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.

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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.

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Sunday, 16 April 2017

Early Retirement Maybe A Luxury That I Cannot Afford

I have blogged about early retirement in the past 2 years, but I really do not intend for this to be an annual series. Moreover, I do not intend to retire early and sit back and do nothing. Nevertheless, there are fresh insights on this topic and it is good to write them down for future reference. 

In the past 1 year, I have read a few books such as "Capital in the 21st Century" and "Rise of the Robots: Technology and the Threat of a Jobless Future". I am concerned about automation and robots taking away jobs. By right, this should not be a concern for someone who has considered early retirement. However, there are additional complexity if I think about future generations. I do not have any children currently, but if I have, then any actions on my part now would have an impact on them in the future.

I do not think I will be replaced by automation and robots any time soon. However, the same cannot be said for the next generation. If the doomsday scenario of robots replacing workers on a wide scale were to materialise, it means that we are back to the very old days when how well we live does not depend on how hard we work, but who our parents are and/or whom we marry. In the case of my children (if any), that parent would be me. Thus, when seen from an inter-generational perspective, the window of human employment is closing soon and early retirement at a time when jobs are still available seems a luxury. Hence, instead of saving enough for my own retirement and retiring early, I should work for as long as possible to maximise the income from human capital and build up sufficient financial capital upon which my descendants could lead a decent life. Early retirement maybe a luxury that I could not afford in the face of automation and robots.

Of course, this is not a fool-proof plan. Whatever I save could be squandered away by future descendents. So, I do hope that the doomsday scenario of robots replacing workers will not happen. Or perhaps the prevailing governments of the day would understand the social implications and implement some basic income for citizens as suggested in the books mentioned above. If I have to pay more taxes for this to happen, I would grudgingly pay them. It is a small price to pay for social insurance for my future generations.

Having said the above, if I can have the option of not relying on some external parties to bail us out, that would be the best. Thus, I will have to use my own efforts and earn as much as possible. Sorry, folks, I have to go back to work tomorrow.

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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. 

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Monday, 3 April 2017

I Didn't Let My Alma Mater Down

How time flies. This is post no. 208, which makes it the 4th birthday for this weekly blog. This is a time for celebrations and reflections. Today's story is about my studies in the Singapore Management University (SMU)'s Masters in Applied Finance (MAF) programme.

I enrolled in the programme in Jul 2004. The stock market had just recovered from a 3-year slump due to the crash in 2000, Sep 11 terrorist attack in 2001, accounting scandals in 2002 and the Severe Acute Respiratory Syndrome (SARS) in 2003. After a prolonged slump, the market staged a strong recovery in 2004 and I made my first (small) pot of gold. I decided to reinvest the profits, not in stocks, but in a formal education in investment. Through good fortune, I heard of the MAF programme in SMU and decided to enrol in it in Jul 2004.

The MAF programme catered to professionals who wanted to advance in their careers in the finance industry as well as people who were looking to make a career switch into the industry. Thus, it took in graduates who were trained in other disciplines. However, being the introvert I am, I had totally no idea what the intent of the programme was all about, nor the hot prospects of jobs in the finance industry then. I was not even aware of the Chartered Financial Analyst (CFA) programme! I was simply happy to be accepted into the programme even though my basic degree is in engineering. It was only after I enrolled into the programme and met my new classmates, some of whom were planning to switch into the finance industry, did I realise what the programme was all about. At one stage, I wondered whether I had deprived anyone with the intention to switch of a place in the programme. Anyway, by then, it was too late. So, I continued my studies.

Frankly speaking, studying for the purpose of gaining knowledge instead of getting good grades is a joy. I enjoyed the lessons and the projects despite having to rush to class from work every Tue and Thu, besides spending the whole of Sat in classes. How could projects be boring if they were on analysis of companies such as Informatics, CK Tang, SIA, etc., since whatever insights we gathered for the projects could be useful for our own investments? Besides, the American education system that SMU adopted encouraged lively exchanges of ideas instead of just copying notes from the lecturer. I even had the curiosity to read up the "Greeks" (i.e. Black-Scholes model for options) outside of the classes! When we were about to graduate 1.5 years later, I felt a sense of loss. Never had I enjoyed classes so much in my life!

After I graduated, I applied for a few jobs in the finance industry, but I was not accepted, partly also because I was over 30 years old by then. Nevertheless, I did not feel too dejected, since my intention of enrolling in the programme was to gain knowledge rather than studying for grades.

A couple of years later, in 2012, I started this blog to share my knowledge and experience about investing. I believe I have a unique combination to offer to readers -- someone who is old enough to have 30+ years of experience in the stock market and has witnessed many stock market crashes but still young enough to blog and share knowledge. Furthermore, that practical experience is complemented by academic knowledge from the MAF and CFA programmes.

It is 4.5 years since I started blogging and 4 x 52 posts later, I believe I have established a useful resource for readers who wish to learn more about investing. What I have shared in this blog has sometimes gone beyond what is found in books. While I did not contribute back to society through working in the finance industry, through this blog, I am returning to society what I have gained from SMU. I like to say that I did not let my alma mater down. Thank you, SMU, for giving me a wonderful education in investment. Last, but not least, thank you readers who have encouraged me to continue writing through your visits to this blog.

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