How Diversified Should You Be?

Diversification is a popular theme espoused by financial advisors. As long as there is a geographical or business sector not included in your portfolio, you'll tend to hear them sharing axioms such as “you shouldn't put all your eggs in one basket” and “diversify to reduce your risk”.

But does diversification surely reduce risk? I am sometimes left scratching my head when asked to diversify into an area where I am not invested in, for the simple reason that I am not invested in it: it does not make sense to diversify into risky areas for higher returns when I can obtain a similarly high returns at less risk. It is equally mind-boggling when bankers advise parking money in financial instruments that is going to give returns lower than the inflation rate. This “diversifying for the sake of diversity” approach is sadly rampant these days.

However, if diversifying can reduce risk while maintaining or even enhancing returns, then it is definitely a great idea to do so! Diversification though, is a really vague phrase, I've grown to realise. Some people thinks that diversification means having a portfolio covering almost every investment out there. Others think holding around 5 different shares is diversified enough.

Due to the intrinsic nature of diversification, being a concept in the dynamic investment discipline, and the difficulty in quantifying investment risk, it is not possible for it to have a fixed quantifiable yardstick. How should we diversify in this case?

These guiding principles are my two-cents:

• Bearing in mind short-term market volatility, pick investments where the risk versus reward is at least comparable to those in your portfolio.
• Based on the above guideline, have as large a variety of investments as you can safely monitor. The size of your portfolio is limited by your time.
• Do not diversify for the sake of diversity.

If you have any thoughts or questions, do share below. Here's wishing everyone a prosperous and bountiful year ahead!

Lesson from China Minzhong

Around two months ago, I researched on this S-chip - China Minzhong. The financials looked sound, the price was right and and I believed that there is a decent chance that a major shareholder of China Minzhong, Indofood, will offer to buy over the company within the year. However, I didn't want to invest long term in an S-chip after all the S-chip accounting irregularities that happened in the past several years. “Nevermind, I'll just buy and hold till year end. If the takeover does not happen by then, I'll sell my shares, hopefully at a profit or worse comes to worse, bear a small loss. Cannot be so suay to hold China Minzhong for a few months and something drastic happen to the company during this time, right?”, I told myself. And so I happily went aheard with the purchase.

Now some of you may find the name China Minzhong familiar or may even have followed the saga that unfolded late last month. The company was attacked by a US short selling company called Glaucus Research. Glaucus issued a report alleging accounting irregularities. Straight after the report, China Minzhong's share price plunged almost 50% within 3 hours after the stock market opened for trading. The stock was suspended shortly after. Little did I expect that so soon after my purchase, China Minzhong is accused of accounting irregularies and my shares' value is halved in the blink of an eye.

Fortunately, the suspension was lifted a week after, with Indofood making a conditional offer on China Minzhong shares. I sold the shares shortly after the suspension was lifted. Even though the trade yielded a profit, it did not erase the lesson learnt. Bad news can happen anytime. If I am not willing to hold a share long term, it's best to not invest in it.

How does MAS's New Debt Servicing Framework Affect You?

MAS's new debt servicing framework essentially stipulates the minimum standards of how financial institutions calculate the Total Debt Servicing Ratio (TDSR) and plugs loopholes that existed previously. Here's a summary of the key details.

• TDSR to be computed based on an interest rate of 3.5%.
  • Previously, the rate that each financial institution used can be quite different. For example, Bank of China used their prevailing housing loan rate, which is below 1.5% for the longest time, while a couple of banks based their TDSR computation on interest rates of more than 4%.
   
• TDSR to be computed based on the income-weighted average age of the borrowers.
  • Most banks used to take the average age of borrowers without factoring in any income difference between the borrowers. Others, like OCBC, simply compute the TDSR based on the younger borrower's age.
   
• A haircut of at least 30% to be applied to all variable income (e.g. commissions, bonuses) and rental income.
  • All financial institutions did not apply any haircut on bonuses while the majority apply a 30% haircut on commissions and rental income.
   
• TDSR threshold should not exceed 60%.
  • Most financial institutions' TDSR threshold is 50%. A couple of banks allowed a TDSR threshold of 60% if borrowers met certain criteria.
   
• Borrowers must now be be mortgagors
  • Unlike HDB housing loans, private property loans did not use to have this restriction.
   
• Guarantors for borrowers who do not meet the TDSR threshold must now be brought in as co-borrowers
  • The housing loan that a guarantor is supporting does not contribute towards his or her housing loan quota (2^nd property loan financing is currently at a loan-to-value of 50% or lower).

How does this MAS framework affect the man in the street?

• For single borrowers or joint borrowers around the same age, they can now borrow slightly less than they could have, assuming these folks know where to look previously. Those who do not know or care to find the bank offering the highest loan may actually obtain a marginally higher housing loan than before.

The new framework impacts the following groups of borrowers most.

• Joint borrowers where a big age gap exists between the borrowers, and the older borrower is earning significantly more than the younger borrower (e.g. father and son)
• Self-employed
• Commission earners like insurance and real estate agents
• Employees where around 35% or more of their annual pay is derived from bonuses

Risk and Returns

Risk commensurate with returns is a common notion among many people in the financial industry, be it financial planners or retail investors. The higher the risk, the higher the potential returns and vice-versa. However, whenever a banker or financial advisor tells me something along this line, I can't help cringing. From my experience, such statements are at best generalisations. I am suspicious that such sweeping declarations are introduced by the financial industry to mitigate adverse performance. My personal experience may not be accurate though, so I decided to investigate further. Here's the gist.

Looking at the US stock market, there are naturally a good number of risky companies that reaped great returns for investors over the long run. One of the most noteworthy is Concur Technologies. During the tech bubble crash in 2001, the share price of Concur Technologies plummeted but subsequently rebounded spectacularly.

Concur Technologies share price Dec 1999 ≈ $29

Concur Technologies share price March 2001 ≈ $0.31

Concur Technologies share price Dec 2010 ≈ $54.13

On the other hand, safe stocks, such as Microsoft, Apple and Walmart, can also yield fantastic returns over a 10 to 20-year period.

Walmart share price Jan 1980 ≈ $0.11

Walmart share price Jan 1990 ≈ $5.90

Walmart share price Oct 1999 ≈ $69.12

There are many more such examples so it is fair to say that safe stocks can also achieve great returns. The question is, are risky shares more likely to give higher returns than low-risk ones? I can't definitively answer this question as the data is blurry here. One cannot really tell exactly when a high-risk stock becomes low-risk or vice-versa. Think Enron, Lehman Brothers, Goldman Sach etc. However, bearing in mind the number of clearly risky company versus low-risk company going bust every year, I am inclined to believe that the average preformance of low-risk shares tend to be better than risky ones.

Coming back to Singapore, if I were to invest in a property in a low-risk area, it naturally has to be at or around Orchard Road. A riskier area would perhaps be Woodlands. Rewinding back to the 2^nd half of 2009, if I were to invest in buy a HDB flat in Woodlands, my flat in the 2^nd half of 2012 would easily be 25% - 40% higher than what I bought it at. Prices for top-end Orchard Road condominiums, such as Orchard Residences or Scotts Square, have however stayed flat over the same period.

On the other hand, there are some investments where additional risk may indeed correspond to additional returns. Wharton finance professor Gary Gorton and K. Geert Rouwenhorst, finance professor at the Yale School of Management, in their paper titled, "Facts and Fantasies about Commodity Futures”, found that investments in the futures index would have performed far better than investments in commodities bought on the spot market. From July 1959 to December 2004, compounding returns averaged 9.98% a year for the futures investment, versus 7.66% for an investment in the spot market.

What is clear is that higher risk does not necessarily equate to a better chance of higher returns. My two cents: each investment should be inspected on its own merits. In the long run, a great investment will largely depend on the fundamentals of the specific investment and timing (basically the price you buy and sell the investment at).

Time to Scrap COV? (Part 1)

I have to admit that this post's title is not really accurate - scrapping cash-over-valuation or COV would involve disallowing HDB flats to be sold over valuation. That would be draconian and goes against everything a free market stands for. What I am driving at, is to consider scrapping the mechanism that leads to the COV.

For many years leading up to 2005, property transactions with COV are the exception rather than the norm. It's not that prices are usually at valuation or lower, but that a property's fair value falls within a broader range. What happened in 2005? HDB made it compulsory for banks giving HDB loans to use valuations only from HDB’s panel of approved valuers. As some of you know, the reason for this is that HDB's panel gives more precise valuations and hence prevent ballooned ones. There appears to be 2 reasons why HDB wants to prevent inflated valuations:

1. A cash-back practice, in which a buyer and seller will agree on a flat’s actual price and an inflated price, was not uncommon. The inflated price enables the buyer to get a bigger housing loan as valuations by banks' valuers will generally match these inflated prices. Sellers will in turn return the difference between the actual price and inflated price to buyers. There are people who say such a practise is illegal.
 
2. The second and in my humble opinion, the primary reason, is that volume of HDB resale transactions involving artificially boosted prices was big enough to influence or at the very least, potentially influence subsequent HDB resale prices. It's naturally in HDB's interest to want to keep flats affordable and not have prices higher than their true market values.

With the necessity of HDB approved valuations, COV cannot be part of the housing loan so cash-back transactions are no longer feasible. However, on hindsight, this measure did not really manage to prevent upward spikes in HDB prices. On the contrary, it possibly also encouraged HDB flat prices to rise faster than it should.

These days, COV has become so prevalent that at the negotiation stage, sellers and buyers will just focus on the COV, practically putting aside a flat's valuation. When the HDB flat resale market is on the upward trend like it is now, even if the COV is 0, the transaction price is going to be higher than similar units transacted recently, as a flat's valuation should have already factored in this upward trend. It is to be expected that any COV above 0 is just going to further exert upwards pressure on HDB flat prices. My gut tells me that this upwards bias will tend to be less if property transactions are negotiated based on one lump sum instead of a fixed sum with an additional variable component, such as the COV.

Furthermore, it's hard for people to change mindsets. When people's mindsets are so used to the existence of COV, it is just tougher for the masses to realise that it's possible for no COV and as such, harder for prices to reverse. As long as COV is widespread, prices will not stay flat, let alone move down. 

I'll end the post on this note. Do you think a HDB approved valuation should be kept mandatory? Drop a comment below and share your views!

The Best Kind of Loan

Personal loans of any kind are traditionally frowned upon, especially by the Chinese. It suggests financial recklessness, lack of discipline and sheer laziness. Even though the financial sector and its loan offerings are nothing like the scene decades ago, many of us still adopt the same mindset as our forefathers. In fact, I had such a tough time shifting the paradigm of two of my close friends that I'm inspired to pen this down.

Being financially prudent is fantastic but financial prudence and loans are not contradictory. Not all loans are bad. I would even go so far as to say that there is a great kind of loan and at this point in time, not maximising it may in fact be financially imprudent. What is this loan I'm talking about? A housing loan. There is a confluence of factors that make a home loan a winning proposition: persistently low mortgage interest rates coupled with relatively high inflation and CPF interest rate.

Low Interest Rate
There is no other type of loan that has a lower interest rate than housing loans. Period.

Not only is the stated interest rate lower than the other types of loans, its amortization methodology is also on a daily or monthly rest basis, making its effective interest rate much lower than the rest. Unlike the monthly interest payment for your car loan, which is computed based on the initial sum borrowed, the monthly interest for your housing loan is computed based on the outstanding balance as of the day (daily rest) or month (monthly rest) of your payment.

Relatively High Inflation
When inflation is higher than the interest rate for your loan, after setting aside your rainy-day stash, it's more sensible to either spend the money or invest it. Why save the money and see your purchasing power dwindle? Only if you do not have anywhere to spend or invest, does it make sense for you to pay down your housing loan.

Relatively High CPF Interest Rate
When the CPF interest rate is generating a higher interest than my housing loan interest, even though I cannot withdraw my CPF monies, I still prefer to keep money in CPF rather than use it to pay off my loan. If I use money from the Ordinary Account to pay down my home loan, not only will I be losing out on the difference between the CPF interest and the housing loan interest, I will also have to pay back from my own pocket the CPF accrued interest if I subsequently sell my property. This is like borrowing money from my own CPF to pay off a lower interest rate loan! There is no hurry to tap on CPF funds as I can always pay down my housing loan subsequently, when my housing loan interest rate goes higher than the CPF interest rate.

As of February 2013,

• Housing loan interest rates are around 1.1% onwards
• Consumer Price Index (CPI) is 4.9%
• MAS Core Inflation Measure (basically CPI excluding property and private transportation) is 1.9%
• CPF interest rate is 2.5% or 3.5% (for the first $60,000 of a member’s combined balances, with up to $20,000 from the OA)

Companies with Durable Competitive Advantages

The Sage of Omaha has emphasised time and again to only invest in companies that has a durable competitive advantage. The phrase “durability” can be subjective so to clear the air, a durable competitive advantage is an advantage that should at least last decades, if not indefinitely, not one that will last a couple of years or less. Companies that have short-term competitive advantages may do well for a year or two but without durability, any success will be short-lived. Beside Mr Buffet's sublime investment reputation, 3 key reasons come to mind on why we should heed his advise:

• It's hard to predict how long a company with a non-durable competitive advantage can milk her cash cow before the curtain falls. If you buy such a share, you may well make a quick buck. However, it's very likely that you will sell too early or too late and not optimise your profit. The more you repeat the cycle, the higher the loss in profits.

• Many cases, such companies may not even have enough time to translate their competitive advantage into profit before being ousted by competitors. If the share is not sold by that time, whatever paper profits you may have made can easily turn into losses.

• Due to the nature of companies without a durable competitive advantage, their shares should naturally be sold before the competitive advantage is lost. After selling, you will have to search for new berths to park your funds. In other words, you have to repeatedly look for short to mid-term investments. Buying and selling of shares involves brokerage fees, which does not amount to much for small volume transactions but will mount up quite fast if you carry out a hundred or more transactions every year. More importantly, sniffing out a good share is a time-consuming process.

Isn't it simply better to search for a company which you can invest indefinitely? How do we find these gems? One of the key signs to spotting a company that has a durable competitive advantage is extremely intuitive - a strong branding. Such companies tend to be one of the market leaders in their industry if not the market leader. Consumer brands, such as Coke and McDonald's, are well-known to most people on the planet and evidently possesses a very durable competitive advantage. Even billionaires would not think to start a business competing against these behemoths.

Non-consumer brands may not be as well-known to the general public but can be easily identified by people in the industry. Just ask any industry person to name the top companies in their sector and the names will generally gravitate towards the same few. Employees of shipping companies will not miss out Maersk or Hapag-Lloyd.

Patents, government regulations or even long-term contracts can also bestow upon a company a durable competitive edge. Pfizer's patents in relation to Viagra allowed it to monopolise and dominate the male sexual dysfunction market. Similarly, China's protectionist measures enabled Baidu to become the top search engine in China. The growth of Singtel into Southeast Asia's top telco also did not come about by chance. Singtel monopolised the Singapore market until 1997, before the local telecommunications sector was liberalised. By that time, Singtel has flourished enough to acquire stakes in other telco companies around the region.

Quantitatively, a company with a durable competitive advantage should have one of the largest slice of the market. Its operating margin (operating margin is the revenue remaining after paying all operating expenses, expressed as a percentage) will be higher than its corresponding industry's average. Such companies tend to invest a minimal amount into research and development, and as a result, are likely to have a relatively higher cash flow. A high cash flow translates to a high chance of dividends. And dividends are great for value investors as that is essentially how we get money back from our investment!

January Property Cooling Measures Pack a Punch!

“TGIF”, I was thinking while gazing at my lovely chicken dinner when my handphone sang a little tune. I took a look at the SMS and learnt my lesson to not ever bring the phone to the dining table. Friday's slew of property cooling measures, unlike the previous few, strongly indicated that the Government is not happy with the pace that property prices are moving up. In fact, my gut is telling me the Government will not be happy until property prices undergo a correction.

The following is a summary of the key residential property measures and my two cents in italics.

• Reduction in the Debt Servicing Ratio to 30% if borrowing from financial institutions — a whooping 20% reduction. For loans granted by HDB, the Mortgage Servicing Ratio will also be reduced from 40% to 35%.
  
• Permanent Residents (PRs) who own a HDB flat will be disallowed from subletting their whole flat.
  
• PRs who own a HDB flat must sell their flat within six months of purchasing a private residential property in Singapore.

• HDB flats are for own-stay and certainly not for PRs to invest in. For Singaporeans, you can still keep one HDB flat for invesment but make sure your cashflow is good.

• Additional Buyer’s Stamp Duty (ABSD) rates will be raised between five and seven percentage points across the board.
  
• The ABSD will be imposed on PRs purchasing their first residential property and on Singaporeans purchasing their second residential property.

Citizenship	ABSD Rate on 1st Purchase	ABSD Rate on 2nd Purchase	ABSD Rate on 3rd & Subsequent Purchase
Singapore Citizens	Existing: NA Revised: NA	Existing: NA Revised: 7%	Existing: 3% Revised: 10%
Permanent Residents	Existing: NA Revised: 5%	Existing: 3% Revised: 10%	Existing: 3% Revised: 10%
Foreigners and non-individuals (corporate entities)	Existing: 10% Revised: 15%	Existing: 10% Revised: 15%	Existing: 10% Revised: 15%

• Loan-to-Value limits on housing loans granted by financial institutions will be tightened for individuals who already have at least one outstanding loan, as well as to non-individuals such as companies.
  
• Besides tighter Loan-to-Value limits, the minimum cash down payment for individuals applying for a second or subsequent housing loan will also be raised from 10% to 25%.

1st    Housing Loan

2nd Housing Loan

From 3rd Housing Loan

LTV Limit	Existing Rules 80%; or 60% if the loan tenure is more than 30 years or extends past age 65 Revised Rules No change	Existing Rules 60%; or 40% if the loan tenure is more than 30 years or extends past age 65 Revised Rules 50%; or 30% if the loan tenure is more than 30 years or extends past age 65	Existing Rules 60%; or 40% if the loan tenure is more than 30 years or extends past age 65 Revised Rules 40%; or 20% if the loan tenure is more than 30 years or extends past age 65
Minimum Cash Down Payment	Existing Rules 5% (for LTV of 80%) 10% (for LTV of 60%) Revised Rules No change	Existing Rules 10% Revised Rules 25%	Existing Rules 10% Revised Rules 25%
Non-Individual Borrowers	Existing LTV Limit 40% Revised LTV Limit 20%

• Residential property investing is only for the very rich – millionaries can own 2 properties but for 3 or more, millionaires do not make the cut. That is only for the multi-millionaires.
• For those who still harbour the thought of making a quick buck (e.g. speculators, specu-vestors and the like) off property, the death knell has struck. Adieu speculators.

3 Things You can do for the Impoverished

It's easy to think that there shouldn't be any Singaporean living in poverty, especially with the recent Straits Times articles reporting of a $3,000 per month dish-washing job, monthly salaries of $5,000 for lorry drivers and a taxi driver who earns $7,000 a month.

The articles are misleading however. The taxi driver has since clarified that he only earned $7,000 once and his usual remuneration is $4,000 to $5000. After some sleuthing, I also discovered that $5,000 as a lorry driver is the exception rather than the norm and even then, similar to a $5,000 a month taxi driver, involves very long hours of work. For the dish-washing job, I had the chance to speak with an NTUC Union staff, who actually put forward many workers for the position subsequent to the newspaper article: not a single one got the job.

While I do believe that most people should be able to earn a decent living in Singapore, there are unfortunately some people who fall through the cracks. Many people who face constant financial difficulties are stuck in low-wage jobs, jobs that pay around $1,000 or less, as they do not possess the skills to get a higher pay one. The majority are unable to converse in English, let alone reading or writing in English. They certainly wouldn't be able to understand this article, which is where you come in. Here are 3 things you can do for these folks in 2013!

Encourage Skills Upgrading

There are a number of Continuing Education & Training (CET) Centres who offer training courses that are 90% - 95% subsidised by the Government (click here for the list of centres). Notably, Mendaki offers a 45-hour conversational English course at just $15 after subsidy. The course is held during weekends and the exact timing depends on the participants.

Some people may find it hard to attend a course, especially when they are already so tired from their struggles trying to make ends meet. Others think they are simply too old to learn new things. Encouragement and support from friends go a long way. On a side note, I used to have a 72 year-old course-mate so one can never be too old to learn!

Sell Flat or Relocate

Some people who are living in poverty may actually be asset-rich but cash-poor. Instead of living hand to mouth, they can sell their asset, free up some cash and downgrade by renting or buying a smaller flat.

These folks are probably not aware, but with HDB flat prices at an all-time high, it's a good time for them to sell their HDB flats soon. Alternatively, cash-strapped elderly (55 and above) who own flats can also sell the tail end of their HDB lease back to the Government under the Lease Buyback Scheme (LBS). Just last Thursday, the Government announced enhancements to the LBS together with the Silver Housing Bonus (elderly home-owners basically get $20,000 cash for downgrading). The improved schemes will be implemented from 1 February 2013 so the best time for these elderly to sell will be shortly after the implementation date. The public can call 1800 555 6363 for more information on these schemes.

For poor and needy Singaporeans, who do not own a flat, monthly rental of a 2-room HDB for poor Singaporeans can be as low as $50 - you can find more details on subsidised HDB rental flats here.

Seek Financial Assistance

For people without flats, financial assistance plans aplenty is a bit of a double-edged sword. Finding the appropriate financial aid may not be easy. I found this out first hand from asking about schemes for a friend, and my friend's case is supposed to be pretty straightforward. Regardless, help is there if you look close enough.

A first step would be to call the Community Chest hotline at 1800 210 2600. Community Chest will then be able to point you to specific charities or government bodies that may be able to offer assistance. Individual Family Service Centres also have schemes that can be found on their respective websites. The applicant should be completely honest when applying for aid as non-disclosure can lead to a lengthy approval process and even jeopardise their chances. For low-wage workers, the Workfare Income Supplement (WIS) Scheme (details can be found here) is a decent financial assistance scheme.