Investment Moats

My friends at Endowus Gregory and Sheng Shi asked me to make a comment about investing with CPF so this is my honest take.

I wrote a post five months ago going through a Morningstar research why fees of funds in Singapore could not be as competitive as some other countries. I explained that Endowus is probably the first ROBO to provide an offering to invest your CPF.

The majority of the competitors were more focused on cash investment because that is the low hanging fruit. And that is where most of us should have our assets (I think).

SRS account was the second-lowest hanging fruit. Now we see almost all ROBO offering it.

As far as I understand, Endowus is the only one who offers it right now. When it first launches, a lot of my blogging friends were very hyped over it. Finally! There is a possible viable option to get a greater expected return than what we are currently earning!

My CPF Philosophy

Before I go on any further, I think it is better I let you in on how I look at CPF to frame the discussion going forward.

1. The CPF OA Rate of 2.5% and CPF SA Rate of 4.0% is very hard to beat for a lot of people
2. The CPF SA Rate is not so permanent and subjected to change
3. Transferring from CPF OA to CPF SA allows you to easily increase the rate of compounding by 1.5% a year. This is provided you have done your financial planning well. Don’t fall into the trap that you transferred all to CPF SA, only to realize you need to cough up mortgage and student loan payment using cash (when you do not have the intention to)
4. I believe folks should learn the skill of investing early and learn to live with uncertainty or volatility in their wealth. In the spectrum of return and volatility, you can move your wealth in your CPF up the spectrum, taking on more volatility and uncertainty in the short run, in exchange for the chance for higher returns
5. You need to get comfortable living with some volatility in your wealth. Sooner or later, a large part of your wealth will need greater returns so that they can meet your financial goals, and so that your retirement income will last. Human beings don’t wake up overnight comfortable in putting 80% of their net wealth into some assets they do not have experience with. This has to be built up over time.
6. If you treat the CPF portion as your bond allocation, and that you have invested in equity-like investment options outside of your CPF, have experience with it, are trying to get comfortable with it, then it is OK. That is sensible
7. When you get comfortable with investing and can see yourself earning 4 to 10% return a year, your opportunity cost whether to invest your CPF or not is 4 to 10% instead of 2.5% to 4%. Putting your money in something earning 2.5% is costing you a lot of money!
8. I tend to take a balanced approach, having enough in CPF SA, enough in CPF OA, invest well with my CPF OA.
9. CPF monies augment my financial independence, not the other way

You might agree or don’t agree with me, and that is fine because we all live different kinds of life.

Do put in the comments if you wish for me to elaborate further.

Why Invest Your CPF OA at All?

I am going to tell you something startling: Some advisers managed to make a business out of advising clients to invest their CPF SA (which yields 4% a year) into an approved unit trust.

Basically, that is as close you can get to selling ice to Eskimos.

But why this question comes in the first place is that if the interest you can earn with your CPF OA and SA is more or less guaranteed, why do you subject your money to volatility?

I guess the justification that I will give you is time.

We only have one life, so we don’t have a lot of time to tryout and compound our money. If someone gives us 2.5% or 4.0%, we take it.

However, should your financial goal requires a larger sum of money in the future, what do you do?

You can accumulate more with your cash. Put my wealthy formula to work, get competent and accumulate more.

From the financial planning perspective, your investment choice depends on your time horizon and your risk tolerance. Your CPF is locked in for your retirement. For many of you, your time horizon is long and you cannot unlock the money in the short term.

Thus, it makes sense to invest and give your funds the opportunity to earn a greater return.

Gregory wrote a piece on why you should invest your CPF monies. Like a lot of his pieces, it tends to be data-driven. If you let people know you are evidence-based, best to show it.

A large portion of the article is the degree of confidence that, if you invest, you can beat the 2.5% a year rate.

There are a lot of data charts & tables that I like but I will pick out a few that stand out.

This table shows how successful each investment option is, to beat that CPF OA rate. Gregory crunched about 29 years of rolling returns data.

Since I am somewhat of a data nut myself, there are 348 1-year instances, 300 5-year instances, 240 10-year instances, 180 15-year instances, and 130 20-year instances. Basically it is not too narrow.

Each cell shows the percentage of success the asset could beat the 2.5%. If we look at Singapore inflation, there is a 24% chance in 3 years, Singapore inflation can be more than the CPF OA, but largely over 20 years, CPF OA can beat Singapore inflation.

There is almost zero chance your Singapore savings rate can beat the CPF OA. The interesting data is the Bloomberg Barclays Aggregate Bond Index. The rolling 3 to 5 years upwards show high success in beating CPF OA.

To measure the equity portion, Gregory used the MSCI All Country World Index (ACWI), World and S&P 500 (the difference between ACWI and World is that ACWI contains a small portion of emerging markets). In the short term, there are some instances where the annualized return is below 2.5%. But in the 20-year rolling return, almost all is greater than 2.5%.

Personally I like the balanced index for its balance between return and volatility. Straight off the 1-year returns, you have a relatively high success rate.

Here is another favorite rolling returns table. It breaks down the average, best and worst return for each investment option.

You would appreciate knowing the average inflation is 1.6% a year instead of the 3.0% a year a lot of people talked about.

The BBGA is particularly impressive in that the worst rolling 5-year return is 2.18%. Instead of investing in an equity heavy portfolio, we could move up the volatility spectrum slightly and invest in a corporate investment-grade bond fund to beat the 2.5%.

You will also observe that in the short term the worst case is depressing but as you hold it longer, the worst-case gets better.

Your returns gets closer to the average.

Last chart. It shows the monthly rolling returns versus the 2.5% CPF OA rate. The red area is the monthly rolling instance that failed to beat CPF OA. Observed that as you hold on it longer, the red portion disappears.

You can see a lot of instances where the returns are 50% greater than the CPF OA rates.

Suffice to say there is a lot of opportunity to do better than 2.5%. I knew that already. It is time for you to discover that.

The Problem with Investing With Your CPF

While the theoretical returns presented look good, the problem has always been the execution.

As an investor, we could achieve higher returns with individual stocks. However, we can only invest 35% of our CPF OA in individual stocks listed on the SGX (and it is not all of them! Only a selected few).

To compound this problem, the number of quality companies that you can invest and hold for the long term in Singapore is dwindling.

Here is a summary of the different investment options available to you to invest your CPF OA and SA monies:

Do note that the first $20,000 of your CPF OA and first $40,000 of your CPF SA needs to be set aside and cannot be invested.

Ideally, Singaporeans can invest in a low-cost global balanced fund or a low-cost global equity fund. If you look at the table, there is tremendous opportunity to invest all your CPF OA in unit-trusts and ILP that are low cost.

However, that is not possible because… unit trust and ILP tends to have a high sales charge and trailer fees. In March 2018, the Ministry of Manpower (MOM) tried to bring this inline by completely removing the sales charges.

MOM also capped the total wrapper fee that firms can charge from 1.5% a year to 0.40% a year.

This helped to a certain extent but they completely missed out on abolishing or capping the trailer fees. The trailer fees are a big cost component and as long as there is one avenue, there is a way to be abused.

Which brings me to Endowus’s offering.

Invest in 6 Different Actively Managed Unit Trust Portfolios with Your CPF OA

Through Endowus, you can invest in 6 different portfolios with your CPF OA.

These 6 portfolios have different volatility and return profile:

1. Very Aggressive
2. Aggressive
3. Balanced
4. Measured
5. Conservative
6. Very Conservative

For those who have lower risk tolerance and shorter time horizon, you can choose the portfolio on the lower spectrum of the risk profile. For those with a longer time horizon, you can choose the portfolio on the higher spectrum of the risk profile.

The minimum starting investment is S$10,000.

These portfolios are currently made up of actively managed funds:

1. Lion Global Infinity US 500 Stock Index Fund (US500)
   • Equity
   • Feeder fund into Vanguard US 500 Index fund
   • 0.68% expense ratio
2. First State Dividend Advantage Fund
   • Asia Ex-Japan Equity
   • 1.71% expense ratio
3. Natixis Harris Associates Global Equity Fund
   • Global Equity
   • 1.71% expense ratio
4. Schroders Global Emerging Market Opps Fund
   • Emerging Market Equity
   • 1.68% expense ratio
5. Eastspring Singapore Select Bond Fund
   • SGD denominated / Forex bonds hedge to SGD
   • 0.62% expense ratio
6. Legg Mason Western Asset Global Bond Fund
   • G10 or SG countries bond
   • 0.87% expense ratio
7. UOB United SGD Fund
   • Money Market Fund
   • 0.67% expense ratio

As an investor, you cannot choose which of these funds go into your portfolio. You will invest based on the portfolio. You can, however, invest in multiple portfolios.

The Cost Structure

Here is how much it will cost you to invest with Endowus’ CPF Portfolio:

1. Endowus charges an annual management fee of 0.40% for their CPF & SRS investment, which is lower than the 0.60% fee for cash
2. No platform fee
3. Endowus will rebate all the trailer fees earned as part of the expense ratio (seen above). More on that later

In my previous article, I have explained that a cost leakage that is seldom mentioned is the trailer fees. Suppose Natixis Harris Associates Global Equity Fund charges you a 1.71% in expense a year. Out of this, 0.75% of this is paid back to the distributor (can be a platform like FSM, Dollardex, Poems or a bank).

Endowus wishes to weed out these trailer fees and thus they will rebate this to the investor.

Kah Kiat from Risk N Returns has a good write up on Endowus’s offering. He has a good table where he broke down the trailer fee cost for the funds and the portfolio. I cannot stand the color so I decided to format one on my own:

The trailer fees in red show the fee embedded in the expense ratio that is paid to the distributor. Endowus will rebate that to the investors. In the last column, you can see a summary of the total annual all-in expense that an investor will incur.

While some of the residual expense ratios for the funds still looked high, when you managed it in a portfolio, the expense is more rationalized. As a comparison, if you invest in Endowus’s most aggressive portfolio with cash in the Dimensional funds, the all-in expense is 1.03%, which is not so far from this 1.18%.

The Cost Advantage of Endowus Partnering with UOB Kayhian

In order to invest in any investment with your CPF, you will need to engage one of the three big banks in Singapore (OCBC, UOB, and DBS) to open a CPF Investment Account (CPF-IA).

What you may be less aware of is that there is there are transaction fees and recurring maintenance fees for making use of the banks’ services.

The table above summarized the additional transaction fees charged by the CPF IA account administrator and if you go through Endowus.

Endowus make use of UOB Kayhian as their broker platform who has achieved CPF Investment Administrator status. This allows UOB Kayhian to offer clients of Endowus lower costs.

Normally, if you invest in one Endowus portfolio (which is made up of at least 5 unit trust funds), the other administrators would levy 5 separate maintenance fees and transaction charges.

If you make use of UOB Kayhian, you deal with only one transaction and service fee. The recurring fee savings would be $36 a year. The transaction fee savings would be more substantial if you dollar cost average often.

The OnBoarding Experience

There are a few bloggers who have written about the onboarding experience and you can check them out here:

1. Endowus Review – Best CPFIS Product?
2. Endowus CPF/SRS Review
3. Investing my CPF OA with Endowus

#3 probably gives you the best onboarding experience. #1 will show you some growing pains.

What I do understand is that if you have not created a CPF IA account (which you need), the process can be a bit arduous:

1. Complete a CPF Self-awareness Questionaire
2. Open your CPF-IA account with UOB (if you have one you should be able to skip this)
3. Linked your CPF-IA to Endowus

You just got to be a bit patient.

The Elephant in the Room

If there is a problem with Endowus’ CPF offering is that people will ask the obvious question: What is with all the active funds?

I think some people are asking but not a lot. To be honest, the majority of the wealth-builders looking for solutions do not see the funds used as a problem. They may likely believe that since these funds are CPF approved then they are the superior funds.

But to many, Endowus have shaped their philosophy to be close to being evidence-based, making a strategic allocation, buying and holding.

Using active funds seemed… uncharacteristic.

Personally, I think this is a reflection of how broken our CPF investment scheme is, then Endowus carrying out actions that go against their original philosophy.

There is only a certain set of funds that are CPF OA and SA approved, so the selection is very limited. There are certain criteria to meet in order to be a CPFIS approved fund, chief among them is a lower expense ratio (less than 1.75% a year). Many of the funds could not fulfill what I believe is a low hurdle.

The funds that we believe are better (Lion Global wrapped 3 Vanguard funds into the Infinity series of funds) are not CPFIS approved. There are not a lot of physical, liquid global equity and bond exchange-traded funds around.

Many investors paying attention to this space would have hoped to invest in Dimensional Fund Advisors’ unit trusts with Endowus.

I didn’t ask Endowus about this but based on what I can gather, that… will take some time.

The play (my guess) from what I can guess is to provide the most viable solution for CPF investors first. Once Dimensional funds are available, it will be much easier to get existing onboarded Endowus investors to switch to the Dimensional funds.

So What is the Risk with Active Funds?

There are enough people talking about active unit trust without having invested in one.

My mom’s funds and a part of my CPF are in actively managed funds.

The biggest problem with active funds is the misdirection that you get. You observe that the global bond or equity index moved up 12% the past six months, and you expect your fund to do the same thing. However, it doesn’t. Sometimes it did better, sometimes it did worst.

Active fund managers have to make a judgment call to be in more cash, concentrate on a few stocks.

Research shows:

1. Active funds underperform their index
2. Funds that did well (to be in the top quartile of their category) have a hard time trying to remain in the top quartile.

What is not often mentioned is that… an underperforming fund may still beat a 2.5% CPF OA rate over time.

But in summary, when you select an active fund, a lot of times all you can do is pray that Endowus have picked the fund that managed to keep up with the index.

Summary

We start this article by asking whether you should invest your CPF OA at all.

Mathematically speaking, there are good justifications to do that.

However, financial planning wise, the decision is more complex. Many Singaporeans prefer to use their CPF monies to service their mortgage. Then, they will upgrade to a bigger place and that will require more CPF OA.

Given this kind of potential cash outflow, it makes them very resistant to commit to long term retirement investing.

CPF OA investing is suitable for those who have used enough of their OA monies to pay for their mortgage, are in their late 30s, ready to grow their CPF for retirement income.

Endowus has worked within challenging cost and available fund constraints to create strategic portfolios suitable for investors with different risk tolerances and time horizons.

Your total all-in cost is around 0.86% to 1.18%. That sounds like a lot but the next best alternative which is to invest in unit trust with DollarDex, Fundsupermart (no management fee) will average 1.50%.

A cheaper solution would be to invest in a 2-fund portfolio of ABF Bond fund and STI ETF. However, that is very Singapore-centric and if you are looking to be less home-based bias, that might not do.

If you are looking for a CPF investing solutions, do check them out.

The problem with CPF Investing is less of any providers but more of how the governing people structure it.

If we go by the recent HDB Built-to-Order trend, it might be the case that future central BTO will be smaller in sizes.

I observed that the latest HDB build to order sales launch was out and it seems rather peculiar that there were no launches in matured estate that is bigger than 4-room.

The biggest size flats for Toa Payoh Ridge and Kim Keat Ripples is 4-room. The sizing of the flats is deliberate and HDB should be under no constraint in their sizing.

Here are some of the past year launches:

My eyes were not playing games with me. But if you were to be strict about it, HDB is still releasing 5 RM HDB flats for a matured estate like Tampines.

A possible explanation is that they are starting to rationalize the supply of the new flats in these areas that are more central, and more in demand.

This would cause some frustration for newlywed young couples. For a long while, my friends prefer to stay in 4 RM or 5 RM HDB. They even lament that 4 RM is too small.

I always think that the sweet spot between affordability, cleaning, enough space, government subsidies is the 4 RM HDB.

Yet, when I spoke to Heartland Boy recently, you realize that there are some nuances that you will struggle to accomplish with a 3-RM flat. Heartland Boy stayed in a BTO similar to the new BTO above and has one daughter.

If you wish to create a better long term sleeping practice for another child, perhaps having only 2 rooms will not be very conducive.

I do get a feeling that there might be a push to rationalize affordability in these central estates.

I was initially thinking the government is saying: “If you want a bigger, yet central flat, go for those older ones. I have already given you the grants to make it more affordable. The leases are shorter but it will fit your needs.”

In matured estates, there should be ample supply of existing 3 RM and 4 RM HDB.

If this trend continues, it may be bad news for some couples. I know of folks who cannot stand living in a place that was inhibited by someone previously. It is damn weird but if that is the case, you would either

1. get a new BTO further
2. get a new Condo instead

You got to pay a higher cost.

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