Saturday, October 31, 2009

Monthly Review - October 2009

October was yet another positive month for my investments. This is actually getting a bit scary - 9 out of 10 months this year have shown a positive return on investments and all ten months have produced an increase in net worth.

Here are the details:

1. my direct equities showed a modest improvement for the month. The Hong Kong portfolio was up sharply while the shares listed in Australia and New Zealand rose more modestly. The only investment made was at the end of the month when I purchased Tai Cheung Holdings;

2. my ETF's also showed a modest improvement with gains in Hong Kong and Russia overshadowing a small decline in India;

3. my commodities were up with recoveries in lean hogs and nickel combining with an increase in the commodities ETF to overshadow a small loss on silver. The only investment made this month was a small purchase of notional silver;

4. real estate was good. All tenants were paying on time and there were no unexpected expenses. My average interest cost remains below 1%. The renovation project is on schedule. The second installment is due next week;

5. FX movements were favourable with the rise in the Australian dollar making a positive contribution to a balance sheet denominated in Hong Kong dollar's;

6. income was average but expenses were high due to the cost of taking Mrs Traineeinvestor to Macau for a weekend to celebrate her birthday, paying the annual bill for the home contents insurance and buying a package of 30 personal training sessions.

The end result was a 2.9% increase in net worth. The year to date increase is 67.8%. I was expecting a good year - but nothing like this.

I am on track to hit my number by the end of 2011. As mentioned elsewhere, I will continue working for at least two years after that to create a safety buffer and to provide some fun money.

Friday, October 30, 2009

Tai Cheung Holdings purchased

Yesterday I came across a report on Tai Cheung Holdings from local broking house Tai Fook and was interested enough to do some further research.

Tai Cheung Holdings is a small cap property investor and developer. Assets comprise a mix of industrial and retail properties, a 35% interest in the Sheraton Kowloon and some luxury residential development projects. There are no unrelated side businesses or past history of departing from the core real estate investment and development business. The company's track record for the last several years has been steady. As far as I can tell from reading the last annual report, the balance sheet is clean - the company has a small amount of debt and capital commitments associated with development projects but net cash. The cash position is likely to improve dramatically in the near future as luxury residential development projects reach completion.

The shares are trading at around $4.50 which represents a discount to the net asset value showing in the accounts. Tai Fook has estimated the net asset value based on current market values at above HK$12 per share - which means that the shares are trading at a 65% discount to NAV.

While I would expect the value of the assets to be materially higher than book value (given what Hong Kong property prices have done since 2003, they would have to be), I am not in a position to confirm or quibble with Tai Fook's estimates. That said, the shares are clearly trading at a discount to NAV which is substantially higher than I would expect to see even for a small investor/developer. The fact that the company has a history of paying reasonable and rising dividends is also encouraging - the trailing yield is 5.1%.

I purchased some shares this morning, paying an average of $4.48 per share.

Thursday, October 29, 2009

Bonus v Raise

Mighty Bargain Hunter picked up on the MSN article about the difference between not receiving a COLA this year and being paid a US$250 one off payment resulting in pensioners receiving US$10,000 less in total benefits due to the future compounding effect of the COLA in future years. While this is obviously bad news for pensioners, it is good news for taxpayers.

MBH also made the comment that, if faced with a choice between a raise and a bonus employees should always take the raise because the effect of the raise will (a) replicate itself each year and (b) will compound future the effect of future pay increases.

I'm not sure if the decision is that straight forward. While the maths may make it look like the pay increase is the better option (for the reasons given above), the decision is not that simple:

(i) the effect of returns on investing the bonus received today need to be taken into account;

(ii) tax bracket creep may start to affect numbers - as income rises you may get pushed into higher tax brackets in the future (or tax rates may go up or down);

(iii) you need to consider how long you will be working for that employer - if retirement is near there may not be much, if any, compounding;

(iv) it is not a given that future salary increases will be the same in percentage terms. Often, employees whose salaries lag their peers get larger percentage increases than equivalent workers on higher salaries - in effect the gap will often close substantially reducing the calculated benefits of taking the salary increase (alternatively, an underpaid worker may be able to change jobs);

(v) more expensive workers may be more vulnerable to being laid off if cost cutting becomes necessary;

(vi) a bonus is more likely to be invested than an increase in income (at least in my case).

Unless the numbers were very one sided, I would most likely prefer the bonus now than the possibility of enhanced future earnings.

Thursday, October 22, 2009

Mortgages to remain cheap?

One of the questions getting a lot of attention is interest rates: when will they start to rise? This is important for a number of reasons:

1. rising interest rates will affect the valuations of equity and debt securities

2. interest rates rising at different times and in different amounts will affect exchange rates

3. rising interest rates will affect the attractiveness of ungeared property as an investment and geared property even more so

4. rising interest rates will increase the cost of funding my floating rate mortgages and adversely impact my cash flow

As recently as last month, a number of experts were talking about 2010Q2 or 2010Q3 for interest rates in the US to start rising with Hong Kong following the US lead because of the currency peg. More recently, expectations of the time for interest rates to rise in the US have been pushed back to the end of 2010. The most cited reason for the delay in raising interest rates is the unemployment situation. Most people would view some inflation as an acceptable price to pay for the creation of jobs. The fact that Australia has already raised interest rates and is now expected to do so again does not seem to have affected the views on US monetary policy.

There is another reason why interest rates may remain low in Hong Kong: supply and demand. Hong Kong continues to remain awash with liquidity. Interest rates were driven to current levels (close to zero on deposits and about 1% on mortgages) because of the amount of liquidity in the banking system. So far this year, total bank deposits have risen by 3.8% while total bank loans have contracted by 2.9%. These numbers are not earth shattering - but they are big enough to appreciably reduce the banks' loan to deposit ratio and to keep the pressure on the banks to hold interest rates at current levels.

Put differently, a market where the supply of money has been materially higher than the demand for money has experienced an increase in supply and a reduction in demand. It is very very hard to see interest rates rising by much in this environment.

Wednesday, October 21, 2009

Equity put option written

The equity put options I wrote against China Construction Bank (939) and Hutchison Whampoa (13) expired unexercised.This morning I entered into a new contract against Hutchison Whampoa (13).

Details are as follows:

Underlying: Underlying: Hutchison Whampoa (13)
Market price: $59.30
Strike price: $58.75
Valuation date: 21 November, 2009
Maturity date: 23 November, 2009
Implied yield: 16.53%
Net purchase price if exercised: $57.95

If I get hit I will have effectively purchased the shares at about a 2.3% discount to the prevailing market price. This is a share which I am happy to hold long term if I get hit.

As a side note, I would have made more money by buying and holding the underlying (even after transaction costs) rather than writing these options. While this is an exercise in increasing the yield on the cash component of the private portfolio, it is something to thing about.

Tuesday, October 20, 2009

The failure of democracy

Democracy is usually associated with many positive features - in particular it provides a greater degree of protection to civil liberties, rights of private property ownership and imposes a degree of accountability on our political leaders which is higher than other forms of government.

However, one area where democracy has demonstrably failed is fiscal accountability. The basic problem is this:

1. politicians must keep enough voters happy in order to be (re) elected

2. politicians must promise more than the other candidates (up to the point of sounding stupid) in order to be (re) elected

3. short term benefits are perceived as being of greater value than longer term costs (refer to numerous papers on behavioral economics and/or psychology). In effect the value of a hand out today is perceived as being greater than the cost of repaying the loan used to fund that hand out tomorrow

4. benefits are specific. Taxation is general. Borrowing is general. Voters and politicians alike focus on the specific benefits which they will derive rather than the costs which all taxpayers must bear

5. there is a misalignment of beneficiaries of government hand outs and the persons funding those handouts. It is very easy for people to want benefits which someone else is paying for. I'd be happy to vote for someone else to subsidise my lifestyle too

6. often the persons bearing the cost of a government hand out (e.g. promises of benefits in the future, debt issuance) have no say in the matter because they are either too young to vote or have not been born yet. In effect, democracy encourages taxation without representation

7. the number of people taking money from the common pot exceeds the number of people contributing to that pot - usually by a wide margin. Politicians will always seek the support of the majority who take from the pot rather than the minority who contribute to it. With a one vote per person electoral system, the ballot box gets to play Robin Hood

The combined effect of the seven factors listed above is that governments, politicians and a majority of voters alike all have incentives to create and perpetuate a system which keeps promising more than the system can sustain and lacks constraints to prevent it doing so. Historically, the result for societies which perpetually live beyond their means is economic stagnation or decline. Always. Look at California - one of the wealthiest places in the world and it still managed to spend its way to the point of bankruptcy. It is also one of the most expensive places in America to live in or do business. Even with its people fully aware of the impossibility of taxing its way out of its deficit hole, the state continues to spend more than it can afford. In adopting the politically expedient approach of soaking the rich though higher taxes, the state is going to drive a lot of people and businesses (i.e. taxpayers) out of state, making a bad situation worse.

Quite frankly, I am happy to live in a place which has only a very limited form of democracy. The taxes are low. I have all the civil and commercial freedoms I could wish for (with the notable exception of clean air in which to exercise my right to freedom of speech).

I also need have no concerns about my eventual retirement being ruined by the government being forced to raise taxes to cover the costs of electoral bribes and voter/civil servant greed. Given the chance, I will vote against any proposals to introduce greater democracy here.

The only obvious solution is to prohibit governments from borrowing (other than for national emergencies such as war, natural disaster or similar). If funding is needed for capital intensive projects like highways, airports and the like, it should be on a non-recourse basis, BOT or other arrangement which has the effect of capping the taxpayer contribution. Put differently, the message to the voters should be a simple one: if you want something you pay for it.

Monday, October 19, 2009

The Anecdotal Recovery (3)

The not so latest anecdotal evidence of a recovery is the air quality. Pollution levels in Hong Kong have been steadily rising for a few months now. Today, the pollution is so bad I cannot see the hills above Kowloon from my office in Central. This is almost back to pre-crisis levels.

While I realise that atmospheric and weather conditions can contribute to the build up of air pollution, the blunt reality is that neither factor causes pollution. The pollution is the direct and partially avoidable result of economic activity. It may be good for our wallets but it is bad for our lungs.

Sunday, October 18, 2009

Book Review: Errornomics

Errornomics is Joseph T Hallinan's short (221 pages) look at how and why people make mistakes and some suggestions for avoiding them. While a lot of the case studies and conclusions were familiar to me from other readings (including the irritatingly flawed (but famous) experiment on choosing to save people from an epidemic), Hallinan presented them in a very accessible and entertaining manner making the book well worth reading. Some of the case studies were as horrifying as they were amusing: professional psychologists who proved to be no better at correctly diagnosing conditions than their secretaries.

I particularly enjoyed the discussion on overconfidence. I was amused by the fact that the author only identified three groups of people who, as groups, did not suffer from overconfidence: weather forecasters, bridge players and people suffering from depression. Since I don't play bridge and am not a weather forecaster, I guess that means I am either overconfident or suffering from depression.

The final chapter with Hallinan's conclusions includes some good advice for avoiding (or at least reducing mistakes):

1. think small: be aware of the small things that unconsciously affect your decision making. One of the examples given was scent in shops;

2. think negatively: ask what could go wrong;

3. keep a list of your dry holes: you will get a better perspective on your real abilities in a particular area by keeping records of all the decisions you made (and the ones you didn't make) and their outcomes;

4. avoid multitasking: ok, we all know that multitasking is inefficient but it is also dangerous. A huge number of accidents and other mistakes are caused by people being distracted from a primary task (i.e. multitasking);

5. be happy: happy people make fewer mistakes than unhappy people;

6. recognise that money does not generally reduce mistakes: that's right - paying people more does not usually improve the quality of decision making.

Hallinan also has some observations for early retirees which I will come back to in a future post.


Longevity and early retirement

This article in the UK's Telegraph caught my attention: Money the key to a longer life

One of the concerns I have as an early retiree wannabe is the stories and studies which show that those who take early retirement tend to die younger than those who keep working. While there have been plenty of doubts cast over those studies, they gave given me cause to think (and are one of the reasons why I intend to do a 1-2 year part time transition after I hit my number).

However as reported in the Telegraph article, the following findings pretty much debunk the view that early retirees die younger. Key quotes:

"The study, for the Economic and Social Research Council, also found that those who get the choice of early retirement are also more likely to enjoy a longer life."

"Early retirement is generally good for people's health and well being unless it has been forced on them."

"Those forced into early retirement generally have poorer mental health than those who take routine retirement, who in turn have poorer mental health than those who have taken voluntary early retirement."

I will try to track down the original study and read for further details. In particular, I will be looking for factors which contribute to the longevity of early retirees (or are at least positively or negatively correlated).

Wednesday, October 14, 2009

What If Interest Rates Increase?

Interest rates are low. Very low. I pay less than 1% on most of my mortgages and earn close to zero on cash in the bank. This ultra low interest rate environment will not last forever (absent a Japan style perpetual deflation).

So what happens to my finances if interest rates start to rise?

All other things being equal, if interest rates start to rise I would expect the following:

1. most assets will start to look less attractive: yields on fixed rate bonds, equities and real estate will all look less attractive and may fall in price

2. borrowers will try to lock in low rates while they can: lots of bond and note issues. Costs to borrowers will start to rise

3. cash will be crowned king (again). Holding cash will, in the short term, be a sound investment

4. floating rate bonds and notes should hold their value (and may even appreciate)

5. option premiums will rise due to the interest rate component of option prices and (potentially) higher volatility expectations

Based on the above, my finances would take a beating:

A. I have used mortgage finance for all my Hong Kong property purchases. All my mortgages float and are linked to either one or three month HIBOR. The effects of rising interest rates would be felt almost immediately. While I run a positive cash flow (assuming full occupancy), it will not take much in the way of interest rate increases to reverse this position. Since the cost of fixing an interest rate for longer terms is prohibitive (you have to assume very large increases in rates), the correct strategy is to make early payments once interest rates cross a pre-determined threshold. I need to decide what that threshold will be.

B. The value of my real estate may decline. However I see no reason why rents would fall. This means that I should not be in a hurry to sell properties in order to discharge debt. Given the transactional costs and the role properties play in my retirement planning, I would prefer to ride out the cycle.

C. The value of my share/fund portfolio may decline. There may be an adverse impact on dividends. It would pay to weight the portfolio towards companies with net cash rather than net debt. Possibly banks as well as they may benefit from expansion of their interest margins. I suspect that I would be a net seller of equities while interest rates rise.

D. Once interest rates appear to have reached their high point, I will start to buy assets again. Possibly long term bonds (not that easy in Hong Kong), equities and real estate (although I already have enough exposure to the latter).

In terms of strategy, the best way for me to deal with a rise in interest rates is to (i) defer making new investments (ii) hold my properties (iii) review the equity portfolio and tilt towards companies with net cash (iv) build cash reserves and/or write more options and (v) if interest rates reach a pre-determined level, start paying down some of the mortgages. If a suitable fixed rate mortgage came onto the market, I could consider a refinancing. However, given the current slope of the HIBOR yield curve, I would consider that unlikely.

This is all a bit tentative because there have been times when rising interest rates have been accompanied by rising asset values. This is usually a product of either demand lead growth or deregulation of some kind (or both) or because of inflation (actual or expected). It is for this reason that, even though I expect interest rates to rise at some point, I will not be making substantial alterations to the portfolio in anticipation. Rather, I will deal with the situation when it arises and focus on the longer terms goals.

Friday, October 09, 2009

The anecdotal recovery (2)

Back in June I wrote about some anecdotal evidence of an economic recovery

Using the same indicators:

1. Taxi queues: they have got longer, although still short of pre-crisis duration.

2. Restaurant bookings: restaurants are getting busier. Today I had to call three restaurants to get a lunch booking for next Tuesday in Central.

3. Property prices: these have risen further since June although not dramatically so. Tellingly, residential rents have started rising again. The latter is good news for me.

I can add the following to the list:

4. Traffic: it takes longer to get to and from work each day. The difference is most easily measured in the mornings where my taxi fare is typically HK$2-3 more than it was at the beginning of the year.

5. Air tickets: airlines are reporting higher loads. Some of my colleagues are starting to encounter problems with getting bookings on popular routes on short notice.

Property purchase completed

My property purchased completed yesterday with no last minute issues.

I have paid a deposit to the contractor and the renovation work will start on Saturday. It will take about two months to rip out the existing interior (absolutely everything is to go) and install the new interior so I will have to cover the mortgage payments and other outgoings during that period and probably a bit longer while I look for a tenant. The latter may be a bit of an issue as the flat will be hitting the leasing market shortly before Christmas/New Year which is traditionally a quiet period. There is enough float in the account I use for mortgage payments to cover this (assuming none of my tenants default) so I should not have to divert money from my salary to cover the outgoings.

Wednesday, October 07, 2009

Equity put option written

The last equity put option written against the Hong Kong Tracker fund expired last week. I delayed rolling the contract over to provide some additional financing on the new property purchase should it be necessary. As the extra financing was not needed, this morning I entered into a new contract, selecting Petro China (857) as the underlying stock.

Details are as follows:

Underlying: Petro China (857)
Market price: $9.13
Strike price: $8.96
Valuation date: 5 November, 2009
Maturity date: 11 November, 2009
Implied yield: 16.80%
Net purchase price if exercised: $8.84

If I get hit I will have effectively purchased the shares at about a 3.2% discount to the prevailing market price. This is a share which I am happy to hold long term if I get hit.
Posted by traineeinvestor

Silver purchased

The Hong Kong dollar is pegged to the US dollar. As a general proposition this has been a good thing for Hong Kong, not merely because it offers a small economy which is closely associated with a number of emerging markets a degree of financial stability but because it forces the Hong Kong government to maintain large reserves to defend that peg and makes it difficult for spendthrift politicians to tax and spend to the unsustainable levels seen in a number of other countries.

Regardless of how beneficial the peg has been, it means that my earnings and many of my assets are effectively denominated in US dollars and are depreciating when measured against a number of other currencies and commodities.

I had a small amount of money left after funding the purchase of the new property (settlement is tomorrow) and decided to invest in something which should be inversely correlated with the US dollar. My choices were other currencies (e.g. Australian or New Zealand dollars), a commodity ETF (which I already hold) or precious metals. I chose silver. Although it has had a great run, it remains volatile, which is attractive from a trading perspective. In terms of fundamentals, silver's industrial uses are also a positive factor.

Since physical silver is not readily available in Hong Kong, I invested using a notional precious metals account.

My purchase price was HK$134.6 (US$17.25) per ounce.

Friday, October 02, 2009

Our TV died

Our TV died yesterday. Although the TV was pretty old and this was not entirely unexpected it's still an expense I could do without at the moment.

The replacement has been purchased (a 40 inch Sony with HD capability and a two year warranty) and will be delivered on Monday afternoon. We were offered an extended warranty but declined. Oddly we were also offered interest free two year financing. Since the total payments under the installment option were the same as making a single payment at the time of purchase, we took the installment option. We had already negotiated our discount and could not get the shop to lower its price further.

Replacing the existing tube TV with a flat screen also meant we could accommodate a bigger screen than we had previously which is a plus.

The old TV (along with a defunct dehumidifier and a broken fan) will be taken away for recycling on the weekend. It's not clear whether we will get paid anything for the old stuff or actually have to pay someone to take it away.

Of course the challenge will be keeping two small children entertained without a TV for four days......

Property purchase update #2

DBS finally got back to me with their mortgage approval in principle, giving me all the terms which I asked for.... except that they will only lend me 50% of the purchase price instead of the 60% which I applied for. Apparently I have reached the bank's limit for aggregate advances to an individual customer which means that all future advances will be limited to 50% of property value. much as I like the service which DBS provides I may need to consider using other lenders next time. This also tells me that DBS is a very conservative institution as the total balance of my outstanding loans with them is, in the over scheme of things, a fairly insignificant amount (although a lot of money to me).

The resulting shortfall in funding was largely covered by the decision to sell all of my actively managed funds earlier this week. The balance of the shortfall will be covered by deferring part of the first installment of the renovation costs and the agent's commission on the purchase until the beginning of October when I get my next salary payment. Both the contract and the agent have agreed to this.

Thursday, October 01, 2009

Monthly Review - September 2009

September was yet another positive month for my investments.

With the exception of a very small decrease in my commodity positions, all other mark to market asset classes appreciated during the month. Gains were compounded by favourable currency movements and supplemented by option premiums and positive cash flows from my investment properties.

Income from my job was good and expenses were low.

Here are the details: actively managed funds were very up. I liquidated all of these investments towards the end of the month;

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

3. my equity portfolio rose. I currently have meaningful investments in 19 companies listed in either Australia (3) or Hong Kong (16). I took a material loss on a position in Amvig after a disappointing results announcement and an inexplicable asset sale and share buy back proposal;

4. my commodity investments declined very slightly;

5. my ELDs produced positive returns for the month. I had no outstanding CLDs this month;

6. 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);

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

I sold shares in Amvig (cutting a loss) and my actively managed funds (to pay for a property purchase completing next month). I entered into two OTC option contracts writing a put options against Hutchison Whampoa and China Construction Bank.

Income was strong (it will be erratic under the new job) and contributed to the gain for the month. My spending was low due to an absence of major items.

October and November will be lean months as I use all my available cash (and possibly a short term loan from my wife) to complete a property purchase in early October, pay for the closing costs and the renovation costs and cover the mortgage payments during the renovation period (and likely a gap beyond that until I can find a tenant).

For the month, my net worth increased by 4.8%. The gains came from the combined effect of increased investment values, a weaker US$, positive rental income from properties and a high savings rate. The year to date increase is 63.1%.

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.