference share which had served very well in the past as a counter-weight to equities in my investment plan (see Ahead of the Grand Battle for the circumstances leading to the current state of affairs). The conclusion from all these thinking is that there will always be certain things that we could not figure out correctly. When that happens, a good solution is to leave it to the war chest to manage all these uncertainties. After all, the war chest exists because we cannot predict what is going to happen. If we could predict accurately what is going to happen, we would have bought or sold at the right time and do not need to keep a war chest for unexpected events.

So, really, what I need to do to manage all these market turmoil, economic news and jittery is to admit defeat in the Battle of the 1st Interest Rate Rise, undo the tactical bet and quickly re-establish a new investment plan. In a game where there are 2 players (i.e. you and the market), at least one person must be rational at any one time. If both players are irrational at the same time, the outcome can be unpredictable. The more irrational the market is, the more rational we must become. If I lose money in the stock market, it is usually not because I lost to the market, but because I lost to myself.

Finally, I leave you with a light-hearted view of how the stock market works to relieve the stress: The Stock Market is a Voting Machine.

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Sunday, 4 October 2015

The Big Picture During Bear Markets

Bear markets can be very frightening. They can cause stocks to drop by 40% to 60% and stay there for a fairly long period of time. It can be quite stressful to go through a bear market, especially for young investors. However, it is helpful to look at the big picture, which is this: even though the prevailing bear market might look very frightening, most young investors are still working, and there are 20 to 30 years of income still to be earned. If you include these unearned income in your total wealth, you will find that the prevailing bear market actually only eats up a small fraction of your total wealth. Let us consider the following example.

Starting Salary	$ 3,000
Annual Salary Growth	5%
Salary Ceiling	$ 10,000
Investment Allocation	10%
Asset Returns	7%
Max. Drawdown	50%

A fresh graduate aged 25 is able to earn a starting salary of $3,000 per month. This salary grows at a rate of 5% annually. Let's further assume that his salary does not grow forever, and his salary ceiling is $10,000 per month. He is able to set aside 10% of his monthly salary for investment, which grows at a long-term average rate of 7% per year. During a bear market, he loses up to 50% of his invested capital in unrealised losses, which can be quite painful for a young investor.

At the age of 30, 5 years after working, he would have accumulated an investment capital of $22,729, comprising the $300 he set aside every month which grows at the long-term average rate of 7% per year. At the depth of the bear market, he would have lost 50% or $11,364 of his investment capital that he has so painstakingly built up over the last 5 years. Although the losses are significant, he still has 35 years of working life in front of him. Assuming that he continues to set aside 10% of his future monthly salary for investment, he would have an unearned present-value capital of $100,457 (discounted using the 7% long-term annualised asset return), or 4.4 times his earned capital. The unrealised losses just make up 9% of his total wealth, which is a lot more comfortable than the 50% unrealised losses. The figure below shows the amount of earned capital and unearned capital at age of 30, 35, 40 and 45 for the same person.

Total Capital for Different Age Group

As the person increases in age, his unearned capital will reduce as it is progressively transformed into earned capital. At age 35, the unearned capital is still 65% of his total capital, which is equivalent to 1.8 times of his earned capital. The unrealised losses just make up 17% of his total wealth. At age 40, the unearned capital is 50% of his total capital and the unrealised losses make up 25% of the total wealth. Only after the age of 40 would the unearned capital fall below 50% of the total capital and the unrealised losses make up a significant portion of the total wealth. By this time, he would need to take less risk to reduce the amount of potential losses.

The point is, if you are a young investor, the prevailing bear market might look very frightening as you sustain heavy losses in percentage terms. However, if you consider the big picture of future cashflows, the amount of unrealised losses is considerably smaller. I would even say that a few years after you have gone through this difficult period and accumulated more capital, you might look back at this period and realised that the "signficant" unrealised losses that caused so much pain is actually fairly insignificant. As an example, at the depth of the 2000-2003 bear market, my unrealised losses were $50,000, which was equivalent to 50% of my invested capital. It was a very significant loss and very depressing. But by the time I got to the depth of the Global Financial Crisis (GFC) 5 years later, the amount of unrealised loss was around $175,000 to $200,000. The $50,000 unrealised loss sustained during the 2000-2003 bear market that seemed so significant then had paled in comparison. You might not believe me now as you go through his difficult period, but in a few years' time, you will realise that this is true. What is important now is not how much money you have lost, but how many lessons have you gained in investing, so that in a few years' time, as your investment capital grows, you will not make similar mistakes again, which are going to cost you a lot more since your investment capital has increased.

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Sunday, 5 July 2015

Stretch Loan & Invest the Rest

You probably have heard of the phrase "buy term and invest the rest". It means to buy a term insurance instead of a whole life insurance and use the savings in insurance premiums for investment. Can this advice be applied to loans as well? Meaning, instead of paying off your loan over a short period of time, you stretch your loan over a longer period and use the reduction in loan repayments for investment.

Let us consider the following scenarios:

Loan
Loan Principal	$400,000
Loan Interest Rate	2.60%
Loan Tenure (Short)	15 years
Loan Tenure (Long)	30 years
Yearly payment (Short)	$ 32,545
Yearly payment (Long)	$ 19,367

Investment
Yearly Available Sum	$ 32,545
Yearly Rate of Return	7.00%

The loan principal is $400,000. You have a sum of $32,545 yearly which can be used to either service the loan or invest in a portfolio of stocks and bonds. The loan interest rate is 2.6% while a balanced portfolio of 50% stocks and 50% bonds can return 7.0% each year on average. You can choose a short loan tenure of 15 years, in which you will pay off the loan in 15 years, after which you can channel all the money to investment for the next 15 years. Alternatively, you can choose a long loan tenure of 30 years, in which you channel $19,367 to service the loan and the remaining $13,178 to investment every year for 30 years. Which option would be better for you? The figure below shows the loan and investment amount for the 2 options.

Loan & Investment Amount for 2 Loan Tenures

As discussed earlier, the shorter loan gets paid off earlier by Year 15, whereas the longer loan is only paid off after Year 30. However, the investment amount only grows to $818,000 at Year 30 for the shorter loan option, compared to $1.24 million for the longer loan option. In terms of the total loan interest payable, the shorter loan incurs a smaller interest of $88,000 whereas the longer loan incurs a larger interest of $181,000, which is nearly $100,000 more than the shorter loan. This means that there is nearly $100,000 less available for investment. Yet, due to the longer period of compounding, the longer loan option is able to generate $849,000 in investment gains, as compared to $330,000 for the shorter loan option. This example shows that the time period available for the investment to compound can be more important than the amount of money available for investment.

From another perspective, the servicing of loan can be considered a form of investment. The "return" from this "investment" is the loan interest rate, which at 2.6% is lower than the 7.0% return available from the balanced portfolio of stocks and bonds. Hence, it is more beneficial to channel most of the money to the investment with higher returns, which is the balanced portfolio. Conversely, if the rate of return from the balanced portfolio is lower than the loan interest rate, then it is better to channel most of the money to pay off the loan as soon as possible. In essence, loans and investments are 2 sides of the same coin and should be assessed in the same manner.

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Sunday, 21 June 2015

Getting Ready for US Interest Rate Rises

After talking about it for 2 years, the US Federal Reserves (Fed) is finally about to raise interest rates. For a good part of these 2 years, I had not been too concerned about interest rate rises and was happy to pick up REITs beaten down by interest rate worries. It was 2 weeks ago that I realised that while interest rate rises were not too worrisome, things do not work in isolation. Here are my thoughts and actions taken in response to interest rate rises and their secondary effects.

Wave 1: US Interest Rate Rises

As mentioned, interest rate rises should not be too worrisome. My guess is that US interest rate should not rise to more than 0.75% by the end of this year and 2% by the end of next year. By pre-Global Financial Crisis standards, 2% interest rate is considered very low. Thus, I am not too concerned over the increased interest that stocks and REITs have to pay on their debt obligations.

Wave 2: US Dollar Rises

When US interest rate rises, US Dollar will become more attractive and rise as well. In fact, this has already happened. Since the middle of last year, US Dollar has started to rise against Singapore Dollar, Euro and Yen. The rise is approximately 7% against SGD and 20% against both EUR and JPY.

USD Movement Against SGD, EUR & JPY

Considering that Japan is in the middle of its Quantitative Easing (QE) at a rate of 80 trillion yen (equivalent to USD650 billion) per year and Europe has just started its QE in Mar this year for a total of EUR1.1 trillion, it suggests that USD will continue to rise. Essentially, the more money that Europe and Japan inject into their respective economies, the more money is available to invest in US assets. Both the World Bank and International Monetary Fund (IMF) have in recent weeks advised US Fed to defer its interest rate rises until next year. Should USD continue to rise due to interest rate increases, it would hurt the competitiveness of US manufacturers and might force Fed to reverse course and lower interest rates again.

Among the regional currencies, SGD is usually the strongest. Against USD, Malaysian Ringgit (MYR) has fallen by 16% and Indonesian Rupiah (IDR) has fallen by 11% since a year ago, as shown in the figure below.

USD Movement Against SGD, MYR & IDR

The effects of the above foreign exchange movements mean that companies that earn revenue in USD will benefit, while those that earn revenue in EUR, JPY, MYR and IDR will suffer. Among the stocks in my portfolio as at end May, LippoMalls earn its revenue in IDR while its debts are denominated in SGD. Metro also has retail operations in Indonesia. Both were sold in early Jun. For more details on LippoMalls, you can refer to A Tale of 2 Indonesian REITs.

The strengthening of SGD against regional currencies also means that it has become more expensive to visit Singapore for holidays, leading to lower revenue for hotel business trusts such as CDLHTrust, FarEastHTrust and OUEHT. All 3 were sold in early Jun.

There is another stock that is based in Indonesia, namely First Resources. However, it earns its revenue in USD, so there is not much concern. It is possible to understand the impact of foreign exchange movements on companies' earnings by referring to their annual reports. There is usually a section that discusses the impact to earnings and equity if the major currencies that the company is exposed to rise or fall by a certain percentage.

Wave 3: US Dollar-Denominated Assets Fall

When USD rises, assets that are denominated in USD tend to fall. Such assets include gold and oil. As at end May, I have about 8 oil-related stocks in my portfolio, such as BakerTech, CH Offshore, ChinaAvOil, CSE Global, Keppel Corp, MTQ, PEC and Rotary. None of them will be sold for 2 reasons. Firstly, oil prices had already fallen by almost half since the middle last year! Going forward, it is unlikely that oil price will fall by a similar extent even if USD were to rise further. Secondly and more importantly, none of these 8 stocks carry a lot of debt. The highest debt/equity ratio among the 8 stocks is 50%. Hence, no massive rights issues are expected from these 8 stocks going forward.

I also have Lyxor Commodity that has exposure to both gold and oil. But it is sitting on paper losses and I gave up hope on this stock (for now).

Wave 4: Stock Market Volatility Rises

With so many effects happening, the stock market may become more volatile. Even if a company has very little debt, foreign currencies and exposure to gold and oil, its stock price may still fall in tandem with the general market. While there are trailing stops to protect the paper gains on some of the stocks, I generally do not expect many stocks to be sold on this ground. The key reason is as long-term investors, we should be more concerned over the economics of the company rather than the short-term volatility of the stock price. A company can lose money if it has a lot of debt, foreign currencies and/or exposure to gold and oil, but it cannot lose money because the stock market is volatile (unless it is a financial company). Hence, not many stocks will be sold on this ground. On the contrary, I will be waiting at the sidelines to pick up good-quality stocks if they were to be beaten down.

On the Passive Side

There are a lot of things happening on the active side of investments. However, on the passive side, all the above effects can be considered as noise. It is business-as-usual for passive investment strategies like Dollar Cost Averaging and portfolio re-balancing. They have in-built defence mechanisms to handle any volatility in the stock market. You may wish to refer to The Anti-Fragile Portfolios for more info.

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