Sunday 30 August 2015

Getting the Best of Both SSB & SGS

You probably have heard a lot about the Singapore Savings Bonds (SSB) and have formulated your investment strategy for it. Even my colleague who did not study finance can tell me that she will churn her SSB for newer ones if interest rate rises. Having studied finance and traded Singapore Government Securities (SGS) before, I should do one better than hers.

Before going into my investment strategy for SSB and SGS, let us understand what are the characteristics of SSB and SGS. SGS is the traditional government bond which is backed by the government. Like any other bonds, its price will rise if interest rate falls and fall if interest rate rises. SSB, on the other hand, is capital-guaranteed by the government. Regardless of the direction of interest rate, its price will never rise or fall. In fact, you cannot trade SSB in a secondary market. You can only sell it back to the government at the original price.

Thus, when interest rate rises, churning your current, lower-coupon (i.e. interest) SSB for newer ones with higher coupons to keep up with the higher inflation rate can be a good investment strategy. SGS, on the other hand, would be a poor investment as its price will fall in such an environment. However, when interest rate falls, instead of keeping your SSB until maturity, it is a good strategy to switch out of SSB into SGS to take advantage of the capital appreciation potential of SGS. When interest rate has fallen low enough, you can then switch back from SGS to SSB for the capital-guarantee feature of SSB.

To understand what kind of figures are we talking about, let us consider a 10-year SGS whose coupon rate is 3% and an equivalent SSB. The coupons from SSB will step-up in such a way that if you hold it for 10 years until maturity, the effective annual coupon rate is equivalent to 3%. On the other hand, SGS will pay a coupon of 3% from the first year onwards for the next 10 years.

Ignoring the effects of decreasing maturity of the SSB/ SGS with the pasage of time, if interest rate (known as Yield-to-Maturity) for a 10-year SGS were to rise to 4%, the price of the SSB would still be $100 (bond prices are quoted in face value of $100, so I will use the same convention here), whereas the SGS would fall to $91.82, a fall of 8%. Conversely, if interest rate were to fall to 2%, the price of the SSB would still be $100, while the SGS would rise to $109.02, a rise of 9%. Thus, if interest rate were to swing between 2% and 4%, the price of SGS would swing by $17.20. If this sounds interesting to you, you may wish to know that you are not limited to a 10-year tenure for SGS. The longest-maturity SGS is 30 years. The corresponding price range for a 30-year SGS for interest rate between 2% to 4% is $82.62 to $122.48, or a swing of $39.86. Not only that, the SGS will pay the full 3% coupon every year, whereas you will get the full 3% coupon from SSB only if you hold it for 10 years. 

Generally, how I view a SGS with a 3% coupon trading at an interest rate of 2% is, you will only get an effective 2% coupon from this point in time onwards (because the price will fall from $109.02 to $100 as it approaches maturity). The remaining 1% (i.e. 3% coupon minus 2% interest rate) is "paid upfront" in the form of capital appreciation. Selling the SGS at $109.02 effectively locks in the 1% coupon for the remaining maturity of the SGS.

How do you know if interest rates are going up or down? I do not know. But every month, I will keep track of where interest rates are relative to historical values. You can find it at my statistics blog, which is reproduced below for July's statistics.

Cumulative Interest Rate Distribution (Jul 15)

The figure above shows that the interest rate for the 10-year SGS (brown line) is finely poised around the 50th percentile mark, which means that historical interest rate for that SGS has been above the current interest rate 50% of the time and below it 50% of the time. Do take note that the 20-year and 30-year SGS were introduced in Feb 2007 and Mar 2012 respectively. Hence, the historical interest rate range that they can trade in might not be representative.

To conclude, SSB or SGS alone might not be a good investment asset for all interest rate environments, but together, they can make a very interesting investment asset!

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Sunday 23 August 2015

Does Aspial's 5.25% Bond Have Sufficient Margin of Safety?

It is easy to be attracted to the high coupon rate of Aspial's 5-year, 5.25% bond, especially when the offering is splashed over the front page of newspapers. I too have made the mistake of not checking whether a bond is safe to buy when I applied for Frasers Centrepoint's (FCL) 3.65% bond 3 months ago, despite having written about how Benjamin Graham would analyse the safety of a bond in The Lost Art of Bond Investment.

So, this time round, I got smarter and analysed Aspial's bond before deciding whether to apply for the bond. There are 2 criteria that Benjamin Graham used, namely, the minimum average earnings coverage and the minimum current stock value ratio. Using Aspial's latest Financial Year's results, the computation of the 2 ratios are as follow.

Earnings Coverage

Profit before tax = $61.7M
Adjusted for:
- Deduct: Non-recurring fair value gain on investment properties = $30.0M
- Deduct: Share of results of associates = $4.9M
- Add: Non-recurring forex loss = $8.7M
- Add: Finance cost = $17.1M
Total earnings available for covering fixed charges = $52.6M

Current finance cost = $17.1M
Add: Interest of proposed bond = 5.25% x $75.0M

= $3.9M
Total finance cost = $21.0M

Earnings Coverage = $52.6M / $21.0M

= 2.50

The earnings coverage of 2.50 times is below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares = 1,862.7M
Share price = $0.35
Market value of shares = $651.9M

Current amount of borrowings = $1,115.4M
- Add: Proposed bond size = $75.0M
Total bond value = $1,190.4M

Stock value ratio = $651.9M / $1,190.4M

= 0.548

The stock value ratio of 0.548 is lower than the minimum stock value ratio of 1 for industrial companies.

Quantitative Assessment

Based on the above figures, the proposed Aspial bond does not pass both the earnings coverage and stock value ratio criteria. Hence, based on Benjamin Graham's criteria, the bond does not have sufficient margin of safety.

Other Considerations

There could be other qualitative considerations that might tilt the decision to be in favour of the bond. For example, the same analysis of Olam's 6.75% bond (now redeemed) showed that it too did not meet the earnings coverage criterion. However, when Temasek launched a takeover offer for Olam in Mar 2014, I did not hesitate to buy into the bond, reasoning that even if Olam were to have difficulty repaying the coupon / principal for this bond, Temasek would step in and lend a helping hand. Likewise, one key consideration for buying FCL's 3.65% bond without first checking the margin of safety was the fact that it is the subsidiary of F&N, which is in turn a subsidiary of TCC Assets. But for Aspial, it does not have the same strong backing as either Olam or FCL.

Hence, Aspial's 5.25% bond does not have sufficient margin of safety according to Benjamin Graham's criteria. To be fair, it does not mean that Aspial will definitely default on this bond, it just means that the risk is higher.

Sunday 16 August 2015

What Can We Learn About Stocks From Bonds

Most people are not familiar with bonds. They prefer the excitement of stocks which brings instant judgement over their buy or sell calls rather than wait patiently for years to collect coupon payments. However, there are something that bonds can teach us about stocks. With the recent volatility in the stock market, it is perhaps useful to know what can we learn about stocks from bonds.

The price volatility of a bond comes mostly from interest rate changes. However, not all bonds exhibit the same sensitivity to interest rates. There are several factors that affect the interest rate sensitivity of a bond. These are: bond maturity (i.e. how many more years before the bond expires), coupon rate (i.e. how much "dividends" the bond will pay semi-annually) and credit risk (i.e. how likely is the bond issuer able to honour its coupon and principal payments). The longer a bond's maturity, the more volatile is its price to interest rate changes. As stocks are perpetual securities with no maturity, they are thus more volatile than many other investment assets. Based on the Dividend Discount Model, any slight change in the discount rate can lead to a huge change in the intrinsic value of a stock because of the perpetual maturity.

As for coupon payment, the higher the coupon rate, the less volatile is a bond's price to interest rate changes. Thus, we can expect stocks with higher dividends to be less volatile compared to stocks with lower dividends. This is the case in practice, since investors are more willing to stay invested in a stock if it is able to pay high dividends while the stock market undergoes a downturn.

Having said that, not all dividend stocks will be equally resilient to market downturns. Much will depend on the stock's ability to keep its high dividend rate throughout the downturn. This is similar to a bond's credit risk. In an economic downturn, the ability of the bond issuer to earn sufficient money to cover its coupon and principal payments is in greater doubt and hence, the bond's price will fall much more than that indicated by interest rate changes to reflect the greater uncertainty in coupon/ principal payments. In fact, if a company does not earn enough money to cover its coupon payments, its stock dividend will also be cut. This is why junk bonds with high yields can be as volatile as stocks in an economic downturn. Hence, among dividend stocks, it is important to identify which of these are vulnerable to dividend cuts and avoid them.

Many investors like REITs for their high dividends. However, not all REITs will be able to sustain their dividends and provide a comparatively safe harbour to sit out the market correction. As an example, I had written about the vulnerability of hotel trusts to currency fluctuations in Getting Ready for US Interest Rate Rises in Jun. Since then, currency fluctuations have increased with the recent devaluation of the Chinese Renminbi and all 3 hotel trusts mentioned had fallen by an average of 12% over a short period of 2 months. 

In conclusion, bonds have certain similarities to stocks and understanding bonds can help us to understand stocks as well.

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Sunday 9 August 2015

Make a SG50 Donation Today!

This National Day weekend, there are many retailers offering SG50 promotions in celebration of Singapore's 50th birthday. However, the most meaningful gift I have received is not in receiving, but in giving. I made a small SG50 donation today. To be able to make a SG50 donation on the day of Singapore's 50th birthday and dedicating it to "Happy 50th Birthday, Singapore!" is the most meaningful thing I have experienced this weekend. This screenshot showing the date, amount and dedication of the donation is forever etched in history.

Make your SG50 donation today! You too will feel the significance of this small but meaningful act. To make a donation to a charity of your choice, just click the image below. It will link you to SG Gives, an online charity portal. Just remember to login/ register as a donor to save this small but significant piece of history in your donation profile.

Just a wild thought; if everyone on this island of 5 million people were to make a SGD50 donation, that would make it SGD250 million. Add on the Government's dollar-for-dollar matching under the Care & Share @ SG50 movement for eligible donations, we would be able to collect SGD500 million! That would be a truly significant achievement for SG50!

Special thanks to Turtle Investor for his post on Bloggers for Charity for inspiring me to make such a meaningful SG50 donation today.

Sunday 2 August 2015

The Insurance Cost of Being a Smoker

Last week, I blogged about the cost of buying insurance at different ages. This week, we will discuss the insurance cost of being a smoker.

The chart below shows the difference in annual premiums for a level term insurance with critical illness benefits for a male with a sum assured of $1 million covering until 70 years old. Using age 25 as an example, a non-smoker would pay $3,149 in annual premiums for 45 years until age 70, while a smoker would pay $4,936. The difference is $1,787, or 57% more. The total premiums payable over the whole duration of the policy is $80,415 more for the smoker.

Difference in Insurance Premiums for Non-Smokers and Smokers

The percentage difference in annual premiums between non-smokers and smokers generally increases with age. At age 20, the percentage difference is 50%, while at age 65, the percentage difference increases to 71%. Thus, from an insurance point of view, it pays to quit smoking. If you have friends who are smokers, please share this blog post with them.

The above analysis is carried out based on level term insurance. There are other insurance products such as whole-life, reducing term and endowment insurance available on You can carry out similar analysis to determine how much you could save in insurance premiums by quitting smoking!

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