Saturday, June 29, 2019

Further Insights into Astrea IV and Astrea V bonds.

I'm a little slow to the Astrea IV and Astrea V bonds issue but I think I can add something that to the excellent articles that are already being share by other bloggers. As I'm trying to get into new territory on valuation of bonds, feel free to correct me if you spot any mistakes in my analysis.

As it stands, both Astrea IV and Astrea V bonds present an interesting proposition to any REIT or equity investor. As we are no longer anticipating a rise in interest rates, bond investors have a decent chance of making some money from coupons as well as lowering of interest rates. This plays well into the possibility of entering a recession as the trade war worsens.

In my analysis, what is interesting is that I assumed that both bonds will be called after 5 years and investors will be getting a 0.5% bonus with their principle when this happens.

If you perform this analysis, based on Friday's closing price of $1.065 for Astrea IV and $1.035 for Astrea V, you will derive a yield to maturity of around 3.83% for Astrea IV and 4.06% for Astrea V. Not too shabby for investing in bonds and at least two points on the P.E bond yield curve that shows an upwards slope.

If you read between the lines, it may be theoretically possible to leverage Astrea bonds but you need to find a cheap source of funding, I would not do it if interest rates exceed 3% and I would like to keep my multiplier low ( somewhere within 3 ).

The missing analysis comes from interest rate risk. Singaporean retail investors are unfamiliar with bond mathematics.

Bonds can shift in prices drastically when interest rates change and modelling this with backtests is highly dangerous.

I did some googling and vaguely recall that one of the proper ways to model interest rate risk changes employs the Vasicek model. This means that interest rates have a random walk component but it also reverts to the mean. As I have no idea what the mean is, I visually inspected SIBOR during its rise and  observe about a 0.5% increase every year for 3 years so that might form a good worse case scenario.

For the Astrea Bonds, sensitivity to interest rates is calculated using this thing called the MacCaulay duration. You can google that, but using a risk free rate of 2.5%, I calculate the duration for Astrea IV to be around 3.94 and Astrea V to be around 4.99 if we assume a call within 5 years and bonus payout after that.

We can conclude several things from this quick exercise :

  • Astrea IV bonds provide lower returns and is less sensitive to a drop in interest rates. Bet on Astrea IV if you see interest rates staying the same or rising further if the trade war abruptly ends.
  • Astrea V bonds in spite of lower yields, provide a higher returns when called and can experience a bigger upside if you believe that interest rates will fall. So the issuance of Astrea V is not so much to take advantage of investors but to present a product with a different behaviour. 
The problem of Astrea V is the higher duration of 4.99. This means that the bond prices will vary by 4.99% for each 1% rise in interest rates. Suppose we take a worse case scenario where interest rates go up by 0.5% every year for 4 years resulting in a 2% increase in SIBOR, these bonds are expected to lose 10% of its value. Not a bad way to stabilise an unleveraged portfolio of equities. 

Do note that with Astrea bonds, things always get complicated because if interest rates gets too high, the call will not take take place and your duration will increase further to around 7-8, so your downside might even be worse. 

So imagine you are one of those guys who attempt to leverage Astrea V bonds to get additional coupons. You may well be facing a margin call even if a default does not occur. 

Rising interest rates can destroy you. 

There is no free lunch in the world of bond leverage.

Thursday, June 27, 2019

The Model Thinker #24 - Mechanism Design.

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This chapter focuses on designing political and economic institutions. I will shoehorn this chapter into a discussion about the relative strengths and weaknesses of our CPF system.

There are four aspects to such institutions.

Information consists of what participants know and what should be revealed to them. All Singaporeans know what interest rates they should expect to receive for their CPF accounts. Singaporeans are probably less clear about what kind of payouts they expect to receive from CPF Life when they hit 65.

Incentives cover the costs and benefits of taking some actions. Contributing your money via the Retirement Sum Topping-Up scheme leads to tax deductions that can benefit folks in the higher income brackets more than those in the lower brackets.

Aggregation show how individual actions translate into collective outcomes. The collective outcome of CPF is that Singapore insures itself from the bad financial habits of other Singaporeans and have a tool to keep inflation low compared to other OECD countries.

Computational costs measure the cognitive demand placed on participants. In this aspect, the complexity of CPF, such as the need to select from a menu of different CPF Life schemes,  makes it one of its biggest flaws.

No perfect mechanism exists, but when we design a mechanism, here are some aspects of the system that makes it good.

The lowest threshold is Pareto efficiency. There simply should not be a case where an alternative exists that everyone should prefer. Cynics will say that Singaporeans do not need CPF Life. But for folks who are very long lived, CPF Life will hedge against longevity risk. So CPF Life meets the requirements of Pareto efficiency. It may be much harder to argue that HK extradition laws are Pareto Efficient.

The next aspect is dominant strategy implementable. The best strategy of a participant should not depend on the actions of others. CPF Life is dominant strategy implementable. Unless your lifespan depends on how others select their CPF Life schemes, you can just choose the program that is best given what you know about how long you are likely to live. For me, I will elect for BRS plus the Basic CPF Life scheme since I am diabetic and not likely to face longevity risk. Our financial markets are not dominant strategy implementable. We can buy dividend stocks so long as yields do not get compressed too much by old uncles who need passive income to buy 4D.

The third aspect is voluntary participation. In this case, unlike many other countries CPF is involuntary. CPF is obviously not perfect.

The fourth aspect if budget balance. If a mechanism involves a transfer of resources, we cannot put in additional money and resources. I am inclined to argue that CPF does not meet this requirement because we have to pay for CPF IT systems, infrastructure and staff. However, if the money eventually gets invested well, the dividends, after paying off citizens for their 2.5%/4% may be able to sustain the CPF infrastructure, then it can be argued that this aspect is met.

Lastly, a mechanism is good if there is incentive compatibility. Participant's best choices should reflect their true preferences. There is simply no reason to game the CPF system by choosing a scheme that does not reflect your true preferences. Systems that do not have incentive compatibility include trading systems that enable high frequency trading.

So by reading this chapter, we get the impression that the two weaknesses of CPF is that it is involuntary and exacts a heavy cognitive load on Singaporeans. We should be simplifying it to make it easier to understand, maybe even merge SA and MA. A voluntary pension fund scheme where members could elect to take on some market risks on a global scale may also make it less involuntary.

Tuesday, June 25, 2019

Thoughts on my Australian Trip.

No photo description available.

I just wanted to round up my trip to Brisbane and the Gold Coast.

First of all, no one can speak with much authority having gone on a 7 day holiday in a foreign land. It is amazing that my first visit to Australia would be at the ripe old age of 44.

I also have plenty of friends who can correct me if my opinion is wrong about Australia. I do have the benefit of mugging a few books while on the flight home, at least one on real estate, one self-help book, and one on humour to get more context on the country.

Here are my thoughts :

a) Australia is a more equal society than Singapore

My tour guide kept saying that unlike Singapore, Australia is much more balanced country. While I largely agree with her, I was still disappointed that a country that has not seen a recession in over 20-something years and with a fairly decent welfare scheme would have more homeless folks on the streets than we do. Nevertheless, the streets are safe, and the homeless kept largely to themselves.

A better conclusion would be that Singapore is highly unbalanced country.

It is only after 7 days in Australia when I realised how much we are exploiting our own hawkers. Australia does not have a hawker culture so we have no choice but to eat at restaurants. I paid $4 AUD for a donut and a ham sandwich can cost about $7 AUD. There is also no Toast-box so every Long Black will set me back a whopping $4. ( It's winter so I have to get at least three cups a day )

Equal societies that respect blue collar labour will have a cost structure much like Australia and less like Singapore.

b) Healthcare seems very affordable in Australia

I did something really stupid during my trip.

I forgot to bring my diabetic drug Janumet with my to Australia but have a Singapore doctor's prescription with me, so I went to the pharmacy to buy some drugs since I will be eating lots of Tim Tams while I am here. A bottle of Janumet cost about $50 AUD. Too bad I can only get 3 days of medication without a doctor's prescription. Otherwise, even with doctor's advice, the drugs would be worth getting.

c) Australians seems to struggle with retirement as well.

I better don't pretend to be an expert but Singaporeans thinking of emigrating into Australia should read up on Superannuation and Self Managed Super Funds o SMSF ( which is roughly equivalent of our CPF system) and figure out how to play this system well.

Even reading a book off-the-shelf will reveal some weaknesses in their system. Which brings us to my next point...

d) Beware of real estate schemes involving Australian Property

I picked up this book called Property Investing Made Simple by Andrew Crossley and it seemed like a realistic writeup on real estate investing in Australia. It seems that Australia has its fair share of real-estate seminars as well and folks who peddle real estate aggressively are pejoratively called spruikers.

This impacts Singaporeans because ASICS ( Australia's MAS ) does not recognise property as an investment security which allows this industry of dubious real estate trainers to flourish. Australian developers are aware that Asians like to buy up property so they sell these units very aggressively to Singaporeans. The backend commissions paid by developers to these commissioned salespeople can be as high as 6%. The stuff Australians would not touch themselves include : vacant land, resorts, timeshare, fractional ownership. 

You can fit what you read about in this book into what is sold on the ground in Singapore.

e) The welfare state is shrinking in Australia

I have a personal theory about why it will be harder to get on the dole moving forward in Australia. It's not politically correct so I will not say it on this blog. You can, of course, get me stone drunk if you want me to spill the beans.

General feelings after coming back...

I am grateful that a more egalitarian society exists within 7 hours flight from here. Australia is the kind of place where plumbers and electricians are treated with the same degree of respect as doctors and lawyers.

While, as a rent-seeking capitalist,  I function better in a society where there is less equality like Singapore, I have no illusions that my children may not make it academically here. If my kids fails to get into a JC, I will start studying the Australian points system to see whether they can start studying for a trade or nursing certificate in our local polytechnic and move to Australia while they are younger and more willing to work hard.

The best time to plan an escape would be when someone is around 18-21 years old after doing NS.

This window is getting smaller as the years go by because Australia would only welcome folks who can contribute to their economy into their country. Judging by the work ethic and pace of work i witnessed there, I think young English-speaking Singaporeans would be welcome there.

Tuesday, June 18, 2019

More insights from attending real estate seminar previews

I'm not a saint.

To become a good trainer I do attend previews from other trainers. When I do attend these previews, I have to with hold judgment on the content being taught and focus on the user experience of previews to figure out how I can raise my game.

This creates a moral dilemma : There is a strong moral push to reveal my inner thoughts on what these seminars teach - I'm human too, I don't like having my time wasted on seminar previews. On the other hand, I don't want my training career to be built on the failure of other trainers.

My latest visit this time is a real "no money down seminar" and, unlike me, the trainer is very attractive and highly charismatic.

Here are some thoughts I have on last session :

a) Purchase of Industrial property should account for 7% GST and depreciation

A major idea in this preview is that industrial property does not attract ABSD unlike residential property. Also, some positive cash flow can result after accounting for mortgage payments and taxes.

I was trying to figure out whether there is a catch to all this and realise that somehow GST was omitted from the calculations. While you avoid the 12% ABSD for residential property, I think you have to pay 7% GST, which can quite punishing.

Also another element not discussed is that industrial leases can be much shorter than residential leases so depreciation is something that needs to be factored into the cost as well.

b) Mechanism for "no money down"

Obviously this was not revealed in a preview, so I want to take a stab at guessing the mechanism behind it.

My first guess is that the 20% funding for industrial property comes from getting a separate term loan from a bank by using the residential home equity as collateral. This is hardly a no money down scheme - that term loan can be invested in dividend stocks if you wanted to.

My wilder guess comes from seeing a trust deed in one of the slides. A trust basically allows multiple investors to pool resources to buy a property and allows some of them to be designated legal owners of the property and others as beneficial owners of the property. This is a highly dangerous as the trust deed will define the legal relationship between the parties moving forward and beneficial owners do not have a lot of power over the property.

( How is this arrangement safer or better than just buying a REIT baffles me. )

c) Some narrative tropes in real estate seminars are a turn off

Apparently, female real estate trainers seem to position pregnancy as some kind of apocalyptic event to gain sympathy points. I have two kids of my own and I just don't buy it. If you get pregnant while your husband is not fully functional as a  breadwinner, this might gain partial sympathy points but from my own experience, having kids is a happy event for me.

Another storyline element which made my blood boil is that some people see financial independence as a way to tell their kids that there is no need to study so hard. This alone would be a reason not to sign up for me. Even if there is no need to study so hard for a job, academic credentials can lead to more social or cultural capital. I don't really want to attract folks who think otherwise to my course. If anything, a good investment course should make you wish you'd study harder for your statistics class.

So some folks who do not want to attend a course may want to experiment with this idea, which, to me, seems to work in theory :

a) Find out whether you can get a term loan from your own residential property, many of us are sitting on quite a fair amount of home equity. If you have an EC like me, it is not uncommon to have $500k in home equity after MOP.
b) Find a real estate agent who specialises in industrial property. Start visiting a few and look out for bargains.
c) Some arbitrage opportunities will arise from property that is particularly run down, you can consult your agent to see how much you need to get a contractor to spruce it up with a new paint job. You can also erect walls to rent out to multiple parties to get more rentals.
d) If you are lucky enough to get away with being cash flow positive, you can see if you can sell the property a few years later and rinse and repeat the process.
e) Just don't ask me why this is better than investing in REITs beyond the high leverage.

If you some insights to share about no money down seminars, do comment on this blog.

I am not surprised that days after attending the preview, my friends alerted me that the company that organised the preview I attended was put under the MAS watchlist.

Well this should be my last article before I fly to Australia tomorrow.

Catch you guys next week !

Monday, June 17, 2019

Letter to Batch 5 of the Early Retirement Masterclass.

It's been a hectic week and I have not been updating this blog.

For the past two days I have been running Batch 5 of the Early Retirement Masterclass while my dad is still recovering in Yishun Community Hospital. At the end of class yesterday, I went to see my dad along with my own kids. We did not really much of a Father's Day celebration but I am really glad that my dad saw my kids the first time after being hospitalised for so long. ( We have been videoconferencing in the past. )

This coming Wednesday, my family will be taking a short trip to Australia. This was planned prior to my dad's hospitalisation. Beyond immediate places like Thailand and Malaysia, my family has not had a trip since I signed up for law school and they are in need of a holiday.

So anyway, here's the latest letter I sent to my students.

<< Letter to Batch 5 >>

Dear Students of Batch 5,

It’s been a great honour and privilege to be able to conduct a 2-Day Early Retirement Workshop for you.

We may be seeing an inflection point in the markets as it is conducted just before the June 20 meeting between President Trump and Premier Xi Jin Ping.

As the markets may go either way, I will invest my proceeds from class training into two different portfolios. The first portfolio consisting of blue chip stocks and the second portfolio consisting of REITs and business trusts. This is also the class where major changes have been made to the key strategy used previous classes so much so that many of the usual REITs we would have bought in previous batches have been changed almost completely.

Also of note is that this class has, very happily, trimmed off half of the REITs selected by the back-tested model. I particularly liked it when one group selected SPHREITs to be included in the portfolio but a dissenting opinion was shared from someone who is not from the group. As we worked to iron out the disagreement, I am glad that the group was willing to change their minds. In investing, we should never cling onto our investment ideas stubbornly. This discussion resulted in a portfolio with even higher yields.

At the end of the day, only history and the markets can tell whether the choices we made are the right ones. Collectively, the overall effect of investing in this batch of securities would be to diversify from what was invested in before so I look forward to putting my money into the markets in about two week’s time.

Our co-created equity portfolio that yields 4.31% can be found in Annex A of this message. Our co-created REITs and business trust portfolio that yields 6.455% can be found in Annex B.

I look forward to investing $10,000 of my own fees into my margin portfolio with an equity multiplier of 2 into each of the portfolios in Annex A and Annex B. You will hear details of my execution in about two weeks time.

Christopher Ng Wai Chung 

Tuesday, June 11, 2019

The Model Thinker #23 - Collective Action Models

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Where situations involve a misalignment between self-interest and collective interest, we can use collective action models.

In a collective model, individuals can choose to free rise or contribute. If every individual contributes, the sum of payoffs is maximised. An individual who free rides, get to keep a higher pay-off for themselves but the collective suffers.

There are three models in this chapter :

a) Public Goods.

When it comes to public goods like paying for the environment or defence, contributions to the public good attain diminishing returns as more contributions are made but contribution to privates have a pay-off that varies linearly with contribution. This creates a gap as the socially optimal allocation to public goods becomes very large compared to the equilibrium allocation.

Society becomes worse off when folks act on their best interests and do not sustain public services.

To resolve the public goods issue, societies levy a tax and make it compulsory to sustain public good services to maximise the utility for everyone.

b) Congestion

The congestion model applies to use of parks and expressways. The pay-off of the use of the resource was found to decrease by the people who utilise it.

To deal with congestion, we can ration these resources, rotate access, run a ballot, levy a fee or enlarge capacity. Singapore is particularly good at dealing with congestion limiting access to folks with a COE and levying a fee to use roads in the CBD area every day. Fees than get channelled into public transport.

c) Renewable Resource Extraction

The third problem concerns systems like fishing. If you fish below a rate, fishes can survive to create the next generation of fishes. If you exceed a critical level when fishing, the population collapses and soon there will be no more fishes left to fish.

To deal with this problem, a monitoring body need to be setup to enforce fishing limits, monitor deviations and impose sanctions. Fishing limits should also be adjusted based on the amount of fishes left in the body of water.

Saturday, June 08, 2019

Early Retirement as a Religious Experience

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Mark Manson's latest masterpiece Everything is F**cked is a work of a genius. It stylishly blends the latest insights in psychology with postmodern philosophy and written in a compellingly unique voice.

This is a must read for fan of this blog.

One of the cooler ideas in this book is on how to start a religion and it is this section of the book that resonated with me the most.

Attaining Early Retirement and becoming Financially independent has always been to me a personal affair which I documented through my books at various stages of my journey. My earlier ideas recast financial independence as being akin to attain Nirvana by adopting a Calvinist work ethic.

One of the impediments of effective training has always been convincing students to take action.

As such, reframing Early Retirement as a Religion is a novel idea that might work. To start acting on one's own intelligence and investment ideas is not so much a logical exercise, but one based on faith and emotions.

Faith that, when a person invests on their own, things will not go south.

I will now imagine how Early Retirement can be re-engineered into a religious movement :

a) Sell Hope to the Hopeless

Early Retirement does indeed seem hopeless to a beginner.

We probably have about 10-15 years worth of work before we get interrupted with a string of retrenchments and retraining initiatives. Most investment products low ball their returns so an exit within 10 years is a difficult enterprise. As a consequence of this, this seems impossible to most laymen.

As I already have a product offering to make Early Retirement possible that combines a quantitative approach with using a bit of leverage, this is already something that is expected in a training course.

b) Choose your Faith

For such a high quantitative investing methodology, folks may argue that faith is unnecessary to invest employing my approach since I am a man of science.

I actually now believe that faith is fundamental to successful Early Retirement.

You must believe that there is a chance that markets may adopt historical risk and returns. Non-stationarity makes it a crap shoot but some evidence is better than making bold proclamations about "good sponsors" and "superior managers" or reading candlesticks.

Furthermore, you must also believe that doing it on your own is better than hiring an active investing professional because you will not be encumbered with expensive management fees.

There are a lot of horrible people showing evidence on the Web that shows that people are bad at choosing stocks on their own. When you ask them what they think about people's odds of choosing a "good" commissioned financial advisor instead, they become silent on this matter.

c) Pre-emptively Invalidate all Criticism or Outside Questioning

This is the stage where training is no longer helpful since I do enjoy addressing criticisms as constructively as possible.

There are, however, some forms of criticism are particularly bad where I would no longer advocate being reasonable to the person levelling it. One is that because most evidence points to most laymen failing at investing, you will also fail at investing.

To deal with this, a good religion needs an enemy. If Early Retirement were to made into a religion, its enemies might well be some commissioned Financial Advisors or MLM practitioners.

" You are an FA, of course you will argue that I cannot attain Early Retirement on my own. I am not paying you commissions to adopt your slave mentality! Go Away ! "

d) Ritual Sacrifice

Early Retirement already calls upon more ritual sacrifice than most real world religions.

  • Tracking your budget with an App. 
  • Forgoing restaurant visits. 
  • Frequent library visits to read investment books. 
  • Pre-funding your trading account to lower commissions.
  • I even started intermittent fasting today. 

Sometimes my job as a trainer is to document all these rituals into one single set of Holy Training Manuals.

e) Promise Heaven and Deliver Hell

The capitalist economy has already installed a Heaven and Hell for adherents to Early Retirement.

Heaven for Early Retirees is a life unconstrained by unreasonable job supervisors, where your taxi fares come from REIT dividends and DBS pays you to visit Japanese restaurants.

Hell is a life of constantly getting Retrenched, Retraining for a new job then going into a new job just to be retrenched again. Hell for civil servants is doing procurement.

f) Prophet for Profit

In case you don't know, we trainers already profit from conducting training.

In my view, the challenge is to sustain a reasonable profit. This means coming up with training that always improves with the times. This may mean adopting some religious practices to improve student outcome. And no, I don't share my insights for free.

As you can see, there is nothing much stopping me from turning Early Retirement into a secular religion.

This is possibly not that new, the FIRE movement is already attracting believers in droves.

Tuesday, June 04, 2019

The Model Thinker #22 - Models of Cooperation

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Models of Cooperation can be used to allow us to think about the shenanigans in the insurance industry, but first let's talk about how to shoehorn this model, originally based on the Prisoner's Dilemma model, to describe the industry as se know it in Singapore.

When a Financial Advisor cooperates, he basically decides to put personal ethics above his bottomline. He will engage with his clients fairly and sell what the client needs. To me, a FA who cooperates operates by the spirit of the engagement. He does not adhere to rules simply to meet compliance requirements.

When a Financial Advisor defects, he basically decides to focus solely on the bottomline without getting caught. He sells primarily for his commissions first and his client's needs second. While he may not engage in illegal acts and will still maintain standards of compliance.

The difference between cooperation and defection is outwardly subtle, but there should be a higher payoff for defection than cooperation. As the gap between defection and cooperation widens, more FAs defect and consumers suffer.

Our models of cooperation can then provide ideas as to how to create a better industry that provides Financial Advice.

The first mechanism to promote cooperation is repetition. If FAs think that they are in it for the long haul, they would be less willing to screw their clients. One possibility is to stagger pay-outs to FAs across a longer period of time so that they will suffer the consequences when clients find out that the product was not suitable later. Another mechanism would be to clawback commissions if they quit the industry after making an immediate sale.

The second mechanism is reputation. If the history of defections can be made more transparent, then the public can choose not to engage with someone with a bad reputation. Some insurance companies track the churn rate of their agencies but this is only made transparent when litigation occurs, imagine what benefit this can bring if these rates can be made public. In my opinion, FIDREC should also allow proceedings to be accessible by members of the public. If a policy sold by an agent is disputed often, even if the outcome is in her favour, the existence of disputes should be made public domain as a warning to potential customers.

The third mechanism is clustering. If we want to engender more cooperation, a group of successful companies must emerge that would be able to profit from cooperative behaviour so that it may spread. The burden cannot be placed on companies like Providend forever. One way I try to contribute to this situation is to direct some of my students to MoneyOwl to see whether they can remedy their insurance woes (and my students have a litany of insurance woes that I can't advice on). I see cooperative synergies between financial education and unbiased financial advice and like to contribute to this moving forward as I get more traction within my own industry.

The final mechanism is group selection. One of the fundamental tensions in group dynamics is this truism : Individual selection favours defection but group selection favours cooperation. We are increasingly seeing commissioned FAs as a coalition. When an FA defects, he makes more money than a cooperative FA. But when a group of FAs all defect at the same time, FA collectively get seen in a more negative light compared to a group of FAs who cooperate. MAS is now starting to drop hints that this current arrangement is not sustainable over the long run.

I believe that changes are coming and maybe defection can be legislated out of existence one day.