Investment Moats

Adding Emerging Markets to Global Allocation

by Leave a Comment

Recently,I decided to look into allocatig a portion of my funds into the emerging markets. Currently, I DCA into UOB United International Growth fund for my Global Allocation. It is a global fund with an emerging market tilt. However, I believe the future growth could come from emerging markets rather than developed markets.

Having emerging market stocks in your portfolio will provide a different correlation to the developed economies. You can find some the he articles over here on this. However, what shoul dbe the right mix?

Research normally shows that one should limit their exposure in emerging markets stocks. This is due to their higher volatility which could cause your overall returns to fluctuate wildly. Risk adverse investors should take note of this. We have seen in the recent May 2006 correction how much your portfolio could go down if your portfolio is heavily skewed towards emerging markets.

In contrast, developed markets corrected less (Still hurts though…) Judging by this, we should be having closer to 30% of our allocation to emerging markets than 50% of our allocation to emerging markets. However, I would choose the later.

Volatility is a double edge sword. When market irrationally correct downwards, your existing holding suffers. Not many who check their portfolio regularly would like to see their 40K worth of investment go down by 10K. This is the kind of short term view most average human being will hold.

In the long run, these dips will enable you to buy more units for the same price. $1000 bucks at $1 gets you 1000 units. $1000 bucks at $0.75 gets you 1333 units. What a deal!This is good if you are in the accumulating phase of your portfolio. But what about your existing holdings??? Wouldn’t it be better if you sell them before they fall and then by them back near the bottom? If not, your portfolio will look ugly as hell!

For the folks who are skilled enough or who think they can anticipate well, great, go ahead by all means. No one stopping you. I for one must admit my bottom fishing and top fishing skills are not top notch ( If you are please email me, i must learn from you.) I would rather spend my time doing something more worthwhile than anticipating and researching the markets everyday.

Being in the market has risks, but being out of market contains enormous risks as well. My experience with anticipation, couple with my risk adverseness has resulted in me missing out on alot of run ups. ( I got out on alot of shit as well btw..) Looking at it in another way, those are HUGE LOSSES.

The best way to systematically do this in my opinion is through an RSP program. There is a difference between RSP and volunteered DCA. I fyou manually add to your funds yourself, ou might be more susceptable to market timing as comopared to forced DCA through RSP. Your emotions will overwhelme your rationality in the face of hugh portfolio loss.

The Ratio

I have decided to go for a 50% developed markets and 50% emerging markets allocation. I will use 2 funds to do this. The re are disadvantages of having 2 funds as a model for the global allocation. For one, rebalancing bloated region (i.e. China according to the index constitutes now 40% of world equity. remember Japan?) is a problem.

The advantages of having less funds in your portfolio is that it is easier to manage. When one learns much about investment it makes you feel like you are IN CONTROL. You want to DIY and construct your portfolio so that it gives you flexibility to add here add there. To me i find the benefits of smaller portfolio to be better. They are as diversified as one that is constructed using 4-5 funds yet you only have to RSP into 2 funds. For an investor with less capital to start with, having 5 funds is difficult to execute. It will be easier to monitor them as well. Active funds need attention to make sure that their performance dun lag behind too much. If you have 5 funds, you will need to monitor what are the best 5 out of these categories. If your global allocation uses infinity global index fund, then its even better cause you dun have to worry about underperforming the benchmark. It tracks the benchmark!

Less to monitor, Less problems in calculating expense cost, at the same time it covers the global region well enough.

The Execution

Currently, I have started RSP 500 bucks every month to UOB United International Growth Fund. I will be RSPing 300 bucks every month into an emerging market fund.

I still haven’t made up my mind which fund to use. Do note that if I were to use ETFs which although has much lower expense cost, I cannot RSP every month cause the cost will kill the portfolio. It also depends on whether you are comfortable accumulating and investing annually. Based on MSCI World Data, baring expense cost, performance if you add every month is better than annually ( with expense thats another nightmare story). I shall not bring up the US ETF vs Spore Unit trust debate here.

Why Candidate?

My Primary Choices are Schroder Emerging Markets and Fidelity Emerging Markets A-SGD. Some of the considerations i take were,

  • Expense Cost (Its a drag. Wish we can have less than 1% ones but fuck,we live in singapore)
  • Fund Size ( You dun want to get caught when the fund close down on you. I experience that. It ain fun. Further more the bigger the fund size the expense as percentage to NAV tends to go down as well)
  • Track Record (These 2 funds have the best long term records. Yeah fidelity does. Take a look at the Funds-sp illustrations. Not the FSM ones. It has an illustration in USD)
  • Turnover (The greater the turnover, the more cost incurred by u investors. Market timing by managers for returns are most of the time grossly overrated)
  • Anymore? (may be you folks can fill me in.)

500 and 300. Where will that bring me? Lets take a look at these 3 funds. By using $500 and $300, the ratio is 62.5: 37.5. Taking the recent fund fact sheet as reference, UOB fund has an allocation as such:

Fidelity Emerging mkt has an allocation as such:

Schroder has an allocatioin as such:

By RSPing this way, I am effectively allocating:

  • 28% US
  • 17% Europe
  • 10% Japan
  • 45% Emeringing Mkt

Thats close enough to a 50:50 allocation. IS this high risk? I think the RSP should make volatility work in my favor. (NOte: if you are near or projected to retire soon, dun do this. This global allocation is more for accumulation by takimg more risks. Retirement goals and strategies are different.)

Conclusion

This plan is not full prove. I can think of a few things that can throw this plan haywire.

  • IT would be good if Singaporeans have access to low cost index funds locally. Although in inefficient markets as those of emerging markets, my research have shown that both Fidelity and Schroder do not faired better than Vanguard emergin mkt ETF and iShares emerging market ETF. However, the transaction costs and estate duty consideration makes investing in US ETFs risky. I would rather earn less than my folks not able to get 50% of my estate.
  • Good active funds will underperform once in a while. That is why it is important that our criterias be well defined.You have to periodically monitor the 2 funds to make sure they do well in the long run. I said that I would prefer to let the porftolio autopilot more but normally funds that used to be in the top 5% quatile will not be in there.

My plan isn’t the best solution. Please do not take this as correct. I hope by putting my constuction here, you can contrast this against how you do it. See whether it makes sense or not.

Sunday Times Article: Surviving Market Turmoil

by 2 Comments

Just a few observations abt the 4 portfolios.

  • For the second update running they have been not performing well. This is “expected” by me since the market didn’t do too well to start with. However, this should be evidence that it is damn difficult for knowledgable investors to perform miracles. Out of the 4, I would think chan Wai Chee and Professor Chong to be very knowledgable men. But even then, their results do not match their pedegree.
  • My opinion is that those 2 fund portfolio contains too much funds. Sure they look well constructed (especially that for FSM portfolio), however, i believe the eventual result of having so much funds equates to the result of having a global equity fund.
  • I have to agree with Mr Ernest Low’s recommendation on Bonds. In the short term, Bonds should do well if the interest rates stabilise or weaken. (That does not mean the long term outlook for bonds is good)
  • Prof Chong is essentially a value investor. The short time period may not be a good judge of whether his picks are shrewd.
  • I’m not sure the intention of this series. To me, its like telling everyone what strategies that can earn a quick buck! there is no objective from the start. It goes to show that it is not to correct punters flawed mindset but to confuse them even further. I would think the most likely readers of these columns are folks who has just started to know abt investments or nerds who intends to finish every article in the news paper.
  • I am beginning to think that SPH do not believe much in investor education. it is driven by advertising from these distributors to create more traffic and business for everyone of them.

Old Q & A on investing in A REIT

by Leave a Comment

Another spring cleaning article. Note that A REIT has ran up alot since that time and has fallen back to a rather fair value.

Q: I read that REITS give out 100% of their earnings as dividends. If that is the case, how do they grow? Without retained earnings, how to buy more properties to manage?

A:

When REIT wants to expand their business, they can either tap on Equity or debt. They can issue more shares, like what A-REIT did. Under the regulations, they can have debt-asset ratio of 35%. A-REIT’s current debt-asset ratio is 25.8%, which means it still has room to raise more debt to fund its expansion without even issuing more shares.

This means that when we invest in REIT, 1 important thing to watch out for is its debt-asset ratio. Once it nears 35%, better hands off from REIT. Beyond this point, if the REIT wants to grow, it has to take back money from investors from new equities. For new investors, this is even worse because they did not even have the chance to enjoy the generous dividends of the past years.

If debt asset ratio is close to 35%, the REIT can choose to raise capital for its expansion. If any acquistion of property is done on a “yield enhancing” basis, then new shareholders will still get a reasonable yield on their capital.

Basically, REIT is for institutions and people who are looking for “yield” and stable returns. It’s not expected to provide high potential capital gains. Thus, importantly is for you to ask yourself what’s your investment objective? What type of investments are suitable for you? Does REIT have a place in your investment portfolio. Different people will have different answers for these questions.

A REIT is not a pure equity offering. When you invest in the REIT, it is like buying property. The REIT increases in value if the underlying property (or its yield) rises.This is notwithstanding the debt picture. Remember that interest rates on debt are not gauranteed to stay low.i.e. you may want to take into account the debt when investing in a REIT. But, really, you are becoming more like a landlord (with a management company that manages everything for you and takes its cut).

REIT prices are supposed to be less volatile than than equity (steady, but not volatile income). The fact that a REIT like ascendas has increased in price from 88 cents (at IPO) to $1.40+ may be a one time exception as the REIT settles into steady state operation and investors settle on a yield that makes sense to them. Assume that I consider 200 basis points above the SGS bond rate to be an minimum yield for a REIT. Assuming a SGS rate of 3.75%, than a yield of 5.75% might be considered a good long term rate.

If I further assume that Ascendas REIT income (my example) will top out at 9.3 cents per share (without raising further equity), than my theoretical intrinsic value for the REIT is about $1.60.

Note that SGS bond rates may change naturally. It is common to assume that an interest rate rise would affect fixed income instruments (of which a REIT can be considered to be a pseudo example) in the sense that alternative investments are possible. In practice, in Singapore, with a limited array of fixed income instruments and a lack of investor knowledge, REITs are a major factor to the income oriented investor.

As a check, here’s another way to calculate it. Assume that the average lease of land (weighted by contribution of property to yield) in the AREIT portfolio is 25 years (I’m sure this can be checked, but I didn’t bother). Assume further that an “optimum yield” given current equity is 9.3 cents (as above), and it increases by an average of 3% per year. A required return of investment is 5.75% as above. Then, using an IRR calculation in your spreadsheet, I arrive at an intrinsic value of $1.63 cents.

A similar calculation where there is zero growth in yield on average, gives $1.22 as the intrinsic value.

This method is probably “better” and allows you to play with growth in yield scenarios.

A home mortgage, while admittedly secured against a “hard” asset, is fundamentally inconvenient for the lender to foreclose on and seize for disposal. It also makes for bad publicity to oust people from their homes, especially the down-and-out hard luck stories. So although the deed or lease is assigned to the bank, the assessment is ultimately predicated upon the aspiring owner’s ability to pay.

In the case of a salaried worker, the quality of the job held (in terms of pay, promotion prospects and resistance to retrenchment) is a key factor. An employer, on the other hand would likely be assessed on the strength of his business, but the control he exerts over the business and its finances would normally tilt the balance in his favour. The self-employed are subject to the most stringent scrutiny of all, on account of the volatility of their earnings.

In the case of A-REIT, its ability to pay is in turn dependent on the creditworthiness of its own tenants. Since there are many tenants, and many of these are large, financially sound concerns, the risk of significant rental arrears is minimal. Correspondingly the risk of A-REIT itself defaulting is low. Together with the low gearing, the margin of safety is good, so the banks lend cheaply.

With homeowners, there is no equivalent diversification – either you have a job or you don’t. Plus, your gearing tends to be higher. The margin of safety is lower, so the rate demanded is higher.

A-REIT’s interest expenses are relatively low because of 2 factors: a) low interest rate and b) low gearing. Notice that REITs in Singapore are restricted to 35% gearing as a matter of prudence to minimise damage from rising interest rates. The average homeowner on the other hand is geared to the tune of 70-80%. So when interest rates rise, the REITs will merely earn a little less, while many people will lose their homes.

If a homeowner decided to gear to only 35% I’m quite sure the bank would happily lend at 2% or less, long-term, for it would take a 65% reduction in property value before there was a risk to the bank’s principal, the inconvenience of foreclosure and disposal notwithstanding. In return for low risk, most banks would willingly take a low return.

Emerging mkts performance

by Leave a Comment

I’m still deciding how i should invest my emerging mkt position. As i was doing my research, i was shocked by the underperformance of 2 of the top 2 active managed emerging mkts fund available to me. With this kind of short term underperformance, does that mean I should take the estate duty risk and stick with ETFs for emerging mkts?