Sunday 28 September 2014

Experience with Lifecycle Unit Trusts

When I started investing my Supplementary Retirement Scheme (SRS) funds 7 years ago, it was with several experiments in mind. Firstly, the SRS account adopts a monthly Dollar Cost Averaging investment methodology, as opposed to market-timing for my cash account. Secondly, the SRS funds were invested in an index fund and a balanced fund, as opposed to individual stock selection for the cash account. Thirdly, the monthly investments were split between an index fund and a lifecycle fund, to understand whether lifecycle funds could serve the needs of an investor throughout his lifetime.  

What are lifecycle funds? These are funds whose asset allocations change from aggressive to conservative as time progresses. Using the fund that I bought (UOB GrowthPath (GP) 2040) as an example, the allocation to equities will reduce from an initial 83% (in 2002) to an eventual 20% by 2040. This saves the need for an investor to regularly and consciously adjust his asset allocation as he ages and is less able to take risks. Besides UOB GP2040, there are several other lifecycle funds in this family, namely, GPToday, GP2020 and GP2030. The timeline indicates the year when investors plan to liquidate and withdraw money from the fund. When the timeline is reached, the particular GP fund will be terminated and converted to the GPToday fund, which has an asset allocation of 20% stocks and 80% bonds. The figure below shows the current asset allocation of the various GP funds.

Figure 1: Current Stock Allocation of UOB GP Funds

So, what has been my experience with the UOB GP2040 lifecycle fund? Besides UOB GP2040, I also have invested an equal amount of money in an index fund, the LionGlobal Infinity Global Stock Index Fund, which provides a comparison with UOB GP2040. As you can see from the figure below, UOB GP2040 (blue line) has underperformed the index fund (green line) by some margin, which prompted a review of my unit trust portfolio after 7 years. While some level of underperformance is to be expected as UOB GP2040 does not allocate 100% of its investments to stocks, the level of underperformance have been too much for my liking.

Figure 2: Relative Performance of Index Fund & Life-Cycle Fund

What caused the underperformance of UOB GP2040 compared to the index fund? While part of the reason is due to US stock prices reaching new highs currently, another part of the reason is due to changes to its initial asset allocation. The figure below shows the initial and current asset allocation of the various UOB GP funds.

Figure 3: Initial & Current Asset Allocation of UOB GP Funds

From an initial 83% stock allocation at the time of its inception in 2002, the current stock allocation for UOB GP2040 has fallen to 59% only. Part of it is due to the passage of time as explained earlier. However, another part of the reason is due to the fund manager changing the asset allocation model for whatever strategic or tactical reasons. By right, the asset allocation for GP2040 today should be similar to that of GP2030 10 years ago, since they have the same investment horizon. However, the current stock allocation for GP2040 is even lower than that for GP2030 in 2002, which was around 74%. Thus, the fund manager has moved approximately another 13% from equities into bonds when compared to the initial asset allocation model. Being an aggressive investor, I would have preferred the initial asset allocation model.

What are the lessons to be learnt from this experience? Firstly, the asset allocation of lifecycle funds do not fit all investors who invest in the same fund. Some like myself prefer a more aggressive allocation while others may prefer a more conservative allocation. Secondly, the actual asset allocation may change from the initial asset allocation model. Thus, while lifecycle funds save investors the trouble of having to adjust his asset allocation regularly, they should not be left to run on auto-pilot. There still needs to be some regular monitoring to ensure that the current asset allocation meets the investor's objectives. 

Considering that the current asset allocation of UOB GP2040 no longer meets my objectives, I will probably be selling this fund and switching to an index fund. Despite not being able to accompany me all the way till 2040, investing in this lifecycle fund has allowed me to understand more about lifecycle funds.

Sunday 21 September 2014

The Value of An Education in Investing

Last week, I blogged about the value of a Chartered Financial Analyst (CFA) education to an investor and concluded that while it is useful in providing a basic grounding on the various investment concepts and methods, it does not guide an investor on what he should look out for in investing. See The Value of a CFA Education for more info. Does it mean that investors should not pursue an education in investing? On the contrary, education is important to achieving success in investing.

I have been exposed to the stock market for 28 years and been investing with my own money for the last 16 years. Prior to 2001, my investments were going nowhere, with as many misses as hits. It was not until when I picked up my first investment book titled "Buffettology" did my investments began to show some progress. You may wish to read Investing Is A Life-Long Learning Journey for more info.

The book triggered my thirst for investment knowledge. I became a regular visitor to the investment section of the National Library, reading investment books ranging from time-tested ones like "The Intelligent Investor" to more contemporary ones carrying fascinating titles like "Dow 40,000", "Dow 100,000", etc.

Among the ones that I found useful, I bought them after reading them in the National Library, to serve as an reference in future. Some of the more important ones are desribed as follow.

Buffettology (by Mary Buffett & David Clark) - This book was written by the former daughter-in-law of Warren Buffett and describes the methods Warren Buffett used to analyse stocks. The book describes the mathematical steps involved in estimating the rate of return of a stock and is fairly dry. Nevertheless, it is an important book for me as the methods in the book became the model that I use to analyse stocks to this date. It is also the book that sets me on my path to an education in investing.

Stocks for the Long Run (by Jeremy Siegel) - This book discusses that in the long run, stock investments beat all the other asset classes, notwithstanding the fact that stock market crashes happen every now and then. It also describes the various effects such as calendar effects, small-firm effects, etc. Whenever there is a stock market crash, I would turn to this book to remind myself that in the long run, my investments would turn out well, despite the heavy paper losses sustained at that time.

Common Stocks and Uncommon Profits (by Philip A. Fisher) - Warren Buffett initially started out as a pure value investor, having learnt his trade from Benjamin Graham, the father of value investing. However, over time, he has introduced a growth element to the stocks he purchases. The influence for this change is Philip Fisher and his book. This book discusses that some companies are so good that there is often no good reasons to sell them at all. The book goes on to describe the various ways of identifying such companies. If Warren Buffett could achieve such spectacular returns with his value-cum-growth approach, then there must be something valuable with this approach.

Security Analysis (by Banjamin Graham & David Dodd) - This book is known as the Bible of value investing and is written by none other than Benjamin Graham. It was written in 1934, during the Great Depression period in US. It describes the ways to value stocks, bonds, preference shares and warrants. You can find an application of its valuation method for bonds and preference shares in The Lost Art of Bond Investment. Despite reading it twice, I still have not grasped the essence of the book, probably because the investing conditions then and now are different. For example, it could be discerned from reading the book that the accounting and disclosure standards are different from today's and hence, the book spends a fair amount of time on the interpretation and adjustment of income and balance sheet items. The basis of valuation is also quite different then, when book value takes on a greater importance compared to today.

The above are just some of the books that I found useful and bought for future reference. There are a lot more books that are useful which I never mentioned, such as "The Intelligent Investor" by Benjamin Graham. Generally, the value of these investment books lies in the fact that they contain practical wisdom from market practitioners who, through past experience, have figured out what works for them. By understanding and following their approaches, we are able to shorten our learning curve and start making money sooner from our investments. After all, with a stock market cycle averaging about 7 years, how many market cycles do we have in our lifetime learning and making money from investments?

Education is important to an investor. Without education, investors can only buy and sell on gut feel and/or follow the crowd. As an analogy, if you were to go to battle, would you select a general that has fought many battles, a general who has studied the art of war, or a general who is knowledgeable in both?

Sunday 14 September 2014

The Value of a CFA Education

I took a course in Masters in Applied Finance and sat for the Chartered Financial Analyst (CFA) examinations in 2004 - 2006. The purpose of studying and sitting for the CFA exams was to understand the various economics, accounting and investment concepts so as to be a better investor. Hence, the topic of this blog post applies to an investor rather than a person working in the financial industry.

The CFA programme covers very wide topics, as follows:
  • Ethical and Professional Standards
  • Quantitative Analysis
  • Economics
  • Financial Statement Analysis
  • Corporate Finance
  • Portfolio Management
  • Equity Analysis
  • Fixed Income Analysis
  • Derivatives
  • Alternative Assets
  • Portfolio Performance Measurement & Reporting
  • Risk Management

Note that there have been some changes to the curriculum since I sat for the exams. You can find the latest curriculum at CFA Program Study Sessions.

Has the programme been useful to an investor who starts from scratch and has no formal education in investing previously? I describe some of the more relevant topics to investors and their usefuln below.

Financial Statement Analysis (FSA) is by far the most important topic as investors need to read financial statements regularly to understand how the companies are doing. FSA teaches how to understand the various items in the financial statements and the various accounting methods. For example, inventory could be recorded as first-in-first-out, last-in-first-out, or weighted-averaged. The different accounting methods will lead to different values in the balance sheet depending on whether prices are rising or falling. Adjustments will therefore need to be made when comparing companies adopting different inventory accounting methods. Also covered in FSA is how to identify red flags where there could be accounting irregularities. However, although providing the basic grounding necessary for understanding companies, FSA does not discuss what are the important items that investors should look out for when prospecting for a company, such as having low debt, high free cash flow, etc.

Equity Analysis teaches the various valuation methods that you can use to determine the intrinsic value of a stock, such as Discounted Dividend Valuation, Free Cashflow Valuation, Market-Based Valuation (e.g. Price/Earnings, Price/Book multiples, etc.) and Residual Income Valuation. However, it does not advise what kind of input parameters (e.g. dividend growth rate, rate of discount for Discounted Dividend Valuation) you should use for each stock analysis. You need to assume the input parameters and hope that they turn out to be correct. 

Portfolio Management teaches about the Modern Portfolio Theory, which is based on that fact that when 2 risky assets are put together in a portfolio, the combined risk (volatility) is less than that of the individual risky assets. It also discusses the Efficient Market Hypothesis (EMH), on whether the market prices reflect all known (including private) information about the economy, industry and company. Here, it discusses and concludes that the market generally reflects all known information and hence, Technical Analysis should not work. However, there are anomalies running counter to EMH such as the calendar effects and small-sized/ neglected companies producing better returns than larger companies with better analyst coverage. Portfolio Management also discusses the Capital Asset Pricing Model (CAPM), which essentially says that to get better returns, you need to take higher risks (beta). 

Risk Management (which was taught more in-depth during the Masters course) discusses what are the potential risks based on past case studies and teaches how to measure risk exposure using the Value-at-Risk method. 

The above are some of the more relevant topics to a investor. As an investor, I find the following topics to be most useful: 
  • Financial Statement Analysis (for finding companies to buy)
  • Fixed Income Analysis (for analysing bond prices & understanding bond features) - see Fixed Income blog posts
  • Risk Management (for computing risk exposure) - see Risk Management blog posts
  • Economics (for understanding how the economy works)
  • Derivatives (for understanding the effects of structured warrants) - see Structured Warrant blog post

Due to the short space allocated for each topic above, I cannot completely describe what these topics teach. Generally, the CFA curriculum is useful for providing a basic grounding on the various concepts and methods, but it does not show what an investor should look out for. As an example, after passing my CFA exams in 2006, I still have investments that were completely wiped out. However, there also have been benefits from the programme. I narrowly avoided the Mini-bonds after reading through their prospectus and understood the effects of structured warrants that were prevalent in Singapore just several years ago. See Investing Is A Life-Long Learning Journey for more info.

In conclusion, CFA builds up your foundations, but do not expect the market to give you additional respect simply because you pass your CFA exams.

See related blog posts:

Sunday 7 September 2014

Giving Back to Society

It is rare for financial bloggers to talk about donations, but as the Chinese saying goes, "取之于社会,用之于社会", which translates to "giving back to society what we take from society". It is important that we occasionally gives back to society, to pass on the help that we received from others. We can do this by sharing our knowledge and experience, but I believe we can do more by making a donation to a charity of our choice on a regular basis. I've set up a new page on this blog that links to SG Gives, which is an online charity portal, for any readers who wish to make a donation to a charity of your choice. I encourage all fellow financial bloggers to do likewise and add a link to SG Gives, to do our part for our less fortunate fellow citizens.

Below are 2 blog posts that I wrote on my other blog, (The) Boring Fisherman, on some of my observations about society and how we can all together make this society a better one for everybody.

It's Mid-Autumn Festival tomorrow night, and I wish everybody 中秋节快乐!

See related blog posts: