Current decline near end, going by past downturns

Teh Hooi Ling
3 Feb 2019

Average duration, market bottom valuation of previous slumps close to those of ongoing dip

Cash outperformed equities last year. It is not uncommon for investors to start doubting the wisdom of staying invested in equities after a prolonged market downturn.

As of December last year, the downturn we faced had lasted for 11 months. How long do stock market retreats generally last in Asia?

Let's look at the MSCI Asia Pacific ex-Japan Index starting from 1987 to get some clues. Over the last 30 years or so, there were seven major market declines, including the one last year. From this perspective, negative market returns are not so uncommon - one every 51 months, or one every 4.25 years.

This is in fact how markets work. When the going is good, investors bid up prices. A lot of news will be seen as positive for the markets. Prices will eventually rise to a level that is not backed by fundamentals.

It is usually at this time that unexpected news or development will trigger a fall. Investors with profits will start to take their money off the table, exacerbating the decline. More news will emerge to compound the bearish sentiments.

Just as prices overshoot on the way up, they too tend to overshoot on the way down. However, at some point, the market will realise that stock prices have fallen to too low a level vis-a-vis prices in the actual physical marketplace and the stock market will start to recover. And the cycle goes on.

The table shows the downturns - their severity, duration, valuation at the time of decline, when they hit bottom, and the subsequent recovery. The table is arranged based on the severity of the market drawdown.

There are a few points to note from the table.

One, the higher the market valuations, the more severe the decline.

The three most stomach-churning declines over the last 30 years happened in October 2007 (global financial crisis), July 1997 (Asian financial crisis) and December 1999 (bursting of dot.com bubble).

In the global financial crisis, the market plunged by 62 per cent. For the Asian crisis, it fell by 57 per cent, and for the dot.com bubble burst, by 46 per cent. Of the three, market valuation was the highest in October 2007, just before signs of cracks started to emerge in the sub-prime housing markets in the United States.

At that time, the stock prices of the major index stocks in Asia were trading at 3.5 times the value of their net tangible assets, and three times the value of all their assets, including intangibles like goodwill or brand names.

Just as prices overshoot on the way up, they too tend to overshoot on the way down. However, at some point, the market will realise that stock prices have fallen to too low a level vis-a-vis prices in the actual physical marketplace and the stock market will start to recover. And the cycle goes on.

Say, a company owns a building valued at $100 million, and it has cash, inventory and other assets worth another $50 million. However, it has bank borrowings and other liabilities totalling $50 million. Thus its net assets amount to $100 million.

In October 2007, such a company was valued at $350 million, that is, 3.5 times its net tangible assets or book value. Assume again that this company has $17 million of goodwill, which is an intangible asset, on its books.

This company's total net book value would be $117 million. Since it is valued at $350 million on the stock market, its shares are trading at three times its book value ($350 million/$117 million).

Various studies have shown that stock price compared to a company's book value is a good indicator of value. Stocks that are trading at prices significantly higher than the book value are deemed expensive, and generally yield low returns for investors, and vice versa.

The price-to-book value or PB multiples for the other two market peaks in July 1997 and in December 1999 were 2 times and 2.1 times respectively. In other words, investors were paying $2 for companies with assets valued at $1.

Meanwhile, for the remaining four market peaks - in April 2015, April 2011, May 2002 and January 2018 - the PB multiples then were slightly lower, ranging from 1.6 to 1.8 times. Because they fell from a lower peak, the declines were also less drastic - at an average of about 22 per cent.

The second point to note from the table is that in each of the previous six downturns, the bottom was established when the PB hit one to 1.5 times, with the average being 1.3 times.

The third point is, downturns can last from as short as five months, to as long as 21 months, from December 1999 to September 2001. The long bear market in 1999 till 2001 was slightly unusual in that it endured two major jolts - the bursting of the dot.com bubble and the Sept 11 terrorist attacks in the US. The average duration of the previous six market declines, excluding the one last year, is 13 months.

The fourth point to note is that the higher the market valuation when the crash happened, the longer it takes for the market to revisit the last peak.

For the global and Asian financial crises and the dot.com bubble burst, the market took an average of 72 months or six years to recoup all the losses. For the other three declines from less lofty heights, the recovery time was about 20 months, or just over 11/2 years.

Fifth, market downturns or crash to the bottom on average took less than a third the time the market took to recover to the pre-crash level.

In other words, it took an average 3.5 times as long for the market to regain its previous peak than the time it took to plunge from peak to trough. This again attests to the saying that markets take the lift down, but take the escalator up.

Finally, the last but not the least point to note is: Returns after a market crash, from levels when PB is between 1 and 1.5 times, are sumptuous. The average is 79 per cent. But if we take the downturns that are more similar to what we are going through now, the average returns from the bottom is 28 per cent over the next 11 months.

Can the study of the past downturns suggest to us a road map on what to expect for the current market decline we are experiencing?

Well, if past cycles are anything to go by, we should be nearing the bottom of the current decline. We have experienced 11 months of the markets going south.

The average for the past six downturns was 13 months. The market PB as of end-December last year was 1.4 times. The average market bottom valuation in the previous six downturns was 1.3 times. If indeed we hit bottom soon, then the returns from current levels could be quite attractive.

• The writer is the portfolio manager of a no-management fee fund, Inclusif Value Fund (www.inclusif.com.sg).

Bide your time until a crash to enter market?

Studies show there is a cost to waiting and a buy-and-hold strategy mostly fares better

Teh Hooi Ling
PUBLISHED FEB 11, 2018, 5:00 AM SGT

The long-awaited market correction finally came last week. The question we'll try to answer is: Would investors have done better waiting for a dip or a crash before entering the market, especially when prices are deemed high; or are you better off deploying your money into the market as soon as you have it?

Consider this friend of mine who, back in late 2013, said to me: "I'm staying out of the market. A crash is coming! I can feel it in my bones!"

In the four years till the end of last year, the Dow Jones Industrial Average had gone up by 58 per cent. With dividends reinvested, it's a whopping 74 per cent in Singapore dollar terms. The Singapore market had done more modestly - at 7 per cent in that time, or a more decent 23 per cent with dividends reinvested.


In contrast, there's another friend who knew of someone who said he would jump into the market only when there is a crash. He would then cash out when the market recovered. Most of the time, he'd be sitting on cash waiting for the next big crash to come. According to him, he hadn't done too badly for himself.

To find the answer, we at Inclusif did a study.

WAITING FOR A CRASH DOESN'T PAY
We looked back over the past 30 years in the Straits Times Index (STI). We came up with eight trading strategies. Each strategy has a combination of buy and sell triggers. The buy triggers range from a 10 per cent to 25 per cent market correction, and the sell triggers range from a recovery of 20 per cent to 50 per cent from the point of entry.


During the 30-year period, the STI - with dividends reinvested - yielded a 7.9 per cent compounded annual return.

Of the eight strategies, only one outperformed the buy-and-hold strategy, and only marginally at that. The strategy of buying after a 20 per cent market correction from the preceding nine-month peak, and selling after a 50 per cent increase from that entry level generated a return of 8.2 per cent per annum over the last 30 years. The rest of the seven strategies underperformed the strategy of being fully invested in the market throughout the whole 30 years. Monthly data is used for this study.

Hence the conclusion is: Waiting for a correction before entering the market mostly fared worse than a buy-and-hold strategy.

Below are our observations from the study:

• The buy and sell thresholds are arbitrarily set and have no bearings on the fundamentals of the market. Each cycle may be different and results may differ slightly if, say, daily or weekly data is used;

• But generally, if you define the crash threshold too loosely (say, a drop of 10 per cent), you are likely to suffer further drawdowns - that is, the market is likely to continue to decline, after you enter the market;

• If you define the crash threshold too stringently (say, a drop of 25 per cent), you stay out of the markets for the most part, which is bad because long-run equity returns are positive. This is what happened in Plan F. The correction in 2015/2016 did not hit 25 per cent, so the buy threshold was not reached. As a result, that portfolio has stayed in cash since May 2013. Consequently, it missed out on a total return of 12.5 per cent from then until the end of last year.

• If you define the recovery threshold too loosely (say, up 20 per cent), you exit the equities market too quickly, which is bad because long-run equity returns are positive.

• If you define the recovery threshold too stringently (say, up 50 per cent), you pretty much get returns that are quite similar to a buy-and-hold strategy, since you will stay invested for a long time once you enter.


THERE IS A COST TO WAITING
Recently, we came across a study which drew the same conclusion - that it does not pay to wait for a stock market correction.

The research, done by Elm Partners, a London-based asset management firm, tried to find out: At times when the market has been expensive, what has been the average cost or benefit of waiting for a correction of 10 per cent from the starting price level before entering the market, rather than investing right away?

It used US market data over the past 115 years and defined expensive as times when the stock market had a cyclically adjusted price-earnings ratio or CAPE that was more than one standard deviation above its historical average level. The waiting period is three years.

They found that:

• From a given expensive starting point, there was a 56 per cent probability that the market had a 10 per cent correction within three years, waiting for which would result in about a 10 per cent return benefit versus having invested right away.

• However, in the 44 per cent of cases where the correction doesn't happen, there's an average opportunity cost of about 30 per cent - much higher than the average benefit.

• Putting these together, the mean expected cost of waiting for a correction was about 8 per cent versus investing right away.

Put in simpler terms, it means that while we may reasonably expect a correction to happen some time in the future, we don't know when for sure. When the correction doesn't happen for some time, some investors may get pushed to invest at higher prices. And when the correction finally happens, it may be from a significantly higher level from today. The after-correction level could still be higher than the level today, in which case, investors would have missed out on that return.

It is well documented that we humans tend to underestimate opportunity costs relative to realised costs. As with my friend at the beginning of this article, he would have suffered significant opportunity cost had he stayed out of the market for the past four years or so.

Elm Partners then did a sensitivity analysis, allowing the entry levels to range from 1 per cent correction onwards to 10 per cent, and reducing the waiting time to one year and increasing it up to five years.

What they found was that across all scenarios, there has been a material cost to waiting. The longer the horizon that an investor has been willing to wait for the correction to occur, or the bigger the correction for which they are waiting, the higher the average cost.

CONCLUSION
If you believe the stock market has a negative expected return to a particular horizon, then waiting for a correction to invest makes sense, said Elm Partners.

However, at least as far as the historical record for the US stock market goes, and quite similarly for other markets, higher market valuations are consistent with lower prospective long-term returns, but not negative expected returns.

• The writer is the portfolio manager of Inclusif Value Fund, a no-management-fee Asia-Pacific value fund (www.inclusif.com.sg).

Putting retirement savings in equities pays off in long run

Teh Hooi Ling
Mar 6, 2016, 5:00 am SGT

By stretching out investment period and making small withdrawals, impact of market volatility is greatly reduced

With the stock markets being so volatile in the past six months or so, people who have their retirement savings in equities must be going through an anxious period.

The most common piece of advice financial advisers have for individuals is to start saving when they are young, and to let the savings compound with time.

With interest rates being so low, putting one's money in fixed deposits is a very inefficient way of achieving the compounding effect. Consider this: It takes 72 years to double your savings from say, $100,000 to $200,000 at an interest rate of 1 per cent a year.

 However, if you can find a way to grow your money at 10 per cent a year, your $100,000 would grow to $200,000 in less than eight years. In 24 years, your $100,000 would have grown to some $1 million. That's the magic of compounding.

One way of letting the money compound at a faster rate is via the stock market. However, this route entails significant volatility, as we have witnessed in the last six months and in various episodes in the past, for example, during the global financial crisis, the Sars epidemic and the Asian financial crisis, to name just three.

Now, let's take a look at how market volatility impacts one's retirement savings. Let's assume that the analysis is done using the Straits Times Index (STI), with dividends reinvested. No transaction costs are taken into consideration.

Let's say the retirement savings plan entails putting $10,000 each quarter into the STI for 20 years, with dividends reinvested.

That's $40,000 a year over 20 years. So the principal amounts to $800,000.

The good news is, over a 20-year period, every single person who has consistently put money into the stock market quarterly would have managed to have a pot which is bigger than the capital put in. Most people would end up with a retirement sum of $1.95 million - double the principal they put in.

The not-so-good news is, depending on when one starts investing in the market and when one retires, the outcome at the end of 20 years can vary significantly. It can mean a difference as large as $1.6 million.

The lucky person, let's call her Jane, who started investing, say in the third quarter of 1987, would have had a pot of $2.7 million after her retirement as at the third quarter of 2007. That was the peak of the market just before the global financial crisis.

However, the person who joined the workforce just four years earlier and started investing in the first quarter of 1983, let's call her Mary, would end up with a retirement pot of just $1.1 million as at the first quarter of 2003. That was when the Singapore market was depressed from fears of the Sars epidemic.

SEQUENCE RISK IN RETIREMENT SAVINGS

This is called sequence risk. A saver may earn a different sequence of returns during the accumulation phase and that made a world of difference to the final outcome. In Mary's case, even though she got good returns early in her savings plan, she suffered bad returns near her retirement, when her account balance was higher. Jane, however, was lucky to have caught the bull run from 2004 till 2007.

Here is how the two retirement savings plans grew over time.

Mary would have got very miserable returns for her 20 years of diligent saving had she withdrawn all her money as soon as she retired.

However, if she left the bulk of the money in the market, and took out just 5 per cent, or $55,000, to fund her living expenses that year, and continued to take out just 5 per cent of the portfolio value every year since, her portfolio as of today would be worth much more.

Between 2003 and 2015, Mary would have taken out $1.5 million to spend, and as at Feb 29 this year, her portfolio would be worth $2.1 million. Mind you, this is valued based on rather depressed pricing for the STI currently.

As for Jane, she would have done better had she taken out her entire retirement pot at the peak of the market. But she had to have the courage to reinvest the entire pool back when the market corrected. Had she not, she would most likely be worse off in a few years' time.

Let's assume she had taken out her total pool of $2.7 million and put all the money in a fixed deposit that yielded her 1 per cent a year from 2007 until now, and that she took out 5 per cent from her pool every year. By now, she would have taken out $1.07 million and her pool would be $1.77 million.

The amount she is withdrawing reduces by the year as her pool shrinks since her interest is not compounding as fast as her 5 per cent withdrawal every year.

In comparison, had Jane left the money in the market as Mary had done, she would have taken out a slightly smaller sum of $969,000 between 2007 and now, and her portfolio is worth $1.69 million as at Feb 29 this year.

Again, market valuations as of now are pretty depressed and there is a very high chance that they will recover.

Notice also that Mary's retirement pot today is larger than Jane's. Starting early does pay.

To recap, for retirement savings, end-of-period market valuation makes a difference if one decides to withdraw the entire sum at that point. It is less decisive if it is a piecemeal redemption.

And for a plan of constant investment over a 20-year period, the starting market valuation doesn't really make a big difference either.

The takeaway is: Stretching out the investment period and making piecemeal redemptions take the stress out of managing one's retirement fund and one will not be held ransom emotionally and psychologically to market gyrations.

That is from the comfort of knowing that one will never run out of money with 5 per cent redemptions a year from a pool invested in a basket of productive and decently priced companies. So one can tune out the market noise.

•The writer is a partner in Aggregate Asset Management, manager of a no-management-fee Asia value fund, and author of Show Me The Money - Fighting Paralysis In A Market Meltdown.

Fighting paralysis in a market meltdown

Having an anchor on where asset prices should be gives us the conviction to fight in face of fear

Teh Hooi Ling
FEB 21, 2016, 5:00 AM SGT

Back during the dark days of the Asian financial crisis, the sell-down of the Straits Times Index (STI) and other regional bourses was relentless. Investors watched in horror as the value of their portfolios got smaller and smaller with each passing day.

When the STI hit 800 points on Sept 4, 1998 - from 1,700 just six months earlier - a panic-stricken remisier went up to his head of equities research, and said: "Oh no! We have only eight days to go before we hit zero!"

The logic was that, if the STI continued to fall by 100 points a day, there would be only eight days left for the market.

It sounds funny now when the story is recounted. But at that time, that was a very real fear of investors and market participants alike. The numbers on the screens represented one's wealth. Every point of decline in the index would translate into a loss in the value of one's portfolio.

The thing is, when we are too absorbed in the violent market actions of the day, we lose sight of reality. If we were to step back and view the market with a cool head, we would realise that there was no way the stock market would hit zero. Why?

One, the stock market represents real businesses with real assets. It represents the real economy. The stock you own gives you a stake in a company that makes money by selling a service or a product. Even if it is not profitable, it still owns assets like buildings and machinery which have a value and a price in the real marketplace. If one can buy the shares of a listed company that owns a drinks bottling plant at half the price of building one, nobody would build a new plant. Those with money would just buy up the existing plants via the stock market.

This will drive up the stock prices of drinks factories. When the stock prices rise to such a level that it may be cheaper to build a new plant, a new set of entrepreneurs will come in to build new plants. This will mark the end of the "up" cycle in the stock prices of drinks factories.

Given that the companies in the STI own a substantial amount of assets in Singapore and derive a significant sum of their income from Singapore which itself is a very open economy, it may be instructive to peg the movements of the STI to the GDP to get a sense of where the stock index should be.
Similarly, stock market prices cannot go so high as to defy market realities. Say, you can install fibre-optic cables for just $1 but you can sell the completed network to investors in the stock market for a whopping $10. On that basis, you could guarantee that many people would want to do that.

This would result in overbuilding and prices for the use of fibre-optic cables would plunge. And when listed companies that own these networks cannot make money, their stock prices would fall. This was exactly what happened in 2001 and 2002.

Two, the productive capacity of the economy (or the company) comes from the skills and size of the workforce and the country's (or the company's) accumulated intellectual and physical capital.

"If gross domestic product (GDP) were to fall by 5 per cent, it would not be because our ability to produce goods and services had fallen by 5 per cent, but because aggregate demand for those goods and services had fallen. When the demand returns, the economy will be able to ramp up production quite quickly," Mr Ben Inker, asset management firm GMO's director of asset allocation, wrote in a paper entitled Valuing Equities In Economic Crisis.

The Great Depression caused the United States' GDP to fall by 25 per cent from 1929 to 1933. But that fall, as extraordinary as it was, was a fall in demand relative to potential GDP. It was not a fall in the economy's productive capacity. The economy eventually got back to its previous growth trend as if the depression had never happened.

Equities are long-duration assets - that is, they are valued based on the assumption that they will generate perpetual streams of income. So even if the economy is going to be horrible for the next five years and dividends are going to be cut by 50 per cent, the present value of the stock theoretically should be reduced by 5 per cent. A 10-year slump would wipe out only 10 per cent of the stock's value.

"To us, the true value of the stock market changes very slowly and smoothly. It is the myopia of investors that causes market prices to vary so wildly," he wrote.

Of course, demand for a company's product or service may never come back after a slump if it can no longer produce things that the market wants, or at a price that the customers are willing to pay. Still, it would own assets like buildings and factories that another competitor may find value in.

There is one drastic scenario where demand would fall significantly and large swathes of industries would be affected - that would be a near complete destruction of the earth with more than half of the world's population being wiped out.

Barring the above scenario, the economic activities of the human race are unlikely to cease.

Where is the bottom for STI?

The markets all over the world have been in turmoil since the start of 2016. It's partly a continuation of the episode we had in August last year, plus renewed fears of a global slowdown in demand and the helplessness of central banks and governments to do anything about it.

As investors are gripped by fear and horror watching the daily meltdown in the local market, it is timely to be reminded of the two points above: that companies own real assets and that the productive capacity of the economy (the company) comes from the skills and size of the workforce and the country's (company's) accumulated intellectual and physical capital.

Given that the companies in the STI own a substantial amount of assets in Singapore and derive a significant sum of their income from Singapore which itself is a very open economy, it may be instructive to peg the movements of the STI to the GDP to get a sense of where the stock index should be.

Let us examine this relationship by setting the STI at 100 points when the market was at its lowest during the Asian financial crisis in the second quarter of 1998. That was crisis-level valuation. We also set the Singapore GDP at 100 points from then onwards. We then track how the two have moved since.

The GDP seems to act as the floor for stock prices. From 2000 to 2003, three major negative events - the burst of the dot.com bubble, the terrorists attacks in the US, followed by the Sars outbreak - halved the value of STI stocks from its peak in end 1999 to a level just 17 per cent above the Asian financial crisis. From 1998 until 2003, GDP grew by about 11 per cent, and the stock prices did not go below the support provided by the GDP.

During the global financial crisis, prices did go slightly below the GDP support, but the rebound came soon after.

Given the level of Singapore's GDP today, the crisis valuation for the STI based on this simple relationship is 2,510 points. If the GDP were to fall by 5 per cent, the crisis- level valuation for the STI is 2,355 points. Admittedly, we are not facing a systemic crisis like that of the Asian financial crisis or the global financial crisis - at least for now.

Having an anchor on where asset prices should be gives us the conviction to fight against our paralysis in the face of fear.

•The writer is a partner in Aggregate Asset Management, manager of a no-management-fee Asia value fund, and author of Show Me The Money - Fighting Paralysis In A Market Meltdown.

The mathematics of how money grows

Rule of 72 - the doubling effect

'Rules of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to double.

For example, the rule of 72 states that $1 invested at 10% will take 7.2 years (72/10=7.2) to grow to $2.


$100K@3%                                > $200K
Bonds/Unit trusts @3-5% p.a. > 24 years


$100K@6%                                                     > $200K > $400K
Index funds/ETFs/Blue chips @ 6-7% p.a.       > 12 years > 24 years


$100K@12%                                               > $200K  > $400K    > $800K    > $1,600K
A basket of value stocks@ 10-12% p.a.        > 6 years > 12 years  > 18 years  > 24 years


By the way, Fixed Deposits will take 72 years to double at 1% interest.

-------------------

Hard facts
Every $200,000 will grow to $800,000 in 12 years' time at 12% compounded yearly.
$800,000 will give you $40,000 yearly retirement income @5% withdrawal rate.
That will be $3,333 a month of lifetime income.
You will not outlive your money and you can still leave an estate for your loved ones.

Key Questions
At what rate is your portfolio currently growing?
Is 10% per annum achievable?

Find the answers at
www.aggregate.com.sg


Studies done by Teh Hooi Ling show that buying a basket of value stocks, based on metrics like dividend yield, price-earnings and price-to-book ratios, can deliver returns upwards of 10% p.a.


Teh Hooi Ling, CFA
Head of Research, Executive Director

How to win at a winning game

Published on Apr 20, 2014


Consistently invest in diversified stocks, don't bail out in bad times, minimise cost

By Teh Hooi Ling

It is a fact. A lot of novice investors in equities ended up losing money.

Consider the track record of Mr Peter Lynch who managed Fidelity's Magellan Fund from 1977 to 1990. He beat the S&P 500 Index in all but two of those years and averaged returns of 29 per cent a year.

That's mind-blowing. It means that $1 grew to more than $27. Had you invested as little as $37,000 with him in 1977, you would have been a millionaire in 1990.

You would imagine that most of the investors who put money in the fund would have made money. But guess what? Mr Lynch himself once said that he believed more than half the unitholders in his fund had lost money. It depended on when they had bought and sold Magellan.

Mr Martin Zweig, a market analyst and investment manager, commissioned Morningstar, the mutual fund research organisation, to track the cash flows in and out of the leading growth funds in the United States in the 1990s.

The contrast between the returns of the investments themselves and the returns of the investors was absolutely breathtaking: The 219 growth funds averaged an annual compounded return of +12.5 per cent for the five years ended June 1994.

But, the investors did much worse. They apparently didn't make any money at all; instead, they lost 2.2 per cent a year with the same group of growth funds!

Both of these findings point to the same conclusion, that is: As a group, investors do a rather poor job of deciding when to buy or sell their investment funds.

The chart on top shows the movement of the Dow Jones Industrial Average (Dow) in the US in the past 10 years. A typical inexperienced investor will probably behave as follows:

July 2005:The market has been quite steady and trending up for the past 21/2
years. All the market experts are saying that prices will continue to go up. OK, I'll invest $10,000 to test the water first.

April 2006: The $10,000 that I invested is now worth $10,816. That's a return of more than 8 per cent in one year. Not bad. Market looks firm. I think I'll invest another $50,000.

May 2007: My capital of $60,000 invested so far is worth $71,682. Wow, this definitely beats leaving my cash in the bank. OK, I'll transfer another $100,000 from my fixed deposit and invest in the market.

January 2008: What's all this news about the sub-prime market? Market is choppy. But it's OK, these investments are for the long term.

January 2009: Oh no! There doesn't seem to be a bottom to the market. Now people are talking about the possibility of another Great Depression. During the Great Depression, the Dow fell from a high of 386.17 on Sept 3, 1929 to a low of 40.56 on July 8, 1932. That's a plunge of some 90 per cent. The market did not recover to the 1929 levels until 1954, some 25 years later! Now my portfolio is down by about 35 per cent only. I'd better take out what I have left.

So the investor exited the market in early February 2009, and got back $103,730 of the original $160,000 invested. As it turned out, the investor withdrew his money near the bottom of the market. Just over a month later, in the second week of March 2009, the market hit bottom, and stock prices rebounded sharply from there.

If the investor had stayed invested and held on to his shares, his $160,000 would have been worth $211,308 as at March 1 this year. All the numbers above exclude transaction costs and dividends received.

Because of this emotional tug of war between greed and fear, many investors effectively manage to lose at a winning game.

So how exactly do we ensure that we win at this winning game?

First, understand that when you invest in a diversified basket of stocks, you are investing in a slice of the economy. As long as we need to buy and sell things - there is no question about this here because we can't possibly produce all the things we need ourselves - then there will always be a value to productive companies.

Second, don't exit the market when everyone else is rushing for the exit. Then, you will not get a fair value for the businesses that you own.

Third, all the more you should buy when you see businesses going on sale at a cheap price.

Now, let's see how someone would have done if he had kept investing in the stock market through the Great Depression. We know that the Great Depression was the worst period the stock market had ever gone through in history - it was many times worse than the recent global financial crisis and the Asian financial crisis. We know that the Dow lost a whopping 90 per cent of its value in the three years between 1929 and 1932 and it didn't climb back to its 1929 level until some 25 years later.

Did an investor who put money into the market during that period see zero or even negative return?

The chart at the bottom shows an investor, let's call her Mary, who started investing in the US market in early 1926. She put in $100 into the market every year. Her investment did well in the first four years. Then the crash of October 1929 happened, to be followed by the Great Depression. Mary watched in horror as her hard-earned savings shrank by the day. But she kept faith. She believed in the continued functioning of the modern economy. As long as companies are allowed to produce what people want and need, they will make money, and the stocks she has invested in will have a value, she told herself. So she kept investing $100 into the market every year.

By the end of 1950, Mary would have put $2,500 into the market. Her portfolio value as at December 1950 was $4,239. This, despite the Dow still being 38 per cent below its September 1929 peak.

Mary managed to grow her capital by 4 per cent a year by consistently putting money into the stock market even through the worst of times. She managed to beat the inflation rate of 1.3 per cent during that 25-year period. In other words, she generated for herself a real return of 2.7 per cent a year in the most adverse of situations.

So, to recap, the secret to winning in a winning game is:
One, consistently invest in a diversified basket of stocks that represents the real economy - especially when prices are cheap. (Some Asian markets are still relatively weak vis-a-vis the US market now. So it may not be a bad time to put some money into those markets.)

Two, don't bail out at the worst of times. All the more, if you can afford it, put in more money at the most depressed of market conditions.

Three, try to minimise your cost as much as possible when getting your equity exposure.

Keeping to these three golden rules will ensure that your savings will grow faster than inflation, and that you will tremendously increase your odds of meeting your financial goals.

stinvest@sph.com.sg

The author, a CFA charterholder, is head of research in no-management fee value fund manager Aggregate Asset Management.

It's safe to invest entire life savings in stocks

 Stress test shows that retirees need not park more of their funds in bonds and cash

By Teh Hooi Ling

Most statements in life, when repeated often enough, will be taken as the indisputable truth, especially so if our general, everyday observations sort of suggest that the statements are right.
Few will stop to question their validity; what are the assumptions embedded in those statements, who made those statements and to what purpose, and have robust tests been done to verify claims made in those statements?

In the field of finance, one tenet which is often purveyed is that of life-cycle investing.

The theory goes that young people should be more aggressive in their investments, namely that they should allocate a higher proportion of their portfolios to equities for the long-term compounding effect to take place.

But when they approach retirement age, they should cut their exposure to equities and hold more of their portfolios in bonds and cash.

This makes intuitive sense: Equity prices are more volatile than fixed-income instruments and, unlike the latter, there is no assurance of regular payouts from equities.

Therefore, it would be "safer" for retirees, who are dependent on their life savings for their daily expenses, to park their money in a less volatile portfolio.

What if a retiree had her entire life savings in equities, and saw her portfolio diminish to less than half during the global financial crisis in 2008? That would be a nightmare scenario, wouldn't it?
But here's the thing: The image of this scenario is likely to be most vivid when the stock market crash is at its worst.

At that point, we see in our minds retirees with their wealth halved compared with the pre-crisis level. "Poor things!" we'd think. "That's why retirees shouldn't put all their nest eggs in the stock market."
But you know what? Markets recover, even from the worst of crises.

As long as retirees don't panic and cash out their entire portfolios at the bottom of the market, there is a good chance that they will see their portfolios recover.

We did a stress test on an all-equities portfolio at each of the previous market peaks in the Singapore market going as far back as 1973.

Let's assume that there were seven retirees.

Each retired with $1 million and decided to put the entire sum into the stock market.

The bull markets at the time of their retirement gave them confidence that the stock market was a good place to keep their savings.

So each of them plonked their $1 million into the market at the beginning of 1973, 1982, 1984, 1990, 1997, 2000 and 2008.

And each wanted to withdraw 5per cent from that $1 million, or $50,000 a year, to pay for their living expenses.

As it turned out, the years that the seven retirees put their money into the market were the years of market peaks. Soon after, major crashes or market corrections took place.

Could the $1 million equities portfolio have lasted them until today?

Well, six out of the seven portfolios did.

The initial $1 million portfolios were worth between $824,000 and $3.4 million as of the end of last year, with one exception.

For the person who retired in 1982 with $1 million invested entirely in the Singapore stock market, her portfolio as of the end of last year was worth $3.4 million.

This was after she withdrew $50,000 a year from the portfolio for the last 31 years. The withdrawal amounted to $1.55 million in all.

For the person who retired on the eve of the Asian financial crisis, her portfolio as of the end of last year was worth $1.6 million. And in the intervening years, she had taken out $800,000 from her portfolio as spending money.

From the table above, you can see that the two who retired on the eve of the two most recent market crashes - the dotcom bubble burst in 2000 and the global financial crisis in 2008 - still had $824,000 and $842,000 in their portfolios respectively.

At a 5 per cent withdrawal rate, the lowest the six retirees' portfolios ever fell to was $429,000. That was for the person who retired at the peak of the dotcom bubble.

But as long as there is still money in the market, there is a chance of recovery.

The only retiree whose portfolio didn't survive was the one who put her money into the market during the massive 1973 bubble in the local market.

At that time, according to Thomson Datastream, the Singapore index was trading at a price-earnings ratio of 35 times. It was the time when OCBC was trading at $50 a share and Metro was at $26.

In other words, there was a massive bubble in the Singapore market.

At a 5 per cent withdrawal rate, her money was depleted by 1984. But if she had reduced her withdrawal rate to 3 per cent - taken out $30,000 instead of $50,000 a year to spend - she would have survived the numerous crashes that followed and would still have an equities portfolio of $1.6 million as of the end of last year.

For the above calculations, we used the Thomson Datastream calculated Straits Times Index as a proxy for how an all-equities portfolio would have performed.

Dividends were added to the portfolio. No transaction costs were taken into account. The portfolios were valued once a year on Dec 31 and withdrawals were done on that day as well.

So what are the main takeaways from the study?

It's that the chances of an all-equities portfolio being completely wiped out at a withdrawal rate of 5per cent a year are minimal under normal market conditions.

The exception is when someone buys into the market at the peak of a massive bubble, as was the case in 1973.

Readers who would like to stress-test their retirement funds over various cycles in the US going as far back as 1871 can check out the website www.firecalc.com

Another noteworthy point is that as long as the portfolio is not too decimated and as long as the money stays invested in the market, there is a good chance of recovery, given time.

Admittedly, the ride can be quite rough at times. The portfolio can plunge by half in a year. The key is to hang on tight.

So the upshot is that someone who has $1 million can relatively safely withdraw $50,000 a year to fund his retirement for as long as he lives, and yet still leave an estate for his children if he puts the entire sum in the equities market.

Time to say goodbye to perpetuals, annuities and bonds, which usually form the core of a retirement portfolio.

But there is one very important caveat here. The equities portfolio must be made up of a diversified basket of stocks of real businesses and purchased at a price which is unlikely to result in a significant permanent loss of capital to the investor.

Buying into stocks such as Blumont, Asiasons or LionGold, whose business prospects are uncertain, and at overvalued prices, is a sure-fire way for you to outlive that $1 million in the shortest possible time.

The writer, a CFA charterholder, is head of research at Aggregate Asset Management, manager of a no-management-fee value fund.

Time the market based on valuations

Those entering market at current levels have good chance of earning satisfactory returns over next 5 years

By Teh Hooi Ling

One of the shrewdest and longest lasting market strategists on Wall Street, Mr Jeremy Grantham, has a bone to pick with some value investors who contend that bubbles and busts can be ignored. You don't have to deal with that kind of thing, they argue, you just keep your nose to the grindstone of stock-picking, said the founding partner of GMO who prides himself and his team as global bubble spotters. These value investors feel that there is something faintly speculative and undesirable about recognising bubbles.

The fact is, the mantra of staying invested, of not timing the market, is not the exclusive purview of value managers. That's the investment adage that most fund managers preach to the retail investors as well. In fact, in The Sunday Times Invest pages recently, the headline for one story is exactly this: "Don't try to time the market, says expert".

There are lots of merits to the "don't time the market" advice. The thing is, the average retail investor tries to time the market based on news flows, or the price movements of the market.

Will the US Federal Reserve start tapering next month? Is that company going to win that lucrative contract? Is there going to be a reverse takeover of this stock? I will only buy when I can discern a clear uptrend momentum, some say.

Let me tell you this. The chances of getting the timing of your stock purchases or sales correct based on news flow and price movements are not good. There are bigger players who can react faster to the news, more sophisticated investors with better access to the news, or can analyse the situations better although I won't place my bets on anyone being able to consistently do that. The modern economy is infinitely complex. And funds are flowing so quickly around the world that an uptrend can easily turn into a downtrend the next day. These are but market noise.

What Mr Grantham refers to in terms of spotting bubbles relates to recognising when markets are overvalued, or conversely, when it is undervalued. Bubbles happen because of investors' euphoria and greed, and the fear of career risks by people in the financial sector.

As the former chairman and CEO of Citigroup, Mr Chuck Prince, famously said: "As long as the music is playing, you've got to get up and dance." Such behaviours will bring market valuations to extreme levels in either directions.

But there is a central truth to the stock market: Underneath it all, there is an economic reality. There is arbitrage around the replacement cost. And the price of an asset has to be justified by the earnings that it can generate.

Say because of a bull market, the shares of a company that owns a factory are now worth $100 million. If somebody can build a similar factory with the same production capacity at $50 million, that somebody is going to do it.

The $100 million factory is going to face competition from the $50 million new factory, and its earnings will be affected. Shareholders, who bought the shares of the $100 million factory, will not see the return they expected when they bought their shares.

They will be disappointed, and they will sell the shares leading to a decline in the share price. The result could be that the $100 million company now has a market value of $60 million.

Now, let's say a third tycoon comes to town. Building and material costs have not risen. He discovers that he can build another factory also at a cost of $50 million. He does that and now there is even more competition in the market. The first factory may not be able to compete with the new factories, and it starts to make losses. Investors sell down its shares even more. Now the factory which used to have a market value of $100 million is worth only $30 million.

The owner of the second factory is thinking of expanding his capacity because he is able to capture an increasing market share due to better branding. But to build a new factory, it will now cost him $70 million because land cost has risen. He sees that his old competitor's factory is selling for only $30 million. He figures that he can buy that factory, upgrade it at a cost of $10 million, and it will be as good as new. So he offers to buy the first factory at $40 million. After the upgrading costs, he still gets the factory at a cheaper price than if he were to build a new factory from ground up.

So there you have it. Stock prices can't be so high that they are detached from market reality. Neither will they stay cheap for long if they are trading below the replacement cost of the assets they are holding.

Consider the price of the Singapore market, relative to the 10-year average of its earnings per share, as calculated by Thomson Datastream. This is measured by the so-called Graham and Dodd price-earnings (PE) ratio.

In the past 30 years, the highest the market price has gone up to was 33.5 times its 10-year average earnings. That was in August 1987 just before the October 1987 Black Monday crash. The lowest the market has plunged to was 10.3 times its 10-year average earnings. That was in February 2009, the darkest point of the recent global financial crisis.

In the past 30 years, when the Graham and Dodd PE fell below 16 times, the returns of the three portfolios five years later tended to be substantial.

They averaged 15.2 per cent a year for the entire market; 25.4 per cent a year for the low (price-to-book) PB portfolio; and 13 per cent a year for the high PB portfolio. The five-year period starting from the lowest point on our PE chart, i.e. February 2009, has not ended yet. But already, those who entered the market at that point are sitting on, or had made, outsized returns.

There was only one instance when buying into the market at the Graham and Dodd PE of 16 times or below did not pay off handsomely five years later. That was in July 1997, at the onset of the Asian financial crisis. Five years later, in August 2002, the market was still trading at similar levels as it struggled to climb its way out of the dot.com bust and the 2001 terrorist attacks in the United States.

The higher the Graham and Dodd PE, the lower the return five years later. Investors who entered the market at a PE of 26 times or higher had seen a miserable 1 per cent average return a year in the following five years for the market portfolio, 7 per cent for the low PB portfolio and minus 2 per cent for the high PB portfolio.

At that market entry level, chances of an investor suffering capital loss are also elevated. Based on monthly numbers in the past 30 years, the probability of loss five years later (at Graham and Dodd PE of 26 times and above) was 42 per cent for the market portfolio, 12 per cent for the low PB portfolio and a whopping 70 per cent for the high PB portfolio.

Finally, where is the Graham and Dodd PE for the Singapore market now? It's at 14.1 times as at end September. This compares with the average of 20.8 times in the past 30 years.

In the past three decades, there were 25 different months when the Graham and Dodd PE traded between 14 and 16.5 times. For those 25 different months, the market portfolio returned an average 15.5 per cent a year over the next five years. The low PB portfolio averaged 24.8 per cent a year, and the high PB portfolio 14.3 per cent a year. The probability of capital loss for those periods was 1-in-25 for the market portfolio, and 3-in-25 for the low PB as well as the high PB portfolios.

So based on patterns in the past, in so far as companies' earnings are not artificially propped up by low interest costs and barring any structural change in the economic environment, investors who enter the market at current levels have a good chance of earning satisfactory returns from the stock market over the next five years.

stinvest@sph.com.sg

The writer, a chartered financial analyst, is head of research at Aggregate Asset Management, manager of a no-management fee value fund.

It’s time to diversify investments

The Business Times
Teh Hooi Ling
31/7/2013

INVESTORS should diversify their investments and not hide in a single asset class any more as the US Federal Reserve's tapering is a game-changer, said Andy Warwick, BlackRock's managing director and portfolio manager of the firm's global multi-asset income fund.

Here in Asia for his whirlwind tour to promote his fund, Mr Warwick said the world is moving on. "The Fed's tapering is a game-changer. It signifies the end of the bond bull market. That has huge ramifications for all asset classes as well."

Investors, he said, have to have a diversified portfolio across as many different asset classes as they can. They have to try to find a variety of streams of income.

Although diversification is supposedly a mantra of good investment practice, not many actually do that, he said. "The fund flows into fixed income in the past five years have been absolutely extraordinary. And up till the beginning of this year, equities have had consistent outflows. We are just seeing people diversifying this year."

Multi-asset strategy

But increasingly, investors are coming round to the idea of diversification. Fund flows into BlackRock's multi-asset strategy have been rising. As at today, there are US$150 billion assets under multi-asset strategy. Overall, BlackRock has some US$4 trillion assets under management.

Mr Warwick said BlackRock is on target in attracting well over US$1 billion this year to its multi-asset strategy funds.

One fund under multi-asset strategy is the income fund managed by Mr Warwick. Established a year ago, the fund is seeing an inflow of "US$1 million to US$2 million" a day. The fund size is now about US$220 million.

About US$100 million of that has come from Korea. The fund has also got good support from Italy. Mr Warwick said the income fund invests in as many asset classes as it can. It invests in loans, real estate debts, infrastructure, solar farms and master limited partnerships - publicly traded vehicles that derive most of its cash flows from real estate, natural resources and commodities.

These instruments generate a net yield of 5.3 per cent. The income fund aims to generate 4 to 6 per cent of yield to pay out to unitholders, and one to 3 per cent of capital growth. In the first year of its operation, the fund chalked up returns of 10.5 per cent.

"Our whole rationale is we want to pay out of the income we generate. We are not going to pay out of capital," said Mr Warwick.

Clients' feedback to BlackRock is that they are not looking for a decumulation type of product. They want something that will give them some form of capital growth as well, he added.

With 40 per cent in equities - 25 per cent in developed market equities and 15 per cent in developing markets - Mr Warwick is looking to increase the equities allocation to 45 per cent. He is positive on the United States, and Europe in particular. He still likes high yields, as the cushion between the spreads is still very high.

Areas which are challenged are government bonds and emerging market equities. But within that two big space, there are pockets of opportunities. Italian and Spanish bonds still look attractive because they are "priced to fail", which BlackRock thinks is the wrong assessment. Brazilian and Mexican government bonds are appealing as well.

In emerging market equities, Mr Warwick is positive on the Asean region, in particular the Philippines and Thailand. "Singapore is simply in a permanent goldilocks scenario - decent growth, low inflation etc."

But China may likely find it difficult particularly in the short term.

"I'm not a perma China bear," qualified Mr Warwick. "I think China can probably come out of this very strongly. But this could be three to five years away. I think the journey to that ending is going to be a rocky one, to say the least."

From an investment point of view, Mr Warwick said the challenge is persuading clients that they are not going to be able to achieve their return expectations and goals by still sticking to fixed income. "You've got to take risks to get return."

Bond selling

One risk that Mr Warwick can identify now is bondholders rushing for the exit at the same time when they see losses in their statements for the first time in two or three years. "Clearly that amount of bond selling would put extreme pressure on bonds and yields. The investment risk here is that bond yields spike too quickly, and the Fed or other governments lose control of their bond markets. That would not be good."

Also, BlackRock's view is that interest rates are on hold until at least 2015. Another risk is that this assumption turns wrong and interest rates rise aggressively before 2015.

Another big risk, he said, is a sudden rise in inflation in the US and emerging markets. "There's no sign of that at all now. But if for some reason, it rears its head, and that forces the Fed to act aggressively, again that will be a big big risk."

BlackRock's main road map, added Mr Warwick, is that "the US grows 2 to 3 per cent, with low inflation, very low interest rates. Corporate profits hold up. And that has obviously a positive effect on the rest of the globe".

Benefits of starting early

The Business Times
Teh Hooi Ling
24/7/2013

HIGH expense fees on many investment products and restrictions on investing in risk assets at an earlier age act to limit the growth of retirement funds of the average Singaporean, a Singapore Exchange (SGX) and Oliver Wyman paper on retirement savings said.

CHART 1 - Risk averse
http://www.businesstimes.com.sg/sites/businesstimes.com.sg/files/BT_20130724_HLRETIREMENT1_680047.pdf

CHART 2
http://www.businesstimes.com.sg/sites/businesstimes.com.sg/files/BT_20130724_HLRETIREMENT2_680048.pdf

Data from the Central Provident Fund (CPF) and research and analysis by Oliver Wyman, a global consultancy, showed that as at the third quarter 2012, CPF members held $196 billion in "fixed deposits" - funds which are invested ultimately in Special Singapore Government Securities. Some $156 billion had been withdrawn for property purchases and only $29 billion were in risk assets. But out of the $29 billion allocated to risk assets, 67 per cent went into insurance policies, 18 per cent into unit trusts and only 15 per cent into stocks, loan stocks and property funds.

Relative to people in other countries, Singaporeans have allocated the highest proportion of their retirement funds to fixed deposits - at 72 per cent. Only 12 per cent were allocated to equities. Malaysians, based on their EPF (Employees Provident Fund) allocation split, had 49 per cent in bonds, 49 per cent in equities and only 2 per cent in fixed deposits in 2011. Australians, meanwhile, parked 69 per cent of their retirement funds in equities, 19 per cent in bonds and 12 per cent in fixed deposits.

Based on its analysis, Oliver Wyman concluded that the average Singaporean in full-time employment today can expect an income replacement ratio (expected post-retirement income versus pre-retirement income) of around 68 per cent. That's still within the range recommended by the World Bank and comparable to those seen in OECD (Organisation for Economic Co-operation and Development) countries. This is attributable to the relatively high savings rate, and the relatively high interest rates paid by the "fixed deposits" offered by the CPF Board.

However, some Singaporeans may aspire to a higher replacement ratio. This can be achieved through both increasing savings rate and to/or target higher rates of return on these savings. But even if Singaporeans were to allocate more of their retirement funds to risk assets, their retirement income is expected to increase only by a measly 3 per cent. The reasons are: one, the high fees on many investment products and, two, investing in risk assets too late in life, concluded the paper. The expense fees on many investment products are too high for long-term investment and can eat up up to about 20 per cent of expected return through time, said the paper. "A high proportion of these fees are paying for the distribution of these investment products rather than actual investment management."

For unit trusts eligible for inclusion in CPF, Oliver Wyman observed total expense ratios (TERs) of between one per cent and 1.95 per cent per annum. These levels are similar to unit trusts' TERs outside the pension system both in Singapore and in other comparable countries. "CPF retirement savers who wish to invest in a unit trust or other investment products typically buy and administer these investments through one of the qualifying Singaporean banks. Much of the fee expenses are used to pay for advice, sales, compliance and administration costs incurred in the process."

Oliver Wyman and SGX observed that in some other countries, systems have been created to offer a simplified, narrower set of investment products for retirement savers. Savers are guided into a particular fund depending on their age together with the use of centralised or similar scalable administration systems.

This creates significant cost savings and typically brings expense ratios down to between 0.3 and one per cent per annum. Some of these systems are state-run, such as the UK Nest or Swedish AP7, while others are sponsored either by corporates, such as the US 401k, and by unions, such as in the Netherlands, or by asset managers, such as i-Shares lifestyle exchange-traded fund products listed in the United States. "If investment costs in the Singaporean system could be reduced closer to this range, this would increase the uplift in expected retirement incomes from 3 per cent to 6 per cent," said Oliver Wyman and SGX.

Meanwhile, the Minimum Sums that are required in the CPF accounts before members could invest the balance in risk assets means that the average Singaporean could invest his or her CPF funds in risk assets only beyond age 40, noted the paper. "If Singaporeans can invest earlier in their lifecycle, the accumulation period of higher returns will be extended and the risk of market volatility should be diminished due to longer holding horizons," the paper said.

A famous Dow Theory letter gave the example of two persons - A and B. A starts saving at age 19. She saves $2,000 every year from age 19 until 25. Then she stops. In other words, she puts only $14,000 into her portfolio. B, meanwhile, starts saving at age 26. And he is very disciplined. From age 26 until 65, he puts $2,000 yearly into his savings. By age 65, he has contributed $80,000 to his portfolio.

Let's assume A and B are able to generate 10 per cent on their savings and portfolios every year. At age 65, the difference in the two portfolio sizes is quite negligible. By then, A's portfolio would be worth $944,641 and B's portfolio would be at $973,704. This, despite A putting in only $14,000 over seven years, while B has contributed $80,000 over 40 years!

That's the magic of compounding. The earlier you allow it to start, the greater the benefits. Now imagine starting investing at age 40, and generating less-than-desirable returns because of all the fees paid to financial intermediaries.

That's the gist of SGX and Oliver Wyman's paper.

Equity risk premium - an added perspective

Professor Aswath Damodaran of the NYU Stern School of Business sees it as a receptacle for investor hopes and fears

15 Jun 2013 08:55
BY TEH HOOI LING

GLOBAL equities markets - especially those outside of the US - have gone on roller-coaster rides since the US Federal Reserves chairman Ben Bernanke suggested on May 22 that the central bank was poised to taper off its money printing action.

Here are the numbers. In Singapore, the Straits Times Index has fallen 8.4 per cent in the last three and a half weeks - giving back all the gains that it had made so far this year.

Hong Kong's Hang Seng Index is down nearly 10 per cent since May 22, and it is down 7.4 per cent for the year. Nikkei 225 has plunged by just under 20 per cent in the last three and half weeks, but it is still up 22 per cent for the year. The South Korean and Taiwanese markets are down by about 5 per cent each since the topic of "tapering" was broached. The former is also down by about 5 per cent for the year but the latter still manages to cling on to a 3 per cent gain year-to-date.

Meanwhile, Jakarta is down 8.6 per cent since the third week of May, but is still up 10 per cent for the year. As for the US, the S&P 500 shed only 1.1 per cent since May 22, and is in the black by nearly 15 per cent for the year.

All the above numbers are in local currency terms. Given the strengthening of the US dollar, the US market's gain is even higher and the losses in some of the regional markets more severe.

Three weeks back, I calculated the equity risk premia (ERP) for some of these markets and showed that these risk premia - the expected compensation to investors for exposing themselves to equity risk - are high by historical standards.

I calculated the ERP by dividing the 10-year average earnings per share of the market by the current market price, and then subtracted the one-year interbank rates. The high levels of ERPs suggest that the markets are not overvalued, and in fact, there may still be room for further appreciation, I noted.

Aswath Damodaran, professor of finance at the Stern School of Business at New York University, in his latest blog post, added a new perspective to the discussion on ERPs.

Comparing the expected cash flows of US stocks relative to the S&P 500 as at May 18, Prof Damodaran came up with an ERP of 5.45 per cent. "The ERP is the extra return that investors demand over and above a risk free rate to invest in equities as a class. Thus, it is a receptacle for investor hopes and fears, with the number rising when the fear quotient dominates the hope quotient. In buoyant times, when investors are not fazed by risk and hope is the dominant force, equity risk premiums can fall," explains Prof Damodaran.

The average implied equity risk premium between 1961 and 2012 in the US is 4.02 per cent. If the equity risk premium, currently at 5.45 per cent, does drop to 4.02 per cent, the S&P 500 would trade at 2,270, an increase of some 38 per cent from current levels.

Prof Damodaran adds more granularity to the discussion on the ERP. "The high ERP in 2013 is very different from high ERPs in previous time periods and extrapolating from past history can be dangerous," he says.

The expected returns of stocks have two components - one, the risk free rate; and two, the ERP.
Prof Damodaran plots the expected returns of stocks from 1962 till last year, and decomposes them into ERP and the risk free rates. (See chart)

He notes that over the last decade, the expected return on stocks has stayed surprisingly stable at between 8-9 per cent. Almost all of the variation in the ERP over the decade has come from the risk free rate. In particular, the higher ERP over the last five years can be entirely attributed to the risk free rates dropping to historic lows. In fact, the expected return on stocks on May 18, 2013 of 7.40 per cent is close to the historic low for this number of 6.91 per cent at the end of 1998.

While the relationship between the level of the ERP and the risk free rate has weakened over the last decade, the two numbers have historically moved in the same direction, says Prof Damodaran. When risk free rate goes up, so does ERP, leading to lower stock prices.

In light of this, consider again two periods with high ERPs. In 1981, the ERP was 5.73 per cent, but it was on top of a 10-year US treasury bond (T.bond) rate of 13.98 per cent, yielding an expected return for stocks of 19.81 per cent. On May 1, 2013, the ERP is at 5.70 per cent but it rests on a US treasury bond rate of 1.65 per cent, resulting in an expected return on 7.35 per cent.

"An investor betting on ERP declining in 1979 had two forces working in his favour: that the ERP would revert back to historic averages and that the US treasury bond rate would also decline towards past norms. An investor in 2013 is faced with the reality that the US T.bond rate does not have much room to get lower and, if mean reversion holds, has plenty of room to move up, and if history holds, it will take the ERP up with it," he says.

But there is some good news. Even if risk free rates move to 3 per cent and the equity risk premium drops to 5 per cent, the S&P 500 index is still undervalued by about 5 per cent, according to Prof Damodaran's calculations. But if rates rise to 4 per cent and the equity risk premium stays at 5.5 per cent, the index is overvalued by about 8 per cent.

So there is still some room for the rates to move around before the market is deemed overvalued.
In a previous post, Prof Damodaran has noted that stocks do not look overpriced based on (1) robust cash flows, taking the form of dividends and buybacks at historic highs for US companies, (2) a recovering economy (and earnings growth that comes with it), (3) ERP at above-normal levels and (4) low risk free rates.
Thus, he says his argument is a relative one: given how other financial assets are being priced and the level of interest rates right now, stocks look reasonably priced.

The danger, though, is that the US T.Bond rate is not only at a historic low but that it may be too low, relative to its intrinsic level, based upon expected inflation and expected real growth.

"If you believe that the T.Bond rate is too low, then you have the possibility that you are in the midst of a Fed-induced market bubble(s) and that script never has a good ending," he cautions.

The scary part is that there are no obvious safe havens: gold and silver have had a good run but don't seem like a bargain and central banks around the world seem to be following the Fed's script of low interest rates. "You could use derivatives to buy short-term insurance against a market collapse but, given that you are not alone in your fears about the market, you will pay a hefty price."

So the market is dancing to the Fed's tune. It is not a question of whether the music will stop, but when, writes Prof Damodaran. "When long-term interest rates move back up, as they inevitably will, the question of how much the equity markets will be affected will depend in large part on whether the ERP declines enough to offset the interest rate effect."

But while Prof Damodaran says he would not be arguing that stocks are cheap, simply because the ERP today is higher than historic norms, he is not ready to scale down the equity portion of his portfolio (especially since he has no place to put that money).

As mentioned, there is enough room for rates to move around before the market is considered severely overvalued.

Hence Prof Damodaran says he will continue to buy individual stocks, while keeping an eye on the ERP and T.Bond rate.

Hopefully, the above analysis will soothe the nerves of some investors out there. Just a note, the professor shares his research and views on his blog frequently and readers can download spreadsheets to input their own numbers to come up with their own conclusions. Therefore, the blog should be a frequent stop for investors keen to continually improve on their investment knowledge.

Coming to grips with valuations

The price of stocks and their value are two different things

25 May 2013 08:34 BY TEH HOOI LING SENIOR CORRESPONDENT

WHEN I was studying for my CFA exams back in early 2000s, I found Aswath Damodaran, Professor of Finance at the Stern School of Business at NYU, to be one of the most lucid authors. He made stock valuation seem to easy.

This week, Prof Damodaran was in Singapore as a speaker at the 66th CFA Institute Annual conference. His extended session was entitled "Living with Noise Valuation in the Face of Uncertainty".

He provided a lot of good reminders and pointers in his presentation that analysts and investors who are trying to do fundamental analysis will find useful.

First off, he said, the value of a stock that emerges from using a discounted cashflow model is imprecise. "But one just has to be less wrong than the market (to make money)," quipped Prof Damodaran.

For example, he valued Amazon at US$35.08 back in January 2000 while the market price for the stock was US$84. By January 2001, Amazon's share price had collapsed to US$14. He updated his analysis and found the stock to have a value of US$20.83.

In May 17, 2012, his valuation of Facebook came out to US$25.39. The Wall Street investment banks - Morgan Stanley, Goldman Sachs, among others - which took Facebook public, sold its shares at US$38 apiece. In its first two trading days, Facebook plunged 19 per cent.

Prof Damodaran said he was asked by CNBC how the investment banks could get their valuation so wrong. His answer was: "They are pricing the issue, they are not valuing the shares."

In his presentation, he reminded the audience that in intrinsic valuation you value an asset based upon its intrinsic characteristics. For cashflow, the intrinsic value will be a function of the magnitude of the expected cashflows on the asset over its lifetime and the uncertainty about receiving those cashflows.

Discounted cashflow valuation is a tool for estimating intrinsic value, where the expected value of an asset is written as the present value of the expected cashflows on the asset, with either the cashflows or the discount rate adjusted to reflect the risk.

He outlined three basic propositions for risk-adjusted value. One, if "it" does not affect the cashflow or alter risk (thus changing discount rates), "it" cannot affect value.

Two, for an asset to have value, the expected cashflows have to be positive for some time over the life of the asset. Three, assets that generate cashflows early in their life will be worth more than assets that generate cashflows later; the latter may, however, have greater growth and higher cashflows to compensate.

Here's how you ascertain the fundamental determinants of the value of a company. First determine what are the cashflows from existing assets. If you are valuing the equity, it's the cashflows after debt payments that you must look at. If you are valuing the firm, then you take cashflows before debt payments.

Second, determine what is the value added by the firm's growth assets. In valuing equity, you look at growth in equity earnings/cashflows. For firms, you look at growth in operating earnings/cashflows.
Third, determine how risky the cashflows are, from both existing assets and growth assets. For equity, it's the risk in the equity in the firm and, for firm, it's risk in the firm's operations.

Finally, determine when the firm will become mature, and the potential road blocks.

In doing all of the above, there are numerous uncertainties. First, there is the estimation versus economic uncertainty. Estimation uncertainty reflects the possibility that you could have the "wrong model" or estimated inputs incorrectly within the model. Economic uncertainty comes from real sources: the fact that markets and economies can change over time and that even the best models will fail to capture these unexpected changes.

Estimation uncertainty can be mitigated by doing your homework, collecting more data or building better models, said Prof Damodaran. But economic uncertainty is here to stay.

Next there is micro versus macro uncertainty. I think this is quite similar to the uncertainty mentioned above. But here's how Prof Damodaran defined it: Micro uncertainty refers to uncertainty about the firm you are valuing and its business model - the potential market or markets for its products, the competition it will face and the quality of its management team. Macro uncertainty reflects the reality that the firm's fortunes can be affected by changes in the macro economic environment, such as the strength of the economy, the level of interest rates and the price of risk (for equity and debt).

Micro uncertainty can be mitigated or even eliminated by diversifying across companies, but macro uncertainty will remain even in the most diversified portfolio, said Prof Damodaran.

And then there is discrete versus continuous uncertainty. Some events that you are uncertain about are discrete. So a biotechnology firm with a new drug working its way through the US Food and Drug Administration pipeline may see the drug fail at some stage of the approval process. In the same vein, a company in Venezuela or Argentina may worry about nationalisation risk.

Most uncertainties, though, are continuous. Thus changes in interest rates or economic growth occur continuously and affect value as they happen.

In valuation, we are better at dealing with continuous risks than with discrete risks, said Prof Damodaran. In fact, discount rate risk adjustment models are designed for continuous risk.
The unhealthy responses to uncertainty are paralysis and denial; resorting to mental short cuts or rules of thumb, herd behaviour and outsourcing to "experts".

Some suggestions for dealing with uncertainty are: one, keeping the forecasting simple, when trying to forecast the cashflows of a new company, take a look at the trajectory of previous similar companies. For example, Prof Damodaran modelled Facebook's growth trajectory after Google's.

Two, build in internal checks on reasonableness. For example, the market share cannot exceed 100 per cent of market size. Three, use consistency tests, for example the currency in which cashflows are estimated should also be the currency in which the discount rate is estimated. Four, draw on economics first principles and mathematical limits. For example, a stable growth rate cannot exceed the growth rate of the economy. Five, use the market as a crutch, when trying to estimate, say the equity risk premium. Six, draw on the law of large numbers. For example, when trying to estimate beta (or volatility), take the beta of the industry and adjust for the debt level of the company you are analysing. Other suggestions include confronting uncertainty by coming up with a probability distribution, constantly adjusting and adapting your model as new information comes out. Finally, accept that you can make mistakes, but keep the biases out. "If you are 'biased' about individual company valuations, your mistakes will not average out, no matter how diversified you get."

There are three ways to view the value/pricing gap. One, if you believe in efficient market theory, then you'd think that the gaps between price and value, if they do occur, are random. Then you'd go for index funds.

If you are a "value extremist", then you'd view market participants who collectively price the stock as dilettantes who will move from fad to fad. Eventually the price will converge on value. If you are in this camp, then you'd buy and hold stocks where the value exceeds the price.

For the pricing extremists, they think value is only in the heads of the "eggheads". Even if it exists, prices may never converge to value. So what they do is to look for mispriced securities and try to get ahead of shifts in demand and momentum.

The dilemmas of "pricers" are that they don't have an anchor on where a security should be and are, therefore, pushed back and forth as the price moves from high to low; they are reactive; and they face the difficulty of trying to read where the crowd is going to move to next.

The valuers' dilemmas are that they are not sure about the magnitude of the value/price gap, and they are uncertain when the gap will close. They can mitigate that uncertainty by lengthening their holding time horizon, and by providing or looking for a catalyst that will cause the gap to close. Prof Damodaran's study of Apple showed that the value/price gap for the company would close by 80 per cent if the holding period is 5 years. That goes up to 90 per cent for a holding period of 10 years.

And, finally, here's a tip for Apple fans from Prof Damodaran. According to his study, there is a 90 per cent chance of the company being undervalued at its current price of about US$440 per share.

Room for appreciation in some bourses

18 May 2013 08:49
BY TEH HOOI LING SENIOR CORRESPONDENT

Still cheap by historical standards

STOCK markets in many parts of the world are hovering at multi-year highs. Should investors be scared? I looked at five markets this week - Singapore, Hong Kong, South Korea, Japan and the US - to ascertain their prices relative to their value over the past few decades.

In the first set of charts, I plotted the various market indexes against the Graham and Dodd P/E. The latter tries to smooth out the business cycle's impact on earnings by using a 10-year moving average of earnings. In these graphs, I have also included the 10-year moving average earnings per share of the various indexes.

The indexes I can find for Hong Kong and Japan in Thomson Datastream with a long enough history are those which excluded technology, media and telecoms stocks.

From the first set of five charts, you can see the rise in earnings per share for all the markets over time. In Singapore's case, the rate of earnings growth picked up significantly from 2004 onwards. Because of the rise in earnings, the Graham and Dodd P/E for Singapore, Hong Kong and Japan are actually at the lower end of their past 30-year range.

The data for Datastream-calculated Kospi 200 Index is shorter, going back to just 1997. For Kospi, the PE is somewhere in the middle of its past 15 years' range. The S&P 500, meanwhile, is about one-third from the bottom of its 35-year range.

The lower the PE, the cheaper the market is supposed to be.

In the next set of charts, I plotted the price index against the "equity risk premium" or ERP. Here, ERP is calculated as the inverse of the Graham and Dodd P/E (that is, the average past 10 years' earnings divided by the current market price) minus the one-year interbank rate. With ERP, we are trying to calculate the earnings yield from the stock market which is in excess of the one-year interbank rate.

The higher the ERP, supposedly the greater the value in the stock market.

For the Singapore chart, the ERP fluctuates over time, but each subsequent peak is higher than the previous one. This is a function of the declining interbank rates.

Each of the previous peaks had also coincided with a market bottom. The last big peak was in early 2009. But even at today's prices, the ERP for Singapore is still at a fairly elevated level of 6 per cent. The story is similar for Hong Kong.

In general, the ERP should move in the reverse direction as the market price. The higher the market goes, the lower the ERP becomes. For Kospi, in the last six months, the market has been moving up, but so has the ERP! This is because of the declining interest rates in South Korea.

Japan's ERP chart looks the best - it's an almost perfect mirror image of the price index! There was great value in the Japanese market in the middle of last year. The sharp rise in the market in the last six months or so has brought the ERP from 5.7 per cent to 3.7 per cent. The current ERP is still high relative to the period from 1995 till 2009. As for the US market, it is still near the top end of its 27-year range.

One concern is that PEs and ERPs are high because of the unsustainably high profit margins. In the US, corporate profit margins has been climbing and are at record highs now. But not so for the other markets, where profit margins have been relatively stable. In fact, for South Korea, margins seem to be coming down (see chart).

In his most recent quarterly letter, Ben Inker, co-head of asset allocation at GMO, noted that "high profit margins should not persist in a mean-reverting world, and yet profitability in the US has been higher than long-term averages for most of the last 20 years, oddly pretty close to the same length of time that the US market has been trading above replacement cost".

High valuations imply a low cost of equity capital, which should encourage corporations to issue more equity. A high return on capital (as evident from high margins) should encourage corporations to do more investing. These pressures should gradually push the cost of capital up and the return on capital down.

"But in the period since the mid-1990s, stock issuance has been down and corporate investment has fallen as well, in apparent contravention of the basic rules of capitalism," he wrote.

And when investments are down, profits should in general be down, not up. The relationship of high investments leading to high profits was strong from 1929 till 1986, with a correlation of 0.75. The correlation weakened to 0.43 between 1987 and 1999. And then it went negative from 2000 till 2012. During this period, investments fell but profits went up.

Negative savings

The fall in corporate investments have been made up by negative savings by the government and households.

If profits are to stay high while government deficit shrinks, the current account deficit would have to shrink, household savings fall and dividends rise.

"All else (being) equal, falling budget deficits will hurt profitability. But if we do finally get the much-delayed recovery in investment or continued strong buyback activity, it is possible falling deficits could be absorbed without margins falling back towards historical averages.

"Rising investment would, in all likelihood, sow the seed of falling profits in time through increased competition, as would buybacks and dividends through rising savings or a societal response. But as for when, it is impossible to know," wrote Mr Inker. And it is GMO's view that profit margins are unlikely to have shifted permanently higher.

As for the other markets that we looked at, since it doesn't appear that profit margins are exceptionally high relative to the past, perhaps there is still room for more value appreciation.

Cash is not king when it comes to investment

All the cash - $528 billion at the end of January - is earning next to nothing sitting in the banks, reports TEH HOOI LING
 06 Mar 2013 09:58

Mr Tan: Dilemma facing many investors - investments at a standstill but goals remain the same

Time to take stock

WITH their judgments clouded by a flawed assessment of risk and return, retail investors who opt for the safety of cash will experience an erosion of their purchasing power and deprive themselves of a chance to participate in a potential increase in wealth, said William Tan, Franklin Templeton's director of retail fund distribution for South-east Asia.

There was $519 billion in cash sitting in Singapore banks as at end-December last year. This rose to $528 billion at the end of January 2013. "If you stack that amount in $100 bills, the height will be two-and-a-half times that of the Singapore Flyer," he said.

All this cash is earning next to nothing in the banks. "This is the dilemma facing many investors - their investments are at a standstill but their investment goals remain the same," noted Mr Tan at a media conference this week entitled "Time to take stock".

According to data compiled by Morningstar, investors have been taking funds out of Asian equity mutual funds in each of the past five years. In total, some US$113 billion (S$141 billion) has been withdrawn from the funds.

At the same time, funds have been flowing into bonds. Globally, between 2006 and Feb 12, 2013, US$823 billion has poured into bonds, while US$562 billion has been drained from the equities market, data from BofA Merrill Lynch Global Investment Strategy and EPFR Global showed.

Such behaviour can be explained by human being's psychological biases. One, people in general are strongly influenced by what is personally most relevant, recent or dramatic. As the stock markets and the global economy have gone through some upheavals in the past few years, "investors continue to remember the bad stuff and are continuing to avoid equities", said Mr Tan. Two, people are more averse to losses than to risks. "If investors wait for data that the economy has improved, they would probably have missed the first nine months of the run-up," he said. And finally, investors are herd-like; they feel safe if they just follow what everyone else is doing.

Many investors have been flocking to bonds and deserting equities. This must be the safe thing to do, so goes the flawed reasoning. According to Mr Tan, of the money Franklin Templeton attracted over the past six months, only 20 to 25 per cent opted for equities, with the rest going into bonds. Still, that's an improvement from the 5 to 10 per cent which were allocated to equities in the previous 18 months. Overall, fund flows has increased by some 20 to 30 per cent in the past six months.

As investors' fears of losses linger, they have missed a few mega trends that are happening right before their eyes.

One is the massive urbanisation of the world's population, especially those in the emerging markets. With urbanisation comes new demand and replacement demand. Infrastructure and housing need to be built. The middle-income group will grow. Mr Tan highlighted China and Indonesia as two countries with huge consumer potential.

Despite the run-up in the market in the last six months and the increased fund flows into equities, Mr Tan reckons that valuations for equities are still not excessive. "Investors are starting to realise that the fundamentals of some of the companies are good, they have solid cash positions etc. But in terms of funds flow, and the push towards higher valuation, we are not there yet. We are just at the start of it. It is still a good time to enter the market," he said.

But risks still abound. "You have to take risk if you want potential return. You just have to manage the risk," he said.

Risks and market volatility is one reason why allocation to bonds continues to be necessary. "Fixed-income instruments dampen the volatility of one's portfolio. Volatility will continue to be in the market," said Mr Tan.

He concluded that Franklin Templeton takes the 3R approach to managing risks - recognise the risks, take rational risks and take risks that one will be rewarded for.

How profitable is a bullet-proof portfolio?

A balanced portfolio with allocations to cash, bonds, gold and equities may have to contend with a lower return

 02 Mar 2013 09:55
 BY TEH HOOI LING SENIOR CORRESPONDENT

IN my column in The Sunday Times last week, I wrote about the "bullet-proof portfolio" proposed by US investment analyst and politician Harry Browne in his book, Fail-Safe Investing: Lifelong Financial Security in 30 Minutes. The so-called bullet-proof portfolio allocates equal proportions to stocks, bonds, cash and gold every year. The author reckons this type of portfolio gives the assurance "that you are financially safe, no matter what the future brings", including economic prosperity, inflation, recession or deflation.

This, the book says, is because some portion of the portfolio will perform favourably during each of those economic cycles. The book calls this type of investment portfolio a "permanent portfolio" and advocates that it be re-balanced once a year so that the 25 per cent allocation is precisely maintained for each asset class.

According to Mr Browne, a permanent portfolio should be safe, simple and stable. Last week, I tested out the performance of this kind of portfolio using data from Singapore. I downloaded the year-end numbers for the Straits Times Index, the price for gold, the price for a 15-year Singapore government bond, and one-year interbank rates. The gold price is converted to Singapore dollars. The starting year was 2003. I started with $1 million in December 2003. I allocated a quarter of the amount - $250,000 - to each of the four asset classes - Singapore blue-chip stocks, gold, Singapore 15-year government bonds, and cash. For stocks, I assumed a dividend yield of 3 per cent, except for 2008 when a yield of 4 per cent was used. The government bonds in 2003 had a coupon of 3.75 per cent, while cash earned one-year interbank rates. By the end of the first year, I trimmed the asset class that had outperformed and redeployed the funds to those which had underperformed so that we would start the second year again with a 25 per cent allocation to each of the four asset classes.

Such a strategy, without accounting for transaction costs, returned 8.2 per cent a year. The initial $1 million grew to $2.04 million by the end of last year. I received a few queries from readers regarding the column. One asked if we could substitute gold with real estate. Another enquired whether insurance could be considered an asset class. My response to the first question was that the purpose of diversification is to hold asset classes that have low - or better still, negative - correlation with one another. If equities are down, you want the other asset classes to be unaffected, or better still, to rise in value. Gold has performed that function in 2008 and beyond. Real estate, however, tends to move in tandem with the stock market.

That said, the advantage of real estate is that it has rental yield. Gold doesn't generate any income at all. Instead, there is a carrying cost for bullion. To answer the second question, insurance doesn't qualify as an asset class. As for policies that come with savings plans, the insurance companies channel your money - after hefty fees - to bonds and equities as well. In general, one should be better off just by buying the protection, and investing the rest separately. Yet another reader asked me to test out two alternative strategies to the balanced four-asset-class portfolio.

Alternative Strategy A: Start with $250,000 in each of the four asset classes, and do nothing until end-December 2012.

"As there are cyclical variations, maybe there will not be much difference between Browne's and Strategy A, and then there will be savings to be made by avoiding the conversion fees amongst the asset classes every year (which are not accounted for in your graphs). But if the final value in A is much lower, then we have demonstrated that Browne's strategy is superior," said the reader.

Alternative Strategy B: If I start with $1 million in December 2003 and allocate a third each to the three asset classes - bonds, gold and equities, what will the final portfolio value be at December 2012? Please do for two sub-cases: (a) Follow Browne's strategy, (b) Do nothing until December 2013. "Since cash is never good wealth with time, maybe it is best to leave it off the portfolio altogether! For emergency uses, cash can always be converted from gold and equities. But your calculations will be telling, either way," he wrote.

So I tested the other three strategies he suggested. Here's what I found. A buy-and-hold strategy that started with four asset classes would end 2012 at $1.95 million. That's $92,000 less than the rebalanced portfolio, or half a percentage point lower in compounded annual return.

As for the three-asset-class strategy, a buy-and-hold strategy grew $1 million to $2.2 million for a return of 9.2 per cent a year. Note that for this do-nothing strategy, cash will still accumulate over time from dividends and coupons from the government bonds. A yearly rebalanced three-asset portfolio will grow $1 million to $2.35 million, or an annual compounded return of 10 per cent a year. In this strategy, cash generated each year was redeployed into the three asset classes.

So what can we observe from the numbers? One, cash drag - the cost of holding cash - is $312,000. A rebalanced three-asset portfolio is higher than a rebalanced four-asset portfolio that includes a 25 per cent cash portion by that amount after nine years, with the starting point set at 2003. Two, for both the three and four-asset portfolios, rebalancing adds to the performance. The former by 0.7 percentage point a year over nine years, and the latter by 0.5 percentage point. I reckon the increased performance more than offsets the transaction costs.

Looking ahead, can the permanent portfolio still provide an 8 per cent return a year? I have some doubts about this. One, Singapore government bonds yields are at historic low levels - the yield for the 30-year Singapore government bond is about 2.7 per cent. In addition to the low yield, there is a risk of the bond prices falling. Two, gold prices leapt 187 per cent in Singapore-dollar terms in the last nine years. It would be hard to imagine that bullion could repeat that performance.

I believe that only equities have the potential to deliver an 8 per cent return a year. A balanced portfolio - with allocations to cash, bonds and gold and equities - may have to contend with a lower return, at least in the next five years or so.