Monday, May 31, 2010

Monthly Review - May 2010

May was a very bad month for financial progress with extensive losses across all my investments compounded by adverse currency movements only partially offset by positive cash flow on my properties and modest savings.

Here are the details:

1. my Hong Kong equity portfolio declined significantly. There were two trades this month with large positions in CCB and Sinopec being added following ELDs being exercised against me

2. my ETFs all fell in line with their respective markets (Hong Kong, Russia, Taiwan and India)

3. my commodities all declined (ETF, silver, HOGS, NICK)

4. all of my properties are let producing a positive cash flow and making a positive contribution to my net worth. I have two repair bills due (a replacement for a very old air conditioner and a partial repainting due to mold)

5. currency movements compounded the losses as the USD rallied strongly

6. I did two ELDs over China Construction Bank and Sinopec - both were exercised against me

7. savings were positive with income and expenses both being average

My cash position is currently low following repayment of a loan from Mrs Traineeinvestor and the ELDs being exercise against me

For the month, net worth fell by 3.9%. The year to date increase is 4.9%. The good start to the year came to a grinding halt with this months significant losses.

While it was expected that the markets would give back some of their gains, the size of the losses in a single month was much larger than my expectations. Given that the 3.9% is net of principal payments on my mortgages and my savings and that about 46% of the net assets is currently represented by property equity (which did not fluctuate), the losses on the mark to market equity and commodity portfolio were much higher than appears - roughly 8.4%. That is a large decline for one month.

Although I do not keep comparative numbers, it seems fairly clear that the portfolio outperformed when the market was rising and underperformed when the market was falling - this is the opposite of what was expected when I constructed what I had believed to be a (mostly) conservative and well diversified portfolio.

The scary reality of retirement

Kiplinger carried this article illustrating the effect of inflation on real incomes over periods of time.

To put the article in perspective:

1. a person who retired 10 years ago on a fixed income would now be facing a 20% reduction in real income;
2. a person who retired 20 years ago on a fixed income would now be facing a 39% reduction in real income;
3. a person who retired 30 years ago on a fixed income would now be facing a 62% reduction in real income.

(Although not stated, I assume that the adjustments have been done using US CPI numbers.)

This sort of data really demonstrates the inadequacy of most standard retirement plans that advocate spending principal for living expenses and having a substantial portion of assets in cash or fixed income. Even in a low inflation environment, the very blunt reality is that you need more than you think you need and you need to invest substantially in assets which have at least some chance of keeping up with inflation. The earlier you retire the more essential this becomes. Any other approach to avoid risky assets like shares and property is a plan to face a declining standard of living and ultimately poverty as you age.

And for those who think that inflation adjusted securities are the answer, this thread on the early retirement forum is worth a read - inflation adjustments have not kept pace with the actual cost of living faced my many seniors. In sort, for the elderly the corrosive effects of inflation are even worse than Kiplinger suggests.

Friday, May 21, 2010

Missing an opportunity

The recent market correction has done two things.

The first is that it has reduced the value of the private portfolio - the amount of the drop is meaningful and absent a strong rally before month end will result in a drop in net worth this month. That's life. Markets go up. Markets go down. As much as it hurts watching the value of the portfolio decline, as I am still an accumulator of assets, a lower market is, in the long run, better for me than a higher market.

The second consequence of the correction is that the local Hang Seng Index has dropped to a point where it is trading at below its long run historical PE ratio (14.0 v 15.7) . This does not mean that the market will not go lower - merely that history and valuations are now more favourable. Given that the sell off has been somewhat indiscriminate, some individual stocks that I would like to add to the portfolio look quite attractive.

There is just one problem. Due to two bad calls on my part, I have almost no cash available to take advantage of the opportunities:

1. when we settled our last property purchase, instead of selling some shares and/or using the money set aside for writing options, I borrowed part of the deposit from Mrs Traineeinvestor and my cash flow for the last three months has been used to pay off that loan. If I had sold shares to fund the purchase, not only would I have sold at higher prices but I would have a useful block of cash available to reinvest;

2. the cash I did have was used to write put options on listed companies just before the market started sliding. Next week those options will most likely be exercised against me with the net effect that I will have brought the underlying shares (Sinopec, CCB) at prices higher than the current market prices.

I'm sure there is a lesson about keeping some cash reserves on hand in there somewhere. In any case, I have now settled accounts with Mrs Traineeinvestor and am hoping the market stays down for at least another few months so I can do some shopping.

Monday, May 03, 2010

A case study in emerging market risk

Emerging markets are littered with companies that go bust (or otherwise manage to destroy all or most of their shareholders' investment), often in circumstances which would not be expected in markets which are classified as developed and which, in theory, are better regulated and offer greater transparency.

The SCMP article on the demise of First Natural Foods Holdings Limited is a case in point. The company was listed in Hong Kong and ran a business of selling a range of food products such as the highly popular and valuable abalone from its headquarters in Fujian Province. In June 2008, it reported shareholders funds of RMB1.2 billion and cash of RMB630 million. In other words, the audited accounts showed a very solid and highly liquid balance sheet.

Within a matter of months, the company managed to more or less implode. In January 2009 the Hong Kong courts declared the company to be insolvent.

The insolvency begged the obvious question - what happened to the cash? At this stage it appears that the answer may never be known. Ernst & Young were appointed as liquidators. After 16 months on the job:

1. they have been unable to take control of the company's business and assets (which are located in the PRC)

2. they have been unable to find the company's former top executives

3. most of the company's books and records have been "lost"

4. the (former) top executives are still holding the company's chops (without which apparently PRC law will not allow the liquidators to take over the business)

5. (for the most part) the PRC courts have refused to support applications by Ernst & Young

6. HK$84 million was removed from a company bank account in Xiamen two months before the company was placed in liquidation - a transaction which was not recorded in the company's books

The reality is that shareholders have no remedy for situations like this.

The First Natural Foods case is not an isolated incident. There are plenty of similar stories of inexplicable insolvencies of Hong Kong listed companies. (That said, there is no shortage of corporate bankruptcies in developed markets as well.)

The clear message for me as an investor is not limit my exposure (unlike the unfortunate individual quoted in the SCMP who put 15% of his stock portfolio invested in First Natural Foods).

Most of the companies I buy are substantive businesses, have sound balance sheets, are state backed (for the PRC businesses), have big four auditors, have a visible management presence and have been listed for a number of years. The exceptions tend to make up a very small percentage of the portfolio. The largest position in any individual share (based on current market values) represents less than 1.6% of our household's net worth and my entry level for new investments is currently just below 0.5% of household net worth for most companies (I will invest more in very substantive companies). If a single company in the portfolio disappears over night, it would hurt but would not destroy my retirement plans.