Sunday 27 December 2015

What I Learnt About Stock Investments from the DomiNations Game

A few months ago, I downloaded a mobile game called "DomiNations". This game is similar to the "Age of Empires", in which you develop your civilisation and lead it through different ages. 

DomiNations Game

Civilisation View

Besides developing buildings, you could also lead an army to attack and loot other players. Likewise, you could also be attacked by others. To master the game, I tried to search online for an official game manual which could describe the strengths and weaknesses of different buildings and army units, as well as how to place the buildings for the best defence. Unfortunately, I could not find a good game manual, much less an official one. It is like the stock market, isn't it, which does not come with an official game manual. It does not teach you what stocks to buy, when to buy and when to sell. Although this void is filled by many investment books written by others, there are still gaps. For example, there is actually no book that talks about "troubleshooting", which advises you what you should do when the stock market "malfunctions", i.e. crashes. 

Consider the recent stock market downturn in Aug, which book could you rely upon to advise you how to navigate the downturn? While there are many investment books on how to pick stocks, read technical charts, analyse financial statements and understand investor psychology, I am not aware of any book which is able to guide investors on how to navigate a stock market decline. The closest book I could think of is Jeremy Siegel's "Stocks for the Long Run", which shows that historically, Sep is the worst month for stocks and Oct is the most volatile month (but can be up or down). Even so, it is not a fool-proof guide; it requires quite a lot of faith to believe that the worst is over once you past Sep and Oct. It is also not a context-sensitive guide; does what is generally true apply to the economic situations we had in Sep when China was slowing, interest rates were rising and oil price was falling, etc? In situations where there are no official game manuals, there are only 2 ways that players can learn how to be a better player.

Learning from Mistakes

When there is no official game manual, the best way players can master the game is to experiment and learn what works and what does not. In the DomiNations game, I thought my original placement of defensive buildings was good. It worked the first time I was attacked, successfully repelling the attacker with minimal loss of gold and food resources. However, when a more sophisticated attacker came the second time, my city's defences were completely and utterly overrun! It exposed, firstly, fundamental flaws in my defensive placements, and secondly, but more importantly, over-confidence in my original defensive strategy. The moral of the story is this: when you win, you practically learn nothing, but when you lose, you learn a valuable lesson in what does not work. In fact, the greater the loss, the more deeply you will learn and not repeat it. The more mistakes you make, the more knowledge you gain on what does not work. Over time, as you gain more knowledge on what does not work, you will eventually become a better player.

Winning generally does not teach you anything. Most people, when they win, they will bathe in the euphoria of winning. Seldom will anyone analyse the reasons for the victory, and even if he does, he might attribute it to the wrong reasons, which will only serve to increase the hubris of the player and eventually lead to a greater downfall! To win, you need a combination of factors in your favour, but to lose, you just need one single key factor against you. Thus, when you win and you managed to find a reason for your victory, it might be only one out of many factors contributing to your win. But when you lose, the key factor resulting in your loss is usually clearly visible. As this might not be the only factor contributing to your loss, the more losses you have, the more factors you will be able to identify that affect the outcome of your battles. The more factors you are able to have in your favour, the more likely you are able to replicate success in your next battle. So, remember to learn from your mistakes!

Learning from Others

In the DomiNations game, you could join an alliance with other players, chat with them and observe their defensive placements. Likely, these players have been playing the game longer and gained a lot more experience than you have. To save time and efforts in learning from your mistakes, you could join an alliance and learn from them. Where there are unofficial game strategies written by experienced players, read them too. It will save you from a lot of unnecessary heartaches later!


While I might be describing my experience from playing a mobile game, these lessons are equally applicable to stock investments that do not come with an official game manual. Learning from mistakes and learning from others are the best ways to become a better investor. Despite having 29 years of experience in the stock market, I am still learning from mistakes and I also have alliance members whom I can learn from – investment books in the library and financial bloggers on and Singapore Investment Bloggers

Thanks for staying tuned to this blog throughout the year. Wishing all readers Merry Christmas and a Happy, Prosperous and Healthy 2016! 

Sunday 20 December 2015

Is CPF Accrued Interest Double Counting of Housing Loan Interest?

This question has baffled me for quite a long time. When you use your CPF money to service your housing loan, CPF will compute accrued interest on the amount you withdraw from CPF until you sell the house. The accrued interest reflects the amount of interest you would get in your CPF account had you not used it to service the loan. When you sell the house, the principal and accrued interest have to be returned to CPF. This raises several other related questions – should accrued interest affects the attractiveness of the housing purchase and is better to use CPF or cash to service the housing loan?

To better appreciate and answer these questions, it is best to consider a typical scenario and leave CPF out of the picture for the time being. Let us assume that you intend to purchase a HDB flat for $500K. HDB agrees to loan you 90% of the purchase price. You will need to fork out the remaining 10% as downpayment. However, your kind-hearted parents, who have been working for several years and have accumulated some savings, willingly offer to pay the downpayment for you. You relunctantly agree, promising to pay them interest for the money loaned so that they could have sufficient money for their retirement. Thus, HDB pays 90% of the purchase price while your kind-hearted parents fork out the remaining 10% and you do not need to pay a single cent.

The HDB loan is a formal loan which requires monthly repayment, whereas the loan from your parents is an informal one which does not have any fixed payment terms, except for your promise to return the full amount borrowed plus accrued interest to them when you sell the house. Each month, you have to make repayment to HDB to pay down the formal loan. Again, your kind-hearted parents offer to service the monthly repayment so that you do not need to fork out a single cent every month. Thus, over time, as you pay down the HDB formal loan, you borrow more and more informal loan from your parents, with accrued interest growing increasingly with time and size of the informal loan. When you have fully paid off the HDB formal loan, you no longer need to borrow additional money from your parents, but the accrued interest continues to accumulate, until you sell off your house.

Assume further that you sell off the house for $1 million and the principal borrowed from your parents plus accrued interest amounts to $800K. As promised, you return $800K to your parents and retain the remaining $200K. Your kind-hearted parents accept the money, but assure you that whatever money they have will eventually belong to you as inheritance. Thus, it does not really matter whether you return $800K or $600K to them, because you will eventually get the full $1 million. 

Now, kind-hearted parents tend to have kind-hearted children. Assume that you decide to use a generous interest rate to compute the accrued interest such that the principal plus accrued interest amounts to $1.2 million. As this exceeds the sales proceeds from the house, you will return the full $1 million to your parents and get nothing. Your parents do not require you to cough up the remaining $200K owed to them. From your perspective, this looks like a "lousy" investment as you end up losing $200K on the housing purchase. However, can this really be considered a lousy investment, since the house doubles in value from $500K to $1 million? The computation of accrued interest merely affects how the sales proceeds are distributed to your parents and yourself. Considering that you will eventually get back the full $1 million, the accrued interest does not affect the attractiveness of the housing purchase.

Now, let us suppose from the beginning that you actually have some cash and do not need to rely on your parents' savings to service the downpayment and/or monthly repayment. Which of these would be a better option to service the loan – using your cash or your parents' savings? It all depends on who can grow the money at a higher rate. If you are able to invest your cash at a higher rate of return than your parents, then it is better to use your parents' savings to service the loan. Conversely, if your cash is left in the bank earning 0.05% interest rate while your parents' savings are able to grow at 2.5% annually, then it is better to use your cash to service the loan. 

We have come to the end of the story. Now, please replace the kind-hearted parents in the story above with your own CPF savings. It becomes a whole lot clearer what the CPF accrued interest is all about and whether it affects the investment and financing decisions. To summarise,
  • CPF accrued interest arises because you are taking out a second, informal loan from your CPF account to service the downpayment and/or monthly repayment so that you do not need to draw down your cash. It is not double counting of interest on your formal housing loan.
  • Computation of CPF accrued interest and return of principal plus accrued interest after the sale of the house merely affects the distribution of the sales proceeds between your CPF account and yourself. It does not affect the attractiveness of the housing purchase. The key interest rate that affects the investment decision is the housing loan interest rate, not the CPF interest rate used to compute the accrued interest. 
  • Whether to use CPF or cash to service the housing loan depends on their relative rates of return. Use the one with the lower rate of return to service the loan.

By the way, topping up your and/or your family members' CPF accounts with cash allow you to enjoy income tax reliefs of up to $7,000 (top-up for yourself) + $7,000 (top-up for family members) next year. If you have not done so, please hurry, before the year ends!

See related blog posts:

Sunday 13 December 2015

Ahead of the Grand Battle

This time round, the US Federal Reserves is probably finally going to raise interest rates. Although the stock market is not at multi-year lows, the impact of the first interest rate rise in almost 10 years from an unprecedented low of 0.25% has far-fetched implications on currencies, commodities, bonds, stocks, properties and world economies. It is undeniably a grand battle on multiple fronts. 

If you have been following this blog, you will notice that my views on interest rate rises have shifted from being bearish in Jun (see Getting Ready for US Interest Rate Rises) to being optimistic at least in the short term in Sep (see A Jittery September). The economic implications of the interest rate rise are still valid, however, I believe that such expectations have been priced in and investor psychology of selling before a bad news would take centrestage at least in the short term. 

In line with this analysis, I have moved approximately 25% of my capital from cash into equities since the stock market rout in Aug just as most investors have moved in the opposite direction. Considering that the Straits Times Index is at a still-high level of 2,800 points versus the final battle during the Global Financial Crisis (GFC) which took place at 1,600 points, such a move appears premature. In fact, a post-event analysis of the investment decisions made during the GFC shows that it is better to wait for some clarity on the situation before making major moves (see Be Cautious While Being Greedy). In other words, is this period of rising interest rates reminiscent of Sep 2007 when stocks were beginning to collapse in an unfolding housing and financial crisis or Feb 2009 when stocks were making a recovery after monetary authorities around the world came to the rescue? Thus, a frantic search for some clarity began in Sep to make sense of the various economic developments since the stock market rout in Aug (see A Jittery September). Rightly or wrongly, some sense had been established with regards to the global economy to guide investment decisions, although the situation on oil & gas have become murkier as they have their own dynamics in addition to being influenced by interest rates.

Coming back to the move from cash into equities, it was also influenced by another factor. In the midst of this stock market roller-coaster, there was a little-heralded announcement in end Oct that affected very few people but shook the foundation of my equity-centric investment strategy. It was OCBC's announcement of its intention to redeem its 4.2% preference share. To understand the impact of this move on my investment strategy, you can refer to Behind Every Successful Bear Market Recovery is A Cash-Like Instrument, which was written when OCBC redeemed another of its preference share 2 years ago. This is the third time I am kicked out of a preference share, having been kicked out of OCBC5.1% and UOB5.05% preference shares previously.

Thus, I had to find a new parking place to replace the OCBC 4.2% preference share. DBS' 4.7% preference share is the most obvious choice. It still has another 5 years to run before it is eligible for redemption. However, the recent liquidity squeeze on fixed-income securities (see Sneak Attack on My Cash Reservoirs) made me reconsider the validity of my assumption that sufficient liquidity is always present when needed. Given the limited number of good fixed-income securities and the underestimation of liquidity risks in times of crisis, the portion allocated to fixed-income securities has to reduce. Moreover, I also dislike paying a high premium for fixed-income securities.

That leaves Singapore Government Securities (SGS), Singapore Savings Bonds (SSB), fixed deposits and cash as the options. While they are good in preserving capital and have very good liquidity, they lose value to inflation in the long run. Moreover, SGS is a poor choice in the current environment of rising interest rates. Cash will always be an important component of my portfolio, but too much of it will drag down the overall performance of the portfolio. So, instead of retreating further into the safety of cash & fixed deposits, I decided to advance deeper into equities, trying to look for 1-2 stocks which I could entrust my capital for a long period of time. It is a totally new investment strategy. Although this might not be the most comforting of times to move from fixed-income & cash into equities, if it were more comforting, the price would be higher.

In another 3 days' time, we will know whether this major move from fixed-income & cash into equities is sheer madness or justified confidence. I do not like war, but if war comes, I will respond accordingly. My biggest worry is the US Fed chickening out again, just like it did in Sep. If so, the casualties will be very heavy. The difference this time is I will no longer have OCBC's preference shares to cover my back.

See related blog posts:

Sunday 6 December 2015

Do Retail Bond Investors Get the Poorer Deal?

When Frasers Centrepoint (FCL) announced the issue of its 7-year, 3.65% retail bond on 12 May 2015, it was preceded by another announcement just a day earlier regarding the issue of a perpetual securities that carry a coupon rate of 5.00%. In fact, the perpetual securities were not the only bonds issued by FCL since its listing on SGX in Jan 2014. There were 2 other bonds, namely a 4.88% perpetual securities and a 7-year, 3.95% Fixed Rate Notes, both issued in Sep 2014. Thus, among all the bonds issued by FCL within a short span of 8 months, the 7-year, 3.65% retail bond has the lowest coupon rate. All other wholesale (i.e. non-retail) bonds have higher coupon rates. It raises the question whether retail investors have the poorer deal when it comes to new bond offerings.

Shortly after FCL's retail bond issue, Aspial, Perennial and Oxley all issued their own retail bonds with coupons ranging from 4.65% to 5.25%. Like FCL, all 3 companies have issued wholesale bonds before the retail bond offering. Let us study whether it is true that retail investors have the poorer deal when it comes to new bond offerings. 

The figure below shows the Yield-to-Maturity (YTM) of the various bonds issued by the above-mentioned companies that are available on Bondsupermart. Each colour represents all bonds issued by a particular company. The retail bonds are identified by a label next to the points. As an example, Aspial have 5 existing bonds, shown in purple in the figure. Its retail bond has the highest YTM and longest maturity among all its bonds. Also shown in the figure are the 3 lines representing the YTM of the risk-free Singapore Government Securities (SGS), high investment-grade bonds rated A3 by Moody's and the lowest investment-grade bonds rated Baa3 by Moody's. These lines provide a reference to determine whether the bonds are fairly priced or not. Please see Benchmarks for Retail Bond Pricing for more details on how to price a bond.

Fig. 1: Wholesale Bonds versus Retail Bonds

At first glance from Figure 1, the retail bonds appear to be priced fairly in line with their wholesale cousins after accounting for unique bond features that could introduce a premium or discount to the YTM, such as putable features (which results in lower YTM) and callable or step-up coupon features (which results in higher YTM). However, on closer look, there are differences in the yield spread between wholesale bonds and retail bonds. In bond pricing, every 0.01% in yield counts. 0.01% is so important that it has a special name – a basis point. If you compute the YTM spread between the bonds and Baa3-rated bonds, retail bonds have lower spreads compared to their wholesale cousins ranging from 0.11% to 0.30%. What it means is that retail bonds are actually more expensive.

The correctness of the above analysis is dependent on 2 assumptions, namely, (1) the spread is constant across all bond maturities and (2) the reference yields are correctly constructed. In view of these limitations, let us consider perpetual bonds which do not have such limitations. There are 3 perpetual bonds listed on SGX, namely, DBS 4.7%, Genting 5.125% and Hyflux 6%. Like the other companies mentioned above, they also have wholesale perpetual bonds. Let us look at each of them.

Fig. 2: DBS' Perpetual Bonds

Figure 2 shows the perpetual bonds issued by DBS. The first bond (DBSSP 4.700% Perpetual Pref) is a retail bond. As can be seen from the figure, it has the lowest YTM among all the bonds.

Fig. 3: Genting's Perpetual Bonds

Figure 3 shows the perpetual bonds issued by Genting. Both bonds have the same coupon, but the first one is the retail version. Again, it has a lower YTM compared to its wholesale cousin.

Fig. 4: Hyflux's Perpetual Bonds

Figure 4 shows the perpetual bonds issued by Hyflux. The first bond (HYFSP 6.000% Perpetual Pref) is the retail bond. Similarly, it has the lowest YTM among all the bonds.

Thus, it is fairly conclusive that retail bonds are priced more expensively compared to their wholesale cousins. This is to be expected, since wholesale bonds are traded in multiples of $250,000 and hence not accessible to most retail investors. Nevertheless, retail investors should be vigilant and not let ourselves be taken advantage of.

P.S. I am vested in FCL's 3.65% bond and CapitaMallsAsia's 3.8% bond.