Thursday, July 30, 2009

The rich - an exploited minority

The IRS data on US tax returns for 2007 have been released and make sobering reading. Some statistics:

1. the US population is 304, 059, 724 (as of July 2008);

2. 141, 070, 971 people paid federal income tax. Only 46.3% of the population pay any income taxes;

3. the top 5% of federal income tax payers contributed 60.63% of the total income taxes paid. This is up from 37.44% in 1986 and shows that the rich have been bearing a steadily increasing proportion of the total tax burden for at least the last 23 years;

4. the 7, 053, 549 people who make up the top 5% of people paying income tax pay more tax than the remaining 134, 017,422 tax payers;

5. in effect a mere 2.3% of the population is paying more than 60% of the income taxes.

The raw data makes political cries of "soak the rich" sound self serving, hypocritical and hollow. Stupid and wrong are also words that come to mind. The facts are that the rich have been soaked already. "Fair" is hardly a word that can be said to describe proposals to increase taxes on high income earners further.

Leaving aside subjective questions of "fairness", having such a narrow tax base is a highly dangerous way of managing an economy:

1. a narrow tax base creates a moral hazard in that there is political incentive to appease the masses by imposing the burdens of new electoral bribes on a relatively small minority of people who have no ability to protect themselves;

2. a narrow tax base is highly vulnerable to revenue shortfalls when something happens to affect the obligation or ability of the taxed to pay. Given that a lot of high incomes are closely linked to economic performance, you would expect those incomes (and the taxes paid on them) to fall during periods of economic contraction. This is what has happened in California, happened in the great depression and has happened in all of the other economic contractions I have looked at. It would be very surprising if tax receipts do not fall substantially during the current downturn;

3. high taxes act as a disincentive to invest (with consequences for job creation) and an incentive to adopt behaviour which is designed to reduce the tax burden (legally or illegally).

The blunt reality is that governments and the people they claim to represent cannot continue to soak the rich ad infinitum. At some point people have to accept that there are limits to what a country can do to provide a better quality of life for its people. Forcing a small minority of people to bear such a disproportionate amount of the burden is simply bad economics.

As much as I dislike her writing style, Ayn Rand's "Atlas Shrugged" would make excellent mandatory reading for those advocating higher taxes. If people want something more contemporary, press clippings on California's budget debacle would do as well.

A well regulated mortgage industry

Two years ago I compared the mortgage business in Hong Kong with other jurisdictions and asked myself whether Hong Kong could expect a mortgage crisis similar to the one being experienced in the US, the UK and a few other places. My conclusion was that it was unlikely that we would see a mortgage led credit crisis in Hong Kong. This was largely due to the way in which mortgage lending is regulated.

In very simple terms:

(i) banks will only lend up to 70% of their valuation of the property (which may be less than the market price) without mortgage insurance (which is not often used). Put differently, you will normally need a 30% deposit in order to buy a property here;

(ii) no-doc or low doc loans (aka liars loans) are not tolerated;

(iii) provision for defaults is required promptly if a borrower falls behind in payments;

(iv) the repackaging of mortgages is permitted and does happen but (i) and (ii) means that the repackaging does not involve sub-prime loans.

Hong Kong has had zero bank failures since the credit crisis. There has been only one relatively trivial run on a bank (BEA due to rumoured losses on derivatives) which did not affect that bank's good standing. In fact even during the Asian crisis when Hong Kong property prices fell by 60+%, there were no bank failures and only one run on a bank (IBA which survived with some support). IIRC, the last bank failure in Hong Kong was BCCI in the 1980s which failed for reasons that had nothing to do with regulatory deficiencies in Hong Kong.

Honestly - how hard is it to properly regulate a mortgage industry?

Wednesday, July 29, 2009

South Sea Petroleum sold - loss taken

Of the 15 companies I have invested in since I commenced buying individual Hong Kong listed shares at the beginning of May, this is the only company which is not only loss making but which is not expected to make a profit any time soon. While the potential upside is large, so is the uncertainty. There is nothing inherently wrong with speculating. However, I have invested almost all of my available cash which is not tied up in either ELDs/CLDs or earmarked for investing in my employer at the beginning of August. If I want to invest in companies that actually have earnings (or at least earning potential), I either need to sell something or reallocate money currently invested in CLDs/ELDs. I have chosen to take the loss on South Sea Petroleum and sold my position this morning at HK$0.049 per share - a loss of about 12% on my average purchase price of HK$0.055 per share.

Tuesday, July 28, 2009

The running of the property bulls

Residential property prices in Hong Kong have recovered most (but not all) of the declines which followed the onset of the credit crisis. Even rents have started rising again. Outside of the luxury sector, prices are still about 30% below the short lived peak of 1996/7. People looking for properties are finding supplies are limited and vendors are inflexible and unmotivated. In a word, it is a bull market.

What is driving the market? Supply and demand.

On the supply side, there is a shortage of both primary (new) sales and secondary sales. The pipeline of new developments is expected to remain low (around 10-12,000 new units each year from 2009-2012 which is below the rate of take up suggested by demographic factors). The situation will be compounded if developers hold delay selling projects. Secondary sales are also limited by a number of factors of which two are probably the most important: an expectation that prices will continue rising and an absence of alternative investments.

On the demand side, the jobs market has stabilised, mortgages are cheap (less than 1%), there is an influx of buyers from the mainland, the stock market has soared, there are few other places to invest and people expect prices to keep rising.

One rather simplistic way of looking at things is that Hong Kong has net bank deposits of HK$3 trillion earning very little (if any) in the way of interest. This is an all time high and that money is not going to sit around generating negligible returns forever.

So will property prices keep going up? How far?

Supply is not meeting demand. Affordability is high thanks to low interest rates. My expectation is that prices will rise further but I have no idea how much. One bank has forecast that residential prices will rise 31% between now and the end of 2010. It could happen - but I will not be taking out another jumbo mortage to join the party. My existing portfolio will give me enough exposure to that asset class.

The making of a new asset bubble

Way back in October 2007 I wrote this post on what I saw as a credit induced bubble in the Hong Kong stock market and the Hong Kong real estate market. Although this was fairly close to the the last high water mark for both markets, I only took limited steps to protect the private portfolio against the likely deflating of those bubbles. (Mainly by building cash by not investing rather than selling assets.)

Starting in about October last year, both property prices and share prices have rocketed upwards. Share prices are still roughly 30% off their peak but property prices are getting much closer to the levels of 2007 and, in the luxury sector, possibly even the top of the pre-Asian crisis boom in 1997. Why?

The explanation for the dramatic rise in share prices is relatively straight forward. At the low point pessimism ruled the market. Banks were expected to fail. Trade was grinding to a halt. Exotic (if stupid) products like accumulators were causing investors a lot of pain as the market made rapid progress towards what would eventually be its low point. People became more concerned with the return of their money rather than the return on their money (to quote Mark Twain). The market was, in a word, oversold. What happened to turn this around? The banks didn't fail. Trade dropped but not as much as many people feared. Governments announced huge stimulus packages. Interest rates were cut from already low levels. Unemployment did not rise as much as people feared. Central banks flooded the world with liquidity and the HKMA was forced to follow the herd in order to keep the HK$ pegged to the US$. All that money had to go somewhere and unless you were happy with zero interest deposits the stock market was an obvious place to put your money. Shares were cheap.

The property market's turn around was less dramatic for the simple reason that prices did not fall as far as share prices but most of the same factors which propelled the share market up over 50% in about seven months have driven property prices up as well: cheap money and lots of it.

Today, neither property nor shares can be considered cheap (although there are still individual shares which offer good value). However, as long as money keeps flooding the market, it is difficult to make a case for preferring bank deposits over either asset class. In effect, we have the makings of a new bubble in the making.

History suggests that money will not remain either cheap or plentiful forever. At some point central banks will start to withdraw money from the banking system and raising interest rates to combat inflation that would likely follow once the economy starts recovering. While it is expected that monetary tightening will be introduced cautiously and (hopefully) after a recovery is well underway, it will happen at some point.

Reducing liquidity and raising interest rates would be expected to have a negative effect on both share and property prices. At some point I will have to adjust my asset allocation to that new reality. The challenge will be to find asset classes that, at the very least, hold their real value during the tightening phase.

Monday, July 27, 2009

Luk Fook - purchased and sold

This morning I placed an order to buy Luk Fook (590). As the stock is relatively thinly traded I placed a limit on my order which was partially filled at $3.96. The stock then jumped above $4.00 which I was not interested in paying. Rather than be left holding and monitoring a small position, I elected to sell the small number of shares purchased at $4.05. Net of transaction costs, the very small profit taken will buy mr and mrs traineeinvestor a nice dinner in a good restaurant.

And yes, you do have to be careful when pronouncing the name of the company.

Equity put options written

Two of the equity put options I wrote last month expired unexercised. Once again, I have rolled the contracts forward for another month using the same underlying stocks. However. I have been less aggressive and used strike prices a bit further out of the money and accepted smaller option premiums as a result.

Details are as follows:

Contract #1

Underlying: Hutchison Whampoa (13)
Market price: $56.30
Strike price: $53.50
Valuation date: 25 August
Maturity date: 27 August
Implied yield: 11.32%
Net purchase price if exercised: $53.00

Contract #2

Underlying: China Construction Bank (939)
Market price: $6.15
Strike price: $5.85
Valuation date: 25 August
Maturity date: 27 August
Implied yield: 16.2%
Net purchase price if exercised: $5.78

Both are stocks I would be comfortable purchasing at these prices. If I get hit I will have effectively purchased the shares at about a 5.9% (HWL) or 6.1% (CCB) discount to the prevailing market prices.

Sunday, July 26, 2009

Diversification revisited - how and how much (2)

In my previous post on how and how much I should diversify the private portfolio, I concluded by identifying two risks that I should aim to reduce through diversification:

(i) the risk of positive correlation among asset classes; and

(ii) the risk associated with individual assets.

The latter risk is the easiest to address - I simply do not put a material amount of money into any single asset. In this respect, I am less concerned with real estate as the risk of a single property suffering total loss of value is (in my opinion) not material. Absent earthquakes, wars, nationalisation etc property does not disappear. Shares are another matter. Shares can and do go to zero value without any prospect of recovery. It happens all the time - even to very large well regarded companies. In terms of diversification against this risk, the largest allocation we have to a single property is 6.05% of net assets (our home) and the largest allocation we have to a single share is 0.9% of net assets (Westpac Banking Corporation) . Most of our shares are around 0.6% of net assets at the time of purchase. If one company I have invested in becomes the next Lehman Brothers, Enron etc the impact on the private portfolio will be trivial.

The risk of positive correlation among asset classes is much harder to address. During the credit crisis and the years which preceded it, most of the major asset classes showed higher degrees of positive correlation than is desirable from an asset allocation perspective. During the crisis itself, real estate, equities, corporate bonds and commodities all moved down sharply. Of the major asset classes only government bonds advanced (negative correlation) and gold more or less went sideways (low correlation).

In Hong Kong I have a problem that low cost index funds are few and far between. US funds are not available and the next best thing (from a cost perspective) is ETFs listed in London which have higher transaction costs, involve FX conversion and (last time I checked) were not convenient to trade on line. In effect, by precluding difficult to access overseas products and high cost actively managed funds, I am currently limited to the following:

1. ETFs listed in Hong Kong which track indices linked to Hong Kong, China, Taiwan, India, and Russia. ETFs linked to the US, Japan, Asia and Europe seldom trade;

2. Equities and REITs listed in Hong Kong, Australia and New Zealand;

3. An ETF linked to a basket of commodities;

4. A limited range of high grade bonds denominated in HK$, US$, Euro, NZ$ and RMB. The spreads on these products are enormous;

5. ELDs over large cap Hong Kong stocks;

6. CLDs over a number of currency pairs;

7. Paper gold, silver and platinum;

8. Cash and bank deposits;

9. Real estate in Hong Kong.

In terms of reducing portfolio risk by diversifying among asset classes which have negative or low correlation, my options are a bit limited. Currencies by reason of being a zero sum game should have a low or negative correlation with equity markets over a period of time. ELDs offer some diversification benefits - especially if I write them sufficiently far out of the money. Bonds offer a degree of diversification benefit but the spreads effectively mean that holding to maturity is necessary to overcome those spreads. Commodities and real estate have shown themselves to be positively correlated with equities. Cash is a safe haven during downturns but a wealth destroyer the rest of the time.

In effect, I have concluded that the best I can realistically do in terms of managing the risks of having a portfolio of assets which are positively correlated are:

1. invest predominantly with a focus on income streams (dividends, interest, premiums, rent). If income is coming in then I should be less concerned about fluctuations in the value of the asset;

2. time the market. Invest aggressively when valuations are cheap and conservatively when valuations are expensive. In practice, this means buy equities when the market is down and shift to low yielding out of the money ELDs when the market is high;

3. consider using the commodity ETF, CLDs and paper metals more than at present.

Given that the range of ETFs listed in Hong Kong is expanding, I should keep an eye on these products with a view to achieving better diversification as and when additional products have enough liquidity to trade.

I am effectively concluding that modern portfolio theory is a good thing for me at this stage of my journey towards financial independence but that the obstacles to implementing that theory necessitate taking a different approach.

Asset Allocation - update

Back in January 2007 I reviewed our asset allocation in light of our retirement plan and concluded that (i) we were heavily overweight Hong Kong real estate and (ii) that the overallocation was in line with our retirement planning but (iii) greater diversification would be beneficial. At the time we had 73.7% of our household net worth invested in Hong Kong real estate.

Our current asset allocation is:

Home: 6.05%
Hong Kong investment properties: 38.64%
Overseas investment properties: 6.28%
Managed funds: 18.62%
Direct equities: 11.28%
Commodities: 1.6%
Cash and bonds: 17.53%

These numbers are calculated on a net basis - that is they reflect the amount of equity invested in a property at current mortgagee valuations rather than the total value of the property. The cash and bonds category is temporarily inflated as some of it will be invested in my employer's business next month and a bit misleading as it includes my ELDs and CLDs. The reality is that we are not holding much cash at the moment.

In any event, since January 2007 although we have added to the property portfolio, we diverted more of our income to other asset classes (managed funds and direct equities). While the timing was awful (too many funds were purchased near the market peak - we would have been better off buying another property), subsequent purchases starting in October 2008 have done extremely well.

In terms of our retirement plan to derive about half of our income from rent on properties and half from dividends on shares, because of the gearing effect we need to add more to the equities asset class than the real estate asset class. That said, the ELDs and CLDs have shown good returns this year and a good case for permanent allocation to these instruments can be made.

I have no particular views on what is the correct asset allocation for us at this time - or even whether there is a correct asset allocation at all. If I can identify properties which can be purchased at prices which provide an acceptable yield (very difficult in the current bull market), I would add to the property portfolio. Absent such opportunities, I am happy to add to the equity allocation or simply do more ELDs and CLDs.

Saturday, July 25, 2009

Plastic bag levy - excellent (but very very late)

It has now been about two weeks since the Hong Kong government finally introduced a HK$0.50 levy on plastic bags in supermarkets and some other shops. From an environmental perspective this is a great development - although no figures have been published yet, simple observation while in the supermarket queues shows that people who use plastic bags for their shopping are very much in the minority. Most people now bring their own recyclable bags. As another observation, the supermarket chains used to have their name and logo prominently displayed on the bags which they used - form of advertisement. With plastic bags now being officially recognised as an environmental problem, the only thing printed on the plastic bags are messages about protecting the environment.

Of course, two questions remain:

1. why did it take the government well over a decade to introduce the levy after it was first proposed?

2. why does the government not introduce more meaningful measures to protect the environment?

While the plastic bag levy is a positive development, it is no more than a very very small token step in the right direction.

Friday, July 24, 2009

Hutchison Wampoa call warrants purchased (again)

Credit Suisse issued a buy recommendation on Hutchison Wampoa (13) today with a price target of HK$69. Having mentally kicked myself for prematurely selling my position in Hutchison Wampoa call warrants (17394) earlier in the week, I decided to admit that the sale was a bad decision and repurchased my position this afternoon paying an average of HK$0.104 per warrant.

Small cap speculative investments

Although I have posted most of my investment decisions on the blog, I have consciously avoided posting the more speculative investments in small cap stocks - largely because of issues I have seen on some stock chat boards regarding ramping ("pump and dump") of thinly traded stocks. Given that one of the purposes of this blog is to create a record of what I have done with my investments and why, I have reversed that policy and decided to post entries on all of my investment decisions goring forward. The two recent acquisitions which I have not previously posted are:

1. Daishomicroline (567): this company makes components for handsets. It recently reported a significant loss due to a number of factors including retooling its plant and equipment to prepare for China's 3G roll out. Given that reports on the PRC telecom companies effectively show significant market growth, Daishomicroline looks like a high return/high risk way of investing in that growth without resorting to margin trading or derivatives. Average entry price is HK$0.46;

2. South Sea Petroleum (76): this company recently announced the proposed acquisition of the mineral rights to a large block of land on-shore in the PRC. My expectation (having observed a number of small cap Australian mining stocks) is that there will be a run up in the share price as and when the company gets closer to drilling the site. My intention is to sell then rather than wait for the results. The acquisition is still subject to shareholder approval. Average entry price is HK$0.055.

Commodity ETF purchased

This morning I added some more of the Lyxor Commodity ETF (2809) to the private portfolio. With signs that industrial production is picking up again (admittedly in a minor way) in response to stimulus measures and a pick up in consumer spending and signs that commodity stock piles for at least some commodities (e.g. nickel) beginning to decline I formed the view that it is a good time to increase exposure to commodities as an asset class. The fact that equity prices have had a huge run this year and it is getting more difficult to find stocks at attractive prices also contributed to my decision - in effect I am investing on the basis that equity prices reflect renewed economic optimism to a greater degree than commodity prices.

Thursday, July 23, 2009

Diversification revisited - how and how much (1)?

In my overview of diversification I commented that my attitude to risk was evolving as my financial objectives began to shift from wealth creation to wealth preservation. I concluded with three questions which effectively asked how much diversification is right for me and how should I structure my investments to achieve that degree of diversification?

The benefits of diversification can be summed up in two sentences:

1. opportunity to improve returns through periodic rebalancing of asset classes which have negative or low performance correlation. In effect there is an element of forced buy (comparatively) low and sell (comparatively) high built around the idea of having a target asset allocation;

2. potential to reduce risk by spreading wealth across multiple assets and multiple asset classes. This reduces the impact of material or catastrophic losses on overall performance.

Diversification has been described as the only free lunch there is when it comes to investments. Academic studies point to the fact that a diversified portfolio which is periodically rebalanced will produce better risk adjusted returns than an undiversified portfolio. I certainly do not have the academic or professional qualifications to dispute this. However, it seems to me that diversification has some disadvantages:

1. more assets means more time spent researching, monitoring etc;

2. more asset classes means that a wider range of knowledge and experience will be needed to monitor a portfolio;

3. more assets and more asset classes means less time spent on each investment decision;

4. more asset classes and more assets mean more money allocated to investments which are not the first choice assets.

After a fairly long debate with myself, I ended up deciding to view diversification as a means of managing two different types of risk:

1. risk that the portfolio will be impacted by negative correlated returns (which is what happened from late 2007 to late 2008) - effectively that all of my asset values move against me at the same time;

2. risk that individual assets will have large negative returns (e.g. individual companies become insolvent).

But, I find that I am still comfortable having a degree of concentration that is inconsistent with traditional portfolio management. Specifically, I prefer to have a high concentration of assets invested in economies that are growing rapidly and have governments that manage their finances prudently (i.e. are not heavily in debt and perpetually spending more than they can afford without resorting to punitive taxation).

Some investors have ready access to very broad asset class mutual funds with very low expense ratios (Vanguard etc) which enable them to construct very simple portfolios and rebalance very easily. Sadly, such funds are either not available to Hong Kong residents (e.g. Vanguard) or are difficult to access or are subject to offshore taxes (e.g. US ETFs). While there are some ETFs available in HK for a number of reasons it is not possible to construct a properly diversified portfolio made up exclusively of such products. There are plenty of actively managed funds that come complete with front end loads and very high expense ratios - which render them unappealing. In short, the easy solution is not readily available.

So how, and to what extent, should I address the two identified risks using diversification?

Wednesday, July 22, 2009

China Gas Holdings purchased

This morning I added China Gas Holdings Limited (384) to the private portfolio paying HK$1.96 per share. China Gas Holdings is (as the name suggests) essentially a utility company which operates in the PRC. While the current PE multiple looks excessive and the dividend yield is anemic, the stock is essentially a growth story - projects coming on stream and continued growth in the PRC are expected to drive earnings going forward.

Tuesday, July 21, 2009

Hutchison Wampoa call warrants sold

With the market having moved sharply upwards over the last week or so, I decided to take some money off the table and sold my Hutchison Wampoa call warrants (17394) this morning at HK$0.092 per warrant. My entry price was HK$0.073 on14 July and HK$0.088 yesterday. Net of transaction costs I realised a profit of just over 17%.

Monday, July 20, 2009

More Hutchison Wampoa call warrants purchased

This morning I added some additional Hutchison Wampoa warrants (17394) to the private portfolio. The additional warrants cost HK$0.088 per warrant which contrasts with the HK$0.073 per warrant paid for my original purchase on 14 July. Not only is Hutchison Wampoa (13) trading on a relatively attractive valuation by historical standards but the stock has been something of a laggard in the market rally.

Sunday, July 19, 2009

Diversification revisited - overview

It was almost three years ago that I set out my views on diversification and concluded that diversification is mostly a good thing. I did highlight some problems with diversification, the most significant being the fact that diversification protects you from many risks, including the risk of becoming wealthy (to paraphrase Max Gunther). In effect, the more you diversify, the smaller the chances of a spectacularly successful investment having a meaningful effect on your wealth.

Since publishing that post, four things have happened which are relevant to my views on diversification:

1. our household net worth has increased significantly: in effect we now have more to lose. Diversification may be an impediment to wealth creation but is also provides a degree of protection against wealth destruction. Although the degree of correlation between asset classes during the current financial crisis was much higher than many people either anticipated or desired, diversification did provide a degree of protection from the declines in asset values experienced from mid-2007 to late 2008. In particular, gold and government bonds provided good diversification benefits during this period;

2. we have experienced a financial and economic crisis: we lost money. We lost a lot of money. Our two main asset classes (Hong Kong real estate and emerging market equities) were both hit hard during the crisis. We were not diversified enough and suffered greater losses than we would have suffered had we been more extensively diversified;

3. we experienced a significant rally in equity prices and Hong Kong property prices: we invested heavily in emerging market equities beginning in October 2008. Since we sold very few of our investments during the crisis, this effectively amounted a doubling down on this asset class. Those investments have performed extremely well since then (outperforming most other asset classes over that period). This is a clear case of benefiting from not diversifying;

4. the timetable to my retirement has (roughly) halved: put differently, a combination of high income, a good savings rate and very modest returns on investment will more or less get me to my "number" by the end of 2011 or 2012. This means that making high returns on my investments will not make a meaningful difference to my target retirement date but taking losses would have an adverse impact on my target retirement date.

To sum up, my views on the pros and cons of diversification have not changed. I believe that diversification is an effective way to reduce risk but excessive diversification is an impediment to wealth creation. Another way of looking at diversification is to say that you should have less diversification when you are attempting to build wealth (particularly if you want to do so quickly) provided that you have the time and expertise to research, manage and monitor your investments (and a few other things as well) but more diversification when you reach the stage were preservation of wealth starts to take priority over wealth creation.

What may have changed is the application of diversification to my personal circumstances. This raises some further questions which I will address in future posts:

1. what steps should I take to minimise the risks associated with using limited diversification?

2. how should my invest my assets when I wish to place more emphasis on wealth preservation than wealth creation?

3. how much diversification is right for me? What is the right balance between the protective benefits of more diversification and the wealth enhancing possibilities of less diversification and how should I invest my money to achieve that balance.

Saturday, July 18, 2009

Herald Holdings purchased

Last week I purchased some shares in Herald Holdings (114) for the private portfolio. Herald Holdings is a small company (market cap below HK$600MM) which, among other things, manufactures toys in the PRC. While their profits fell substantially last year, a significant part of the loss was due to losses on investments (i.e. they were speculating with shareholders' money in the share market) which is not something I would like to see management doing with my money but those losses have depressed the share price to the point where it looks very cheap. Even with the reduced profit the company is still on a single digit PE ratio and the combined interim (3cps) and final (5cps) dividend gives a yield above 10% pa. The company has very little debt and a considerable amount of net cash giving a significant margin for safety.

Wednesday, July 15, 2009

Equity put option written

The equity put option I wrote last month against Sinopec (386) matured today without being exercised against me. This morning I wrote a new put option against the Hong Kong Tracker fund (2800). Details are as follows:

Underlying: Hong Kong Tracker fund (2800)
Valuation Date: 13 August
Maturity Date: 17 August
Strike Price: $17.68
Market Price (at the time of writing the contract): $18.40
Implied Yield (annualised): 15.01%
Net Purchase Price (if exercised): $17.46
Discount to Market Price (if exercised): 5.1%

This is a more conservative investment than the previous three equity options written. The reason for the more conservative approach is that the options I wrote against Hutchison Whampoa (13) and China Construction Bank (939) which have a valuation date on 23 July are both in the money at the moment.

Tuesday, July 14, 2009

When is a beverage not a beverage?

When it's a buy one get one free promotion from Starbucks.

My local Starbucks offered a free "beverage" with every "beverage" of equal or greater value purchased by customers who completed an on-line survey. There were no qualifications on what was meant by "beverage". I duly completed the survey, went back to the shop and attempted to redeem my coupon for a free juice.

Sorry. No. Apparently juice is not a beverage. Only coffee and tea are beverages.

The Starbucks definition of beverage reminded me of Bill Clinton's definition of sex - something different from what most people, and the dictionary, would use.

Needless to say, the coupon has been passed to a colleague who drinks coffee.

Hutchison Wampoa call warrant purchased

Wanting to take advantage of the recent pull back in share prices, I went shopping on the stock market today. After looking at a number of stocks which have come back from their highs a few weeks ago, I decided to invest in Hutchison Whampoa (13). Hutchison is one of Hong Kong's largest diversified conglomerates with substantial interests in (among other things) retail and ports. With the shares trading at around $48.10 when the market opened this morning, the stock was yielding a respectable if unspectacular 3.6%. I have seen brokers' valuations or price targets of between HK$57 and HK$65.

Rather than simply buying the shares, I elected to put a small amount of money into some long dated call warrants. Details of the warrants purchased are:

Stock code: 17394
Purchase price: HK$0.073
Maturity: 19 July 2011
Strike Price: $58.88
Conversion ratio: 0.01

In effect, if Hutchison gets close to the broker's valuation in the near term, I will earn a very high return on my investment. If Hutchison fails to rise materially at some point between now and 19 July 2011, I may lose 100% of my investment. The latter is the reason why the amount invested is relatively small.

Monday, July 13, 2009

Ooops - forgot to file a tax return

That was one deadline that made absolutely no sound as it came and went. Yep. I forgot to file the annual tax return for my overseas properties. I'll put it in the post tomorrow and hope that I do not get slapped with a fine.

Unfortunately, it is not the first time I have been late with this particular return. I missed the deadline by about a month a few years ago and got a standard letter warning me that the revenue authorities took failure to file tax returns very seriously and reminding me of the consequences of failing to file on time.

At least I was not late with paying the tax - that is an automatic 10% penalty.

Thursday, July 09, 2009

The anecdotal recovery (1)

As the debate over whether we are seeing green shoots or a spay painted slab of concrete continues, a look around town shows some signs of a recovery. Here is a sample of day to day observations that may be indicators of improving economic conditions:

1. Taxi queues: during boom times taxi queues were long and not just at peak times. In 2008Q4 taxi queues had dwindled to negligible levels. Over the last couple of months the queues are back - but not to the extent that they had to be endured before the credit crisis. Given the time(s) and place(s) where I typically take taxis from, this could be an indicator that people are (a) working longer hours and (b) visiting shopping malls more;

2. Restaurant bookings: as recently as May, getting a booking in popular business restaurants for lunches could usually be done on a same day basis - and the restaurants would be far from full. In the last few weeks, I have had to book a couple of days in advance and the occupancy rate has been noticeably higher;

3. Property prices: residential property prices have more or less got back to where they were before the credit crisis - a combination of plentiful cheap money, moderate supply and, I suspect, a belief that the worst of the lay-offs and pay cuts are behind us. Rent levels have stabilised but not yet recovered.

Tuesday, July 07, 2009

Put option sold

Last Thursday I purchased some put warrants (64184) on internet gaming company Tencent (700), paying HK$0.23 per warrant. This morning, BNP Paribas issued a buy recommendation with a price target of HK$100 per share (compared with yesterday's closing price of HK$87.55). While I take broker recommendations with the proverbial grain of salt, I see little point in fighting the market. Accordingly, I closed out my position this morning at HK$0.242 per warrant for a small profit. Net of transaction costs, I cleared enough money to take the family to Macau for a night this weekend.

Monday, July 06, 2009

2009 - mid-year review

All I can say about the financial results for the first half of 2009 is WOW! My net worth has grown by 43% since the beginning of the year.

Just about everything that could go right did go right....and then some. My financial objectives for 2009 (set back in early January) are here. Going through them one by one:

1. income from employment at my new job is now excellent (after a slow start to the year). Getting the payout from my old job also provided significant one time boost to my net worth;

2. I have added to my investments this year, buying funds, equities and a token amount of bonds. I have also invested in ELDs and CLDs. So far my investments (viewed as a whole) been highly profitable. I still hold quite a bit of cash (mostly as a result of last month's pay our from my old job), so I would have been better off being even more aggressive, but that is with the benefit of hindsight;

3. I did not buy another property. I looked back in January and February and decided that the market had not come back far enough. With prices now getting close to the 2008 Q1 peak, this was a bad call. While I will look for an additional property investment, I am not optimistic that I will find anything that meets my criteria;

4. my active trading on small caps has been profitable, but I do not pretend that the returns justify the risks. I will keep trading where it belongs - as a small hobby rather than a strategic asset allocation.

I did take advantage of aggressive lending practices by Hong Kong banks and refinance three mortgages. I also drew down additional principal against our home to fund an investment in my employer (instead of selling investments) given how low interest rates have got.

Where next? Obviously I cannot expect similar returns on investment or gains in net worth to repeat themselves. They don't need to. Steady savings, modest investment returns and avoidance of large risks with a clear objective of meeting my retirement objective by the end of 2011 or 2012 is what is required. Even if markets move against me in the second half of the year, 2009 should still be remembered as a stellar year for my financial progress.

In terms of vulnerability, I am exposed to the risk of losing my job, stock market risk, property market risk, interest rate risk and currency risk. I suppose this is a good thing - if I am not exposed to any risk then I would not be exposed to the potential to earn a worthwhile return on my investments.

Friday, July 03, 2009

Put option purchased

Yesterday I purchased some put warrants (stock code: 64184) on Tencent (stock code: 700), paying HK$0.23 per warrant.

I made this trade as a partial hedge of the rest of the Hong Kong shares in the portfolio. The put warrants on Tencent do not expire until 19 January 2010. The second is that the company is selling on a trailing PE ratio of about 51 which I regard as expensive even if the growth expectations eventuate.

In effect I need this stock to drop materially between now and 19 January in order to make a profit. If this does not happen I may lose up to 100% of my investment. The prospect of losing 100% of an investment is not attractive which is why the amount of money involved is small - less than one month of savings.

Thursday, July 02, 2009

GBP/HKD FX contract entered into

I have received a payment in GBP. As I have no plans which involve investing in GBP denominated assets, I have no need to hold GBP cash in the private portfolio. That said, I have no immediate need for more HKD either which leaves me rather neutral on whether I keep the money in GBP or convert to HKD.

Accordingly, rather than simply convert back to HKD at the prevailing spot rate (less the bank's spread), I entered into an FX contract.

Details are as follows:

Currency pair: GBP/HKD
Strike rate: GBP1.00 = HKD 12.76
Spot rate: GBP1.00 = HKD 12.7626
Annualised premium: 12.775%
Calculation date: 31 July 2009
Maturity date: 3 August 2009

In effect what I have done is written a put option on the HKD against the GBP. If the HKD rises/GBP falls, I will end with HKD at a better conversion rate than I would get if I did the conversion today (including interest, the effective rate would be 12.902). If the reverse happens, I will still hold the GBP but will be earning a rate of interest well above what I could get on bank deposits.

Given my (marginal) preference to hold HKD rather than GBP, I have used a strike price which is close to the spot rate (in spite of which the premium is actually quite low). The only thing I do not want to see happen is for the GBP to fall significantly against the HKD during the contract period. My break even closing FX rate is 12.62. If GBP drops below this level on 3 August, I would have been better off doing a straight conversion.

Wednesday, July 01, 2009

Monthly Review - June 2009

May was yet another positive month for my investments. Modest gains in mark to market investments (shares, funds etc) were amplified by favourable currency movements and supplemented by positive cash flows from my investment properties. However, the biggest boost to the private portfolio came from the final payout from my previous job which arrived this month.

Here are the details: actively managed funds were mixed. 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 slightly. I currently have exposure to Hong Kong, India, Taiwan and Russia;

3. my equity portfolio appreciated slightly. I currently have meaningful investments in 13 companies listed in either Australia (3) or Hong Kong (10). I also have some smaller residual positions dating back many years and some small speculative day trading positions which, collectively, are not meaningful;

4. my commodity investments were went up (with an increase in the price of nickel and a rise in my commodity ETFs more than offsetting a further decline in the price of lean hogs. I am now convinced that not only do pigs not fly but they are in fact burrowing animals;

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). A bill for fixing two air conditioners did not change this;

6. currency movements were positive as the US$ declined.

I purchased several Hong Kong shares (CNOOC, Pacific Basin, Amvig, Yangzhou Coal and China Molybdenum) , one Australian share (Caltex) and entered into four OTC option contracts:(i) short NZD/USD (ii) writing a put options against Sinopec, China Construction Bank and Hutchison.

Income was strong (it will be erratic under the new job) and contributed to the gain for the month.

As mentioned, I received the final payout from my previous job which was a major boost this month.

My spending was low due to an absence of major items. The increased mortgage payments resulting from the refinancing completed yesterday will bite next month but most of the payments will be principal.

For the month, my net worth increased by a staggering 12.1%. The gains came from the combined effect of higher asset values, a weaker US$, a high savings rate and the payout. The year to date increase is 43.9%.

Even allowing for the payout arising from changing jobs, it has been fantastic progress this year. The possibility of retiring at the end of 2011 is, once again, very real.

Refinancing completed

Yesterday we completed the refinancing of the mortgage on our home. This was the last of the three refinancings we undertook to take advantage of the reduced interest rates on offer. The refinancing involved four changes:

1. changing banks. Standard Chartered Bank offered the best terms;

2. a reduced interest rate. Our interest rate fell from Prime - 2.75% (works out at 2.25%) to one month HIBOR + 0.7% (works out at 0.95%);

3. drawing down additional principal. I need to put some capital into my firm next month and decided that borrowing against my home at 0.95% pa was a better option than spending my residual cash and/or selling some of my equities/funds;

4. reducing the term. Our old mortgage had about 16 years left to run. The new mortgage is for a 12 year term. While the net effect of a shorter term and additional principal (partly offset by the lower interest rate), will increase the monthly payments by about 60%, this is still well within my comfort zone.

Legal fees were HK$6,000 which is less than amount of interest saved in a single month at the reduced rate.

All I have to do now is make sure I earn more than 0.95% pa on my investments.