Saturday, February 28, 2009

Monthly Review - February 2009

February marked yet another down month for my investments. The positive was that the losses were relatively trivial.

I started my new job. However, my income is more erratic than my previous job and, as expected, this month's income was low. I continued to enjoy full rental income from my properties - a state of affairs that will come to an end this month with one property becoming vacant.

Here are the details: actively managed funds were mixed with a net decrease during the month. I am 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 down slightly. I currently have exposure to Hong Kong, India and Taiwan;

3. my residual equity portfolio appreciated slightly;

4. my commodity investments went sideways. 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). One has moved out and will cease paying rental at the end of February;

6. currency movements were marginally unfavourable as the USD gained against a number of currencies.

I made no portfolio investments this month but did enter into three OTC option contracts:

(i) long HKD/GBP - the option was exercised against me at levels which produced a net profit for me (i.e. the option premium was higher than the FX conversion loss);

(ii) short HK Tracker Fund - the option expires on 5 March and, with the strike price still out of the money, it looks like I will make the premium on this contract as well;

(iii) long NZD/USD - this is a more aggressive trade.

I intend to continue experimenting with option trades (much like I did with warrants last year), but only with relatively trivial amounts of money and against underlying assets which I am prepared to hold on a longer term basis.

Income was low (it will be erratic under the new job) but sufficient to tip a small loss into a small gain for the month. My spending was also low. I already make accruals against my net worth for holidays, luxuries and tax. This month I have decided to start making a general accrual for long term expenses (such as refurbishment of our flat).

For the month, my net worth increased by 0.09%. The year to date increase is 10.54%.

Thursday, February 19, 2009

The anecdotal recession (3)

Dress casual is definitely on the decline. Just wandering around the central business district in Hong Kong it is obvious that the proportion of (assumed) office workers who are wearing formal attire compared to those dressing more casually has risen steeply.

It's not too hard to understand the cause. People who are worried about their jobs, want to look more professional and serious. Those whose jobs involve dealing with clients on a face to face basis tend to need to dress to a similar standard as those clients - if the clients start wearing suits then those wanting to do business with the clients will also wear suits.

Sadly, I am in that position - the number of my clients wearing suits instead of business casual has risen and even before changing jobs, I was having to change my dress habits to match. At my new employer, wearing a suit is more or less compulsory.

I miss dress casual.

Wednesday, February 18, 2009

Who will bail out the taxpayers?

Everybody from large banks and insurance companies, auto makers to Larry Flint is asking for a bailout. Huge numbers of over committed borrowers are all seeking (and often getting) a bailout in the form of debt relief. The bail out may be provided through capital injections or the acquisition of assets of questionable value, but all of that money has to come from somewhere. Likewise, debt relief for borrowers comes at the expense of either the lenders or the taxpayer.

There is no such thing as a free lunch and not even governments can freely print money without consequences. So where is the money coming from?

Ultimately, it can only come from four sources:

1. higher tax revenues: in a recessionary economy raising taxes is obviously a good way to make a bad situation worse because higher taxes (i) divert money from private sector consumption and/or (ii) inefficiently divert money from private sector capital formation. Higher taxes typically hit mid-higher income earners the most - and this is the same group of taxpayers who include small business owners. In most developed economies small businesses generate a very high percentage of new jobs. Cutting taxes (or similar) is a better move;

2. borrowing: the government can borrow the money. As a short term fix this is a better alternative than options 1 and 3, but someone (future taxpayers) will have to repay the loan with interest. Low interest rates make this a more attractive option but is comes with a price beyond the obligation to repay - because government debt is perceived as being lower risk, it has the effect of crowding out or increasing the borrowing costs of private sector borrowers. There is also the question of who the money is being borrowed from? If the lenders are domestic, then it can be argued that it is simply a case of redirecting money from one group of participants in the economy to another group of participants;

3. printing the money: many governments/central banks have been running the printing presses pretty hard in recent years. Conspiracy theorists would argue that the decision to stop publishing M3 data is evidence of just how much money is being printed. The trouble with simply printing money is that every new dollar printed has the effect of devaluing all the existing dollars. In effect, when new money is printed, the holders of old money become poorer. This is inflation in its most simple form. While there is plenty of evidence and conventional wisdom that says that mild inflation is better than deflation, even mild inflation has adverse consequences (see what happens to a person on a fixed income over 30 years experiencing "only" 2% or 3% annual inflation);

4. spending surpluses: Keynesian economic theory holds that governments can smooth the economic cycles by accumulating surpluses in good times and spending those surpluses in bad times. This is what some countries are going now (e.g. China and Hong Kong). Unfortunately, many countries seem to have forgotten the part about accumulating surpluses and were already heavily in debt when the current crisis began.

Whatever the source(s) of the bailout money, someone has to pay for it. In the end it will either be future taxpayers or the holders of money and other assets which get devalued with inflation. Put differently, all a bailout does is transfer the pain from one group of societal stakeholders by imposing a burden on another group.

This is not say a bailout is a bad thing, but ignoring the costs and future pain associated with the bailout would be a very bad thing. The point can be illustrated with the contrasting examples of Japan and Zimbabwe. Japan spent massive sums of borrowed money attempting to stave off the consequences of its financial markets collapsing in the early 1990s. Over a decade later, the economy has continued to contract and remains burdened by high public sector debt levels. Zimbabwe simply ran the printing presses too much and rendered the local currency close to worthless.

So, who will end up paying the price for the current round of bailouts?

The anecdotal recession (2)

More evidence of the recession has hit me.

I go to a gym three days a week (OK, I try to go to the gym three days a week). The gym I use was selected because it is close to the office (any further and distance would reduce the likelihood of using it) and my then employer negotiated a good discount on the membership fees (it was cheap). The gym provides full service - shirt, shorts, socks, towels, shaving cream, disposable razors etc etc. This made life very convenient - all I needed was my running shoes and an alarm clock to get out of bed in the morning.

Things have changed. With no notice to members, the disposable razors and shaving cream have gone (turning up to work unshaven earned me a few funny looks) and there have been no socks on my last four visits. Small things, but indicative of people either trying to cut costs or being forced to.

Monday, February 16, 2009

Second homes - a bad idea?

With the current economic conditions there have been several stories about people being forced to sell (or attempt to sell) their second homes. While a second home has its attractions from a lifestyle perspective, and may provide a sense of well being etc, from a financial standpoint they are a poor way of allocating capital.

I ran a spreadsheet comparing the cost of owning and maintaining a second home against the equivalent amount of money invested in long term bonds and renting serviced apartments when needed. The result is at least partly dependant on what property you are looking at and how frequently it will be used, but based on the particular example I considered, the bond portfolio was a clear winner.

With the ownership option, there is the purchase price, the costs of acquisition and the cost of furnishing the property. I assumed that I would not have to redecorate or do any repairs. On an on-going basis I would have to pay rates (property taxes), body corporate fees and routine maintenance and would have to pay someone to visit periodically to air it out etc. Longer terms, it would need repainting and more substantial maintenance which was ignored for the purpose of my comparison.

With the the serviced apartment option, there is no immediate cost - I would buy a portfolio of bonds (or bond funds) and collect the interest payments. I would pay for the use of the serviced apartment as and when I use it. I assumed three months a year of usage (which is the longest time I can spend in the country without triggering a possible tax residency). Shorter periods of usage would make this option even more favourable.

If I could assume that the numbers would remain static for as long as I wished the arrangement to continue, the serviced apartment option would be a clear winner. In fact the cost of renting the serviced apartment would only be about 20% higher than the annual short term expenses of owing the second home. Put differently, I would have to allocate 3.6 times as much capital to owing a second home than I would need to invest in bonds to pay for the serviced apartment.

Unfortunately, the numbers will never be static. Inflation will play a role. It will increase the costs of renting the serviced apartment, increase the costs of owning the second home and increase the value of the second home. There is also roll over and reinvestment risk on the bonds. However, if I use the property for three months a year, I would have to experience long term inflation of more than 3.6% pa before owning a second home becomes the better choice. Even then, this ignores longer term maintenance issues and the likelihood of using the property for less than the full three months each year.

For completeness, I did not consider renting out the second home for short term periods when I am not using it. If it is my home, I would not want other people living there. However, if I did rent it out for part of the year, this would obviously reduce the cost of owning a second home. I also ignored factors such as the greater flexibility and possible non-availability of the serviced apartment option and the ability to take out a mortgage against the second home or simply convert it into a rental property.

In conclusion, a second home only makes sense from a financial perspective in a high inflation environment. In a low inflation environment, investing in bonds and renting serviced apartments as and when needed is the better choice.

Sunday, February 15, 2009

The anecdotal recession (1)

Even without the media coverage, it is easy to see evidence of an economic downturn. Day to day observations can give a pretty good indication of the state of the economy. Here are some examples:

1. shipping volumes: our home has a partial view of the shipping channel into the Hong Kong container terminal. The number of empty or only partially loaded ships is very noticeable. This is a good indication that trade volumes are down;

2. taxi queues: the length of the queue for a taxi during peak hours has fallen to insignificance over the last 12 months or so. Given that a large number of the people in the queue are either directly or indirectly working in the financial industry, this is a pretty fair reflection of the state of the banking and finance industries;

3. vacant shops: we are just beginning to see more shops become vacant. One assumes that retail sales have fallen;

4. restaurant bookings: in better times, lunches at popular restaurants required a booking two weeks in advance. I can now get same day reservations and there will be plenty of empty tables making the reservation unnecessary.

None of 2, 3 or 4 have reached the state of affairs that prevailed during SARS at the end of the Asian crisis. The most noticeable difference is the shipping volumes which remained robust during the Asian crisis. This reflects the fact that this time it is different - the whole world is facing economic problems - not just Asia.

The trick is to identify the things which will indicate that the economy has turned. Some of these indicators will be evident before the economic data reflect a recovery.

Friday, February 13, 2009

Valentine's Day - annual romance killer

Tomorrow is Valentine's day - that day of the year when florists, restaurateurs and others do their utmost to kill romance with inflated prices, tacky advertisements and poor value pre-packaged services.

I had hopes that one of the fringe benefits of the economic recession would be a reduction of the extent of the price gouging. Sadly, those hopes have not been realised. The cost of a dozen roses actually went up this year and restaurants still insist on offering "specials" comprising over priced meals that offer limited choices on food and very ordinary wine at prices that would embarrass a hedge fund manager.

As usual, I have succumbed to the pressure to deplete the bank account for the flowers (in spite of mrs traineeinvestor's request not to waste money) but will boycott the restaurants and cook a candle lit dinner for two at home with an only somewhat overpriced bottle of very good wine.

Tuesday, February 10, 2009

Prospering in a recession

Well, not my finances but some people seem to be doing well out of the recession:

1. Disneyland: They recently announced a significant increase in the cost of admission to Hong Kong Disneyland for tourists (the fees for locals will be reviewed in a few months). It wasn't cheap to begin with;

2. Physiotherapists: With more people having time to exercise (not necessarily by choice), more people are injuring themselves. Given that I recently had to wait three days before getting an appointment, I can personally testify to this one;

3. Civil servants: The greatest drain on the Hong Kong tax payer awarded themselves above market pay increases in 2008. Needless to say, it would be too much to expect any cuts in either civil service remuneration or numbers;

4. Banks: Banks have widened their spreads between interest paid on deposits and interest charged on loans. Several have also increased fees and charges. So why aren't they doing well? Something to do with management apparently;

5. Tenants: rental levels have fallen significantly for both office and residential leases.

Sadly, all of these are benefiting at my expense - lower income for #5 and higher expenses for the remainder.

A number of potential investments have become a lot cheaper (stocks, real estate), but I am still waiting for any of my living costs to come down.

Friday, February 06, 2009

Writing put options

Writing options is generally regarded as a risky idea (unless as part of a hedging/spread strategy or similar). The reasoning is generally stated as being that the option writer receives a relatively small payment in exchange for accepting a much larger risk.

The current market turmoil has resulted in the premiums paid for put options being inflated above normal levels (not sure what is "normal"). Given that I believe that the Hang Seng index is reasonably attractive at these levels (i.e. I do not mind buying the index), I have written some put options against the Hong Kong Tracker Fund (which tracks the Hang Seng Index). My strike price is HK$12.00 (against a market price of HK$13.24 at the time of writing) and the contract is for one month.

If the Tracker Fund is higher than HK$12.00 on the fixing day, I will keep my money and pocket the option premium.

If the Tracker Fund is at HK$12.00 or less, I will end up buying Tracker Fund at HK$12.00 and keep the option premium.

Of course, if the market drops below HK$12.00 (less premium) then I will lose money. If the market rises above HK$13.24 (plus premium) then I would have been better off just buying the Tracker Fund outright. Essentially, I am betting that the market will go sideways or down less than 9% on the fixing date.

Since my primary motivation for this trade is to improve the yield on my cash balances, I have gone for a strike price which is well out of the money. I could have got a higher return by taking on more risk and selecting a strike price which is closer to the current market price.

Sunday, February 01, 2009

Off balance sheet items

The impact of cashing out a long service payment when I left my old job had a significant impact on my net worth (about 11% on my balance sheet and about 7% on the combined balance sheet) for the simple reason that no provision had been made in the balance sheet for this benefit. This was deliberate - it was difficult to value and in certain circumstances it might have amounted to a lot less than it did. The purpose of running a balance sheet is to help with my financial planning. Including assets which are of uncertain value and have the potential not to eventuate at all is more likely to harm than help my financial management.

However, receiving the payment did lead me to think about any other assets and liabilities which are not on the balance sheet. I came up with the following items:

1. a whole of life insurance policy taken out when I was at university. It matures when I am 50 and the amount involved would pay for a modest car or an extensive bout of travelling for us after I retire. The justification for not including this is the intention to spend it (unless I need it at the time);

2. a modest collection of claret in bond with UK wine merchants. While the wine could be sold, the amount is not large and it is likely that at least some of it is an investment in future drinking rather than financial well being;

3. paintings and carpets. The resale value of these is uncertain (but certainly small) ;

4. mrs traineeinvestor's jewelry. I strongly suspect that if I suggested selling my wife's engagement ring, she would list some of my surplus body parts on e-bay;

5. depreciating items such as furniture (or a car if we had one) would not qualify as investments and would never be included as assets in a balance sheet.

Even if the guesstimated value of items 1-4 above were added to the balance sheet, the effect would be minimal (about 1%).

I couldn't think of any liabilities which are not included in the balance sheet.