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Monday, December 31, 2012

Fisher's Eight Investment Principles

Monday, 31 December 2012
1. Buy companies that have disciplined plans for achieving dramatic long-range profit growth and have inherent quailities making it difficult for newcomers to share in that growth.

2. Buy companies when they are out of favour.

3. Hold a stock until either (a) there has been a fundamentall change in its nature (e.g., big management changes), or (b) it has grown to a point where it no longer will be growing faster than economy as a whole.

4. De-emphasize the importance of dividends.

5. Recognise that making some mistakes is an inherent cost of investment. Taking small profits in good investments and letting losses grow in bad ones is a sign of abominable investment judgement.

6. Accept the fact that only a relatively small number of companies are tryuly outstanding. Therefore, concentrate your funds in the most desirable opportunities. Any holding of over twenty stocks is  a sign of a financial incompetence.

7. Never accept blindly whatever may be the dominant current opinion in the financial community. Nor should you reject the prevailing view just for the sake of being contrary.

8. Understand that success greatly depends on a combination of hard, intelligence, and honesty.

Sunday, December 30, 2012

Price-to-book worth a look

Buying shares trading below book value can pay off if the firms are profitable in long run

Published on Dec 30, 2012
By Teh Hooi Ling

Last week, we showed that consistently buying the basket of stocks whose prices are lowest relative to their earnings would allow you to vastly outperform a buy-and-hold strategy for the Straits Times Index.

Price-earnings (PE) ratio, as the name suggests, measures the value of the company relative to the earnings it is generating.

Another valuation metric used by the market relates to the assets that the company has.

Let's go back to the example of the ABC coffee shop which made $50,000 profit this year. We established that paying $250,000 for the coffee shop - five times its earnings - is cheaper than paying $500,000 (10 times its earnings).

Today, we will look at the balance sheet, the financial statement which shows the assets and liabilities of ABC.

Let's say ABC has cash of $100,000 in the bank. It also has inventory (the canned drinks, beer and coffee that it has stocked up) worth another $100,000. Assume also it has paid a rental deposit of three months which came up to $100,000. Its other assets include its ice-making machine, the refrigerator, the coffee machine, tables and chairs, and so on. In total these assets have a value of $200,000.

So on the assets side, ABC has $500,000.

But not all of the $500,000 is funded by the equity of ABC's owner, Mr Tan. He has taken out a bank loan of $100,000, and he owes his suppliers $100,000.

So, taking out ABC's liabilities, the coffee shop's net assets, or book value of its equity, is $300,000.

So if you offer to pay $250,000 for ABC coffee shop, then you are offering to pay only 83per cent of its book value. That's a discount of 17 per cent. If you agree that Mr Tan has valued his assets - the refrigerator, coffee machine and so on - fairly, then you are getting a bargain if he is willing to sell the coffee shop to you at $250,000.

However, if you put in a bid of $500,000, then you are offering to pay 1.7 times above the book value, or a 70per cent premium over the book value. To offer this kind of price, you have to be very confident that the business can generate good profits from its assets.

Again, if ABC is a listed company and it has one million shares listed, then its book value per share is 30 cents ($300,000/1,000,000). If the shares are trading below 30 cents, say 25 cents, then they are trading below book value at just 0.83 times price-to-book (PTB).

That buying stocks with low PTB pays handsomely has been proven time and time again. It was first discovered in 1992, when US professors Eugene Fama and Kenneth French published a breakthrough study on the use of PTB ratio as a predictor of a company's future stock performance.

Their study showed convincingly that the lower the company's ratio of PTB value, the higher its subsequent stock performance tended to be.

"No other measures had nearly as much predictive power - not earnings growth, price/earnings, or volatility," they said, with data supporting the claim.

Does Singapore exhibit the same pattern? Well, I repeated the test I did with the PE ratios last week.

I rank all the stocks listed on the Singapore Exchange every year based on their PTB ratios. I then put them into 10 equal groups. Stocks with the lowest PTBs go into Decile1, second-lowest into Decile2 and so on. The following year, I rank the stocks again based on their PTBs at that time, and group them into 10 groups again. The process is repeated every year from 1990 until 2012.

Again, assume we started with $100,000. The first $10,000 goes into the stocks in Decile1. At the end of the first year, we liquidate that portfolio and roll over the profits to the Decile 1 stocks for the second year. Ditto for stocks in the other deciles.

The accompanying chart shows the results. The $10,000 in March30, 1990 used to invest in the baskets of stocks with the lowest PTB every year for 22 years would have grown to $355,135. That's a compounded annual return of 17.6 per cent. Money invested in the second basket, or Decile2, grew to $108,830 for a return of 11.5 per cent a year.

Remember last week, we showed that consistently buying the lowest PE stocks in Singapore turned $10,000 into $199,847 for a return of 14.6 per cent a year during the same period?

So buying low PTB stocks beats buying low PE stocks as a strategy!

But truth be told, buying low PTB stocks is a much more difficult thing to do than buying low PE stocks. Low PE stocks are profitable companies. For low PTB stocks, many times, they trade below their book values precisely because they are not making money.

But many of such stocks eventually turn around because of the phenomenon called mean reversion. Very high profit-margin companies will see their profits come down to the mean, or average levels, over time as competition enters the market. Loss-making companies will restructure or be taken over, and become profitable again.

But be warned that some of the low PTB stocks will go bankrupt. So for this strategy to work, one has to take the portfolio approach: that is, buy a basket of such stocks, and let the gains from the winners make up for those which go kaput.

But many times, profitable companies also trade below their book values. During the bubble in the late 1990s and early 2000, many of the bricks-and-mortar companies were trading at below book. Even today, many real estate developers are trading below their book values. Perhaps it will pay to take a closer look at what assets they are holding.

Buying low PTB stocks is a much more difficult thing to do than buying low PE stocks. Low PE stocks are profitable companies. For low PTB stocks, many times, they trade below their book values precisely because they are not making money.

Thursday, December 27, 2012

Analysis: Ordinary folks are losing interest in stocks

Associated Press
December 27, 2012

Andrew Neitlich is the last person you'd expect to be rattled by the stock market.

 He once worked as a financial analyst picking stocks for a mutual fund. He has huddled with dozens of CEOs in his current career as an executive coach.

 During the dot-com crash 12 years ago, he kept his wits and did not sell.

 But he's selling now.

 "You have to trust your government. You have to trust other governments. You have to trust Wall Street," says Neitlich, 47. "And I don't trust any of these."

 Defying decades of investment history, ordinary Americans are selling stocks for a fifth year in a row. The selling has not let up despite unprecedented measures by the Federal Reserve to persuade people to buy and the come-hither allure of a levitating market. Stock prices have doubled from March 2009, their low point during the Great Recession.

 It's the first time ordinary folks have sold during a sustained bull market since relevant records were first kept during World War II, an examination by The Associated Press has found. The AP analyzed money flowing into and out of stock funds of all kinds, including relatively new exchange-traded funds, which investors like because of their low fees.

 "People don't trust the market anymore," says financial historian Charles Geisst of Manhattan College. He says a "crisis of confidence" similar to one after the Crash of 1929 will keep people away from stocks for a generation or more.

 The implications for the economy and living standards are unclear but potentially big. If the pullback continues, some experts say, it could lead to lower spending by companies, slower U.S. economic growth and perhaps lower gains for those who remain in the market.

 Since they started selling in April 2007, eight months before the start of the Great Recession, individual investors have pulled at least $380 billion from U.S. stock funds, a category that includes both mutual funds and exchange-traded funds, according to estimates by the AP. That is the equivalent of all the money they put into the market in the previous five years.

 Instead of stocks, they're putting money into bonds because those are widely perceived as safer investments. Individuals have put more than $1 trillion into bond mutual funds alone since April 2007, according to the Investment Company Institute, a trade group representing investment funds.
 Selling stocks during either a downturn or a recovery is unusual. Americans almost always buy more than they sell during both periods.

 Since World War II, nine recessions besides the Great Recession have been followed by recoveries lasting at least three years. According to data from the Investment Company Institute, individual investors sold during and after only one of those previous downturns—the one from November 1973 through March 1975. And back then a scary stock drop around the start of the recovery's third year, 1977, gave people ample reason to get out of the market.

 The unusual pullback this time has spread to other big investors—public and private pension funds, investment brokerages and state and local governments. These groups have sold a total of $861 billion more than they have bought since April 2007, according to the Federal Reserve.
 Even foreigners, big purchasers in recent years, are selling now—$16 billion in the 12 months through September.

 As these groups have sold, much of the stock buying has fallen to companies. They've bought $656 billion more than they have sold since April 2007.

 Companies are mostly buying back their own stock.

 On Wall Street, the investor revolt has largely been dismissed as temporary. But doubts are creeping in.

 A Citigroup research report sent to customers concludes that the "cult of equities" that fueled buying in the past has little chance of coming back soon. Investor blogs speculate about the "death of equities," a line from a famous BusinessWeek cover story in 1979, another time many people had seemingly given up on stocks. Financial analysts lament how the retreat by Main Street has left daily stock trading at low levels.

 The investor retreat may have already hurt the fragile economic recovery.
 The number of shares traded each day has fallen 40 percent from before the recession to a 12-year low, according to the New York Stock Exchange.

 That's cut into earnings of investment banks and online brokers, which earn fees helping others trade stocks. Initial public offerings, another source of Wall Street profits, are happening at one-third the rate before the recession.

 And old assumptions about stocks are being tested. One investing gospel is that because stocks generally rise in price, companies don't need to raise their quarterly cash dividends much to attract buyers. But companies are increasing them lately.

 Dividends in the S&P 500 rose 11 percent in the 12 months through September, and the number of companies choosing to raise them is the highest in at least 20 years, according to FactSet, a financial data provider. Stocks now throw off more cash in dividends than U.S. government bonds do in interest.

 Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend. But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends. In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller—exactly what is happening now.

 So maybe that's normal, and the past five decades were the aberration.

 People who think the market will snap back to normal are underestimating how much the Great Recession scared investors, says Ulrike Malmendier, an economist who has studied the effect of the Great Depression on attitudes toward stocks.

 She says people are ignoring something called the "experience effect," or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on "Depression Babies," the title of a 2010 paper she co-wrote, she says many young investors won't fully embrace stocks again for another two decades.

 "The Great Recession will have a lasting impact beyond what a standard economic model would predict," says Malmendier, who teaches at the University of California, Berkeley.

 She could be wrong, of course. But it's a measure of the psychological blow from the Great Recession that, more than three years since it ended, big institutions, not just amateur investors, are still trimming stocks.

 Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year, breaking at least 40 years of generally rising stock allocations, according to "State and Local Pensions: What Now?," a book by economist Alicia Munnell. They're shifting money into bonds.

 Private pension funds, like those run by big companies, have cut stocks more: from 70 percent of holdings to just under 50 percent, back to the 1995 level.

 "People aren't looking to swing for the fences anymore," says Gary Goldstein, an executive recruiter on Wall Street, referring to the bankers and traders he helps get jobs. "They're getting less greedy."

Sunday, December 23, 2012

In buying low PE stocks, beware of value trap

While stocks with the lowest PEs generally offer the best returns, there are duds as well

23 Dec 2012 16:40

Last week, we discussed one of the measures used by the market to value stocks – the price-earnings or PE ratio. We noted that the market likes high-growth companies and accords them a higher earnings multiple.

The higher the price a stock trades at relative to its current earnings, the more difficult it is for it to meet the market’s expectations. As such, the higher the probability its share price will underperform.

In one of my finance courses years back, the lecturer told us that we should distinguish between a growth stock and a growth company.

Most times, growth companies are not growth stocks, because the hype of the growth has been worked into the share price.

Growth stocks, on the other hand, are stocks whose price will grow because they have unappreciated value or business fundamentals. We want to buy growth stocks but not necessarily growth companies.

Using a hypothetical example, we showed how a 21 per cent downgrade in earnings can potentially cause a 62 per cent plunge in stock price in a high PE stock, and how a 5 per cent upgrade in earnings can lead to a 150 per cent jump in share price for a low PE stock.

So what proof is there that this is actually happening in the market, that buying low PE stocks pays?

Well, I carried out a study of the stocks listed on the Singapore Exchange in the last 22 years.

I ranked all the stocks listed here based on their PEs every year. The ranking is done at the end of March so as to capture companies with financial year ending Dec31.

I then clustered them into 10 groups with equal numbers of stocks. Decile 1 is made up of stocks with the lowest PEs. Decile 2 has stocks with the second-lowest PEs, and so on. Stocks with the highest PEs go into Decile 10. I then tracked the performance of these stocks a year later. The average return of the stocks in each group was taken.

Let’s assume that I start with $100,000 in 1990. After doing the ranking on March30 that year, I put $10,000 equally in the stocks in Decile 1.

At the end of March in 1991, I liquidate these stocks and put my pot of money, including dividends received in that past year, into the basket of stocks with the lowest PE in that year. The next $10,000 is allocated to stocks in Decile 2 and so on. I keep doing that for the next 20 years.

The accompanying chart shows the performance of the 10 baskets of stocks with the return rolled over for 22 years.

The $10,000 put into the lowest PE stocks would have grown to $199,847. That’s a compounded annual return of 14.6 per cent a year. Guess what the bonus is? Low PE stocks on average also have higher dividend yields.

The second basket of stocks, those with the second-lowest PEs, returned 10.1 per cent a year. Not too bad. It grew the original $10,000 to $83,684. (Please note that all the calculations exclude transaction costs.)

How would someone who consistently goes for the high PE, glamour stocks have done? Well, they managed to grow their original $10,000 to just $16,766 for a compounded annual return of a mere 2.4 per cent a year. That doesn’t even quite beat inflation.

In comparison, buying and holding the Straits Times Index from March 1990 until March this year would have yielded you a capital appreciation of about 4 per cent a year. Add in dividends of say 3 per cent a year, and your $10,000 invested in the STI would have grown to $44,300 over that time, with the dividends reinvested in the market.

In other words, buying a basket of low PE stocks would allow you to vastly outperform the Straits Times Index.

But note: Some stocks trade at low PEs for a reason. They could be value traps, in that their stock prices would go lower as the company’s operations continue to falter.

Many of the S-chips, or China stocks listed in Singapore, were trading at very low PEs. And as we all know, many of them have bombed. Those still listed are trading at very low PEs because the market doesn’t quite trust the numbers due to the poor corporate governance issues of their peers.

Meanwhile, some stocks trade at PE of 100 times or 200 times because they are transitioning from a loss-making patch to profitability.

So when we look at PEs, it is also important to look at the quality of earnings, and the sustainability of the earnings. We will talk about how to ascertain the quality of earnings in a future article.

But all things being equal, holding a low PE stock beats holding a high PE stock.

Just to give you an idea of which stocks made it to the lowest PE stock list in 1990. They were Dairy Farm, QAF, SIA, Jardine Cycle and Carriage, Jardine Strategic, Hongkong Land, and Boustead.

Stocks which made it to the second-lowest PE group were Jardine Matheson, Mandarin Oriental, ICP, Chemical Industries, Sing Investments & Finance, UOB, The Hour Glass and Wing Tai Holdings.

In recent years, however, the low PE stocks are made up mostly of micro cap stocks, or as mentioned S-chips. So, investors have to be more discerning in making sure that the underlying business is sound before buying into these low PE stocks.

Next week, we will look at another valuation metric used by the market to value stocks and we will see how they perform vis-a-vis the low PE strategy.

Monday, December 17, 2012

Watch PE when valuing a company

Markets jack up the price earnings ratio in expectation of growth and this, in turn, boosts the share price

 17 Dec 2012 09:39 TEH HOOI LING

 Groupon spurned Google and went for a public listing instead. For a while, it appeared that Groupon had made the right decision. - REUTERS

How does the market value a stock?

Take the example of Groupon, the online coupon service provider. This year, its stock price sank by some 80 per cent – from above US$20 (S$25) to below US$5.

Back in 2010, Google wanted to buy Groupon for US$8 billion.

But Groupon spurned Google and went for a public listing instead. For a while, it appeared that Groupon had made the right decision.

On the first day of its trading, its shares surged to US$26, giving it a market value of US$16.7 billion. Now Groupon is only valued at about US$2.8 billion.

So within one year, nearly US$14 billion disappeared from the value of Groupon, the company.

How did that happen?

Well, it’s got to do with market’s expectation of its future growth.

Bloomberg reported recently: “As competition intensifies and demand wanes, analysts see (Groupon’s) revenue growth slowing to 0.6 per cent in 2015, down from 45 per cent in 2012 and the 1,233 per cent average in the past two years.”

It’s rare to have a company that can sustain a growth of 30-40 per cent a year for a long time.

If it is a high growth market, you can bet that a lot of new entrants will be attracted to it – unless there are licensing rules or intellectual property restrictions to stop them from coming in.

Otherwise, new entrants would compete for market share, drive down prices, and crimp a company’s growth.

When growth slows, valuation falls.

Stock analysts and the stock market use various methods or metrics to value a company.

The most common metric is the price-earnings (PE) ratio.

Say there is a coffee shop called ABC. This year, ABC raked in sales of $500,000. After deducting all its costs, the owner – say a Mr Tan – made a net profit of $50,000.

Next year, Mr Tan has a big marketing campaign planned for his coffee shop. With the campaign, he reckons he can increase traffic to his shop, and raise his prices as well.

He forecasts sales will go up to $725,000 and net profit to $65,000. Mr Tan wants to sell his coffee shop. How much would you pay for it?

If you pay $250,000, then you are paying five times the historical earnings of the coffee shop, or a PE of five ($250,000 divided by $50,000). Based on this past year’s earnings and assuming it stays constant, you’ll take five years to get back your initial investment.

If you pay $500,000, you are paying a PE of 10 times. This means you will take 10 years to get back your capital.

But if you believe Mr Tan’s forecast, that the coffee shop’s earnings will grow by 30 per cent to $65,000 next year, then a price tag of $250,000 translates to a prospective or forecast PE of just 3.8 times.

Potentially, you can get back your investments in 3.8 years, or shorter if the earnings continue to grow the year after.

So in expectation of the growth, the market will jack up the PE ratio today.

One theory has it that a stock should trade at a multiple equivalent to its sustainable growth rate.

If the company can grow at 10 per cent a year, then it should trade at 10 times earnings. Twenty five per cent a year, and the valuation goes up to 25 times.

But as we have discussed, growth is not guaranteed.

A lower growth outlook poses a double whammy for prices of high PE stocks.

Say ABC is a listed company with one million shares. So its earnings per share (EPS) is $50,000 divided by one million shares. That works out to 5 cents a share.

The market is bullish about ABC and is expecting it to grow its EPS by 40 per cent next year to seven cents. To take into account its fast growth, investors value the stock at 25 times its forecast earnings. That would put its share price at $1.75.

But subsequently the global economy slowed down, or news emerged that a new formidable competitor has entered the market.

Now the outlook for the company is less certain. Analysts start to downgrade ABC’s forecast growth to, say, 10 per cent.

That would put its forecast EPS next year at 5.5 cents. Lower growth also means lower multiples of, say, 12 times. Hence, the share price would fall to 66 cents.

A 21 per cent downgrade in earnings forecast could lead to a whopping 62 per cent decline in share price!

What you want to be is on the other side of the equation. Buy a stock when it is trading at, say, five times its EPS of 5 cents, that is, at a price of 25 cents a share.

The following year, assuming the company makes 5.5 cents, the market starts to notice it.

Analysts become excited about the company and think it can grow its EPS by 15 per cent to 6.3 cents the year after.

And they think the company deserves a PE of 10 times because of its higher growth and consistent record.

So the price goes up to 63 cents. Voila! You’ve made 150 per cent return on your investment!

Next week, I will show the performance of consistently buying a basket of low PE stocks over a period of 22 years.

It’s pretty impressive.

Friday, December 14, 2012

Amid low rates, REITs soar as business trusts struggle

14 December 2012

SINGAPORE - With investors desperate for yield in a prolonged low-rate environment, shares of trusts have surged in Singapore and elsewhere in Asia. But that enthusiasm has been largely focused on real estate investment trusts (REITs) and has not been reflected in demand for business trusts.

In Singapore, 90 per cent of the assets in a REIT must be fully developed and already drawing income. Business trusts, meanwhile, can house assets such as ports, ships or water management facilities, as well as real estate. But these assets may still be under development and the returns tend to be less predictable.

"In the current risk-averse environment, people are flocking to buy into high-yielding bonds. With that kind of mentality, the stable structure of a REIT is more appealing, compared to the business trusts," said Ms Vivian Lam, partner in the corporate department of international law firm Paul Hastings.

"Business trusts are more difficult to understand and are a more complicated asset class in terms of assessment for investors."

Singapore-listed REITs have current yields of between 6 and 7 per cent, compared with an interest rate of about 0.25 per cent on Singapore dollar deposits over a 12-month period. That kind of stable yield has kept investors interested in REITs. Yields on business trusts tend to be even higher, reflecting greater risk.

Still, in recent months, planned business trust offerings in Singapore by a shopping mall operator, an aviation company and a telco have been delayed.

Last month, Japanese shopping-mall operator Croesus Retail Trust delayed the US$650 million (S$793.5 million) initial public offering (IPO) of a business trust of shopping malls because of uncertain markets, people familiar with the transaction said. The yield being offered was between 7 and 8 per cent, they said.

In the same month, GE Capital Aviation Services, the jet leasing arm of General Electric of the US, pushed back its planned US$750 million IPO in Singapore. This was due to general wariness about aircraft being a depreciating asset, on top of lack of interest in IPOs in general, people involved in this transaction said.

Both GE and Croesus declined to comment.

In July, India's Reliance Communications postponed a plan to list its undersea cable assets in a Singapore IPO of up to US$1 billion. The company had been offering a yield of around 11.5 per cent, twice the average yield of other Singapore-listed business trusts and REITs.

Mr Christopher Wong, Senior Investment Manager at Aberdeen Asset Management in Singapore, said the less familiar asset classes were a harder sell for investors. "Although there's a chase for yield, investors are getting more discriminating about the underlying assets," he said.

In Hong Kong, a planned US$800 million business trust listing of serviced apartments by billionaire Li Ka Shing called Horizon Hospitality Holdings was pushed back last month. The company said it postponed its plan to raise money with a Hong Kong IPO and was considering "other options" for the assets.

In general, business trusts that have been listed in Singapore have not done well after their IPOs.
Religare Health Trust, a collection of hospitals owned by Indian hospital chain Fortis Healthcare, is down 3.9 per cent from its October IPO price. Perennial China Retail Trust, whose portfolio includes some offices and shopping malls still under construction, is down 22.9 per cent from its IPO price since listing last year. Hutchison Port Holdings Trust, which holds the port assets of Mr Li, is down 24.3 per cent from last year's IPO price.

In contrast, many REITs have done well. Singapore's Far East Organization and Ascendas group listed their hotel and serviced-apartment assets in the second half of this year through REITs. Far East Hospitality Trust and Ascendas Hospitality Trust are up 8.1 per cent and 4 per cent, respectively, from their IPO prices.


Monday, December 10, 2012

Balancing amount of liquidity held

10 Dec 2012 10:18

Keeping a lot in cash is risky but the market rewards you if you can supply it in a liquidity squeeze
The stock market, like life in general, overvalues glitz, glamour and grand promises. It undervalues groundedness, consistency and conservatism. People and companies which just do the work and deliver results are oftentimes overlooked. Consequently, we have the phenomenon of low-risk, high-return investments.

But one risk that the market seems to price more accurately, or in other words, one risk that the market will reward investors for taking is liquidity risk. That is the risk of you not being able to cash out any time you want without losing part of your capital.

Cash and bank deposits have little liquidity risk. You can take your money out any time and in exactly the same amount that you put in – unless of course the bank has fallen into financial difficulties and is in danger of going kaput. Then you may lose your deposits.

Otherwise, you are assured of getting back your money. This is one reason why bank deposits’ returns are so low. They are “safe”.

“Risk” assets, or assets whose prices fluctuate with the market, are different. These assets include equities and real estate. Mr Ben Inker, co-head of the asset allocation team at US asset management firm GMO, put it this way: “Equities cost you money at such an inconvenient time. The worst returns to equities come in recessions (bad), financial crises (very bad), depressions (very, very bad), and major wars (not good at all).

“While the average return to the S&P 500 since 1900 was a reassuring 6.6 per cent real, at those times when you were most at risk of losing your job, your bank account, your house or your life (during wars), you could rely on equities to be piling on the misery.”

Therefore, it is only rational for equity holders to demand, and be rewarded with, a decent return for taking that very unfortunate return path. Such a path of return also applies to assets like investment real estate. At a time when the economy is bad, your rental income is falling, you are not sure if you can hold on to your job, and you want to raise cash by selling your property, there are no buyers – unless you sell it cheap.

But there is a flip side. The flip side is, if you have cash when everyone else is trying to raise it, your money can go a long way. Put another way, if you can provide liquidity when the market most needs it, you will be amply rewarded. It’s the same with help extended to someone in dire straits. That help will be well-remembered and appreciated and, most times, repaid generously.

So when do we usually see a liquidity squeeze in the market? Well, when there is a shock and panic and everyone is rushing to get out of the market at the same time.

Do we have a liquidity squeeze now? Perhaps in a small way, in the sense that everyone is hoarding cash and not putting that liquidity to use, especially in the equity markets. This suggests that those who are willing to take that risk may be well rewarded.

Shocks and panic typically happen at the least expected times. In stock markets, it usually happens in the midst of a euphoric bull market when the last sceptic has been won over. We haven’t had that feeling in the stock market since 2007.

A savvy investor told me once: Bull markets are the time to accumulate cash.

“A lot of people have got it wrong,” he said. “They borrow more and more during a bull market. This goes back to school, which tells us that, in a bull market, we must gear up in order to get a high return on equity. Of course, if it is a sustained bull market, one can make a lot of money.
“But it is usually hard to tell whether you’re at the top, middle or just starting. It’s only when it ends, then you know, oh, the end is here.”

So your cash in the bank does serve some purposes. It meets your liquidity needs – your daily expenses as well as when you need emergency funds. Also, over and above the funds kept for your own liquidity needs, some can be set aside to meet the market’s liquidity needs.

In one extreme case, a friend told me of someone he knows who keeps cash all the time only to pile it all into the market when there is a crash. He exits completely when the market recovers. Apparently, he hasn’t done too badly for himself.

It takes a rather extraordinary person to be able to do that. For mere mortals like us, a sensible thing to do, as with everything else in life, is to have a balance.

A disproportionately high cash holding is a risk in itself. With inflation of about 4 per cent, and banks paying you less than 1 per cent, you are losing purchasing power by some 3 per cent a year. At this rate, $1 million cash kept in the bank will decline in value to just $740,000 in purchasing power terms in 10 years’ time. It is like dropping coins as you walk, eat and sleep.

So keep some cash to meet your own liquidity needs as well as to seize any opportunity that may present itself. Put some at “risk” so that it can work for you. How much to put on each side will depend on how cheap you deem an asset class to be.

Friday, December 7, 2012

In Picking Winning Stocks, Boring is Best



A study of bourses throughout the world concludes that a portfolio of "low-volatility" equities outperforms riskier alternatives.

Chances are that the stock you should be buying for your portfolio right now is one you might have passed on to an elderly relation.

In fact, the portfolios that perform the best, over time, are those that contain stodgy and uninteresting stocks that are the very antithesis of the exciting and volatile issues that get most of the financial press.

That's the main lesson to be taken from a recent study, "Low Risk Stocks Outperform within All Observable Markets of the World." Its authors are Nardin Baker, Chief Strategist at Guggenheim Partners, and Robert Haugen, a one-time finance professor who retired after three decades in academia and is now chairman of

The researchers focused on how steady a stock was from month to month. Those with the steadiest returns were put in the "low-volatility" category; current examples include energy-producer Dominion Resources (ticker: D) and electric-utility Duke Energy (DUK).

In contrast, a stock that experiences large gyrations in month-to-month performance is put in the "high-volatility" category. Two current examples are Fleetcor Technologies (FLT) and Arena Pharmaceuticals (ARNA).

The researchers found that, in each of 33 countries' stock markets between 1990 and 2011, an investor on average would have made far more money by buying low-volatility stocks than with issues having the highest historical volatilities. And not by just a small amount, either: A portfolio that held the 10% of stocks with lowest historical volatilities did 18% per year better, on average, than the decile containing the most volatile stocks.

Note carefully that this result stands finance theory directly on its head. According to Investments 101, the riskiest stocks — which are, after all, the most volatile — should provide higher returns, on average, than the least risky issues.

What this new study shows, in contrast, is that, far from compensating investors for the countless sleepless nights, the highest volatility stocks tend to produce the worst returns. That's adding insult to injury.

To be sure, Baker and Haugen aren't asking us to throw academic orthodoxy out the window just because of one study, comprehensive as it otherwise is. They point to a series of additional studies over the last two decades, covering stock market history as far back as 1926, that have almost universally come to the same result.

While it's certainly understandable why academia might not have welcomed findings that call into question the very foundation of what they've been taught, we might wonder why real-world investors have not discovered that low-volatility stocks consistently do better than the most volatile ones. One major reason they haven't, according to the researchers, is our tendency to focus the bulk of our attention on the stocks that are volatile and exciting.

As a result, Baker told me "we tend to overpay for the most volatile stocks" — and that, in turn, leads such stocks to be poor performers.

The researchers documented this by carefully measuring the relationship between the performance of a stock and the number of stories about it that had previously appeared on the Dow Jones News Wires. Sure enough, they found a stark inverse correlation: The most volatile stocks garnered by far the most stories and produced the lowest subsequent returns.

In contrast, the least volatile stocks — the ones that consistently proceed to turn in the best returns — are so boring and uninteresting that few if any Wall Street analysts, journalists or even investment columnists are drawn to write about them.

Putting this new research into practice requires us to become conscious of the ways in which we are drawn to the exciting stocks that are in the news, and to be willing to give up our craving for excitement. Are we willing to instead invest in a stock that may hardly ever get mentioned over cocktail conversation or be the subject of any major news story?

If we are, then we can either construct a low-volatility stock portfolio ourselves or invest in an ETF that does so. It's clearly a lot less work for us to go the ETF route. The one with the largest assets in this space is the PowerShares S&P 500 Low Volatility ETF ( SPLV), which invests in the 100 stocks in the S&P 500 with the lowest volatilities over the trailing 12 months.

How would you pursue a low-volatility strategy if you wanted to purchase the individual stocks themselves? To strictly follow the researchers' methodology, you would need to rank all stocks according to their monthly volatilities over the trailing 24 months — and invest in a diversified group of stocks at the bottom of the ranking.

That's a daunting task, to be sure, though Haugen's website ( does do the work for you (though it will cost you $9/month).

Happy hunting for boring stocks!

Monday, December 3, 2012

High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says

High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says


Published: December 3, 2012

A top government economist has concluded that the high-speed trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors.

The chief economist at the Commodity Futures Trading Commission, Andrei Kirilenko, reports in a coming study that high-frequency traders make an average profit of as much as $5.05 each time they go up against small traders buying and selling one of the most widely used financial contracts.

The agency has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics. But Bart Chilton, one of five C.F.T.C. commissioners, said on Monday that “what the study shows is that high-frequency traders are really the new middleman in exchange trading, and they’re taking some of the cream off the top.”

Mr. Kirilenko’s work stands in contrast to several statements from government officials who have expressed uncertainty about whether high-speed traders are earning profits at the expense of ordinary investors.

The study comes as a council of the nation’s top financial regulators is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system.

The Financial Stability Oversight Council, an organization formed after the recent financial crisis to deal with systemic risks, took up the issue at a meeting in November that was closed to the public, according to minutes that were released Monday.

The gathering of top regulators, including Treasury Secretary Timothy F. Geithner and Ben S. Bernanke, the Federal Reserve chairman, said in its annual report this summer that recent developments “could lead to unintended errors cascading through the financial system.” The C.F.T.C. is a member of the oversight council.

The issue of high-frequency trading has generated anxiety among investors in the stock market, where computerized trading first took hold. But the minutes from the oversight council, and the council’s annual report released this year, indicate that top regulators are viewing the automation of trading as a broader concern as high-speed traders move into an array of financial markets, including bond and foreign currency trading.

Mr. Kirilenko’s study focused on one corner of the financial markets that the C.F.T.C. oversees, contracts that are settled based on the future value of the Standard & Poor’s 500-stock index. He and his co-authors, professors at Princeton and the University of Washington, chose the contract because it is one of the most heavily traded financial assets in any market and is popular with a broad array of investors.

Using previously private data, Mr. Kirilenko’s team found that from August 2010 to August 2012, high-frequency trading firms were able to reliably capture profits by buying and selling futures contracts from several types of traditional investors.

The study notes that there are different types of high-frequency traders, some of which are more aggressive in initiating trades and some of which are passive, simply taking the other side of existing offers in the market.

The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.

Large investors can trade thousands of contracts at once to bet on future shifts in the S.& P. 500 index. The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study.

Industry profits have been falling, however, as overall stock trading volume has dropped and the race for the latest technological advances has increased costs.

Mr. Kirilenko warned that the smaller traders might leave the futures markets if their profits were drained away, opting instead to operate in less transparent markets where high-speed traders would not get in the way.

“They will go someplace that’s darker,” Mr. Kirilenko said at the conference. That could destabilize futures markets long used by traders to hedge risk.

A spokesman for the C.F.T.C. said the agency had no comment on the study. But the paper was immediately hailed by Mr. Chilton, who is a Democrat and a critic of recent shifts in the markets.

Mr. Chilton said that the study would make it easier for regulators “to put forth regulations in a streamlined fashion. It’s a key step in the process and it should fuel-inject the regulatory effort going forward.”

Terrence Hendershott, a professor at the University of California, Berkeley, said there was a limit to the importance of Mr. Kirilenko’s work because it focused on profits and did not address the benefits high-speed traders bring.

Mr. Hendershott and many other academics have found that the competition between high-speed traders has helped lower the cost of trading for ordinary investors. But Mr. Hendershott said that limited data available to researchers had made it hard to determine whether the benefits outweighed the costs.

The speed and complexity of the financial markets jumped onto the agenda of regulators after the so-called flash crash of 2010, when leading stock indexes fell almost 10 percent in less than half an hour, before quickly making up most of the losses.

In its first annual report, in 2011, the Financial Stability Oversight Council noted the concerns raised by the flash crash, but not in great detail. This year’s report included a much fuller discussion of the risks posed by the increasing speed and complexity of the financial markets and called for regulators to look for more ways to limit the risks.

Regulators have said that devising new rules has been hard, in part because the trading world has become so complex, making it difficult to determine the total effect that all the innovations have had on traditional investors. Mr. Kirilenko said in an interview Monday that his study was intended to address that.

“We’re not estimating,” he said. “Our data is excellent.”

For Warren Buffett, the Long Run Still Trumps the Quick Return

December 3, 2012, 4:54 pm

Donald Bowers/Getty Images for FortuneWarren Buffett at a New York book party for “Tap Dancing to Work,” by Carol Loomis.

“If somebody bought Berkshire Hathaway in 1965 and they held it, they made a great investment — and their broker would have starved to death.”

Warren E. Buffett was sitting across from me over lunch at a private club in Midtown Manhattan last week, lamenting the current state of Wall Street, which promotes a trading culture over an investing culture and offers incentives for brokers and traders to generate fees and fast profits.

“The emphasis on trading has increased. Just look at the turnover in all of the stocks,” he said, adding with a smile: “Sales people have forever gotten paid by selling people something. Generally, you pay a doctor for how often he gets you to change prescriptions.”

Mr. Buffett, 82, is famous for investing in companies that he sees as solid operations and essential to the economy, like railroads, utilities and financial companies, and holds his stakes for the long run. The argument that the markets are better off today because of the enormous amount of liquidity in the stock market, a function of quick flipping and electronic trading, is a fallacy, he said.

“You can’t buy 10 percent of the farmland in Nebraska in three years if you set out to do it,” he said. Yet, he pointed out, he was able to buy the equivalent of 10 percent of I.B.M. in six to eight months as a result of the market’s liquidity. “The idea that people look at their holdings in such a way that that kind of volume exists means that to a great extent, it’s a casino game,” he said. Of course, unlike many investors, he plans to hold his stake in I.B.M. for years.

Mr. Buffett was in a reminiscing mood about a bygone era, in part because he was in New York to make the rounds on television to discuss a new book chronicling his 61-year career, which began in 1951 at Buffett-Falk & Company in Omaha. (After lunch, he was going to visit “The Daily Show With Jon Stewart.”)

The book, “Tap Dancing to Work,” by a longtime journalist and good friend of his, Carol Loomis of Fortune magazine, is a compendium of articles that she and others wrote in Fortune that creates a series of narratives spanning the arc of his career.

Ms. Loomis, who first met Mr. Buffett in 1967 — and whose long career is a story unto itself — also came to our lunch. Ms. Loomis may know more about Mr. Buffett than he knows about himself. (“There’s nothing here you’re going to like,” she said, after surveying the various pies when the dessert cart came around. She was right: he took a quick look and asked if they served ice cream. They did.)

As we talked about the “good old days” — he spoke of some of his early friends who were successful hedge fund investors, like Julian Robertson, who founded Tiger Management — it became clear that he was less enamored of the investor class of the next generation.

When I asked, for example, if there were any private equity investors that he admired, he flatly replied: “No.”

When I asked if he followed any hedge fund managers, he struggled to name any, before saying that he liked Seth Klarman, a low-key value investor who runs the Baupost Group, based in Boston.
“They’re not as good as the old ones generally. The field has gotten swamped, so there’s so much money playing and people have been able to raise money by just saying ‘hedge fund,’” he said. “That was not the case earlier on; you really had to have some performance for some time before people would put money with you. It’s a marketing thing.”

For a moment, he paused, and then posited that if he started a hedge fund today, “I’d probably grow faster, because a record now would attract money a lot faster,” speculating that his record of returns would attract billions of dollars from pension funds and others. But he then acknowledged a truism of investing that he knows all too well, as the manager of an enterprise that is now worth some $220 billion: “Then money starts getting self-defeating at a point, too.”

Until 1969, Mr. Buffett operated a private partnership that was akin in some ways to a modern hedge fund, except the fee structure was decidedly different. Instead of charging “2 and 20” — a 2 percent management fee and 20 percent of profits — Mr. Buffett’s investors “keep all of the annual gains up to 6 percent; above that level Buffett takes a one-quarter cut,” Ms. Loomis wrote. However, in 1969, he announced he would shutter his partnership. “This is a market I don’t understand,” he said, according to Ms. Loomis.

He believed that the stock market of 1968 had become wildly overpriced — and he was right. By the end of 1974, the market took a tumble. Instead, he remained the chief executive of Berkshire Hathaway, one of his early investments.

“If you want to make a lot of money and you own a hedge fund or a private equity fund, there’s nothing like 2 and 20 and a lot of leverage,” he said over a lunch of Cobb salad. “If I kept my partnership and owned Berkshire through that, I would have made even more money.”

Mr. Buffett says he now considered himself as much a business manager as an investor. “The main thing I’m doing is trying to build a business, and now we built one. Investing is part of it but it is not the main thing.”

Today, Mr. Buffett is particularly circumspect about the investment strategies that hedge funds employ, like shorting, or betting against, a company’s stock. He used to short companies as part of a hedging strategy when he ran his partnership, but now he says that he and Charlie Munger, his longtime friend and vice chairman of Berkshire, see it as too hard.

“Charlie and I both have talked about it, we probably had a hundred ideas of things that would be good short sales. Probably 95 percent of them at least turned out to be, and I don’t think we would have made a dime out of it if we had been engaged in the activity. It’s too difficult,” he explained, suggesting that the timing of short investments is crucial. “The whole thing about ‘longs’ is, if you know you’re right, you can just keep buying, and the lower it goes, the better you like it, and you can’t do that with shorts.”

One of his big worries these days is about what’s going to happen to all the pension money that is being invested in the markets, often with little success, in part because investors are constantly buying and selling securities on the advice of brokers and advisers, rather than holding them for the long term. “Most institutional investors, whoever is in charge — whether it’s the college treasurer or the trustees of the pension fund of some state — they’re buying what they’re sold.”

Most pension funds probably didn’t buy Berkshire in 1965 and hold it, but if they had, they would have far fewer problems today. At the end of her book, Ms. Loomis notes that when she mentioned Mr. Buffett’s name for the first time in Fortune magazine in 1966 — accidentally spelling Buffett with only one “t” — Berkshire was trading at $22 a share. Today it is almost $133,000 a share.

Getting good returns without too much risk

03 Dec 2012 06:39

 How does one get good return from an asset? Well, the more cheaply you can acquire a good asset, the higher your return will be. Your dividend yield is higher, your capital appreciation is higher. - REUTERS

What is risk? The conventional definition of risk in finance literature is price volatility. But to super-investor Warren Buffett, risk is the permanent loss of capital.

Unless you need to cash out at very depressed market levels, or the investments or stocks/companies you own have no more capacity to recover, price volatility is just noise in the market, says Mr Buffett.

On the other side, what is return? Return to an investor is the income you get from your investment, as well as the rise in the price of the investment. Of course, you’d want to be able to get back at some point the entire sum of the capital you put in as well.

How does one get good return from an asset? Well, the more cheaply you can acquire a good asset, the higher your return will be. Your dividend yield is higher, your capital appreciation is higher.

Next question. When you get a good asset cheap, what are the chances of you suffering a permanent loss of your capital? Small. Hence, your risk is low.

So, to get good returns, does it mean we have to take high risks? Not necessarily!

It is very common for us to miscalculate the probabilities and act less than rationally because of our tendency to, among other things, prefer excitement over staidness, to want instant gratification instead of staying for the long haul, and to seek “safety” in numbers, that is, to just follow the crowd.

Take Apple. Given how well the stock has done, I’m sure most of us wish we had the stock in our portfolios, preferably from as early as 10 years ago. A sum of US$10,000 (S$12,200) invested in November 2002 in that “fruit company” – as Forrest Gump described it – would have grown to US$750,000 today.

But nobody could have predicted back then how well Apple would do. This is but one of the many trajectories that the company could have taken in the intervening 10 years. It could have gone the way of Nokia.

In expectation, as scholar and investment expert Nassim Taleb puts it, a dentist is considerably richer than the rock star, the hedge fund manager who made it with one big bet or the successful entrepreneur. “One cannot consider a profession without taking into account the average of the people who enter it, not the sample of those who have succeeded in it,” he says.

We talk about Apple today because it has succeeded. And that’s how typically a stock comes onto the radar of a novice retail investor. The stock is in the news because the company has had three or four years of good growth, or has a novel concept. Our friends and family members talk about the stock because it is in the hottest industry today.

But most times, such stocks will prove to be a less-than-satisfactory investment.
A few things are at play here. One, because of their promise, the hype factor and the fact that many people are chasing after them, the prices of these stocks or asset classes are bid up. They become expensive.

Two, because their prices are bid up and the market’s expectations for them are so high, everything must go right for them. Any little disappointment – and they will definitely run into some – will cause the stock prices to fall. The higher they are, the further they can fall.

Three, being the darlings of the stock market does something to the managements of the companies. Their egos become a bit bigger, they take a few more risks and they become a tad more tyrannical. Thus, the seeds of their downfall are sown.

Studies after studies have shown that, on average, investing in stock-market darlings, buying into high-growth companies, chasing after the latest investment fads, does not pay. Instead, it’s the boring stocks, the neglected stocks, the shunned stocks, that give investors the greatest upside.

Contrast companies that promise world domination with the unexciting ones that cough up consistent cash flows without the need for massive capital expenditure on a regular basis. Without a doubt, the latter group is a much better bet.

Which stocks have been the best performers on the Singapore Exchange in the past 10 years? They include the likes of Dairy Farm, the pan-Asian retailer that runs the Cold Storage chain in Singapore; Vicom, the largest technical testing and vehicle inspection firm in Singapore; and Raffles Medical Group.

An investment of $10,000 in Dairy Farm 10 years ago would be worth about $240,000 today, with dividends reinvested in the stock. Not too shabby.

There you have it – you can have your cake and eat it. You can get good returns, without taking on a lot of risk. So a strong conviction is required.

Just a note: Some of the stocks mentioned above have risen so much in the past 10 years, they might not be that cheap anymore. Hence, they might not be as “low-risk” as before. And their returns are unlikely to be as spectacular as in the past 10 years.

And so, the search continues for the next batch of safe and good stocks.

Saturday, December 1, 2012

The Perfect Income for Happiness? Try $227K for Singapore residents

By Robert Frank | CNBC
Saturday, 1 December 2012

More than one study has tried to determine the financial price of happiness. Some look at wealth. Others look at income.

One well-publicized study last year put the optimal income for happiness at around $75,000. Rising income, it turns out, produces greater happiness until you get to around $75,000. After that, there are diminishing returns, with more income leading to little or no gain in real happiness.

This is a fraught question, of course. "Happiness" itself is not easily defined, and money, as the winners of this week's Powerball jackpot will tell you, doesn't always guarantee it. And the financial requirements for happiness usually depend on geography, peer groups and other external factors.

The latest to weigh in on the issue is Skandia International's Wealth Sentiment Monitor. It found that the global average "happiness income" is around $161,000 for 13 countries surveyed. The United States wasn't specifically measured.

But there was a wide range of answers depending on the country. Dubai residents need the most to feel wealthy. They said the needed $276,150 to be happy. Singapore came in second place, with $227,553, followed by Hong Kong, with $197,702.

The region with the most modest needs for happiness is Europe. Germans only need $85,781 to be happy, placing them lowest on the list. The French need $114,000, while the British need $133,000.
The survey doesn't ask about total wealth needed to feel happy. But it does ask about the amount of wealth needed to feel "wealthy." Globally, the average amount needed to feel wealthy was $1.8 million.

Singaporeans took the lead on the "wealth" needs, with $2.91 million needed to feel wealthy. Dubai ranked second with $2.5 million, followed by Hong Kong with $2.46 million.

Surveys show that among Americans, most say they need $1 million or more to feel wealthy.
All of this shows that wealth and financial happiness is not an absolute number, but is relative to your peers and surroundings. Living in Dubai, with all those oil barons and oligarchs, the needs are higher.

In Germany, where wealth is more evenly distributed, the needs are not as high.

Thursday, November 29, 2012

S’poreans achieving more but are less happy: Survey

Andrea Ong 29/11/2012

SINGAPOREANS feel a stronger sense of achievement today than six years ago, but they are not any happier.

They are also enjoying life less, according to a survey by two dons from the National University of Singapore Business School.

The findings suggest that money does not necessarily buy happiness, with economic growth - measured by gross domestic product (GDP) - and happiness seeming to have moved in opposite directions since 2006.

"A reasonable level of GDP is necessary but it's not a sufficient condition for good standard of living," said Dr Siok Kuan Tambyah, who co-wrote a book on the survey findings with Associate Professor Tan Soo Jiuan.

Last year, they engaged a research firm to survey 1,500 Singaporeans on areas ranging from perceptions of their well-being to the values they find important and political rights.

The results showed Singaporeans' sense of achievement last year rose by 13.7 percentage points from the figure in 2006, when the professors did a similar study.

But happiness levels dipped by 3.5 percentage points while enjoyment levels slipped 1.3 points.
Dr Tambyah said this could be a sign of a phenomenon - seen in other developed countries as well - where happiness levels tend to stagnate after a point, even as national wealth continues to rise.

Said Prof Tan: "Very often, you are so busy paying off your mortgage; you can have a very nice home, but how much time do you spend in it to enjoy the landscaping?"

The widening income gap could be another factor as some citizens may feel overlooked, said Dr Tambyah.

Singaporeans aged 25 to 34 were the most unhappy. That is when people are stressed by their careers and the struggle to start a family without being able to afford a car or a house, said the professors.

And what makes Singaporeans happy? The survey holds some answers: ties with family and friends.
Prof Tan highlighted a paradox where respondents were more satisfied with life in general but less satisfied with life in Singapore than they were in 2001.

Generally, people were most satisfied with their relationships with their children and parents.

But in a separate question on life in Singapore, people were least satisfied about cost-of-living issues such as the affordability of cars, property and health care.

A "bright spot" is that "family relationships and social networks are holding up very well", said Dr Tambyah. "People feel it's so important to them."

The findings indicate a need for Singapore's economic goals to be balanced with social and communal goals, said the dons.

Dr Tambyah is glad questions on happiness, values and the kind of society Singaporeans want have been raised in the ongoing national conversation.

She said: "That's what contributes to a better society and nation, apart from GDP."

Monday, November 26, 2012

Living with risks in a random world

26 Nov 2012 08:40 TEH HOOI LING

“Life cannot be calculated. That’s the big mistake our civilisation made. We never accepted that randomness is not a mistake in the equation – it is part of the equation,” says British writer Jeanette Winterson.

Nassim Taleb is another one of my favourite authors. I was struck by how many truths there were in Fooled By Randomness: The Hidden Role Of Chance In Life And In The Markets when I first read it a few years ago.

He followed that up with The Black Swan: The Impact Of The Highly Improbable, which presciently was published in 2007 – just before the global financial crisis erupted. His latest book, Antifragile: Things That Gain From Disorder, is about how stability engenders a false sense of security – one of the things we talked about last week.

Yes, there are loads of randomness and hence risks out there.
Goldman Sachs’ latest shrewd investment was in sandbags and back-up electricity generators. As Hurricane Sandy approached New York, the bags were stacked around its headquarters. It was one of the few offices in downtown Manhattan to remain dry and well-illuminated as the “Frankenstorm” battered the city, reported The Economist.

In contrast, a block farther down West Street, the headquarters of Verizon was awash with salty flood water, soaking cables delivering phone and Internet services to millions of customers. The firm was able to re-route much of the traffic through other parts of its network, but local service was disrupted.

Last year’s Japanese tsunami reminded many companies that moving to “just-in-time” manufacturing through global supply chains can bring new risks. American carmakers found that they could not get essential parts made in Japan. Floods in Thailand last year caused a global shortage of hard-disk drives. It turns out, a large proportion of global supply comes from a rather small area near Bangkok.

The takeaway from the quote, the books and the examples in The Economist article is: We shouldn’t cut things too finely. We shouldn’t bank on things to work perfectly all the time. There should always be a buffer for things to go wrong. And there are always unforeseen things that can happen to mess up our best thought-out plans.

So in this random world, how do we manage our risks?
First, always work with a margin of safety. Yes, it means some wastage. But it’s a necessary cost. Margin of safety is a big concept in value investing. A value fund manager draws this analogy: “It’s like driving on the highway. You keep a safe distance behind the car in front of you. So if anything happens, you have the buffer. You have time to react. That’s margin of safety.” We will talk more about this in a future article.

Two, be prepared for the unexpected. It is a natural human tendency to underestimate the probability of bad things happening to ourselves. Yes, there are precautions we can take. Don’t put oneself in harm’s way. Take good care of one’s health. Still, one can never predict when accidents can happen, or when illness will strike.

Insurance is one way we can protect ourselves financially against such unexpected but “high-impact” events that can result in losing one’s capacity to work and needing to pay significant amounts for medical expenses and so on. So insurance policies are must-haves.

Another form of insurance is what I call social insurance. That is, to build relationships and share our surplus – for we never know when we may fall on hard times and may need the generosity and goodwill of others.

For philosopher Immanuel Kant, this is not a good motivation for sharing. To him, we should do something because we think it is the right thing to do, and not because we want something in return. But hey, we are all so used to incentives. So if anyone needs a reason for sharing his good fortune, this is one way to rationalise it.

Third, don’t put all your eggs in one basket. United States energy giant Enron was a model corporation and darling stock in the 1990s. Many of its employees worked for decades in the company, had their pensions there and invested their savings in its stock. When Enron collapsed in 2001, these employees lost their jobs, their pensions and their savings.

Note that one basket doesn’t just mean one stock or one asset. It could mean a group of baskets that generally suffer the same fate. If you work in the financial sector and invest the bulk of your money in financial stocks even though they are not your own company’s, you are, in a sense, putting many of your eggs in one basket as well.

So to recap, some of the ways to mitigate risks in this highly unpredictable world of ours are: cut yourself some slack, buy yourself some insurance and do not put all your eggs in one basket.
Next week, we will talk about whether high risks necessarily mean high returns.
One basket doesn’t just mean one stock or one asset. It could mean a group of baskets that generally suffer the same fate. If you work in the financial sector and invest the bulk of your money in financial stocks even though they are not your own company’s, you are, in a sense, putting many of your eggs in one basket as well.

The writer is editor of Executive Money, a weekly section in The Business Times. Her column is also available in BTInvest (, a free personal finance and investment site of The Business Times covering five main categories: Personal Finance, Wealth, Markets, Insurance and Property.

Go to BTInvest for expert views on the latest market developments and tips on how to better manage your dollars and cents.

Friday, November 23, 2012

Singapore "the most emotionless society"?

Emotions not taking over?

23 November 2012
Neo Chai Chin

SINGAPORE - Yes, the Government has a role to play in the emotional well-being of its people and Singaporeans could, perhaps, express more emotion.

This was the general consensus among academics and Members of Parliament whom TODAY spoke to yesterday, a day after the Republic had the ignominy of being dubbed the "most emotionless society" in the world - or among more than 150 countries and areas, to be more specific - following a poll by research and analytics firm Gallup.

And while there were some criticisms about Gallup's methodology, they agreed that the Government could do more in this area, as Gallup called on the Singapore leadership "to include well-being in its overall strategies if it is going to further improve the lives of its citizenry".

A Bloomberg report on the survey results went viral on Wednesday, and became a talking point among Singaporeans.

Gallup published its findings and methodology, as well as an article on the survey's implications late on Wednesday night. Noting that Singapore has one of the lowest unemployment rates and highest gross domestic product per capita rates in the world, Gallup partner Jon Clifton said that the research "shows that the solutions to improve positive emotions or decrease negative emotions do not necessarily go beyond higher incomes".

The survey was done from 2009 to 2011, with about 1,000 individuals from each country polled each year. The respondents were asked if they had experienced five positive and five negative emotions a lot the previous day.

To measure the presence or absence of emotions, Gallup took the average of the percentage of residents in each country who said they experienced each of the 10 positive and negative emotions.
Singapore scored 36 per cent, with countries such as Lithuania, Russia and Nepal also among the lowest scorers; the Philippines was the most emotional with a score of 60 per cent, with countries such as Oman, Colombia and Canada following closely behind.

The implications for an emotionless society are "significant", Mr Clifton said. "Well-being and daily emotion correlate with some of the most important societal outcomes, such as community attachment and brain gain (acquiring and retaining top talent)," he added.

Findings useful but flawed

Academics said the findings are useful and thought-provoking, but not without flaws. Each country's scores "actually represent the averaged intensity of emotions experienced without regard to the positive or negative valence of the emotions", noted Professor David Chan, Director of the Singapore Management University's Behavioural Sciences Institute.

"So when we distinguish positive and negative emotions and consider them jointly, as we should, Singapore will have a moderate ranking ? on emotional well-being," he pointed out.

National University of Singapore sociologist Tan Ern Ser said he would have obtained separate scores on positive and negative emotions felt, and tried to find out if respondents' emotions were due to personality or contextual factors. But he noted that Singapore has ranked well in recent happiness surveys - in Gallup's 2012 World Happiness Report, for instance, Singapore was third in the Asia-Pacific after Australia and New Zealand.

Associate Professor Tan suggested several ways that the Government could indirectly increase emotional well-being. These include creating quality jobs, providing good education, housing, healthcare and transport, as well as reducing social inequality.

Prof Chan also proposed other ways such as building trust and social capital, treating economic growth as means rather than ends, and implementing integrative policies that ensure growth is translated into outcomes that benefit citizens and contribute to well-being.

The Government could leave more room for "compassionate considerations" when applying policies, suggested Member of Parliament Baey Yam Keng. In communicating its decisions to stakeholders, more can be done to show their interests have been taken into account, he said.

But residents too can improve their emotional well-being by showing more neighbourliness and reaching out more to one another, said Mr Baey and fellow MP David Ong.

Mr Ong disagreed with the survey results. He said it could be a Singaporean trait to opt for "less risky" answers in surveys, and that they could be more expressive in certain settings, such as with friends, but not during public events such as concerts. "Maybe it's the culture of not wanting to stand out too much," he said.

Time to tighten rules for business trusts?

Of the 11 business trusts, only two made money for their unitholders who got in at the initial public offering stage. -BT

Teh Hooi Ling
Fri, Nov 23, 2012
The Business Times

SINGAPORE - Eleven business trusts had been launched on the Singapore Exchange since the first one - Pacific Shipping Trust - hit the market in May 2006.

That maiden business trust on SGX has since been taken private.

And then there are 10.

How has this asset class done so far? Not good at all.

Of the 11 business trusts, only two - Pacific Shipping Trust and K-Green Trust - made money for their unitholders who got in at the initial public offering stage.

But even for these two trusts, unitholders would have done better just investing in the Straits Times Index.

Pacific Shipping underperformed the STI by 3.8 per cent a year, and K-Green by 4.8 per cent.

The worst performer is Indiabulls Property Trust, followed by the two remaining shipping trusts - First Ship Lease and Rickmers Maritime.

Overall, on average, a unitholder who bought into these trusts at IPO price would have lost an average of 23.4 per cent.

This is after taking into consideration the distributions if any.

The average underperformance relative to the STI is a whopping 11.5 per cent a year.

Hence the indisputable conclusion: business trusts have not been a rewarding asset class for investors so far.

Compare them with another type of trusts - real estate investment trusts (Reits) - and the performance of the two cannot be more different than night and day.

What could cause the vast difference in the performance of these two types of business structures?

Is there something inherent in the rules of business trusts that favours the sponsors over investors?

Well, yes.

Business trusts are managed by trustee-managers.

Under the Singapore Business Trusts Act, the trustee-manager can be removed only if 75 per cent of unitholders vote in favour.

At a discussion organised by CFA Institute's Standards and Financial Market Integrity committee last week, numerous participants noted that for sponsors, business trust is "a ready structure to exercise their control disproportionate to their cashflow rights".

Sponsors can sell off 74 per cent of the value of the assets, and still retain full control via the trustee-manager.

In Reits, the manager can be removed by a simple majority of unitholders' vote at a general meeting.
Business trusts also have fewer restrictions which allow them to do a lot more things and hence make them riskier.

They can hold various types of assets, like real estate, infrastructure assets or ships.

Some, like ships, may not have any meaningful terminal value. For real estate, they can undertake development as well.

On the other hand, Reits can only hold income yielding real estate.

On the borrowing front, there are no limits for business trusts.

The gearing for Reits, meanwhile, is capped at 35 per cent, or up to 60 per cent if it obtains, discloses, and maintains a credit rating from rating agencies.

In terms of distribution, business trusts are not required to distribute any dividends. They may pledge to distribute a certain percentage of income as dividends, but this can change.

As for Reits, they must distribute at least 90 per cent of income to enjoy tax transparency under Income Tax Act.

The less rigorous regime of the business trusts allows sponsors to exercise their boundless creativity.

Caveat emptor is a fair argument to make in a market populated by highly sophisticated investors.
In Singapore, the average investor is far from being sophisticated.

Given their atrocious performance thus far, there is a strong case for rules to be tightened for business trusts.

Thursday, November 22, 2012

Managing risk in a time of deleveraging

22 Nov 2012 08:00
By David Hollis
Vice President & Multi-Asset Portfolio Manager
Allianz Global Investors

When the credit bubble burst in late 2008, it was evident the next economic phase would be a period of deleveraging. It brings with it a completely different economic backdrop, entirely changing the manner in which returns can be generated within financial markets. Many developed markets are facing a debt overhang on four fronts; private, public, household and pension. In the “Golden Age”, developed market credit growth was allowed to persist way beyond sustainable levels as interest rates were set too low on the premise inflation had been eradicated, hence the cost of credit was artificially cheap. In reality, emerging markets were exporting deflation via low goods prices produced with inexpensive labour, and developed countries were funding purchases of these goods via cheap credit.

In a recent working paper, the economists Reinhart & Rogoff identified 26 episodes of public debt overhang, specified as periods when debt to GDP exceeds 90%, since 1800. In 23 out of the 26 episodes countries experienced growth rates that were lower than the average during other periods, proving that deleveraging results in sub-trend growth[1]. Alarmingly, the average period of a debt overhang episode was 23 years, implying that some countries may not achieve a sustainable debt level until 2031, during which they will experience sluggish growth[2]. In just under half of the 26 episodes of debt overhang, real interest rates were lower, or the same, than other periods and at the same time growth was lower.

We can extend this empirical evidence and use simple mathematics to conclude that real (nominal) interest rates must be below real (nominal) GDP during a deleveraging cycle, otherwise the debt to GDP ratio of a country cannot fall. As a result, those securities such as sovereign bonds, inflation-linked bonds, and corporate bonds are likely to outperform. In fact, corporate bonds have empirically out-performed sovereign equivalents during low growth.

Methods of Public Sector Deleveraging – Financial Repression
The preferred method of deleveraging is through a combination of austerity and growth measures, as in Ireland, Denmark, Sweden and Belgium from mid 90’s to mid 2000. However, these episodes occurred when the global economy was expanding, allowing them to depreciate their currency and export themselves out of debt. Today, simultaneous developed market deleveraging results in competitive currency devaluation, and even then export demand from other highly indebted developed countries is depressed. This can only really be overcome by opening up new trading channels with emerging markets.

Financial repression, the means by which governments indirectly or directly compel investors to purchase debt, is the most likely deleveraging route that will be adopted in coming years. It is already evident in extremely low bond yields, which reflect superior demand for sovereign debt, and ultra-stimulative central bank rates. Having exhausted traditional methods of monetary policy central banks have turned to “non-standard measures” such as Quantitative Easing, which involves government bond purchases, to further improve liquidity and lower real interest rates.

There has been widespread pressure on banks to purchase government bonds. For example, peripheral Eurozone banks have been encouraged by their national central banks to exchange non-domestic bonds with the ECB for money that can be invested in domestic bonds. This self-funding of deficits on a national scale is another example of financial repression.

Banking regulation, such as the Basel III and Solvency II Acts, although primarily designed to improve the quality of collateral on bank balance sheets to prevent another Lehman style scenario, invariably involves an increase in low risk assets, such as government bonds, on balance sheets.
Investing During Deleveraging

Under financial repression, yields on low risk investments will remain depressed and capital will flow to the highest yielding risk-adjusted asset. Unfortunately, with free flowing global capital, this will depress asset class return autocorrelation, hence a more dynamic asset allocation process is preferable to a buy-hold strategy.

Moreover, a greater proportion of return will come from income, rather than capital. For example, earnings growth in equity markets is likely to be muted as growth has been empiricially proven to be lower during periods of deleveraging, as a result the capital return on equities will be lower relative to income.

The focus on investing in high yielding and high income assets may result in the mis-allocation of resources, hence investment in traditional growth industries may be deficient and represents a headwind to capital returns.

Low yields in developed countries will prompt investors to seek income opportunities elsewhere; this is best achieved through asset class diversification. However, we would caution that price momentum may drive illiquid markets to excessively high valuations, at which point capital outflow can lead to an abrupt reversal of the positive return trend. Therefore, a dynamic asset allocation process is preferable.

Rising asset class correlation since since 2008 suggest that returns are more easily generated through beta strategies. Alpha generation has become distorted by macro-economic factors such as country risk premia impacting individual stocks.

The key to generating returns and managing risk during deleveraging is to maximise diversification beyond traditional asset classes. This is best executed in the context of a dynamic investment strategy conbined with a proven risk management approach.

Wednesday, November 21, 2012

The year of betting conservatively

21 November 2012
Nouriel Roubini

The upswing in global equity markets that started in July is now running out of steam, which comes as no surprise: With no significant improvement in growth prospects in either the advanced or major emerging economies, the rally always seemed to lack legs. If anything, the correction might have come sooner, given disappointing macroeconomic data in recent months.

Starting with the advanced countries, the euro zone recession has spread from the periphery to the core, with France entering recession and Germany facing a double whammy of slowing growth in one major export market (China/Asia) and outright contraction in others (southern Europe).

Economic growth in the United States has remained anaemic, at 1.5-2 per cent for most of the year, and Japan is lapsing into a new recession. The United Kingdom, like the euro zone, has already endured a double-dip recession and now, even strong commodity exporters - Canada, the Nordic countries, and Australia - are slowing in the face of headwinds from the US, Europe, and China.

Meanwhile, emerging-market economies - including all of the BRICs (Brazil, Russia, India and China) and other major players like Argentina, Turkey and South Africa - also slowed this year. China's slowdown may be stabilised for a few quarters, given the government's latest fiscal, monetary and credit injection; but this stimulus will only perpetuate the country's unsustainable growth model, one based on too much fixed investment and savings and too little private consumption.


Next year, downside risks to global growth will be exacerbated by the spread of fiscal austerity to most advanced economies. Until now, the recessionary fiscal drag has been concentrated in the euro zone periphery and the UK. But now it is permeating the euro zone's core.

And in the US, even if President Barack Obama and the Republicans in Congress agree on a budget plan that avoids the looming "fiscal cliff", spending cuts and tax increases will invariably lead to some drag on growth next year - at least 1 per cent of GDP. In Japan, the fiscal stimulus from post-earthquake reconstruction will be phased out, while a new consumption tax will be phased in by 2014.

The International Monetary Fund is thus absolutely right in arguing that excessively front-loaded and synchronised fiscal austerity in most advanced economies will dim global growth prospects next year. So, what explains the recent rally in US and global asset markets?

The answer is simple: Central banks have turned on their liquidity hoses again, providing a boost to risky assets.

The US Federal Reserve has embraced aggressive, open-ended quantitative easing (QE). The European Central Bank's announcement of its "outright market transactions" programme has reduced the risk of a sovereign-debt crisis in the euro zone periphery and a break-up of the monetary union. The Bank of England has moved from QE to CE (credit easing), and the Bank of Japan has repeatedly increased the size of its QE operations.

Monetary authorities in many other advanced and emerging-market economies have cut their policy rates as well. And, with slow growth, subdued inflation, near-zero short-term interest rates, and more QE, longer-term interest rates in most advanced economies remain low (with the exception of the euro zone periphery, where sovereign risk remains relatively high).

It is small wonder, then, that investors desperately searching for yield have rushed into equities, commodities, credit instruments, and emerging-market currencies.


But now a global market correction seems underway, owing, first and foremost, to the poor growth outlook. At the same time, the euro zone crisis remains unresolved, despite the ECB's bold actions and talk of a banking, fiscal, economic and political union. Specifically, Greece, Portugal, Spain, and Italy are still at risk, while bailout fatigue pervades the euro zone core.

Moreover, political and policy uncertainties - on the fiscal, debt, taxation and regulatory fronts - abound. In the US, the fiscal worries are threefold: The risk of a "cliff" next year, as tax increases and massive spending cuts kick in automatically if no political agreement is reached; renewed partisan combat over the debt ceiling; and a new fight over medium-term fiscal austerity.

In many other countries or regions - for example, China, Korea, Japan, Israel, Germany, Italy and Catalonia - coming elections or political transitions have similarly increased policy uncertainty.

Yet, another reason for the correction is that valuations in stock markets are stretched: Price/earnings ratios are now high, while growth in earnings per share is slackening, and will be subject to further negative surprises as growth and inflation remain low. With uncertainty, volatility and tail risks on the rise again, the correction could accelerate quickly.

Indeed, there are now greater geopolitical uncertainties as well: The risk of an Iran-Israel military confrontation remains high as negotiations and sanctions may not deter Iran from developing nuclear-weapons capacity; a new war between Israel and Hamas in Gaza is likely; the Arab Spring is turning into a grim winter of economic, social and political instability; and territorial disputes in Asia between China, Korea, Japan, Taiwan, the Philippines and Vietnam are inflaming nationalist forces.

As consumers, firms and investors become more cautious and risk-averse, the equity-market rally of the second half of this year has crested. Given the seriousness of the downside risks to growth in advanced and emerging economies alike, the correction could be a bellwether of worse to come for the global economy and financial markets next year. PROJECT SYNDICATE

Nouriel Roubini is Chairman of Roubini Global Economics, Professor at New York University's Stern School of Business, and co-author of Crisis Economics.

Investing for income in a lower growth world

21 Nov 2012 08:00
By Aymeric Forest
Fund Manager
Schroders Multi Asset Investments

Investors everywhere are looking for income; at the same time, traditional sources of income are drying up. It is time to widen the opportunity set.

Relying on one asset class for income reduces opportunity and carries more risk than in the past
A benchmark-unconstrained multiasset fund has the flexibility to find attractive yield wherever it arises

It is important to focus on quality and risk management to avoid capital erosion and ensure sustainable income

Traditional sources of income are drying up…
The ‘traditional’ way to earn income has been to hold government bonds (issued in your home market) or money market instruments. In this economic environment these no longer provide an answer since they do not provide a yield high enough to satisfy investors’ objectives, either in inflation-adjusted or absolute terms.

Since 2007 government bond yields have dropped to levels unseen since the Great Depression. Governments and central banks across the world are committed to providing the lowest possible cost of refinancing so that the banking system is gradually able to repay debt without causing too much damage to already low economic growth.

Very low interest rates and quantitative easing (where the government prints money to buy assets such as government bonds), combined with risk aversion and the poor outlook for growth, have contributed to the falls in government bond yields.

…in a lower growth world
The excessive borrowing accumulated since the 1990s is likely to continue having an effect on economic growth for several years ahead. Governments are being forced to tighten fiscal policy and reduce spending in order to reduce their debt, while households and banks are also over-borrowed.
Historically economic growth rates have on average been 4 percentage points lower when a country’s debt exceeds 90 per cent of its GDP.

This level of debt, already reached by some developed markets, may soon be reached by more countries.

With slowing economic growth, capital gains from investments will be harder to find – and come at a greater level of risk.

…while demand for income increases
The pressure on public finances is likely to prevent governments from meeting all of their pension promises and the responsibility for generating investment income will increasingly fall on individuals. But with traditional sources of income yielding less, investors are currently unlikely to make up this gap unless they take a new approach to income investing.

Schroders carried out a ‘European Wealth’ study to assess the attitudes and outlook of investors across Europe (taking 1,400 investors into account across nine countries). We found that there is a substantial gap between the level of income in retirement that these investors desire and their likely retirement income. Excluding the UK, the annual shortfalls ranged between €10,000 and almost €23,000 per annum.

Why investors need to consider a multi-asset approach to income
With yields from traditional sources of income falling, and with risk rising, investors need to maximise their opportunities and diversify.

Single asset class risks have increased
Previously, the level of risk was directly related to the yield provided by any particular asset class. In other words, higher-yielding assets carried more risk and lower-yield assets less. However, the current economic background is vulnerable to shocks and any single asset class is likely to suffer from a higher level of systemic risk. This makes diversification more important than ever.

Widen the opportunity set
A multi-asset approach delivers an improved risk/return trade off in comparison to holding each asset class on its own.

It can take advantage of a wider range of income-generating asset classes – not just the traditional government bonds or money market instruments. This includes higher yielding equities, infrastructure, and different types of bonds, such as investment grade and high yield debt, emerging market debt and municipal debt, from all around the world.

… with an unconstrained approach
A benchmark-unconstrained approach means taking advantage of yield opportunities in whichever region or sector they arise – without having to ‘hug’ a given multi-asset benchmark.

It is possible to construct a multi-asset portfolio yielding in excess of 5% – providing that you are unconstrained in terms of asset allocation and use a non market-cap approach to security weighting.
A global and unconstrained framework is required to open more doors to hidden opportunities. Even in low-yielding markets it is possible to find high-yielding securities. By reducing constraints investors can capture income more safely.

… focusing on quality
It is important not to chase the highest yields, but look for income that is sustainable. What matters for investors is not only the promise of a future yield but the associated probability of default on the payment of a coupon or of a dividend cut.

Through a disciplined risk management process
One way of managing risk is to ensure that the portfolio is diversified and not overly-concentrated in companies, industries, currencies, countries or asset classes.

In today’s market, high dividend companies tend to be concentrated in sectors such as telecoms or financials, or in some countries like Australia and the UK.

Sometimes diversification is not enough and you need to be able dynamically to hedge unwanted sources of risk. This can include hedging duration (the risk that interest rates go up) and equity market risk.

The evolution of downside risk management techniques and derivative instruments enables the astute investor to have access to the required income while aiming at a lower level of volatility than is typically the case when investing in a single higher-yielding asset class.

In conclusion
Income investing is not new. What is new are the challenges faced by investors in creating a portfolio with the right level both of income and risk in this low yield, low growth, more uncertain world.
And yet the demand for incomegenerating asset classes and solutions is increasing all the time.

Investors are aware that with low returns from cash in many markets the only chance to achieve their objectives is to take more risk but that this increases the probability of capital erosion. This is why managing risk and avoiding drawdowns is as important as finding income.

We believe that the best strategy to achieve a positive real return and a high income is to combine unconstrained security selection focused on sustainable yield with a strong dynamic risk management focused on diversification and capital preservation.