Investing in Banks that are "TOO BIG TO FAIL"

www.investinsingapore.blogspot.com
Citibank has some 2Trillion of assets and falls under the category of "too big to fail"

Any problems with the banks will lead to a bail-out. So the bank will be more or less "safe". So that's what many says.

However there are uncertainties over what terms the bailouts will be. In case it is being re-nationalized in a bail-out, it will almost always be under very bad terms. And when that happens, the shareholder's interests may or may not be protected. Given that the bailor is most likely the US government who is already in debt tot he tune of >10 Trillion USD with a huge annual deficit funded practically by China, Japan, South Korea and Middle east sovereign funds, I suspect the government cannot be too generous.

Any offers to bail-out will likely have very stringent terms that could potentially and almost instantly diluted the ownership of existing shareholders.

If no bail-out is necessary, this would be the ideal situation, because that would mean that the bank would not need to sell at ridiculous prices. And when the market volatilty reduces, assets becomes more liquid, Citi can bounce back strongly.


Financials (In millions of USD)
Citigroup
Balance Sheet
Total Assets 2,050,131.00 2,187,631.00 1,884,318.00
Total Liabilities 1,924,069.00 2,074,033.00 1,764,535.00
Total Equity 126,062.00 113,598.00 119,783.00
Cash Flow
Net Income/Starting Line -2,815.00 3,617.00 21,538.00
Cash from Operating Activities 45,442.00 -71,430.00 -44.00
Cash from Investing Activities 14,538.00 -62,377.00 -204,206.00
Cash from Financing Activities -40,461.00 144,494.00 206,487.00
Net Change in Cash 18,202.00 11,692.00 2,882.00
(Source: google finance)

SAFETY In numbers?

Information takes time to flow downwards from the top of the pyramid. At Time = T0, insider BUYS, soon after at Time = T1 knowledgeable investors or inner circle follows suit after learning of the news. (This is called following the smart money). At T2, Hopeful investors see that the market is moving gets excited and starts to get greedy.


Finally at Time = T3, every aunty and uncle up and down the street thinks that the stock is a great stock with great prospects.

Everyone is buying, so there is collective knowledge and courage.

As the cycle is at it’s end at T3, Insiders have either sold or moved on, knowledgeable investors, mostly hedge funds, smart investors have started to sell just before T3.

So let’s say insider constitute 3% of the buying public, knowledgeable investors 7%, the rest takes up 90%.

So while at Time = T2, some hopeful investors could still pocket some gains and get out unscathed, most of the clueless investors will be the ones holding on to the shares which they cannot find buyers. Simply because almost everyone has sold out leaving them the main holders.

So Safety in numbers?

I seriously doubt that.

If safety in number holds any water (at least in equities), then the world will not be in a situation where 10% of the people controls 90% (Percentages vary from country to country) of the wealth. Simply because of information asymmetry, some people will always get richer at the expense of others who holds on to the believe that there is SAFETY in NUMBERS.

I am just being cynical. I would be happy to be proven wrong.

MORTGAGES FAQ - SINGAPORE

TYPES OF MORTGAGES
By www.PropertyBUYER.com.sg
09 Nov 2008

The numbers stated herein are for illustration purposes only.

Fixed Rate Packages: -
This is the most traditional package. Home owners have certainty over future payment amounts. Fixed rate packages are often discounted off from a “Board Rate” or “housing loan rate” or some other terminology introduced by the bank. Fixed rate loans may be offered for 1 year, 2 years or longer depending on the prevailing packages that banks offer.

For example, a bank may have a “board rate” of 5% while they can offer a housing loan to you at 3%. This simply means that the bank offers you a loan of (Board rate – 2%)

Staggered Fixed Rate Packages
Often Banks would try to induce customers to sign-on to a package with a cheap entry point, but the bank would typically make their money back in the later years with more expensive interest rates. The function of increasing interest rates in later years plays 2 functions, 1st as a means to increase profitability, 2nd as a means to reduce the risks as banks undertake risks in guaranteeing fixed rates.

For example: -
• Year 1 = “Board Rate 5% – 2%” = 3% (fixed for 1 year)
• Year 2 = “Board Rate 5% - 1.5%” = 3.5% (fixed for 1 year)
• Year 3 = “Board Rate 5% - 1%” = 4% (fixed for 1 year)
* Year 4 onwards = "Board Rate" = ???% (Prevailing Board Rate at the 4th year)

Depending on the bank, the bank may specify that the rate is Board Rate - 2%, board rate - 1.5%, etc, at the point of issuing the offer, however the Board Rate is only used as a reference and serves no purpose other than to build into the document the "Board Rate" because on the 4th year, the interest rates reverts to "BOARD RATE".

Other banks may completely omit mention of the board rates if their later years reverts to a SIBOR/SOR + Margin rate.

Variable Rate Packages
Variable rate packages are often pegged to a Bank’s “Board rate” or “Housing Rate” or any similar terminology.

For example: -
• Year 1 = “Board Rate 5% - 2.5%” = 2.5% (not fixed)

A bank may at it’s discretion change the “Board Rate” based on it’s own calculation of positive or negative spread within a basket of "loans" pegged to a "Board Rate". Variable rates tend to be cheaper than Fixed rate loans because the bank has the ability to change the rates at any time, thereby reducing their risks. The risks of fluctuation interest rates is passed on to the consumer.

As there were previously some grievances against banks that raise their “Board Rates”. The complaints leveled at banks were that they are not transparent enough as to when to raise the rates. Variable packages which offered a SIBOR or SOR pegged rates become popular.

SIBOR/SOR PEGGED VARIABLE PACKAGES
SIBOR = Singapore Interbank Offered Rate
SOR = Swap offered Rate (SOR is the bank's cost of funds)

What is 1-month Sibor, 3-months Sibor, 6-months Sibor and so on?

These are Fixed deposit rates that the banks offer other banks within the Association of Banks in Singapore (ABS).

Does the rate vary every month? Every 3 months? Every 6 months?

The rates vary daily. The rates changes based on supply and demand of funds available for lending at any point in time within the interbank market. Once a bank takes up a loan, for example SIBOR (1 month) at 1.25%, it is equivalent in lay-man's term to us borrowing a loan that needs to be repayed in 1 month, the interest rate is fixed at 1.25% for 1 month.

So if I sign up to a SIBOR (1 month) for my Home Loan, what does this mean?

For example, your loan is S$1m, when you sign up for a Sibor (1 month) loan for your mortgage, the bank will go to the interbank market to borrow S$1m at the point of disbursement of funds or slightly just before that. If on the day of the disbursement, the rate is 1.29% and the bank charges SIBOR (1 month) + 0.7%, the bank will charge you 1.99% for that 1 month.

Your loan interest rates will be Re-priced every month!

SIBOR/SOR pegged variable packages gives the home owner the transparency. Banks simply offer a “SIBOR + Bank Margin” package.

However there are the 1-month SIBOR rate, the 3-month SIBOR rate and 1-year SIBOR rate packages as well as the equivalent SOR packages.

Example: -
• SIBOR + 0.75%

1-month SIBOR is re-priced every 1 month while a 3-month SIBOR is re-priced every 3 months. This means, your loan repayment quantum changes every month or every 3-months depending on your choice of the peg.

This types of loans are transparent but highly volatile. Because the bank undertakes very little risk, it is usually able to offer the cheapest loan out of the many different possibilities of loans out there.

FIXED AND VARIABLE MIXES
Some banks now offer a variety of Fixed and Variable loans where the home owner is able to specify the percentage of loan to be fixed and variable.


VARIABLE PACKAGE LINKED TO A CURRENT ACCOUNT
This type of mortgage is most useful to businesspeople. They allow a home owner to offset their outstanding loan amount with money deposited in a designated current account linked to the mortgage. This is called Interest offset account.

Example: -
• Mortgage amount for Home is S$800,000.
• But the Home Owner is cash rich and has an emergency fund of S$300,000 which he/she doesn’t need to use, he/she can leave it in the designated account (which he/she can withdraw at anytime).

• Outstanding Mortgage amount = Mortgage amount – Account Balance
• Interest rate = 2%, that means interest cost is S$16,000 (per year) for S$800,000.
• But since the home owner has S$300,000 which he/she doesn’t need to use yet, he/she leaves this S$300,000 in the designated account. The outstanding loan amount is S$500,000, and therefore the interest cost is reduced from S$16,000 --> S$10,000. A saving of S$6,000 while still retaining the financial flexibility.



• Interest rate payment is based on prevailing outstanding balance.


DRAWING MONEY FROM YOUR HOUSE (TERM LOANS)
Most banks will lend you up to 80% and sometimes even 90% of the valuation of your home. Some home owners will suddenly find that their home valuation has gone up. Consequently, the banks are willing to lend you more money.

Example: -
Previous valuation of your property = S$800,000
Mortgage Loan amount @ 80% = S$640,000
Outstanding loan = S$500,000 (An illustration: incl CPF used, eg. 100K)

New valuation of your property = S$1,200,000
Possible Loan amount @ 80% = S$ 960,000
Net Additional Cash borrowings = S$ 960,000 – S$500,000 = S$460,000

For example the interest rate is 2.5%. This is considered very low interest rates because unsecured loans typically cost > 10% in currently.

This money if used carefully is considered the lowest possible rate, which you can use for purchasing another property, pay for your children’s education or travel the world or start a business. Any lower interest rates, you will have to borrow from your parents.

The result of this package is: -

* Mortgage will be S$400,000
* Term Loan will be S$460,000


INTEREST PAYMENT ONLY PACKAGES
Uses either Fixed or float, however the home owner pays only interests and does not pay down the principle. This type of packages are suitable for people who needs the extra cashflow or for investors looking for maximum leverage to boost Return on Invested Capital. This can be a risky proposition in cash flow becomes an issue.
http://www.propertybuyer.com.sg/viewnews.php?article=21

SUPER COMBO PACKAGES
This option involves a Bridging scenario. A home owner staying in his/her existing place (Property A) buying another property (Property B) while trying to sell his existing property.

Property A and Property B involved

* Refinance of Property A to Sibor/SOR package with No redemption penalty, in anticipating of a sale.
* Equity Loan (A term loan tied to property A and B) from Property A to pay for part of downpayment of Property B.
* Property B using Equity Loan from Property A was able to stick within the Loan to valuation (LTV) of smaller or equal 80% and hence enjoys cheaper interest rates.
* Property B borrows 80%, of which 40% is Fixed rates for 3 years and 40% is Sibor/Sor based Floating rate.
* There is also an interest offset current account (Can offset interest against the Variable rate) with a Built-in Over-draft facility.


We have seen more complex cases and we are happy to help you with it.

PENALTY AND LOCK-IN PERIOD
Most banks want to lock you in from typically between 2 years to 5 years. This is because many banks use a step-up interest method where the later year interest rates are higher. Consequently the penalties of breaking the loan at Year 1 may be higher than Year 2.

Example: -
Penalty for full redemption of Loan within year 1 = 2% of outstanding loan amount.
Penalty for full redemption of Loan before year 2 = 1.5% of outstanding loan amount.

LEGAL FEE CLAWBACK
Banks typically offer you legal fee subsidy of 0.4% of loan amount subject to maximum of S$4,000 (for very big loans), but typically S$2,000 (some banks more, some less). In the case of an early redemption (Usually within 3 years), the house owner will be required to pay-back the full legal fees.

Many Property Buyers DO NOT know that they can choose their lawyers. Sometimes they used the given panel of conveyancing lawyers, the rates can be higher. An example, most Condominiums within S$1.5 to S$2m price range, their legal fees should be no more than S$2,000 to S$2,300. Any more, you are over-paying and it will cost you when you refinance.

HOME VALUATON FEE CLAWBACK
Some banks offer free valuation of your property as part of their mortgage loan offers. Other banks offer free valuation of your property provided that you do not redeem your loan within a specified period (Usually 2 years or 3 years). You are most likely required to reimburse the bank at the point of Loan redemption.

The valuation typically cost between S$150 to S$500 for apartments and condominiums, but can cost between of S$1000 to S$10,000 in landed property depending on the land size, property built-up size and terrain.

Some banks give generous VALUATION SUBSIDY, make sure that in case you have a CLAW BACK Clause, push the banks to use your own approved Valuer, because this ultimately comes out from your pocket.

FIRE INSURANCE
There is usually no claw back for fire insurance beyond 1 year of the loan. But it depends on the banks.

MORTGAGE INSURANCE
Most banks do not provide Mortgage insurance in a Home Loan Finance or refinance deal. However some banks have started to cross-sell products from different divisions or re-sell products by insurance companies by putting in a form together with your Home loan package. Mortgage insurance is usually preferred for Joint-Tenancy ownerships. Because in the unfortunate event of the mortality of 1 partner, the partner takes over the assets, but the joint-tenancy partner (Usually a spouse) also take over the debt servicing, if any.

The above is an article provided by www.PropertyBUYER.com.sg

NETWORKING EVENT BY: MGSM Students and SHRI (INVESTING IN PROPERTY?)

Please note, this event is an event by Macquarie Graduate School of Management students and is not endorsed by Macquarie University or MGSM.

US GOVERNMENT KNEW ABOUT THE FINANCIAL CRISIS IN 2006

The fundamentals of the economy is strong, John McCain the US presidential candidate said in 2008.

I think the US companies are probably one of the most competitive on earth. The the US economy is fundamentally strong?

US Trade secretary Hank Paulson visited China in 2006 at the behest of George Bush. During the visit to China, he addresses issues such as trade imbalance, and lectures China on over-saving and pressures China to re-value China's currency.

One of the issues was that China used it's massive savings to buy US treasury bonds. This in effect finances the US trade deficits, but on the other hand, it keeps China's Yuan artificially low as the reserves/surplus was immediately shipped out of China.

I remember (though I can't find the article, someone who has it, please send it to me) that Hank Paulson was asking China to diversify it's reserves. He was actively Touting Freddie Mac and Fannie Mae bonds to China, in that visit.

China said, thanks but NO Thanks.

Hank Paulson was the ex-CEO of Goldman Sachs, he has enough knowledge to know that Freddie Mac and Fannie Mae were time-bombs waiting to blow up. The US government was smart enough to ask China to buy those useless bonds as early as 2006.

In fact the problems of Sub-prime dated back to the early 2000, but over-leveraging, off-balance sheet risks and derivatives were probably started much earlier.

What I could not understand is that, what the US government say was the train running out of tracks, but did not do anything to stop it from crashing.

Had China bought Freddie Mac and Fannie Mae bonds in large amounts (like Hank Paulson suggested China should do), these 2 over-leveraged companies would have been able to delay facing the "music" and continue to lend irresponsibly. The US government bail-out would not have been necessary and in case they go bankrupt, China would have been burnt the most.

So the key thing to do is, read more, learn more. Do not despair when it seemed hopeless (for hope is around the corner) and do not GREED when everything seemed perfect (Doom often follows greed). So many of these BOOM and BUST cycles are timed almost to perfection for the well-informed to get more wealthy while the rest gets burnt.

Now that things are very bad and it is set to get worst. But do not despair, people like Warren Buffet has begun to take biggest stakes in well run companies whose share prices have been beaten down. So controlling the emotions is the key to maintaining your wealth in this volatile market.

Is it usually good idea to stretch a home loan as long as possible?

20 years Interbank Interest rate chart (1988 - 2008) - Adapted from MAS, by Paul Ho Kang Sang, www.propertybuyer.com.sg (info@propertybuyer.com.sg)

Recently i was also offered a 3-month sibor package where the monthly installments are fixed, but the principal paid varies with the interest rate.

I think it sounds like a good package as there is some certainty in the amt of monthly installments paid, but any potential pitfalls from this? And the equity accumulation is quite slow due to the length of loan.

Dear Home Buyer/Owner,

To answer your first question. It is important to understand whether you treat the property as a single home, an investment property or simply a property in which you can use as a collateral for your business.

Different people may react differently as a property can be an emotional issue/decision.

AFFORDABILITY
For some it is an affordability issue, therefore stretching the home loan will allow you to stretch your budget to buy the home of your dreams.

COST / FINANCIAL CONCERNS

Stretching the home loan incurs higher total interest cost. However some investors have been known to stretch the home loan as long as possible to maximize their return on invested capital (If this area is of interest to you, I can elaborate more). Longer term loans tend to be more costly because all loans are structured in such a way that mostly interests are paid during the earlier years. So you will see that your outstanding loan amount seems to be standing still.

On the other hand, some people may opt instead of 30 years, to take a loan of 20 years and at the end of every 2 years, they take another 20 years loan, such that the total repayment may still be 30 years, but they end up paying lesser interest. But it is rather troublesome and few people are inclined to do it.

3-Months Sibor with Fixed repayment structured. In this case, the total interests are variable and re-priced every 3 months, higher Sibor means you pay more interests and less principle. But you have some peace of mind such that you don't have to worry about how much to pay, though you are deferring the cost till later to smooth over short term financial flexibility. Over a 20 year period, interbank rates (Sibor) Singapore dollar Sibor has approached reached about 9% in around 1990. If you are paying Sibor + 0.9%, that would mean you are paying almost 10% interests. Fed overnight rates has gone as high as 20% during the recent financial crisis in which banks stop lending to each other or tightened credit drastically. So markets such as the Libor (London), Sibor (Singapore) are technically not immune to fluctuations in the market and liquidity crunch. And as a rule of thumb, a 3-months Sibor fluctuates more than a 6-months Sibor. While the 1-month Sibor is more volatile than the 3-month Sibor

There are quite a few fine prints which you need to note, it could be a Legal fee clawback or lock-in period penalty. Or other forms of administration fees.

If the loan has no lock-in period, then you are largely open to interest rates shocks (if any). Though Singapore market is generally flushed with liquidity and hence low GDP (economic growth) tends have also have low interest rates, but that cannot be taken for granted. We have seen first hand in the US, whose markets have much more depth and yet the funds dried up when banks tightened credit, leading to sky high interest rates. In fact, the Federal Reserve (FED) has to intervene to pump money into the market to reduce the interest rates as seen in the Sub-prime fiasco.

Where is Interest headed?
There is likelihood that interest rates may stay low (same as 2002 to 2005), but this time, there is some marked differences, the M1 money supply is much higher in Singapore. In fact the money supply has grown much faster than the economy in Singapore since around Dec 2006. From 2003, to 2008, money supply M1 doubled. Surely this money will absorbed into the economy over time if they are not being brought outside of the country, hence this is one of the many possible reasons that the Singapore market is rather resilient.

There is also some risks that US bail-out of private enterprises and banks to the tune of almost 1 trillion (1000 Billion USD), plus US annual trade deficit of over 500 Billion (http://www.census.gov/indicator/www/ustrade.html), the USA cannot afford it.

Even China with the largest reserves on earth to the tune of US$1+ trillion cannot afford to bail USA out (considering that much of this research is already in US government bonds and other financial instruments). Collectively USA corporations are very rich, but there is no way the USA government can make them come out with any money.

There is a real risk that USA might expand money supply (aka print more money), there may be elevated inflation risks and therefore interest rate hikes possibilities. Because money supply takes time to filter down, there is usually a time lag effect. Right now, it's anybody's guess. But within 6 months to 1 year my personal opinion is that it will stay at current levels, perhaps with a little room for slight drop.

The reason why USA is important is because the US market accounts for ~14 Trillion USD in GDP, or about 25% of the world's total output. THe link on GDP, http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

U.S. bets that the FED will lower rates

U.S. sneezes, the rest of the world catches a cold. Singapore is right smack in the middle of that sneeze as Trade (Import/Export) makes up a large percentage of Singapore's Economy. Weakness in the USA directly impact the economic outlook of Singapore.


Source: IMF, http://www.imf.org/external/pubs/ft/survey/so/2008/RES012908A.htm

"In Western Europe, signs of a future slowdown in credit growth are just now emerging and there is some potential for worsening credit quality as lending has been very robust in some countries and several countries face housing markets considered overvalued, the IMF warned.
Lending in some segments of the corporate sector also expanded rapidly in the first half of 2007 with the rise in leverage buyouts. Weaker quality corporates have already seen a substantial rise in the cost of credit although yields investment grade debt have remained relatively stable. Additionally, a slowing economy will likely exacerbate the tighter credit environment further as unemployment picks up and job growth slows.
Emerging markets have been resilient so far, but face challenges ahead. Emerging market equities have outperformed mature equity markets, but prices in some markets have declined steeply since the start of the year on expectations that the U.S. economy may slow more rapidly. "Signs of spillover are most evident in the sharp fall in private emerging market bond issuance, particularly in some emerging European economies whose banks have relied heavily on external financing to support rapid domestic credit growth," the Financial Market Update stated. Generally, flows to emerging markets have remained positive up to now."

Most banks in Singapore charge a Step-by interest rates in which you pay higher interest rates at the later years. In a refinance, the other bank takes over the outstanding loan balance from the previous bank.

However, banks are tightening credit the world over.

If you are expecting some changes in personal circumstances, you may not qualify to refinance your home to get better offers and end up paying elevated rates if the following occurs: -

YOU LOSE EMPLOYMENT
YOU SALARY IS REDUCED
YOUR PROPERTY VALUE DROPS
CREDIT TIGHTENING in general

It may be advisable to get a free mortgage health check to determine your risk level.

REFERENCE:
CHICAGO (Reuters) - U.S. short-term interest rate futures rose sharply on Monday to reflect higher prospects for a rate cut at or before Tuesday's Federal Reserve policy meeting.

Dealers responded to a fresh crisis in financial markets after investment bank Lehman Brothers filed for bankruptcy over the weekend, and to sharply lower calls for the U.S. stock market.

The Federal Open Market Committee holds hold a regularly scheduled meeting on Tuesday.

Implied prospects for the Fed to lower the benchmark fed funds rate to 1.75 percent traded as high as 92 percent and have now subsided to 72 percent. On Friday, prospects for a September rate cut were a slim 12 percent.

A single, quarter-point rate cut is fully priced by the December FOMC meeting.

"It looks like the market is looking at just a 'one and done' scenario," said Rudy Narvas, analyst at 4CAST Ltd in New York.

The Fed late on Sunday announced several measures aimed at mitigating strains in financial markets.

Those moves included enlarging the range of available collateral for the Primary Dealer Credit Facility and the Term Securities Lending Facility.

"It is only prudent to consider all available tools at the Fed's immediate disposal ... The option of adjusting the funds rate per se is probably not at the top of the priority list," said Thomas Lam, senior Treasury economist at United Overseas Bank Group in Singapore.

(Reporting by Ros Krasny; Editing by James Dalgleish)

BUYING A PROPERTY IN GEYLANG

"Success is a thought process"

Recently in 2007, a friend of mine bought a property in Geylang. The property is in decent condition, it's Freehold and it is about 1000 square feet. With all the promises of KALLANG Expansion and being near to the city, etc. It seemed too good to be true at S$400,000. She was planning to lease it out for S$1500/- per month.

So here is the calculation: -

Rental revenue --- S$1500 x 12 months = S$18,000
Downpayment 20% --- S$80,000
Cost of Financing S$320,000 @ 2.5% --- S$8,000
So the Return of Investment --- (18,000 - 8,000) / 80,000 = 12.5%

So 12.5% gains is quite OKAY right?

So she went to the bank and tried to borrow money, the banks told her, sorry you have to pay 30% to 35% downpayment.

NOW, new calculation: -

Rental revenue --- S$1500 x 12 months = S$18,000

Down payment 30% of 400k --- S$120,000

Cost of Financing S$320,000 @ 2.5% = S$8,000

So the Return of Investment = (18,000 - 8,000) / 120,000 = 8.3%

Where are you going to get that extra S$40,000 all of a sudden.

People can avoid these pains if they get a PRE-APPROVED LOAN. Just provide the unit number, development name, the banks can usually reply to you in 1-2 days to give you a YES/NO answer. Do bear in mind that some banks may say NO and you have to go check with some other banks and wait some more days. So it is a tedious process. A Independent mortgage consultant such as

http://www.propertybuyer.com.sg
can quickly help you get a loan pre-approval (and subsequently get you the best fit loan). So you can put your heart at ease to buy the investment property/home of your dreams.

This is just a simple calculation which does not YET include the Rental property tax of 10% p/a. Conservancy charges, maintenance and depreciation of property as most tenants will want you to re-furbish it, and it can cost $$$. Don't forget stamp duty, lawyer's fees, fire insurance, surveying cost, etc.

DON'T RISK IT, get pre-approved loans first before signing the option to purchase.

Valuing A Property - A layman's approach

"Success in a thought process."

What explains the price differential between 2 adjacent properties? Often you will see 2 adjacent properties sometimes a big enough price gap to warrant a big WHY.


Say for example, Condo 1 is asking an average price of S$900 psf and Condo 2 is asking a S$1200 psf.

What could be the reason???

Here are some possible explanations: -

SIZE
1. Condo 1 offers bigger units and Condo 2 offers smaller units. Towards the pricier end of properties, affordability is an issue. For example: -
Condo1 unit sizes may be in the average of 1500 square feet (10.76 sq feet = 1 sq meter). That means that an average unit would cost around S$1.35m.
Condo2 unit sizes may be around 700 to 800 square feet. That means an average unit would cost S$960k.

AGE
2. If size is not an dissimilar, Condo 1 may be older than Condo 2. Newer units generally command a premium as their design tends to be more up to date with current trends. Over time, property value tends to become higher, therefore newer properties tend to have better finishing, technologies (intercom systems), lighting, marble floors, feature walls, large lobbies, Bigger and faster lifts, air-con lobbies, nicely manicured gardens, etc. You name it, they have it. You are paying for the luxurious lifestyle. Good marbles and feature walls can cost upwards of 30 to 100 dollars (per sq feet).

LOCATION
3. Even if a property is across 1 road, the feel and surrounding attributes may be totally different. In feng shui, the road cuts across the "chi" 气 of the area. That may also explain the price differences. An example of that is Garden Vista a 99 years development (by Far East) in Dunearn Road, the going rates in 2006 were $850 to $900 psf and in 2007 and 2008, Far East was asking $1350 psf onwards. But across the road/highway is Sherwood towers, it is going for $400-$700 psf tops (and it is either Free Hold or 999 years). Location effect, in this case, garden vista is "Bukit Timah" while Sherwood towers is "Beauty world" branded, but of course more factors are at play.

LAND ATTRIBUTES
4. Two developments side by side may have similar finishing, however one may have a stream or is hilly and the other is flat. If developed and planned nicely, the rolling and hilly terrain may enhance the feeling of space and conveys a sense of well-being. As a result, people may like it more and are happy to part with more of their hard-earned money.

DESIGN ATTRIBUTES
5. Not all developments are the same. Different design appeal to different people. As Singapore is generally land scarce, properties are becoming expensive. Older designs used to have balconies. As Singaporeans become more and more utilitarian, the balconies disappeared to become part of the living space. Hence those without Balconies are more highly valued. Of late, as more and more developments are built without Balconies, developments with Balconies are making a come-back due to demand from certain segment of the home buyers who cherished the balconies, they are priced at a premium.

6. Some designs are awkward, they deliberately squeeze out 4 rooms when it should only comfortably have only 3 rooms. There are several twists and turns, corridors are long and space is "wasted". This is because you cannot really put anything along the corridor. Therefore the place feels smaller than it actually is. Though this kind of design may find some fans, it is generally not well liked by the Space minded and bargain hunting Singaporean home buyer.

FENG SHUI
7. Feng Shui, an age old art of harmonious living. More and more people are subscribing to this school of thought. And Feng Shui plays a big part in the valuation of a property. Even if you do not believe in it, many others do. It will eventually affect the price of your property either positively or negatively.

CONNECTIVITY
8. Properties near to major roads, bus stations and train stations are generally valued more. There are about 750,000 cars in a population of 4.6m. About 1 in 6 people own a car. But other family members still need to go to work, go to school, go to buy stuff and run errants, so connectivity is still very important. Despite Singapore's small size and famed public transport system, some private residential areas are a bit off the beaten track. If they are near to public transportation nodes, they are generally of the 99 year lease hold type.

VICINITY
9. Most good properties have good connectivity, but also great vicinity. The locality is near the Sea, near a nice lake, the hills, the forest or near heavily forested areas with lots of shade and foliage. Bukit Timah is one such place, East Coast park, Katong, Siglap, Yio Chu Kang are other such areas.

SCHOOLS
10. In Singapore, most children of school going age (6 to 7 years old) will have to go to Primary school. Being the usual KIASU (a hokkien word to describe, "Afraid to lose out") Singaporean parents, most parents will try to get their children to the best Primary Schools. And in Singapore, priority is given to families living within 1 km of the primary school (subject to the family having stayed there 2 years prior to the registration exercise). With good Primary schools within 1 km, most properties within 1km of the school is highly sought after.

AMENITIES
11. Singaporeans hate to walk. For an average foreigner, it would seem surprising that Singaporeans generally do not have the same sense of distance compared to a foreigner. So there is a premium to be near to the super markets, wet markets, shops and shopping centers.

LAND TITLE
12. In Singapore, most people prefer Free Hold land followed by 999 years lease hold and the least liked is 99 years. For some people from Hong Kong or China for instance, they do not seem to understand what is the big deal about 99 years and Free Hold, because no bodies lives that long. But I tell you, in Singapore, most people prefer Free Hold and that is a fact. If they did not buy free hold properties, it is usually a matter of budget constraint.

13. There is also a difference between Free Hold Strata titled land and Free Hold land with individual title deeds. Though the difference is not always reflected in the price of a property. Free Hold Land has more intrinsic value generally as it cannot be over-written by a majority vote. Strata titled land with properties on it, means that each property owner owns a "share" of the land that their property sits on. And older properties over 20 years old have Strata title laws that governs it, as long as 80% or more vote to demolish or sell the property, even the dissenting 20% of property owner will have to agree. In other words, you have no control over your home, even if you do NOT want to sell it, you may be force to sell it if the majority opts to sell or re-develop it.

FACILITIES AND SIZE OF THE DEVELOPMENT
14. A development needs to be of a certain size in land area in order to economically provide all the facilities. A full facility condominium (Condo) will have facilities such as: -
Swimming pool
Jacuzi pool
Gymnasium
Sauna room
tennis court
exercise bay
children playground
function room
Barbeque pits
Squash court (most condos do not provide this now)

The facilities differential will be create a price differential in 2 different developments.


LAND VALUE VERSUS PROPERTY VALUE
15. Property and buildings depreciate. Fittings degenerate, paints peel. The once sought after property is no longer deemed HOT. However, in land scarce Singapore with an expansive immigration policy, more population and lesser and lesser land is a recipe for higher land prices. Land appreciate, buildings depreciate.

16. Singapore is a country where the government likes to micro manage. Some call it good governance, others call it, "they plug every loop hole". So developers cannot buy large tracks of land and keep it till it appreciate. This is because the Government levies development charge and penalties on delay of building the "proposed" building and/or amenities. So that is out of the question.

However, there are many good gems out there that are DIRTY and OLD and FORGOTTEN. Many old buildings that sit on rather good land asking very reasonable prices.

Why is there such a price differential given that those are gems???

This is because buying and staying in a property is an emotional process. Many gems are over-looked because they are
simply "Dirty and NOT polished". It's definitely a different decision altogether. In this case, this property may be an
investment gem, but not a lifestyle gem, unless you can do some modifications work to it.


http://paulhokangsang.blogspot.com

http://investinsingapore.blogspot.com

CHINA PURCHASING PARITY AS INDICATOR

quote: "Success is a thought process", "Positive thoughts create positive outcome"

The USA has the highest nominal GDP followed by EU, Japan and China. However once you calculate GDP using the Purchasing Power Parity (PPP) method, China comes to 2nd place at around 8 Trillion USD.

If we try to understand the way in which PPP was computed, it looks at a baskets of goods and services in which a person who earns a certain income in a certain can afford to buy locally. The underlying principle is that of an efficient market theory such that a similar product that is produced and being sold at any where in the world should be sold at the same price. But we all know that the market is distorted from time to time and inefficient and of course, no one product can span the entire globe, so naturally we can only compare and group similar goods and services without regard for brand and quality.

In other words, China produces the known basket of goods and services defined under PPP in a way that it’s people can afford. As China’s PPP is almost 3 times that of the GDP, this goes to say that China as a country is not short on finished products and goods and services for it’s people and does so affordably too as compared to many countries on the PPP list. (See Note 1)

In this respect, it would be premature to say that if China produces say 1 TV, that TV would be the same as 1 TV produced in the USA for instance. There are of course brand, quality as well as features differences amongst many other attributes. But, it would be fair to assume that for most basic goods, China has the productive capacity to produce them cheaply. (As we can conclude that only China has a big PPP to nominal GDP gap, in would be fair to assume that even if countries that import china made goods do tend to sell them with some degree of mark-up as there is no significant increase in purchasing power, parity in those countries. However, even if the PPP GPD is high, it could also mean they have high local productive capacity rather than being able to import and sell at low prices. However more studies may be needed.)

In saying so, these Chinese companies that are producing these products cheaply are surviving on the local China market. Low price is of paramount concern. Hence, once they realize the potential of trade, they will export relentlessly in search of new markets as margins are generally slim. In essence, once a foreign market can accept a China made substitute good, given the huge price differential, the sales of these companies will take off and profits will also rise for these exporters. (See Note 2)

The rest of the Chinese manufacturers will also find its way to these markets and hence price will again become depressed in markets being invaded by cheap chinese goods. With low prices, China products will gradually kill the local industries. The only ones to survive are those that has intellectual property protection, those that have innovative products as well as branding to differentiate themselves from the Cheap Chinese goods.

However, the China exporters will face huge pressures amongst themselves and some of these companies will gradually move up the value chain by innovating or upgrading their products. Some of these companies will become bankrupt due to overtrading and negative capital spread. Also
cheap manufacturing capacity in the form of China exports will cause some raw materials to become scarce (at least temporarily), and eventually these prices increases will have to be passed on to the consumer. In a fiercely competitive environment, these companies usually do not have pricing power, the companies that have key differentiators will attract more customers and once the many of their competitors are bankrupt, they will be able to command better prices and upgrade.

The increased value adding of the products will lead to better pricing power, followed by a rise in real GDP. Therefore, the gap between the REAL GDP and the GDP using the PPP measure will close.

Hence I consider the PPP as a leading indicator of the future economic progress in GDP of a country. But on the other hand, high GDP ppp versus real GDP means that China products still have some quality and branding issues to bridge.

Hence, it would be safe to say that China export boom will continue for some more time to come. The only problems that would potentially stop such growth will be trade barriers (internal or external), war or natural disasters.

Note 1: Other countries that do not have the productive capacity would have to resort to importing the/a product. If the product is not available in a low cost country, importation with it's many layers of middlemen tend to make the end sale price high thereby reducing the purchasing power. Though imports/outsourcing can often reduce pressures on increase on CPI in the case of the USA, because a lot of industries are no longer efficient, importation actually helped the USA control their CPI else real GDP growth would be negative.

Note 2: However these companies do undertake big risks in currency fluctuation, changes in raw material prices as well as many other bureaucratic and legal hurdles just to name a few. Due to the large number of chinese companies exporting, these companies tend to also compete in the foreign market and hence they do not normally have pricing power.

APPENDIX 1
http://english.people.com.cn/200404/12/eng20040412_140147.shtml
Dismal Scientist (for 2006)
1 United States 12455.83
2 Japan 4567.44
3 Germany 2791.74
4 China (Excluding Hong Kong) 2234.13
5 United Kingdom 2229.47
6 France 2126.72
7 Italy 1765.54
8 Canada 1132.44
9 Spain 1126.57
10 Brazil 795.67

APPENDIX 2
http://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP_PPP.pdf
PPP GDP 2005
(millions of
Ranking Economy international dollars)
1 United States 12,409,465
2 China 8,572,666a
3 Japan 3,943,754
4 India 3,815,553b
5 Germany 2,417,537
6 United Kingdom 1,926,809
7 France 1,829,559
8 Italy 1,667,753
9 Brazil 1,627,262
10 Russian Federation 1,559,934
11 Spain 1,133,539
12 Canada 1,061,236
13 Korea, Rep. 1,056,094
14 Mexico 1,052,443
15 Indonesia 847,415
16 Australia 643,066
17 Turkey 612,312
18 Argentina 558,755
19 South Africa 557,971b
20 Thailand 549,265
21 Iran, Islamic Rep. 540,207
22 Netherlands 537,675
23 Poland 533,552

References: -
1. Dismal.com
2. http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita
3. http://english.people.com.cn/200404/12/eng20040412_140147.shtml
4. http://siteresources.worldbank.org/DATASTATISTICS/Resources/GDP_PPP.pdf
5. OECD; http://www.oecd.org/faq/0,2583,en_2649_34357_1799281_1_1_1_1,00.html#1799075
6. U.S. Real GDP vs. Nominal GDP (1929-2003); http://faculty.hacc.edu/jhuang/econdata/htm/rn_gdp/rn_gdp.htm

GROW 1 Million to 4 Million in 15 years.

HOW TO GROW YOUR MONEY FROM ONE MILLION TO FOUR in 15 YEARS!!!

quote: "Success is a thought process, positive thoughts create positive outcomes"

1 EXECUTIVE SUMMARY
This paper outlines the investment strategy for a client who has recently won S$1,000,000 via lotto. Our client Mr Lee, has asked us to evaluate his investment needs and recommend a portfolio of investments, which will ensure his financial freedom at retirement, plus ensure he has enough liquidity to ensure he can enjoy life.

This paper therefore analyses Mr Lee’s financial risk tolerance and recommends a portfolio of investments to ensure he meets his wealth goals. In making these recommendations we first outline the risks and rewards associated with the investing in various asset classes, and then make out recommendations by asset class.

In making our recommendations for Mr Lee’s portfolio of investments we use the Post Modern Portfolio Theory to structure the portfolio in such a way that returns generated by the portfolio consider the downside risks involved in investing in assets. This portfolio theory encourages investors to take less of a short term, risk averse approach to investing by highlighting the downside probabilities of failing to meet our long term investment goals. In constructing Mr Lee’s portfolio we have considered the information given to us about his investment horizon, liquidity constraints and financial risk tolerance.

We further our advice by outlining exactly how Mr Lee should go about building this portfolio of investments, including details of trading into individual asset classes.


2 INVESTORS OBJECTIVES AND PROFILE
Our investor is Mr Lee is a 40 year old sales manager on an expat assignment in Singapore. Mr Lee is married and planning children in the coming years. Both Mr Lee and his wife are of Hong Kong origin, however both were educated and spent their formative year in Vancouver Canada. Mr Lee has recently won S$1,000,000 in the lottery and is in search of investment advise that will ensure he and his wife are able to “slow down” by the age of 55. Even while he has won a lottery, he is also highly educated and is holding a very senior position within the company. Mr. and Mrs. Lee saves 30% of their combined annual salary of S$300,000 and have S$500,000 savings and do not see themselves needing to dip into their investment funds.

We interviewed Mr Lee to gauge his risk profile as an investor and to get a better understanding of his investment goals and objectives. Mr Lee’s investment goals are standard for someone who has recently won lotto, however he is not planning to take excessive amounts of time off in the near future.

As a reward for deferred gratification, Mr Lee wants to be certain that he has S$110,000, which he sees as money to be used for personal consumption in five years time. He is prepared to forgo greater gains to ensure he has the liquidity & flexibility to meet this personal commitment.

Using AMP’s risk profiler we have established that Mr. Lee is a balanced investor and an average risk taker, achieving a score of 29. By plotting Mr Lee’s age and risk score on the graph below we get an indication of where AMP’s, Lifesteps Investment Programme would invest for Mr Lee.



Having determined Mr Lee’s risk profile, we put together an investment portfolio option which we believe is most suitable for Mr Lee. Our investment policy is approached from the perspective of wealth creation through the focus on value. In the long run, the mix of asset classes in your portfolio will determine your wealth. Not how you traded into and out of individual assets.

In assessing Mr Lee’s investment needs we have taken into account his risk tolerance, time horizon, liquidity constraints, tax concerns and legal factors.

3 EQUITIES

After understanding Mr. Lee’s goal for retirement, we confirmed with him our understanding is correct.
In order to achieve the investor’s goal of retiring with at least SGD$4m within 15 years, with an initial investment of SGD$1m, a CAGR of 9.68% (or Net Minimum Accepted Return (MAR) ) is required, net of taxes and costs. The investor’s investment horizon is 5 years with a possible extension to 15 years. Hence both the time horizons need to be considered.



Expected Future Value at End of Year 5 = $1,587,401

Expected Future Value at End of Year 15 = $4,000,000


This section evaluates the various equity classes and equity class types.


3.1 OUR METHODOLOGY



We listen to an investor’s financial goals and needs. From Mr. Lee’s needs, we formulate a Minimum Targeted Returns and check it against various empirical data on feasibility. We are acutely aware of human’s behavioural biases and preferences, as such we pass it through a very strict process to take out subjective judgement at the early stages of Strategy formulation.

However, in this posting, I have deliberately omitted detailed discussions around Fixed income and REITs discussions as I do not have time to compile them.

After forming our strategy, we then allow subject opinions where by and large are our collective experience come into play for the next stages of evaluations. We also supplement our own judgement with that of third party independent research houses such as Morningstar to form a concrete executable plan.

We aim to achieve the investor’s goal with the least possible risk by using research on Inferred data on Coefficient of Downside Deviation.

3.1.1 EMPIRICAL DATA ON EQUITIES RETURN
Our approach is to first check for feasibility of this minimum accepted return based on
empirical data to find the most optimum way to achieve the target returns. According to a study by S. Mukherji , for medium and high target returns, the optimal portfolio for long-term investors is to be fully invested in small stocks.



From the above table, based on a portfolio constructed for a target return of 8%, the actual real return is 14.17% for a 15 years holding period and 10.49% for a 5 years holding period.
During the period of evaluation, the annual inflation rate averages 3.17 .

HOLDING PERIOD ON RETURN: SANITY CHECK
Therefore, the actual nominal returns based on a portfolio constructed for a target return of 8%, the actual nominal return is 17.34% for a 15 years holding period and 13.66% for a 5 years holding period.



The sanity check however did not take into account the market valuation at the beginning time of the analysis. Hence the effect of timing on returns especially for a holding period of 5 years could be not as certain, while there if generally more returns certainty for a 15 years holding period as it smooths out market timing issues. Therefore we would need to assess timing risks on returns.

MARKET TIMING ON RETURNS: FIVE YEARS HORIZON
The investor is looking at a 5 years horizon as an exit point with the possibility to exit at 15 years. Therefore market timing is important.
John Rogers said, “successful investors do more than just analyse a company”. For Philip Fisher, there are also hints for timing stock purchases of companies that meet the investment criteria during “Start-up period of a substantial new plant” which “has depressed earnings and discouraged investors.” Or when there is a “bad corporate news: a strike, a marketing error or some other temporary misfortune.” Another successful investor Warren Buffet, also times the market and buys good businesses during stock market crashes or during periods of depressed stock market prices .

Notes
1 S. Mukherji, 2003, Optimal Portfolios for Different Holding Periods and Target Returns, Financial Services Review 12, 61-71.
2 --- ditto ---
3 John Rogers, Mar 2004, Learning from the Masters, Professional Investor, page 26-27.
4 --- ditto ---



During the period between the year 2000 to 2005, apart from AMEX, Russell 2000 and NYSE, all other indices on the above chart returned a negative value over the 5 years period. This chart is deliberately shown with time period 2000 to 2005 to highlight the perils of bad market timing. It is inherently difficult to time the market, therefore it is imperative to identify stocks with a lot protection against any downside and that are positively skewed in it’s returns distribution.



Chart: Russell 1000, Russell 2000, Russell 3000, NYSE Composite Index, S&P 500, Dow Jones Industrial Average and Nasdaq between Dec 1992 to Dec 2007, Chart created using Yahoo.com)
By investing with a 15 years time horizon, all the benchmarks hovered between a 250% to 310%. This roughly equates to 7.6% Annual Returns without consideration of dividends. However for anyone who bought during the internet bubble between the year 1999 and 2001, the returns are still negative today. During certain periods of increased optimism, investors tend to be exuberant about the market prospects and have elevated risk appetite. The price of stocks reflected expected future earnings. When the company’s earnings disappoint, the risk appetite disappear and the stock price revert back to the mean causing huge lost of capital value to investors.


If dividends are considered for S&P 500 and reinvested, the total annual returns for S&P 500 would be enhanced by slightly less than 2% per annum on average.





SIZE EFFECT ON RETURNS
Empirical data obtained from Fama & French (1992) shows that for all stock types between July 1963 to December 1990, the monthly returns average 1.23%. This is equivalent to 15.8% on an annualised basis.




Table: Monthly returns of stocks sorted by BV/MV versus Market-Cap (Size) categories, July 1963 – December 1990, Louis K.C. Chan and Josef Lakonishok, 2004, Value and Growth Investing: Review and Update, Financial Analysts Journal, Page 76, Table sourced from Fama and French (1992)

Looking at Large or Small Stock regardless of Book/Market category: -
• Large stocks monthly return is 0.89%, or 11.22% on an annualised basis.
• Small stocks monthly return is 1.47%, or 19.14% on an annualised basis.

STOCK TYPE (GLAMOUR OR VALUE) EFFECT ON RETURNS
Now simply by checking against monthly returns sorted by Book/Market categories, Category 1 (glamour) stocks have a 0.64% return while category 10 (Value) stocks have a 1.63%.
Looking at Type regardless of Market Capitalisation (Size): -
• Glamour stocks monthly return is 0.64%, or 7.96% on an annualised basis.
• Value stocks monthly return is 1.5%, or 19.56% on an annualised basis.

COMBINATION OF SIZE & VALUE EFFECT ON EARNINGS
From empirical data sourced from Fama and French (1992) and presented by , the combination of size and value return are: -
• LARGE VALUE gives monthly return of 1.18%, or 15.12% on an annualised basis.
• SMALL VALUE gives monthly return of 1.63%, or a whopping 21.41% on an annualised basis.

EARNING/PRICE EFFECT ON RETURNS
We go on to investigate the effects of earnings/price effects on returns.



Chart: S&P 500 with Bollinger Band and P/E Ratio, 13 Dec 2007, CNNMoney.com

Since the year 2002 and 2003 where the P/E peaked at above 40 times, where there is an economic downturn led by SARS, Bird Flu and various pandemics, earnings were decimated. As earnings recover quickly after the year 2003, P/E continue to drop while at the same time, the prices continue to rise. The P/E today of less than 20 times, looking at the past 10 years average is in face quite low. There is no indication of a bubble.

However, it must be cautioned that the US economy was at it’s 3rd longest economic expansion in United States history which has brought many earnings upside to stocks, which could account for the low P/E (excluding periods of major mobilizations such as during world wars I and II) which “started back in November 2001 just after the 9/11 terrorist attacks and the 2001 recession, which was brought on by the sharp stock market drop and tight financial conditions in 2000 . With a possible US economy slow down, both the earnings and P/E may also fall due to reduced risk appetite, thereby severely affecting the capital value.

Of course it would be natural to want to put all the investments into an investment segment that gives the highest potential returns. However it must be cautioned that the sub-prime has still to run it’s full course, the prospect of a global economic slowdown is almost certain. In a slowdown or a recession, large capitalised companies with larger cash flows and reserves are better able to withstand the impact of an economic slowdown or recession in the worst case scenario.

Foot Notes (Part 2)
Louis K.C. Chan and Josef Lakonishok, 2004, Value and Growth Investing: Review and Update, Financial Analysts Journal, Page 76.
U.S. economic forecast for 2007: cooling off but no recession, The Manufacturer US
Published: 07 Dec 2006, http://www.themanufacturer.com/us/detail.html?contents_id=4895

1.1.1 EQUITIES RISK
As equities shall form the largest portion of the total portfolio, it is important to match the investor profile with special emphasis to analysing the possibility of not meeting targeted returns and take the necessary protection against capital loss. We recommend going for non-cyclical segments and a global spread to diversify away country specific risks.

MACRO ECONOMIC RISKS
The average Market valuation (P/E) of stocks rise and fall as business confidence rise and falls. During the year prior to a recession in 1999, the P/E was trading at about 35 for S&P 500. Therefore it is important to assess where the bottom line is with regards to average P/E valuations of stocks in the recession years so as to get a gauge of the possible downside risk should P/E fall to as low as in previous recessions, the capital is always protected.

The US economy is expected to slow down in 2008 and 2009, consumer confidence is at an all year low of 87.3 (1985=100) while the present Situation index decreased to 115.4 and the expectations index declined to 68.7 . (Consumers account for some roughly 70% of the US GDP of US$1.4 Trillion) . Credit risks remains on the horizon with bank writing down assets on Special Investment Vehicles or sub-prime lending. However with the federal reserve’s monetary easing policy in Credit risk reduction bias over inflation targeting, we remain cautiously confident that the market will not be too adversely affected. US will likely in our opinion be able escape recession in 2008, though the growth may slow sharply. In the Asia pacific region, China’s GDP is expected to ease to 10% in 2008 and 9.3% in 2009 providing some support to Asian economies, though not able to completely offset the US economic slowdown.



There is some expected slowdown overall in the world’s economies, but for countries which have large reserves such as China, Hong Kong, Singapore, UAE, major oil producing countries and Australia which has low debt, there is large fiscal policy flexibility.

COUNTRY & CURRENCY RISK
Therefore in selecting a portfolio, we shun funds with a narrow segment focus on country or industry. As the funds would then search for good stocks only within the country specified, leading to opportunity cost on potentially lesser returns. As Singapore’s economy is small and fairly narrow in nature, we advocate country diversification through purchase of US based equity funds. Funds typically have Large Capitalisation companies in their portfolio, these companies tend to have global coverage hence the risk is spread out globally. Currency risk is likely to be muted as the investments are spread out globally and any fluctuations will cancel out somewhat (though not fully). For example, a loss in US dollar versus Singapore dollar is likely to be offset by better performance for US companies exporting goods and services and hence better earnings and market valuation. So we are neutral on currency for the longer term.

Foot Notes: -
The Conference Board, November 2007 Consumer Confidence Index, http://www.conference-board.org/economics/ConsumerConfidence.cfm.
The Economist, http://www.economist.com/countries/China/profile.cfm?folder=Profile-Forecast

SEGMENT RISK AND HOT STOCKS RISKS
In the example of NASDAQ in the year 2000, these segments fluctuate wildly, if you buy at a wrong time, massive capital values are lost. Investors are generally lured by “Hot funds” using the law of “small numbers” and projecting current returns into the future, driving up the capital value massive. We do not want to take the risk to buy over-valued funds/segments even though empirical data shows that they could have years of out performance relative to value segments before eventually reverting to the mean in the longer term.

BEHAVIOURAL BIAS RISK
Investors are not more rational now that they were in 1945 . Human still has the same fear and greed and could mistake good company for good investments, filters bad memories in favour of good ones, etc, . We do not want to be biased in our choices of investments. Our charter is to “NEVER LOSE MONEY” for the investor. And along with that, we created a methodology of screening funds with objective parameters. Naturally some aspects of selection will be subjective or experienced based, but being aware of the behavioural biases we largely minimise that risk also by looking at Downside variation.

RISK OF SUB-OPTIMAL FUND MANAGER & EXCESSIVE TRADING
According to (Dowen & Mann) an efficient manager should be able to operate a fund at lower cost. Funds should only trade when it is advantageous to the shareholder. In order to catch up on returns, some fund manager trade aggressively in an effort to catch up on lost ground. It could only lead to even higher cost if the trade did not succeed thereby inflicting more damage on returns or affecting the ability of the investor to meet his targeted returns.

ETHICS & COMPLIANCE
This is an area that is the one of the most critical. Fund managers should be acting in the best interests of their investors. Therefore a fund manager or fund rating agency and it’s close associates must declare their holdings and ensure that no conflict of interests arise in the companies in which they are writing about.

REGULATORY RISKS
There appear to be no particular high probability regulatory risks that we can see on the horizon. Singapore could tax earnings remitted from outside of Singapore.

SIZE & EXPENSE RATIOS
Dowen & Mann found that over time, the managers of larger fund families produce greater returns at lower cost . Returns increases and the expense ratio decreases, this indicate economies of scale, although (Latzko 1999) found that the benefits of economies of scale are exhausted beyond 3.5 billion. However, most funds do not pass on the savings to investors, in fact the expense ratio had soared from 0.76% in 1945 to 1.56% in 2004, “despite the substantial economies of scale in these economies, they have actually incurred higher costs of ownership.” According to morningstar average expense ratio reported for all funds is 0.98% of assets. The highest average expense ratio is 1.86% reported for aggressive growth funds, and the lowest was 0.58% for the California Municipal Bond funds.

However, as the funds selected are “Small Value”, it is important to choose a fund size that is neither too big nor too small, this is because there is a limited universe of small capitalisation companies, increasing the fund size may lead to more companies qualifying as good investments and thereby reducing returns. Therefore a fund’s charter is very important, if there are no investments meeting their strictest criteria, the fund must instead hold cash and not just invest in sub-grade investments to make up the numbers.

Although big fund size tends to have lower expense ratio, the valuation tends to be richer. Funds that have a “Big Value” investment style type must then buy big capitalisation stocks. Big stocks tend to be better covered by analyst, more favoured by the market and hence more expensive, thereby reducing potential future returns. The reason for such reduced returns is due to an “ecology” of agency factors at play in our opinion. Good growth companies or Big companies tend to get more press coverage and sometimes positive reviews. All these considerations play into the career concerns of Professional money managers and pension plan executives (see Lakonishok, Shleifer, and Vishny, 1992). The fund managers may find that touting such companies stocks or story-lines to individuals are an easier sell. All these agents at work drive up the prices of such big companies.

SAFETY MARGIN
In order to have a Margin of Safety we need to buy funds which are trading below it’s intrinsic value. In this case, trading below it’s book value with good growth prospects plus dividend growths prospects with strong financial strengths and business viability. But to find stocks that are trading at a MV/BV < 1 is very difficult and maybe in not enough quantity. The investment opportunity window is very small. Therefore it is even harder to find a fund with a composite average of MV/BV < 1. All good companies with positive growth should be trading at a premium to Book value. But we will take into account P/E, Growth rate, and a maximum MV/BV of less than 2. Where possible we will supplement our safety margin with non-tangible information and analysis. "Foot Notes": - 5 Meir Statman, 2005, Normal Investors, Then and Now, Financial Analyst Journal. 6 H. Kent Baker, John R. Nofsinger, 2002, Psychological Biases of Investors, Financial Services Review 11 , pages 97-116. 7 Richard J. Dowen, Thomas Mann, 2003, Mutual fund performance, management behaviour, and investor costs. 8 R.J. Dowen, T. Mann / Financial Services Review 13 (2004) 79-91, page 280 9 John C. Bogle, 2005, The Mutual Fund Industry 60 Years Later: For Better or Worse?, Financial Analysts Journal, January/February 2005, page 16 10 (Morningstar pg 274, from the Morningstar Principia Mutual fund database with data last updated on March 31, 2003), 11 Benjamin Graham, Investopedia.com, http://www.investopedia.com/terms/m/marginofsafety.asp DOWNSIDE RISK (DR) PROTECTION We protect against downside using a top down view and a robust methodology as described in earlier sections. Protection layer: Macro We evaluate the macro economic conditions going into the next year and beyond to determine whether the prices and valuations are reasonable compared to historical trend. Protection layer: Country and Segment Risks We then look at individual countries and industry segment and check against whether they are undervalue or over value and whether specific investment opportunities exists. Protection layer: Empirical data sanity check We use empirical data to find the best risk-return categories. And we assess whether these historical empirical data can be used successfully under current investment climate. Protection layer: Fund selection Criteria We use a combination of the Benjamin Graham’s method of finding valuable stocks/funds and Philip Fisher’s idea of assessing a suitable market timing. Protection layer: Morningstar rating system. We supplement our approach with a third party independent rating system. We especially like the morningstar stewardship assessment. This rating provides us across the board assessment of capability of management. With a small sum of $1m to invest, we would not likely be able to get access to senior leadership of big companies. The morningstar rating system can be found on Morningstar . LIQUIDITY RISK Funds are usually not as actively traded compared to stocks. Funds typically cannot be traded quickly enough to prevent a loss in case of a falling market. This illiquidity usually results in a wider bid-ask spread, resulting easily in cost of 2% or more. POTENTIAL CAPITAL GAINS EXPOSURE RISK Singapore domiciled residents do not pay capital gains tax, however dividends are taxable. LITIGATION RISK Well managed fund with a high morningstar rating should be fair protection against litigation. Most litigation and fines are levered against inappropriate behaviour of funds or fund managers. But there is no way to gauge our exposure, perhaps all we can do it to stay vigilant to watch over expense ratio as well as fund management’s compliance and renewed ratings from independent sources such as Lipper and Morningstar. MORNINGSTAR STAR RATING FOR RISK MANAGEMENT To supplement the risk management process, we use morningstar Star rating system to screen the funds. There are also factors such as stewardship index which we really like as this provides an added dimension on top of evaluating hard financial data. Footnote: - 12 Morningstar, Mutual fund data definition, http://quicktake.morningstar.com/DataDefs/FundRatingsAndRisk.html However this exposes us to Type II error in the case where morningstar erroneously rate a fund 1 star or 0 star leading to us rejecting the fund where in fact the fund turn out to be a top performer. This error leads to a missed opportunity and is a cheaper risk compared to Type I error in which we take a fund for a 5 star fund, we purchase it, but in fact it turned out to be a failure. For Type I error, our stringent methodology should be able to minimize it. 1.1.2 PORTFOLIO SELECTION I choose the morningstar fund screener as it is quite easy to use (no particular preference) as a basis for narrowing down the selection of funds. From empirical data analysis: -

DOWNSIDE DEVIATION COEFFICIENT (CDD) FOR EQUITIES




SMALL CAP VALUE FUND
Selection Criteria (SMALL VALUE)
• Fund group: All
• Morningstar Category: Small Value
• Ratings and Risk: 4 stars to 5 stars
• Portfolio turnover less than or equal to: 75% (Richard J Dowen, page 269)
• Expense Ratio: less than 1.2%
• Average market cap (US$mil): Greater than or equal to $250million.



As there is no demonstrable benefit of excess performance with high expense ratio13 . I have weighted heavily a focus on Low expense ratio in the selection criteria. High earnings growth rate will likely lead to better chances of capital gains while low P/E with a high morningstar rating protects capital loss in case of any downturn in the economy. (Louis K.C. Chan and Josef Lakonishok, page 204) says that value stocks out-perform glamour stocks across all eligible stocks. And it was found that small cap segment of value stocks returns are even higher than big cap value stocks. It was conjured that mis-pricing patterns was more pronounced in the small-cap segment, which could be due to lack of analyst coverage. Thereby a focus of small cap value could yield richer opportunities than big cap value. However the exact reason for the mis-pricing is still being debated in the academic circle.
These are very rough selection criteria that returned 69 qualified funds.
Ken French says that you can’t beat the market. And excess performance cannot be easily measured between one fund and the other as different fund with a different focus chooses a different benchmark. Most fund managers will mirror their selected benchmarked with some minor differences. As a result most fund do not significantly outperform or lag the index in which they are being benchmarked. And there is no commonality in comparing different funds which track a different benchmark since they cannot be compared apples for apples.

Foot notes: -
12 R.J. Dowen, T. Mann, 2004, Mutual fund performance, Management behavior, and investor costs, Financial Services Review 13, 2004, pages 79-91, Hypothesis 2.

Therefore we recommend selecting funds based on Ethics and Star Ratings with higher weighted focus on Low P/E, emphasis on 5 Year returns and low expense ratio. The funds we have in mind are value funds with Average P/E tracking below the average S&P 500 historical P/E.



LARGE CAP VALUE FUND
Selection Criteria (BIG VALUE)
• Fund group: All
• Morningstar Category: Big Value
• Ratings and Risk: 4 stars to 5 stars
• Portfolio turnover less than or equal to: 75% (Richard J Dowen, page 269, too much trading activity is negatively related to returns)
• Expense Ratio: less than 1.2%
• Average market cap (US$mil): Greater than or equal to $250million.







1.1.3 TAXATION
The Securities Exchange Commission (SEC) has mandated that funds must reveal the Potential Capital Gains Exposure (PCGE) to investors and allow the investor to choose the most tax efficient way in which to pay for the Capital gains. Singapore tax residents do not pay capital gains tax.


2 PORTFOLIO ALLOCATION
We considered the fictitious Mr. and Mrs. Lee as investors with moderate risk profiles. However has they have aggressive savings rate, they have revealed that they are able to stomach some short term risks and volatility. Therefore we propose to use Post modern portfolio theory (PMPT) to optimise their portfolio. In doing so, we calculated inferred Cooefficient of downside deviation to obtain a portfolio that may have higher volatility, but towards a 5 years or 15 years horizon, have large margins of downside protection.

We have hypothetically structured a portfolio consisting of 10% Bonds, 10% REITS, 40% Small Capitalisation Value Equities and 40% Large Capitalisation Value Equities. Large Cap value balances against the more volatile Small cap value as empirical data shows that Large Cap value holds out better during a downmarket.

2.1 MINIMAL ACCEPTABLE RETURN AND DOWNSIDE RISK
Mr Lee’s stated investment goal is to have S$4,000,000 in 15 years time. This equates to a MAR of 9.68% over the investment horizon, as seen in the below graph. The graph also plots the expect return for each asset class. In our academic studies, we



Downside risk is a composite of three sub measures, namely, downside frequency, mean downside variation and downside magnitude. Downside frequency is expressed as a percentage of returns below MAR over the course of 100 months. So a downside frequency of 25% would mean that the asset class is going to return 25 months of under performance over 100 month time frame. Downside mean variation is the average size of the return below MAR and downside magnitude is the worst case return below MAR. Once we have calculated downside risk we can calculate the risk adjusted return for the portfolio. It is imperative at this point to ensure that asset classes selected for the portfolio have adjusted returns greater than MAR.

The below figure is a graphical representation of a positively skewed asset class, plotted against a normal distribution and the MAR.




2.2 POST MODERN PORTFOLIO THEORY CALCULATIONS




Access to fund price data is fairly impossible to obtain without paying a huge price and membership fees to buy data points. As a result, calculating Downside Deviation is almost impossible. However we have done the next best thing, which is to use inference based estimates for our portfolio. Our calculations gives a minimum return is around S$4.5m which we feel is already quite conservative and achievable while for Year 5, we are expecting a to end at S$1.66m.










To summarise, Mr. and Mrs. Lee could safely achieve their goals with minimum downside. By looking at the chart, the downside deviation (weighted in 80% equities, 10% bonds and 10% REITS) in Year 1 is an expected maximum of 0.12377 on every dollar.

For the 5 years downside deviation is a maximum of 0.27785 on a dollar, while the weighted expected mean value would be 1.66151816.

For every dollar invested, the expected minimum value (Weighted expected mean value less weighted CDD): -
Year 1 → 0.97992
Year 5 → 1.42701316
Year 15 → 4.58662782

To Sum it up, the maximum downside risks for Year 1 is likely to be 2.1% while from year 2 onwards, the portfolio is expected to have positive (nominal) returns. If the investor stays invested for the entire 15 years, One million could grow to 4.58 million, exceeding Mr. and Mrs. Lee's targeted minimum Accepted Returns of 9.68% with a very high degree of certainty.


NOTE:
** REITS assumed mean return = 5%.
Small stock is used as a Proxy for Small Capitalisation Value Stocks
Large Stock is used as a proxy for large value stocks
*REITs carry characteristics of Bonds while also behaves as an equity. In view of absense of data, we assume that the CDD of REITS will mirror 50% of the behaviour of Long term government bonds and 50% of Large stocks.