Investment Moats

This week, I read something Nick Maguilli wrote about why own bonds when yields are so low.

He basically came to roughly the same conclusion that I came to, but I think he has a better explanation then me.

Some things just stopped working so well. Not stop working. Stop working so well.

He gave a good example of what Buffett implemented in his earlier years:

For example, in the 1950s Warren Buffett and Benjamin Graham made lots of their money purchasing companies selling below their net current asset value (“net-nets“). This style of investing is the equivalent of paying $50 for a suitcase that has $100 in it. But good luck finding such “net-nets” today.

It is true that you would struggle to find net-nets, but that does not mean you could not make money. I have one or two friends whose portfolio are focus on the Graham style type of investing that is based on identifying mispricing, buying something worth $1 for $0.50.

And they have a few home runs.

In a year where that will lead you to believe that unless you are in tech stocks, you would get no where, they got somewhere.

But in a way, we are seeing enough shit talk about strategies like this that if the trend continues, less and less people will invest in strategies like this.

Maybe This is Better for the Strategy

But perhaps one of the reasons why these strategies could not work so well is because in this computer age, any inefficiency in the markets can be removed.

A lot of what Buffett did was based on what can be found in the financial statements. Computing the intrinsic value by computing what is worth liquidating is very fixed.

This can be done by computers which means that many of us can do it.

So do any of us have an edge over others?

But at least if less people feel that this is a long term investing method that give us an advantage, it is less crowded.

I have always favored the less crowded way. If something is crowded, it makes me wonder if there are alot of sentiments involved.

There are some rules or axioms that stays true throughout time and human behavior is one. So if everyone does something, it makes me wonder if certain strategy is too crowded that we are all paying too much for something that works (which can be rather bad in investing).

How does Investing in Ugly Things Feel Like?

For a large part of my investing journey, I realize what worked better was investing in fundamentally positive things.

When the fundamentals are well and things are healthy, but I feel there are enough people mispricing it.

The mispricing could be

1. The quality of the cash flow
2. In the duration of how long the quality of the cash flow can be

The turnaround plays do not work so well because I have this psychological issue of not sitting well with ugly things. Ugly things are stocks whose fundamental “seemed intact” but the share price will drift lower.

What is difficult about these stuff is that more often than not, I question if I got the thesis wrong, or that deductive work done lacks the depth required.

So if I know that my behavior is like that, I better shift to a strategy that does not put me in a position where I have to contend with ugly things.

However, in a way, if I were to buy a seemingly quality company, there would be a point where the prices does not “realize” that quality.

The stock price would go sideways or even go unloved. Then how would I feel about that? Would I second guess my decisions?

I admit I don’t like to invest in ugly things or things with ugly moments. The problem is…. quality investments go through ugly moments. So what are we supposed to do about it?

What made us hard to stay with ugly stuff… is often our own psychology. In this time and age where you have a lot of forums, chat groups, it is tough to not be affected.

Perhaps this is why some of the great managers choose to park themselves away from Wallstreet. This is so that they can make independent decisions.

Professional Managers and Advisers Have a Hard Time Sticking With Ugly Things

There are also strategies that would look pretty ugly if you put them against the basic indexing strategies.

For the past few years, trend following, Graham style value strategies, quality strategies based on profitability, multi-factor strategies, risk-parity, you name it have not worked well against indexing.

And it becomes a hard game when your investors chided you for doing worse than an index. Advisers don’t want to recommend your funds or switch away because they are under pressure to deliver returns.

You start shifting your strategy as well.

Shifting your strategy have its good points and bad points. The bad points would be how would you explain to new prospects or existing clients your constant shifting in ideology?

Perhaps you need not explain so much because what you “promise” your clients is that you are able to get them a certain rate of return.

If that is the case, you will live and die by your investment decision. Your clients would likely follow you when you are able to give them returns and leave you when you go into a funk.

You will have to Think About How You Handle Investments That Do not Go Your Way

I think each of us have to think about how do we handle our investments looking ugly.

• There are investments that look ugly and you should not hold on to them, and you should sell them off
• There are investments that looked ugly and there are reasons to hold on. You would just need to learn to compartmentalize and manage them well.

Sooner or later what worked will look ugly.

When Seemingly Good Stocks… Go Nowhere

A good example is when you have a seemingly fundamentally sound stock with a good network effect. Much of the growth is built into the current price.

There will be a point where the growth slows down. And the share price goes nowhere. What is your course of action then?

What if it is more than one stock but a bunch of them? This is very possible since… most folks invest in themes…. a bunch of REITs…. a bunch of tech stocks… in a portfolio of physical properties.

Would it be to stick to your guns, ride through the ugliness or would you shift to other “strategies”?

The earlier you confront this question, and think of how you handle this the better.

Bottomline

I wrote this because… I felt that when times are good people might not have pondered about this. There are enough optimism in the markets to lure folks to believe this optimism would sustain throughout your investment journey.

It doesn’t.

In investing, you need to put your money into something that have liquidity risk, credit risk, possible insolvency, fraud risk, entreprenueral risk to potentially earn higher expected return.

If there isn’t any volatility, then there should not be outsized returns.

The second reason that I wrote this is because of what I observed at work.

This is a business that cannot tahan uglyiness. When markets go a bit crazy, it is when advisers are suppose to earn their money by getting you to continue to stick with your investments. But it also places a lot of stress on the advisers because re-programming natural human instincts is a tough proposition.

In a way, I think most investors do not know how factors such as value, size, profitability, momentum, credit, term show up.

Hell, I have to dig deep to try and understand to know that these factors show up when they want to show up, and it is not something that we can predict. Sometimes when they show up, one or two occurrences make up for years of underperformance.

Sometimes, it is one thing to say “we do not know when these factors will show up because we cannot predict the markets” and it is another thing to truly understand what that statement means.

Factors can choose to not show up for months or years while in your head, you were hoping these gaps between factors showing up is in weekly intervals.

I came to a conclusion that most people cannot take ugly things. Only the odd weird souls are able to.

And it makes money management challenging if you are basing your investment philosophy on strategies where your client’s investment go through ugly moments.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

On 29th Sep, URA has announced that they will restrict the re-issuing of options to purchase (OTPs) to the same buyer for the same unit within 12 months of expiry.

These new restiction written into the law would:

1. Restrict developers from providing upfront agreement to buyers to re-issue the OTP and
2. Restrict developers from re-issuing the OTP for the same property, to the same buyer, within 12 weeks after the expiry of the earlier OTP

Sometimes, when you are not in the industry, I did not comprehend the ramifications of these changes. My friend has to explain to me what it all means.

Typically, when I buy a property, the transaction starts with obtaining an option to purchase or OTP and a deposit of 1 to 5% of the property price. I would have 14 to 21 days to exercise the OTP, meaning I would have to cough out the rest of the amount needed for the downpayment.

If I do not do that, the OTP will lapse. If I put down a 5% deposit, I would forfeit 25% of the deposit. If I put down 1%, I would forfeit 100% of the deposit.

The issue is…. some developers decided to play around with this OTP.

After the 2018 cooling measures, some developers would extend the OTP validity period. Developers would also re-issue lapsed OTPs.

Now, if I do not have the finances ready to purchase the condo, some of the developers would be very happy to re-issue the OTP to me after the OTP lapse. This gives me enough time to sell off my existing property, getting some cash to pay for the downpayment.

What was achieve through this?

The sales figures for the projects looked better than the reality.

I think if you are on social media, you would see those images posted by your property agent friends how HOT the deal was.

This gives you the feeling that many of your peers are trying to get into some good deals here.

In reality, not all of those sales figures that you see were eventually followed through. You could have 600 units sold but 300 returned.

What URA wanted to stemmed out was: This creates wrong market signals.

It distorts the market into thinking like the whole of Singapore, despite the ABSD and TDSR, are so flushed with cash to afford.

But Re-issuing OTP is Not the Only Distortion to the Demand and Supply of the Property Market

Property Agents, like insurance agents and car sales people mostly work on incentives.

Incentives would motivate people to sell certain kind of things, as oppose to something else. For example, the quantum of premiums and the commission structure would motivate agents to sell cash-value insurance.

Higher commission for certain model of vehicles would nudge sales person to influence clients that certain vehicle should be strongly considered.

You could hide or withhold information about certain products that paid less well, but in truth, more suitable for the client. This is not lying just not revealing.

If a resale property agent list and successfully sell a resale property, this seller agent will earn 2% of the transacted value from the seller.

This seller agent would have to give 1% to the buyer’s agent.

Some seller agent may reduce their commission to 1.5% or even 1.0% of the transacted value. What this will result is that the buyer’s agent will get 0.75% or 0.50% respectively. It is debatable whether reducing the commission is a good idea.

The Fat Discount Given to Property Agents for Marketing New Private Property Developments

What I have explained above is the resale market. Post July 2018, property agents marketing newly launched properties have enjoyed a significant rise in commissions.

Developers of newly launched private properties started giving discounts to property agents in order to give them incentives to move sales to clear the developer’s inventory.

Take Treasure at Tampines for an example.

The developer of Treasure at Tampines was willing to give the property agents who was able to move sales 4% of the listed price in commission.

This is not fixed.

Arena Residence was able to give up a 4% discount to the listed price.

The discount for Mon Jervois was 6.5%.

Now, you may ask the question: Why don’t developers just lower the sale price?

These new launch are released in tranches to the public, if there is too much volatility in the sale prices, this would upset the buyers from the previous release if those who bought the latest release got it cheaper.

So the route that they take is to vary the margins they earned, vary the incentives given to property agents to motivate them to market the property in their own way.

How These Developer Discount Creates Incentives that May have Tilted the Market

These discounts given to agents as commissions could range from 3% to 8%.

The higher the discounts given as commissions to the agent, it usually means the property is less in demand and developers need to give a greater incentive to motivate agents to help move sales.

Suppose an agent sold a unit of Mon Jervois for $4.8 million. He or she will pocket $312,000 in commission.

For an equivalent resale unit that is worth $4.8 million, he or she would pocket $48,000 in commission.

Now if you are someone looking for a property agent for advice which would be a better purchase: A resale condo or a new development.

What would the property agent’s advice to this prospect? The one that he or she could potentially earn $312k or $48k?

The answer is quite obvious here.

It gives the agent an incentive to better market the proposition of new development, and emphasize the downside of choosing a resale.

It is no wonder those agents who were dealing with resale would now be more willing to do new launches.

There may be something more.

Now property agents cannot give these all or part of these commissions that they could earn from developers to the property buyer.

This is not legal.

If they were able to give some of these commissions to the buyers, the buyer would have gotten a cheaper private property.

But that does not stop some property agents from giving relatives of the property buyer an introducer fee. This is an indirect way for the property agent to give the prospective buyer a discount.

Some property agents were willing to do this, some are not willing to.

The buyers probably know about this, so they would try their luck and ask each agent. For those who toe the line, they risk losing the deal to those who do not toe the line.

As a client, for the same property development, you might not buy at a more attractive price as some of your future neighbours.

All this really creates an opaque layer that benefits those in the know and penalizes those who do not know enough.

Bottomline

The government wanted everyone to see the property market as real as possible. In a lot of ways, it means the demand and supply data should show what is actually happening.

But the tightening measures from the government have resulted in developers coming up with antics (re-issuing OTP, discount to property agents) that have created a market that looked like:

1. More buyers than actually is
2. Property agents recommending new launches over resale to prospects
3. Uneven private property cost price for buyers

Currently, you may be able to observe a spread between the values of resale properties and new launches. Are the resale private property cheap or are the new development units too inflated?

I do not have a good answer to that. The reality may be that actual demand for private properties is much more muted than what we perceive.

The carrots given out have swayed the marketing and messaging to the general public to the side of new launches.

When the incentives changed (e.g. government coming down hard on these discounts), perhaps the messaging to the general public will change to how undervalued these resale are versus the new ones!

These inefficiencies in pricing in the property market may have created areas where you may be able to profit from if you are in the know. This is much like the equities and bond markets.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works