Investment wisdom

Costs are the best single predictor of the future performance of an investment. Keep costs lower — by tracking an index rather than investing in attempts to beat it — and for any given level of risk your returns should be a little higher.

Why investors need to know about indices.

Research by London’s Cass Business School shows that randomly chosen portfolios — that might as well have been picked by monkeys — are overwhelmingly likely to beat market-cap-weighted indices. But most monkeys failed to match equal-weighted indices, or indices based on most sophisticated measures to limit risk.

So the hierarchy is that simple equal weighting indices beat monkeys, who beat value-weighted indices like the S&P, which beats the average active manager (who nonetheless complains that the S&P benchmark is unfair).

Yet our money is still mostly run by active managers, while none that I am aware of is run by monkeys. For these reasons, and many more, we need to know more about indices.

Mr Markowitz’s comment on this: “One lesson from 2008 is that if it’s very complicated and you don’t understand it, maybe you shouldn’t buy it.”

Anyone with a simple rule that required them to keep 40 per cent in bonds and 60 per cent in stocks would have “rebalanced” — bought stocks — near the market’s nadir five years ago, he points out. 

Innovation from scientific research

Often, we see amazingly successful products emerging from research. The original research purpose can be entirely different from the eventual commercialized product. You would recall that Post-it notes emerged from a project to discover adhesive. Viagra emerged from heart disease research. Many claim that these innovation were random outcomes. This is an easy assumption because it does not require further discussion.

But we can breakdown the innovation path into two: Demand led or Supply led. We are familiar with demand led innovation because that is what marketers believe in. They think that it is always possible to discover what consumers value and create a product that meets that value. Yet, it is arguable that consumers may not be aware of their future demands. In many instances, disruptive technologies emerge from such supply led innovation.

We must allow scientists to follow their intuition in developing something that may not have clear commercial value. Because of their curiosity, they just might discover something that an entrepreneur can bring to the market years later. Scientific discovery is not always a straight path. In many cases, a seemingly useless discovery can spark off a bunch of ideas.

Existing demands can change. Consumers may decide to weigh product attributes differently over time. Firms have to make incremental changes to meet these incremental or changing demand. But meeting existing demand does not stimulate innovative activities. In an industry where every firm attempts to read demand more accurately, it leads to a commercial bloodbath and unsustainable operations.

Radical technologies create new markets. New markets are less defined but it gives a firm more parameters to grow

The case against large immigration flow

The economic effect of positive net immigration to Singapore is negative relative to older people working longer. When the population base remains stable and retirees extend working life, we have a higher GDP per capital.

If we continue to bring in more immigrations without an end, there will be more stresses on our infrastructure. Comparatively, except for healthcare infrastructure, old people demands lesser for road usage, transport services and natural resources.

Intuitively, it makes more sense to retrain our aged population and to encourage them to work longer than to expand our population without end. This is perhaps why Japan rather deal with an aging population than tolerant aggressive immigration.

(I understand the need for a critical mass of population. Perhaps 6.9m or 10m is the defined figure, but there must be an eventual limit to our planning parameters)

Want to invest in Commodities? — Must Read

Commodities usually involves high costs of storage and procurement. For this reason, investors have relied on futures or commodities firms to obtain commodities exposure. With the introduction of commodities ETF, there is renewed interests. ETFs provide cheap and transparent way to invest in commodities futures.

Factors affecting commodities comprise weather, geopolitical developments, supply constraints in physical production, unanticipated increases in demand as a result of prosperity in emerging markets, and incidents that create political or economic turmoil.

Recent crisis have shaken investor’s confidence in equities. This motivate investors to explore alternative investments in commodities. What are some ways an investor can invest in commodities?

Exchange Traded Funds provide the cheapest way to buy commodities exposure. These ETF track major commodities index
Exchange Traded Notes track non interest paying debt and the credit risks of commodities contracts. Payoff to the ETN depends on the counterparty risk of the futures issuer.

Unit trusts have higher fees than ETFs as they typically employ discretionary management methods to invest in commodities or companies in the businesses related to commodities.

An investor can also trade derivative contracts such as futures and swaps directly. The most direct way of investing in commodities is to buy the physical commodities incurring storage costs. One of the most indirect ways to gain exposure to commodities is to buy equities of related businesses.

Commodities have unique characteristics. Metals are seen as safe haven for investors and demand can be driven by the stability of the value of money. Soft commodities such as grain, crops and coffee generally react well to extraordinary detrimental events.

Agriculture sector is less dependent on economic conditions and more dependent on factors such as global weather. The low correlation (even lower than bonds) is an important tool for portfolio allocation. Commodity prices can also hedge inflation.

For long term investors, commodities will be a strategic allocation tool for the portfolio due to the low correlation with equities. For short term tactical allocations, commodities rise when inflationary pressures increase.

HDB is not your retirement plan

Depending on your HDB asset for long term retirement?

This is not an attack of the policy. I believe the HDB system of providing for housing is cool. But it is not a sufficient retirement asset provider. This article seeks to urge Singaporeans to prepare for adequately for their retirement.

Your HDB is a lease

When your house has a maximum lease of 99 years, you may be really just renting the space for 99 years. It is unlike the traditional freehold structure. In other words, the amount of money you are paying is considered advance rent. The financial implications are clear. The value of the lease decrease as your time runs out. A 40 year old HDB flat will be worth much lesser than a 99 year old HDB unit. This may not behave like a real asset.

You don’t sell, you just transfer your lease

When you decide to sell your HDB flat, you are actually transferring your lease to another family. HDB as your ultimate land lord needs to approve your unit’s assignment. If someone pays a premium to take over your unit, he believes that he is willing to pay a monthly rent more than you do. Perhaps this is due to the proximity to the MRT or a famous school.

Your CPF pays prepaid rental expense and it is not being invested!

Remember what you are using to pay for the HDB — CPF. Yes, in fact, you are using your retirement fund to pay for rent. How is this preparing for your future? If your HDB price does not increase or if you decide to live in the unit for 99 years, your unit will surely, without any possibility, be an asset. In fact, you are not well utilizing your CPF for investments and there is an opportunity cost.

What’s worst? You are prepaying 99 years of lease but you are borrowing to prepay the lease. HDB grants you a loan, makes interest off you and wants you to pay them the entire rent upfront. Do you ever want to pass your asset to the 2nd or 3rd generation? This is not possible in Singapore. Your lease ends in 99 years and the value of the house drops quickly after 50 years. Ask yourself, would you buy a flat with less than 50 years lease?

Simply put, you will still need to invest wisely. Do consider the lowest cost and broadest index funds!

Technical focus can shortchange development

In many consumer firms, managements become top-heavy with engineers and scientists.

This creates an environment favoring R&D at the expense of fulfilling consumer needs. The firm must remember that the core of competitive advantage is consumer value, not technical superiority. Therefore, technology development should be a supporting function to marketing and insights division.

However, there are cases are selected cash rich firms to be focused on technology development. Often, these cash rich firms can lead supply side innovation. They can create a technology for a non existing market. The argument is that the consumers do not always understand their own demands in the context of new technology. I suppose consumers did not demand instant messaging in the 1800s. They probably demanded for faster horses.

Summarily, most firms must consider technology as a function supporting product development. A few of these cash rich firms can take the lead to uncover supply side innovation.

Difficult Choices that Singaporeans cannot outsource to the Government

As the elections in 2015 closes, Singaporeans are starting to share their views more aggressively. Dormant political parties have also re-surfaced to share their party’s stances on national level policies.

The path towards growth is a straight forward one. There are only 3 factors to balance: 1. taxes, 2. wages and profit and, 3. subsidies. The size of our tax base is a function of wages earned by workers in Singapore and profits collected by business entities. Subsidies are simply put, negative cash outflow.

If we want to sustain our tax base for national growth without increasing tax rates, we must create better jobs, have more profitable firms in Singapore and be more prudent with introducing subsidies. We cannot create better jobs and grow businesses without managing scarcity of resources and adopting a more open immigration policy.

We have a dangerously low birth replacement ratio which cannot be addressed simply by offering women more child birth subsidies. Highly qualified women have the right to decide to focus on their careers. This trend will continue to erode our tax base. Instead of acknowledging some of these pressing issues, some political parties in Singapore have simply advocated for more social policies. They want more subsidies in areas such as healthcare, transport and retirement. But they also want the incumbent government not to raise tax. Their basis: the Singapore government has a lot of money in their reserves.

I find these policies regressive. I acknowledge that Singapore has to offer subsidies to some groups of low income earners. I also recognise that the definition of the underprivileged group may have to broaden overtime. But we have to do it carefully. After all, an increase in subsidies leads to higher economic burden for a nation. So we must set basic rules and principles for such definition.

Unfortunately, some Singaporeans may have fell for the sweet promises of more subsidies, greater government expenditure and a more manageable population, without a corresponding increase in tax. Singaporeans must decide for themselves, if they should face the hard facts or believe those who simply promise the sky.

Timeless advice on Investing

One should commit at least 20% of your income to savings. Such reserves are badly needed in urgent situations. The accumulation of your savings should be committed in liquid financial instruments. Liquidity is the primary consideration because you want the option to retrieve the money quickly at a low cost.

Some of my friends invest in land related structured products that lock up their money over a long time. Some others invest their money in alternative schemes. Always put your money in traditional instruments such as stock, bonds, exchange traded funds, mutual funds and money market funds.

Investing in a long term affair. Anyone that tells you otherwise isn’t a real adviser. Your returns are a function of cost and risk. The riskier your instrument, the lower your returns. The costlier your investments, the lower your returns. This is pretty straightforward.

There is no magic formula in investing. Diversification allows you to reap benefits of lower risk with the same expected return over time. The cheapest way to diversify is to put 2/3 of your money in stocks and 1/3 in bonds. Some recommend a 60/40 split. This is fine too, as long as you rebalance your portfolio annually. The proof of the benefits of diversification is mathematical. Giants in the financial industry have also urged individual investors to adopt such a simple investing rule. I recommend two books that you need to read; Common Sense on Mutual Funds and The Intelligent Investor.

My opinion is that you do not need a financial adviser. They increase your investing cost. The rules of investing is relatively simple. You do not need to outsource this responsibility. First, select low cost funds. On average, managed funds charge at least 2% over passion exchange traded funds. This reduces your overall returns in the long run by a gigantic amount. Beware of unique fee structures. Some fees can be hidden in sale charges, some in wrap accounts.

William F. Sharpe, a Nobel Laureate in Economics said “The first thing to look at is the expense ratio”. You will definitely earn the highest returns in a low cost index fund. An index fund that mirrors the market will also likely outperform any funds in the long term. In fact, more than 90% of funds fail to outperform the benchmark index. Funds with high expenses will under-perform their benchmark. Funds performance typically exhibit mean reversion. In other words, the worst fund of the year will more likely outperform the best fund of the year in future. To me, past performance means nothing. I will always only look out for index funds with the lowest costs.

Within the equity portion of your portfolio, simply invest in low cost index funds in the U.S and the U.K and in Asia. Avoid synthetic exchange traded funds because there is an additional layer of counter-party risk. Actually, you only need to hold a couple of funds in your entire lifetime. If you hold too many funds, it can be difficult to manage the exposure. Many of your funds will overlap significantly.

Why does GIC borrow from CPF, really?

In his article, “There is no reason for GIC and Temasek Holdings to borrow money from your CPF”, Mr Jeremy Chen upholds the government’s defence that it is not borrowing CPF monies as a cheap source of funds.

He misses the point that if the government were to borrow from the market on a large scale, Singapore’s credit rating would no longer be triple-A.

We can agree with the government’s defence if it were to borrow, say, 10% or 20% of GDP from the market. But if the government were to borrow up from the market up to 100% of our GDP, the credit ratings of Singapore will quickly fall. In turn, this affects how much the government can borrow further.

For the record, Singapore recorded an overall government debt of 105.5% of GDP in 2013.[1]

It is not news that Singapore and Japan enjoy reasonable credit ratings because the national debt of these countries is internal. The rationale behind such a credit rating is that Singaporean and Japanese citizens are unlikely exit their countries en masse suddenly, like in the case of a bank run.

The debates over CPF should rightly be focused on questioning the need for a compulsory annuity scheme for all account holders (see also our article for instance). But Singaporeans are right to also question the flows in the monetary system, not least when it affects their own money in their CPF accounts.

What we really need to fix about the CPF

Giving CPF account holders the free choice to decide what to do with their own retirement savings is the key.

In the midst of all the recent debates on the Central Provident Fund (CPF), and the government’s moves of raising the CPF minimum sum and enforcing a compulsory annuity scheme on all account holders, we must go back to the fundamental principle behind the CPF — that it is a compulsory savings plan for retirement.

The key issue, therefore, is that we must allow CPF account holders the free choice to decide whether to withdraw everything at 55, or opt into an annuity scheme, or opt for something in between.

If CPF account holders think they can benefit from the annuity if they live long well beyond 80 years of age, let them do so. If they want to withdraw their retirement savings in toto to invest in a private scheme that provides for a higher yield of annuities, let them do so.

CPF account holders do not withdraw their savings just for reasons of pleasure and holidays, although it is perfectly their right to do so. Health care costs, for themselves, for family members, for rare diseases, for their children’s further education — these are the things Singaporeans need to spend on in this non-welfare state system.

Compulsory annuity scheme for CPF: where is the justification?

So why is there a need for a compulsory annuity scheme for CPF? Where is the statistical substantiation that a mandatory annuity is needed across the board — is there a substantial enough proportion of the population that has such a dire lack of savings that warrants this? Is there such a substantial proportion of the population that is proven to be absolutely incapable of planning their retirement financially?

Our policy working group has not seen any such analysis or evidencing that typically accompanies government policymaking. Without this information, it is understandable why Singaporeans simply cannot accept the latest changes to the CPF.

Since the government has said that it is helping Singaporeans plan for retirement, then we would need to know — how were the projections for the minimum sum and the monthly annuity worked out? We don’t believe it is out in the public domain.

This brings us to the issue of income replacement rate (IRR) — what percentage of a worker’s income should we replace when he or she retires? Note that the higher the IRR, the greater the present burden on the worker who is at the threshold of retirement. The 2012 Chia and Tsui study on the IRR,[1] typically cited by the government, reported that the median male earner will be able to replace 70% of his wages when he retires, and female workers 64%. But these are the result of their academic study — it is not the government’s planning target, of which we have not been informed.

This makes the compulsory annuity scheme like a straitjacket for a madman — you are forced wear it to restrain yourself, so that you would not hurt yourself and those around you, we are told. But what if you are not a madman in the first place? What if you’ve been wrongfully diagnosed as a madman?

Management of the CPF funds

Then there are the issues about how the government should manage the CPF funds.

Our sovereign wealth funds should raise capital from international capital markets.

The default linkage of CPF funds to the sovereign wealth funds should be severed. This would give us the chance to rethink and restructure our retirement funding mechanisms.

The government has tried to defend the contention that CPF money a cheap source of funds for the sovereign wealth funds.[2] And we are told that government bonds still the most secure, with its AAA rating.

We can agree with this statement if the government were to borrow 10% or 20% of GDP. But note that if the government were to borrow up to 100% of our GDP, the credit ratings of Singapore will quickly fall, leading to very high borrowing rates.

In fact, it is not news that Singapore and Japan enjoy reasonable credit ratings because the national debt of these countries is internal. The rationale behind the credit ratings is that Singaporeans and the Japanese will not exit their countries en masse suddenly, like in the case of a bank run.

As such, we believe it is unfair for the government to claim that CPF is not providing a cheap source of funds.

Changes to CPF must pass through Parliament from now on

In conclusion, it is paramount that CPF account holders must have the choice and flexibility what is to be done with their retirement savings. They should have choice on whether to have their funds invested in the sovereign wealth funds or other instruments such as an equity index, a fixed income scheme, in funds or other such instruments. This would give Singaporeans the freedom of choice over the interest rates they wish to see from their savings, corresponding to their risk appetite.

And if they wish to withdraw all the CPF savings, whether to foot an urgent medical bill for treatment of a rare disease, for their children’s education, or for the holiday they have also dreamt about, they must be allowed to do so.

Finally, all changes to CPF policy must be presented to and passed by Parliament, and not be made a matter for subsidiary legislation. The political climate in Singapore on the CPF issue has reached such a point that the government ignores the voices of the people at its peril.

Is CPF Cheap funding source for Singapore Government?

The contest is Government can get cheap source of fund at below 2.5% in the open market given Singapore’s credit rating.

Authorities may say that they can borrow at below the existing 2.4 to 2.5% CPF rate. Some may agree with the Government given Singapore’s strong credit ratings.

This is especially in the case where Singapore borrows only 10% of 20% of GDP.

But what is unclear is if Government were to borrow 100% of our GDP (Our existing debt levels), the credit ratings of Singapore will quickly fall, leading to very high borrowing rates.

In fact, it is not new to commoners that Singapore and Japan enjoys reasonable credit rating because the national debt is internal. One would argue that local Japanese and Singaporeans will not exit Japan and Singapore respectively, immediately.Polices can also be put in place to guard the exit.

As such, it may be unfair for Government to claim that CPF is not providing a cheap source of funds.

Prudent retirement strategies

We want to ensure investors adopt retirement strategies that mitigate longevity risk. Between the ages 40 and 50, the simple solution is to convert lump sum capital into income streams by way of annuities. This simple strategy mitigates longevity risk but the decision is a difficult one because investors part with their long life savings to exchange for an income stream. The decision is emotional because investors know they will never be able to get the money back.

For this reason, while annuities are part of a simple strategy to exchange lump sum for income stream, many prefer to use strategies that preserve liquidity while meeting retirement needs. It is possible to use Treasury Inflation Protected Securities (TIPS) to create payouts during their lives. The key is working with your advisor to create an expected cash flow over a predetermined time frame. This is not a simple task. The set of future cash flows will have to meet retirement benchmarks shaped by inflation. It is intuitive for this custom set of cash flows to be benchmarked against the payout of a simple annuity instrument that is inflation protected. This will ensure the maintenance of real purchasing power.

Enhancing the retirement income

One other consideration is phased retirement. Besides creating a prudent retirement investment strategy, the investor should also consider postretirement positions, reduced workload and salary. The ability to create an alternative stream of salary, albeit reduced from previous scale, can enhance the retiree’s quality of retirement life. Gradual retirement allows the individual to reduce working hour and to acclimatize with a lifestyle of lower income. The individual can continue to receive predictable income and some health benefits.

Risks to consider

Retirement risks can be hard to incorporate into the investment strategy. How do we mitigate long tail market risks? You may own a sound dividend income plan, but a sudden crisis can create a volatile change in asset values and dividend payout plans. Fixed income investment strategies dependent on reinvesting coupon payments can fail to provide the required rate of return when rates turn for the worse systematically.

Relative to inflation and longevity risks, which can be often managed using a statistical framework, personal circumstances can also affect one’s retirement plans. To manage these risks, an individual must start considering insurance plans early. Use investment strategies to mitigate statistical risks such as longevity, inflation and market risks. Take on insurance plans earlier to mitigate future health risks and circumstance risks.

The entire retirement process may be complex. One way is to engage a prudent adviser to discuss your options early.

Gender Equality: 3 Major initiatives

Talent has become a decisive factor of production in the global business context. A business competes on innovative capabilities, no longer just on the accumulation of assets. In this context, businesses cannot treat gender parity as superfluous. Women are half of the potential talent available in any country. Gender parity and efficient use of women in all sectors will be a competitive advantage for countries and for any global firm.

The onus is on global firms to work with governments in creating gender equality benchmarks in order to measure gender gaps globally, regional and even down to sub-industry sectors level. Policy makers can use standard benchmarks that track gender gaps economically and socially to capture the magnitude of inequalities. This understanding is necessary for us to prescribe tools that close the gap in homes and in workplaces.

The lack of female representation in public offices is a barrier to gender equality. Women’s access to public office may in many cases be restricted by party bias for male politicians. We need women to be adequately represented in government and politics to ensure sound policies that close the gender gap. It is possible to install gender quotas for women. In Singapore, women Member of Parliament make for less than 30% of the parliament. We have racial quotas ensuring minimum representation for Malays and Indians.

Gender equality benchmarks and female representation in public offices are ingredients for gender equality. Equally important is the level of women education and women’s access to information and resources. Access to information and education is necessary to create equal opportunities for women to success in the future.

Can Singapore survive the knowledge and education revolution?

Higher education is no longer the privilege of the few. Middle class can now access higher education. The number of graduates is growing exponentially. With the introduction of quality Massive Open Online Courses, students from around the world have access to quality education.

Example

Udacity, has teamed up with AT&T and Georgia Tech to offer an online master’s degree in computing, at less than a third of the cost of the traditional version. Harvard Business School will soon offer an online “pre-MBA” for $1,500. Starbucks has offered to help pay for its staff to take online degrees with Arizona State University.

Unopar University offers low-cost degree courses using online materials and weekly seminars, transmitted via satellite. In America, Minerva University has lower fees (around $10,000 a year, instead of up to $60,000). The first batch of 20 students has just been accepted for Minerva’s foundation year in San Francisco, and will spend the rest of their course doing online tutorials while living outside America, with an emphasis on spending time in emerging economies as a selling-point to future employers.

Singapore at risk

Singaporeans are at risk if the global MOOCs provider offer common standards for accreditation. Should common accreditations be accepted globally, Singaporeans will be competing with a huge pool of readily available talent from emerging markets.

Online learning will take the world by storm. The financial and technological disruption will render many universities useless. The cost to train a Singaporean costing $100,000 per student over 4 years will no longer be competitive if MOOCs can train the same quality student for a fraction of the price.

Trend of automation

Carl Benedikt Frey and Michael Osborne, of Oxford University, suggested 47% of occupations could be automated in the next few decades. White collar jobs are not safe from elimination. What can the Singapore government do by then?

Cheap online education will eventually replace faculty. Star professors will outshine their peers. The gap between the best faculty members and the average will widen. Starlets will deliver key lectures. Their online seminars can be distributed to an unlimited number of students. The learning can be automated and the Q/A guided by a cheap graduate student.

I believe the quality of education will sustain and may even increase as students can now hear from the best professors. The question is how will Singapore respond in a global environment filled with cheap talents?

Origination of complex investment management fee structure

Fee structures direct investment management behavior and influence the KPIs of funds.

Fund managers cannot guarantee returns. But they will need to receive salary even in losing months. This causes stress between the manager and investor.

The effort to reduce fee may lead to a reduction in quality of talent and regulations. This can reduce performance and increase risk management capabilities.

Performance related fee structure that pays managers only if the fund makes money is risky. This structure may lead to managers taking extra risk to avoid losses, even if the strategy does not fit the fund objectives.

A more complex fee structure can lead to better risk management outcomes. For example, we may want the manager to reduce volatility instead of pursuing alpha.

The yardstick to measure performance in investment management is complex. Do we pay managers for high returns and risk deviating from the investment objective? Or do we pay managers for mirroring a specific beta type?

In short, do we pay for better management quality or for higher earnings? It takes better managers to stick to management objectives than to seek opportunistic investments.

This is why managers are subject to complex fee structures such as risk adjusted returns and clawback schemes.

CPF payouts are not inflation hedged

Non salaried retirees face a greater risk than salaried employees in the face of inflation. At least, we assume salaries increase with inflation. Government need to help citizens mitigate the risk of 1. Inflation and 2. Longevity.

In Asia, most governments do not offer inflation protected benefits to their citizens. Given that revenues received by the state is linked to inflation, it could be the responsibility of the state to offer inflation protected schemes.

Such a scheme should have 3 core features:

1. Reasonable level of payout.

2. Payout that lasts for as long as the retiree lives

3. Payout level is inflation protected

At the moment, the CPF life meets only #2. For retirees with meagre CPF sum, payout sums can be minimal. Our payouts are also not pegged to inflation growth. To provide inflation pegged payouts, we need inflation linked annuities. To overcome the need for inflation pegged payouts, Singapore government can consider issuing bonds that are inflation indexed such as the US TIPS and Australia CAINS.

I understand that inflation indexed products can imply risks to the government. This is especially of concern when Singapore’s y-o-y inflation can range between 4 to 8%. I also note that Singapore is a small country and can be easily impacted by global demand. In the face of inflation, currency appreciation is a good way to manage risks.

Singapore should also consider financial innovation to create inflation indexed products. One way is to create a mixed basket of inflation linked products globally and hedge the currency exposure. I am not a financial expert and suspect that such intricate hedging techniques may be too costly to implement. But this could still be better than for Singapore to issue sovereign inflation indexed products. In the latter case, Singapore government would bear the entire inflation risks on behalf of citizens.