Moving cash to bonds

Over the last 12 months or so, I have built up a level of cash on deposit which, at its peak, was the equivalent of almost five years of living expenses for our family. The build up was due to a combination of saving money from month to month and what amounted to a long service payment when I left my previous job.

The problem is that cash in the bank pays almost no interest at all in Hong Kong and I have been looking for ways to invest. Since November, 2008 I have added to my investments in the Hong Kong listed ETFs for Hong Kong (2800), India (2810 and 2836), Commodities (2809) and Russia (2831). I have also entered into some structured deposits against the Hong Kong Tracker Fund (2800) and the USD/NZD. The structured deposits are still effectively cash in the bank unless and until the underlying options are exercised against me.

Today, I invested some of the cash into bonds:

(i) HSBC USD due June 2038 with a yield to maturity of 7.23% pa. Credit rating is A+/A1;

(ii) Export Import Bank of China RMB due September 2011 with a yield to maturity of 2.3% pa. Credit rating is A1/A. 2.3% pa is unattractive - but better than 0% pa which is what RMB deposits earn in the bank.

In addition to credit risk, I am taking currency risk on both bonds and, with the HSBC bond, a considerable amount of interest rate risk as well.

As a retail investor, the two practical issues I have found with investing directly in bonds are:

(i) the range of bonds available to Hong Kong retail investors that offer reasonable yields is very limited. I can access a wider range of bonds if I am prepared to invest a minimum of USD250,000 in each purchase (this is too much for me);

(ii) the bid-offer spread in the market is much larger than for shares. This reflects the fact that the longer term bond market in Hong Kong is relatively limited. In effect, if I want to sell the bonds back to the market it will be expensive.

Russia ETF

I attempted to complete my investment in the Russia ETF (2831) this morning. Unfortunately, the market price quickly overran my limit of $18.10, leaving the order only partially filled. Together with the previous purchase , I have now acquired 56% of the total investment that I was seeking to make. I'm not inclined to chase the market, which, at the time of writing, had reached $19.04.

100% occupancy once again

I am back to having 100% occupancy on the property portfolio and have successfully rolled over all of the leases which fell due (or, in one case, found a new tenant) - finally. The last two tenants took up a considerable amount of time in either (i) haggling over the rent or (ii) haggling over the terms of the lease, but finally signed up for renewed leases this week.

Given the potential pain that could have arisen with multiple vacancies due to the unfortunate bunching of several leases termination or opt out dates, it was a relief to reach a position where:

1. the gross rent roll has fallen by less than 6%;

2. I only had one vacancy and that was for only two weeks;

3. I had minimal involvement of an agent (which saved commission);

4. I still have a positive cash flow on the portfolio (even with all mortgages on P+I terms);

5. absent a default, the earliest any tenant can terminate is December this year.

It is comforting to know that I will not have to draw on my cash reserves to top up any mortgage payments this year.

The anecdotal recession (4)

Air points are something that I view with deep suspicion. Airlines offer them. Credit card issuers hand them out. But when do you get to use them? In the case of Asia Miles (Cathay Pacific's mileage programme), the answer used to be very very seldom, My own personal experience was that it was pretty much a waste of time trying to redeem Asia Miles for a "free" flight and the best that could be hoped for (but not expected) was to use them for upgrades. My experience was far from unique.

The recession has brought with it a downturn in air travel. As a result, I am hearing increasing numbers of people say that they have succeeded in redeeming their Asia Miles for free flights at off peak times. My own recent experience in successfully using points for an upgrade was also met with a much quicker response than I have come to expect.

This is another example of their being some upside to the recession.

Mortgage refinancing

In December last year Hong Kong banks started raising mortgage rates. Prime linked mortgages were offered at higher margins than had been seen for some time and most (if not all) banks stopped offering HIBOR linked mortgages. Lending criteria were also tightened. At the time I speculated that Hong Kong may have seen the end of cheap mortgages .

In the space of four months I have been proven wrong with several banks again offering HIBOR linked mortgages. The terms are not as good as what was offered during the peak of the mortgage wars in 2005/6, but are still better than some of our existing mortgages.

The best deal I have found so far is from Standard Chartered which is offering what amounts to HIBOR + 0.8%. Importantly, they are offering borrowers the option of fixing using the 1 month HIBOR (or longer if wanted). Given the shape of the yield curve this works out at nearly a whole percentage point below what we are currently paying on our home mortgage and on one of our investment properties (about 1.2% pa).

Running the numbers for refinancing at this level would suggest we could either:

(i) keep the payments at the same level and cut the term of both mortgages by about 18 months for one mortgage and and 21 months for the other;

(ii) keep the term the same and reduce the payments, freeing up the difference for other investments.

Given that I can find plenty of relatively low risk investments with much better yields than the interest payable on the mortgage, (ii) looks the better option. (If I wanted to push this line of thought, I would extend the term to take maximum advantage of the arbitrage opportunity.)

The problem is that there is a mismatch between the exposures to changes in interest rates. The mortgage rates are (very) short term and could increase. In fact, over the term of the mortgage, I would be surprised if we do not have higher interest rates at some point. In contrast, the term of the alternative investments is fixed for longer terms (decades for some long bonds) or carries principal risk (in the case of equities). In addition, rising interest rates often result in lower capital values for both debt and equity investments, meaning that responding to rising interest rates by selling assets to repay the debt is not always an attractive option. Given that I will be carrying these mortgages into retirement, this is not a trivial risk.

That said, there is no downside to doing the refinancing. The only question is the extent to which I wish to trade off a shorter repayment period against improved cash flow.

USD/NZD FX contract renewed

Last month's USD/NZD FX contract was exercised against me. The strike price was USD1.00 = NZ$0.5756. Based on the prevailing spot rate this morning (0.5644), the loss on conversion was actually marginally less than the premium earned.

I have entered into a new contract as follows:

Currency pair: NZD/USD
Strike price: 0.5756
Spot price: 0.5644
Maturity: 27 May, 2009
Fixing date: 26 May, 2009
Implied yield: 11.375%

In effect I have written a slightly out of the money put option on the USD with a lower implied yield.

Retirement target date revisited

Prior to the current financial crisis, I had been planning on hitting my retirement number at the end of 2012 or 2013: 2008 Financial Goals . This was based on an assumed return on investments of 6.7% from 2008 onwards, savings levels of both myself and mrs traineeinvestor continuing at their high historical levels and an assumed level household expenditure. All three assumptions are now wrong:

1. my return on investments since January 2008 has been less than 6.7% pa ( I lost money in 2008);

2. our savings rates have taken a hit because mrs traineeinvestor's income used to include a significant bonus component - and bonuses in the financial industry have been significantly reduced;

3. our household expenditure is actually higher than I had previously believed. We run a mixture of separate and combined finances and, while each of us had healthy savings rates, until recently we had never run a combined budget. In effect we had each assumed that the other was spending less (saving more) than had actually been the case. This was an embarrasing case of taking about savings in general terms but only investments and longer term plans in detail.

In effect the entire basis of the 2012/2013 target retirement date calculation has collapsed.

Feeling a bit disillusioned, I went back to the spreadsheet and spent the best part of a week reworking the numbers. The reason it took a week is that the revised numbers showed that we can still achieve our number and retire in 2012/2013. My initial reaction was that I must have messed up (again). Most of the time went into trying to figure out why, in spite of all three of the critical assumptions being wrong, we are still on target to retire in 2012/2013. The answers were as follows:

1. asset prices are lower. I can buy assets with higher yields today than I could in early 2008;

2. the range of investable assets available to me in Hong Kong has expanded. There are more low cost ETF's listed in Hong Kong, more derivative products available and long dated corporate bonds are now available to retail investors;

3. interest rates have dropped by enough to ensure that my property portfolio is still cash flow positive in spite of having to roll over leases at lower levels;

4. in the process of changing jobs, I cashed out what amounts to a long service payment which had not previously been included in my calculations.

The combined effect of all of these is that we are still on track to hit our number in 2012 or 2013. That was a nice surprise. Of course, a lot can happen between now and then (or after), but the fact that our financial objectives are capable of withstanding the current economic crisis was encouraging.

Russia ETF

I placed an order to purchase the Russia ETF (2831) this morning. Due to the limited liquidity and consequentially wide bid-offer spreads, I kept the order size small and placed a tight limit of $18.10 per unit and only managed to purchase about 30% of what I had ordered before the market price ran away from me. The units closed at $18.64.

I'm not inclined to chase the price to complete the order next week and will have to decide between closing a position which is too small to be meaningful and patiently waiting to complete the order by buying any dips in the market.

Equity put option written

I wrote another put option against the Hong Kong Tracker fund (2800) today:

Strike: $14.36
Price of underlying : $15.40
Determination date: 21 May 2009
Maturity: 25 May, 2009
Implied annualised yield (if not exercised): 9.03%

This is a lower yield than my other outstanding contract, reflecting the perception that risk levels have fallen.

As an aside, I could get much higher yields by writing options against individual stocks. However, this carries higher risks and I am more comfortable with lower yields against an index fund. Contracts on individual contracts would also require me to get approval under our staff dealing policies.

Book Review: Your Money & Your Brain

One of the problems with making sound investment decisions is the inability to make consistently rational decisions. The number of times I have made investment decisions (buy or sell) which I have subsequently viewed as being, for want of a better word, dumb is depressingly high. Buying into bubbles with regrettable frequency is my most common error of judgement.

Recognising that this is a common problem for investors, I picked up a copy of "Your Money & Your Brain" by Jason Zweig. Zweig explains why people make so many irrational decisions and provides some very basic advice for dealing with issues like overconfidence, group think and inaccurate risk assessment.

On the whole the book was useful and interesting. Behavioural economics is certainly a subject which it helps investors to have at least some basic knowledge of (Zweig uses the term "neuroeconomics) and this is a helpful introduction. The frequent case studies and summaries of psychology experiments served to illustrate the issues and helped frame the solutions. My one gripe is that Zweig included the much used but fatally flawed psychology experiment involving supposedly equivalent decisions about either saving part of a population from a disease or allowing part of the population to die.

Outrageously bad advice

The relationship manager at my bank invited me to meet a "wealth manager" to discuss possible ways to invest the cash balance in my account. I acquiesced but made it clear that I was not interested in insurance based products. I should have known better. The suggestions of the "wealth manager" were appalling:

1. I was offered life insurance. I repeated that I had no need of any further life insurance;

2. I was offered an annuity that would have required me to invest lump sums over three years, was projected to achieve a non-guaranteed break even after eight years and a non-guaranteed annualised return of 4% pa on maturity after 20 years. (Why it was called an annuity is beyond me.) I pointed out that an investment that showed a guaranteed loss for the first seven years was a really stupid idea and, in any case, I could buy bonds of similar duration which offered better yields as well as reasonably good liquidity;

3. I was offered an unlisted, closed end five year corporate bond fund which had a front end load of 3% and a management fee of 2% pa (I didn't bother trying to identify the other expenses). The projected annualised return was around 4% pa not guaranteed. I pointed out that I could get similar yields with greater potential upside by buying a portfolio of shares or higher yields with better liquidity by investing directly in high grade corporate bonds;

4. my relationship manager (who had been silent up to this point), then offered me a longish term bond issued by the bank which had a yield to maturity of above 7% pa and which was reasonably liquid. I refrained from pointing out that the bond had the same credit risk as the annuity, but a much better return which was guaranteed and reasonable liquidity making it impossible to justify investing in the annuity.

I really fail to see how anyone could even attempt to sell #2 and #3 to anyone (bearing in mind that the bank was in an advisory relationship with me).

India ETF purchased

Yesterday I added to my investment in the Sensex India ETF (2836) at HK$9.95 per unit. The purchase reduced my cash on hand balance back to about four years of living expenses. This is still way too much cash to hold in accounts which yield very little interest, but I am still nervous about near term economic conditions.

I gave considerable thought to investing in the Lyxor Russia ETF (2831), but was deterred by the more limited liquidity.

Equity put option written

The previous put option I had written against the HK Tracker Fund (2800) expired without being exercised and I pocketed the premium.

Yesterday I wrote another one month put option against the HK Tracker Fund at a strike price of HK$14.42 per unit (the market price was HK$15.32 at the time). The annualised yield is about 15% (assuming the option is not exercised).

Whil I have made money on all my option trades this year, given the extent of the market's advance, I would have made more money by simply buying the underlying.

Monthly Review - March 2009

March was a great month for my investments. Just about every investment I hold appreciated in value and the gains were compounded by sharply favourable currency movements. In addition, I continued to enjoy full rental income from my properties, although reset lower rental levels will start applying from April onwards.

Here are the details:

1.my actively managed funds all appreciated during the month. I am still holding losses on many of them. I currently have investments in actively managed funds investing in Thailand, Taiwan, Eastern Small Companies, European Small Companies and Vietnam;

2. my index tracking funds were up. I currently have exposure to Hong Kong, India and Taiwan;

3. my residual equity portfolio appreciated slightly;

4. my commodity investments appreciated slightly. I have small positions in the Lyxor Commodities ETF, nickel and lean hogs;

5. all my properties are all fully rented and the tenants are paying the rent on time. I have both a positive cash flow and a surplus of income over expenses (which represents an increase in net worth).

6. currency movements were favourable as the USD retreated against a number of currencies.

I increased my exposure to the HK Tracker fund and entered into two OTC option contracts:(i) long NZD/USD (ii) writing a call option against the HK Tracker Fund.

Income was low (it will be erratic under the new job) but sufficient to contribute to the gain for the month. My spending was also low. I already make accruals against my net worth for holidays, luxuries and tax.

For the month, my net worth increased by 5.28%. The year to date increase is 16.37%.

Travelling in the US

I spent the last two weeks on an extended business trip in the US. As a "new" country for me to visit (my only previous visit to the US was a three day business trip in the mid-1990s), I found the experience interesting.

Some random observations:

1. airports: with two international flights and seven domestic flights on the schedule I was not looking forward to the experience of going through immigration and security checks repeatedly - the horror stories of very long queues, unpleasant treatment and flight cancellations or delays were numerous. I was pleasantly surprised. The TSA staff (and others) were always polite, efficient and professional. Queues were short and efficiently processed;

2. the airlines: nobody I know will fly any of the US airlines when there is another option available. Travelling domestically, there was no choice and I ended up with flights on American Airlines, Delta and United. In all cases, the check in was a pain - none of the self service check in terminals worked for either myself or my colleagues - but the cabin crew on all airlines were great and tried very hard to make the flights as pleasant as possible. One flight was cancelled but all other flights left on time;

3. food: the portions of food in restaurants was consistently bigger than I was used to and red meat seemed to make up a much larger portion of the diet. Needless to say I put on weight on the trip;

4. hotels: the hotels (all four or five star) were a mixed bag. Some were good. Some were very average and, quite frankly, did not deserve the reputation or ratings associated with their brand names. Service standards were below those of similar hotels in Asia - which is very surprising given the different tipping cultures;

5. car culture: I live in a city where a car is completely unnecessary. Seeing the extent to which Americans rely on their cars was interesting and was, perhaps, the most striking cultural difference between Hong Kong and the US (in particular LA);

6. the bailouts: just about everyone I spoke to was pro-Obama, against the bailouts of the auto industry and had some reservations about the bailouts of the financial sector (in particular AIG). While the AIG bonus issue got most of the financial headlines, most of the people I was speaking to were more concerned with the much bigger sums of money which had been channelled through AIG to institutional counterparties, the size of the debt being racked up and future inflation;

7. the economy: the American economy has obviously been hit harder than the Hong Kong economy. However, the people seemed more optimistic - perhaps a reflection of the fact that most of the people I was speaking with still had well paying jobs;

8. air quality: even in big cities like NY and LA, the air quality is much much better than HK. I miss clean air;

9. things to do: I had very few opportunities to play the tourist and generally confined myself to art galleries when I did. I particularly enjoyed MOMA in NY and Venice Beach in LA.

I certainly enjoyed my time in the US and, if I can swing another business trip next year, will try to take a few days to see more of the country.