Funds - some new choices

I have written previously about my frustration with the very limited range of low cost no load funds available to retail investors in Hong Kong.

The situation has improved this year with a number of new ETFs being launched and listed on the Hong Kong Stock Exchange. Unfortunately, for most of them the volume of units traded each day are very small (for a few, the volume is zero), but there is enough in a few of them (Commodities, Russia, China, India and Hong Kong) to have at least a few viable low cost investment options. Unfortunately some of the ETFs for broader markets that I would be interested in have almost no turnover so I will have to continue to look elsewhere for many of my investment needs.

New Property Purchase (3) - Refurbishment

I have had a preliminary meeting with the contractor. Looking at the rough cost estimates for the basic redecoration and the full fit out and the comparable rental yields, the full fit out option should be the better financial option when looking at this project in isolation. The factors for and against the full fit out were as follows:

1. Yield: the yield on total cost will be higher;

2. Cash Flow: I will have a positive cash flow on a 20 year P+I mortgage (which I will not get with the basic fit out);

3. Pay Back Period: the pay back on the additional expense is 3.9 years on the preliminary figures. I have identified a few areas where some costs can be saved without having an adverse impact on the rental income. I hope to get the pay back period down to around 3.6 years with the final numbers. This is an important point, because the fit out will depreciate so it has to pay for itself and provide an acceptable return before it needs to be replaced;

4. IRR: the projected IRR obviously depends on what numbers I input for (i) the basic fit out (ii) the full fit out (iii) the additional rental and (iv) how long I expect the additional fit out to last. The latter is the most important factor. Some items could last 10 years. Others will need reworking/replacing every 3-4 years. If I assume an average of 4 years, my IRR is a low 5.2%. If I assume 5 years, the IRR jumps to 12.9%. The former does not justify the expense. The latter is acceptable to me as it is comfortably above the return I need to earn on my investments in order to retire on schedule (but would not get a property developer excited);

5. Time to next project: this actually favours the basic fit out. The additional money that I will spend on the full fit out (compared to the basic) is money that is not available to contribute to the next purchase;

6. Time to lease: the full fit out will take about 10 weeks. The basic fit out will take 4-5 weeks. This effectively costs me about a month in income.

New Property Purchase (2) - Financing

I started the search for the lowest cost mortgage for my new investment property today.

So far the best offer on the mortgage financing is prime - 3.2% (effectively a floating rate of 4.8%) with 0.9% cash back and the usual 3%, 2%, 1% early repayment penalty in the first three years.

I was rather disappointed to find that the banks I approached have all stopped offering HIBOR linked mortgages. Although the rate quotes above is actually slightly lower than the current HIBOR linked rates I am paying (about 0.1 - 0.3% less), the responsiveness of the HIBOR fixing mechanism has always been preferred especially when interest rates fall.

I will keep looking and see what is available, but the best offer so far already looks like the one I will use. The fact that it happens to be one of the banks we already use is an added bonus as I will go through less of the tiresome money laundering checking that banks have to do when taking on a new client.

I have also instructed lawyers. Given the relationship and the fact that the lawyers we use are already very cost competitive, I do not see any point in spending time shopping around for cheaper legal fees.

New Property Purchase (1) - Provisional Contract Signed

Well, that was quick.

We signed the provisional agreement to sell one property (our smallest) on Thursday and I have signed the the agreement to purchase another property today.

The new property is larger than the one sold. The projected ungeared yield will be between 4.1 and 4.6% if I do minimal repair and redecoration work and 5.6 and 6.2% if I do a high quality fit out. Yields are calculated using gross costs and net rental income and are, therefore, real net yields.

The yield should be at or slightly above the target yield from properties in my retirement plan (4%) depending on the actual rental and the vacancy rate.

The building has several features which make it attractive:

1. very efficient floor plan;

2. the building is currently undergoing a refurbishment of the common areas. The lobby has been done and work has started on the very modest club house (a couple of mah jong rooms, a small recreation room and a small pool) and is expected to extend to the exterior of the building later this year. At least 3 or 4 other flats in the building have recently been purchased and are being (or will soon be) renovated by the new owners;

3. close to good transport links, good schools and shops;

4. above average size. I will be writing a post on the rise of the middle class in emerging markets and explaining why mid size and larger flats have more potential for growth than smaller ones.

The downside is that I will be putting down the minimum deposit (being cash poor is a necessary consequence of trying to be fully invested at all times). Even after I get the property rented out it will have a negative cash flow on a 20 year mortgage if I go with the basic fit out option (although income will still exceed expenses by a meaningful margin). Also, the portfolio as a whole will have close to break even cash flow. Put differently, any vacancy will result in negative cash flow on the properties.

As a final point, the net rental income on the portfolio as a whole will now meet the revised contribution to our retirement income. Going forward, purchasing properties becomes "optional" and I could, should I wish, concentrate on building up the equity portfolio (funds) required and/or pay down some of the mortgages to improve the cash flow.

An unsolicited offer (4)

Sold! After the initial unsolicited approach did not result in a sale, we decided to let the agent look for a buyer at the price we had counter offered at. Our motivation for selling was primarily recognition of the fact that, while the property (our smallest) should always be easy to rent out due to its location, it has limited potential for improvement. After looking at some other properties we see better opportunities elsewhere.

We achieved our asking price and signed the provisional sale and purchase agreement yesterday. Completion is due at the end of June.

The IRR on this investment (after all costs) will be about 13.3% pa. This would not excite a private equity investor but it is well above what we need to be able to retire at age 50.

A Small Touch Of Envy

For the last few days our living room has commanded a view of Paul Allen's luxury motor yacht moored at the Kennedy Town wharf. At 127 metres (416 feet) "Octopus" is one of the largest private yachts in the world and comes complete with a helicopter and submarine.

Even living in a city where conspicuous displays of wealth are common place, a boat like that serves as a good illustration of the colossal gulf between the genuinely wealth and the merely mass affluent members of the middle class.

OK, so the only way I will get near a luxury mega-yacht is if I undertake a bit of training and sign on as a crew member, but it has rekindled my one time ambition to own my own, much more modest, sailing yacht and I ended up spending a few hours gazing lustfully at the websites of various yacht builders and brokers. The thought of spending at least part of my retirement years sailing around Greece and Turkey or the Caribbean is a very pleasant one.

Of course, the classic definition of a boat is "a hole in the water into which money is poured" so I am well aware of the cost involved and the implications in terms of retirement if I do succumb to temptation. Sigh....it is easy to understand how people become addicted to consumption based lifestyles.

Back to reality......

Book Review: The Only Three Questions That Count

Ken Fisher is a well known investment manager and long running Forbes columnist. I have read his columns on and off for many years (although comments on specific US companies are of limited direct relevance to me). He also appears in the Forbes list of the richest Americans. So it was that I picked up his book with considerable anticipation. I was not disappointed.

The most important lessons I took from Fisher's book were:

1. the need to challenge conventional wisdom as a matter of course when making investing decisions. He provides explains the theory and gives some good examples of this (although the notion that deficits are bad is not exactly a universally held belief - basic Keynesian economics teaches that deficit spending is a good way to boost an economy). He also makes the point that the power of the internet and some basic tools such as spreadsheet software make it very easy for individual investors to do some quite sophisticated investment analysis;

2. the need to keep your own thinking processes under tight control. Again, this is nothing new (many writers have covered the sorts of cognitive errors that Fisher talks about) but Fisher does express the issues and illustrate them with examples in a manner which makes for practical reading.

Fisher's key investment principles can be summed up as:

3. benchmarking is better than seeking absolute returns. Seeking absolute returns is a poor strategy involving unacceptable levels of risk;

4. if you want to beat the market (after defining what market you are referring to) the preferred approach is to over or underweight various sectors - but only where you believe that you have a basis for knowing something hat the rest of the market does not. It logically follows that (i) unless you have a basis for believing that the market will be "down a lot" in the short term, you should be fully invested at all times and (ii) no one style of investing will be best;

5. if you have a reasonable amount to invest (US$200,000 or more) you are better off investing directly in shares rather than buying index funds and ETFs.

One rather trivial negative: it would have been very useful if the websites referred to in the text had been listed in an appendix for ease of future reference.

All in all a very educational and interesting read.

Another look at wine

I'm not sure if this is sensible or not. I have been building a (very) modest collection of wine for five years now. To date I have been treating the wine purchases as a hobby (or an investment in future drinking) and have kept the amounts involved quite small. However, the reality is that I will be very unlikely to drink all of what I have been buying. So far I have been treating my wine purchases as an expense and do not include their value in my balance sheet.

The value of my wines (quoted in GBP) has appreciated, although not by enough to get excited about. The currency factor has also worked in my favour. While the initial focus was on wines which were intended ultimately be drunk, I am giving serious consideration to purchasing some of the more expensive wines for investment purposes. My expectations in terms of returns would be modest - although I am not sure how easy it would be to quantify those expectations. Also, the amount of the investment would be low - wine would not be a core investment.

Is this a good idea?