This month I have had to deal with two bond maturities (i) the first tranche HKSAR government iBonds and (ii) PRC govt RMB bonds. In the current interest rate environment*, I basically view bonds as a place to hold money that would otherwise be earning next to zero in bank accounts. Since I already have more cash on hand than I would like, finding new home(s) for the matured principals is desirable. Holding an asset that is earning less than the rate of inflation is irritating and expensive.
Unfortunately, a quick look at the HSBC and BOCHK lists of bonds available is discouraging - the massively wide spreads are a complete turn off - and the rates offered for term deposits are equally pathetic. So I will have to look a bit further. If all else fails, I would consider adding to some of the safer equities and collect the dividends. But, given the rally in the HK market over the last few months, I am not sure if I want to do this either.
More thinking needed.
* if postive real returns could be achieved, I would be buying bonds for their risk/return profile.
Showing posts with label Investment Products. Show all posts
Showing posts with label Investment Products. Show all posts
Wednesday, July 30, 2014
Tuesday, January 21, 2014
Random thoughts on the barbarous relic
Okay, so Keynes was referring to the gold standard rather than gold itself, which is something I have been thinking about. While I am a long way from being a gold bug, the sell-off in the price of gold combined with gold getting an increased amount of press coverage for various reasons got me wondering whether it might be time to allocate more than a token amount of capital to this asset.
A collection of observations:
Potentially bullish factors:
A collection of observations:
Potentially bullish factors:
1. the ability of banks to import directly into the PRC has the potential to enable more PRC investors to buy gold - in simple terms, more people in China will have access to gold distribution channels. As a matter of policy, I can see the PRC government encouraging this as a means of diverting money from both an over heated property market and away from shadow lending activities. Increased gold imports also have the effect of lowering China's trade surplus (gold is an imported commodity for these purposes) and effectively substitutes onshore gold for offshore USD securities (which is where the bulk of China's trade surplus ends up);
2. global demand has been partly suppressed by India imposing import restrictions (now joined by Pakistan) which may or may not have reduced Indian imports by eighty(?) percent (less however much is being smuggled in through one means or another). At some point, there will be an element of catch up;
3. the pick up in demand for physical bars and coins when gold dropped below USD1,200 per oz was huge;
4. COMEX inventories continue to fall - this is not something that can continue for ever;
5. ETF holdings continue to fall - this cannot continue for ever;
6. unexplained delays in returning Germany's gold are a cause for concern;
7. current gold prices may be low enough to render some current and future production uneconomic.
Potentially bearish factors:
8. gold has no fundamentals which can be analysed;
9. gold has few uses other than as a store of value and therefore no more than a very limited intrinsic value (silver is better in this respect);
10. historically it can be argued that gold has more or less provided no substantial real return and, if that is correct, the current price is (depending on where you start the analysis) above its long term trend;
11. the rise in nominal yields on debt securities increases the opportunity cost of holding gold;
12. the ready availability of unbacked paper gold products and the absence of restrictions on the creation and issuance of such products divert some buying interest away from physical gold;
13. the buy-sell spreads on physical are very large;
14. there is a non-negligible risk of fake gold;
15. there is a risk of government confiscation which I view as being extremely low in Hong Kong (but devastating if it happens);
16. banks in Europe and the US are reducing their involvement in non-trade commodities businesses . While this is largely due to regulatory pressures making it more difficult and expensive for banks to take on the risks involved (i.e. it is not part of some conspiracy to manipulate the price of gold), the practical effect is to reduce the accessibility of gold and gold related products by clients of these banks. Put differently, banks will be selling different products to their clients.
Issues which may be relevant, but on which I have no views:
17. storage risk - there is storage risk or equivalent with all asset classes;
18. Deutsche Bank withdrawing from the London fixing mechanism - which is a redundant throwback to the days when the price of gold was fixed and should have been done away with in the 1970s;
19. the emotional appeal of gold - undoubtedly one of the reasons why gold continues to be a popular investment but emotions are very fickle things;
20. digital currencies like Bitcoin diverting some money away from gold.
Issues which could be either bullish or bearish:
21. inflation;
22 deflation,
as much would depend on other circumstances at the relevant time (e.g. an inflationary environment which saw high interest rates could be either bullish or bearish for gold).
The real difficulty is that it is difficult to quantify most of these items (not all, obviously). FWIW, I am more bullish than bearish at this time (which means nothing because my track record is not so good either).
Tuesday, June 04, 2013
iBond application submitted
My views on the Hong Kong government's third issue of iBonds are the same as for the first two issues - they are a poor investment in general but better than leaving cash on deposit with the banks. My previous comments are here.
Needless to say, I expect the allocations to be as small as last time. If it required any more effort than a few clicks of a mouse, it probably wouldn't be worth it.
Needless to say, I expect the allocations to be as small as last time. If it required any more effort than a few clicks of a mouse, it probably wouldn't be worth it.
Thursday, August 23, 2012
Retirement - getting closer
After a series of discussions with my immediate boss, we have agreed that I will retire either end of March or end of June 2013. Previously, I had been thinking about either end of 2012 or early 2013 but have been more or less persuaded that early 2013 makes more sense for a variety of reasons which I will not go in to here.
This means that I will be earning and saving for an additional 3-6 months. I was already going to be in a position where I would have too much cash at the commencement of my retirement and now I will have even more. Leaving more cash in a bank account than is needed to ride out potential periods of poor investment returns is a bad idea in an inflationary environment. So, what to do with the additional money? I could, of course, simply add to the portfolio or knock a hole in one of the mortgages, but where is the fun in that? Besides, the mortgages are only costing us 1% pa and I expect zirp to be with us for some time.
I have already decided to allocate some to physical gold. I am also considering a few other options: more wine (prices for first growths have fallen in recent times), old maps (prices have gone up a lot), stamps (ditto), rare books (ditto) and art (ditto). With the possible exception of gold, I can't really regard any of these as proper investments - not only is my knowledge limited but their markets are neither transparent nor efficient and suffer from asymmetric information issues. There is also a storage issue for some of them. That said, I would expect whatever I buy to provide both an element of interest and act as a possible long term store of wealth.
I have considered increasing my support of some charities but feel more comfortable delaying that until I am more settled into the retirement and have got past the initial sensation of no longer having a pay cheque coming in each month.
This means that I will be earning and saving for an additional 3-6 months. I was already going to be in a position where I would have too much cash at the commencement of my retirement and now I will have even more. Leaving more cash in a bank account than is needed to ride out potential periods of poor investment returns is a bad idea in an inflationary environment. So, what to do with the additional money? I could, of course, simply add to the portfolio or knock a hole in one of the mortgages, but where is the fun in that? Besides, the mortgages are only costing us 1% pa and I expect zirp to be with us for some time.
I have already decided to allocate some to physical gold. I am also considering a few other options: more wine (prices for first growths have fallen in recent times), old maps (prices have gone up a lot), stamps (ditto), rare books (ditto) and art (ditto). With the possible exception of gold, I can't really regard any of these as proper investments - not only is my knowledge limited but their markets are neither transparent nor efficient and suffer from asymmetric information issues. There is also a storage issue for some of them. That said, I would expect whatever I buy to provide both an element of interest and act as a possible long term store of wealth.
I have considered increasing my support of some charities but feel more comfortable delaying that until I am more settled into the retirement and have got past the initial sensation of no longer having a pay cheque coming in each month.
Monday, August 13, 2012
Annuities just became less attractive
The UK's Daily Telegraph carried this article explaining why a court ruling will mean that men will get smaller annuities going forward.
Leaving aside the legal and social issues, the implication is very simple: if you are a man, then when you buy an annuity which falls under the new rules, you are effectively subsidising the women who buy annuities. This is because men (on average) will die at younger ages than women (on average) and annuities are priced based on the average life expectancy of the people in the relevant demographic. In effect, male purchasers who buy annuities will be paying for something that they will not be getting.
Since buying an annuity was always a somewhat marginal decision effectively involving accepting lower investment returns as the price for longevity insurance, the additional cost may well be enough to tip the balance against purchasing annuity. If I ever get to the point where I would consider an annuity, I will be asking some very pointed questions about the basis on which the quotes given to me are made.
Put simply, annuities just became even less attractive.
Since a lot of other goods and services effectively involve averaging risk across different groups of people (e.g. health insurance), I don't actually have an issue with the court decision itself - it's only the implications for myself as an investor that I am concerned with.
Leaving aside the legal and social issues, the implication is very simple: if you are a man, then when you buy an annuity which falls under the new rules, you are effectively subsidising the women who buy annuities. This is because men (on average) will die at younger ages than women (on average) and annuities are priced based on the average life expectancy of the people in the relevant demographic. In effect, male purchasers who buy annuities will be paying for something that they will not be getting.
Since buying an annuity was always a somewhat marginal decision effectively involving accepting lower investment returns as the price for longevity insurance, the additional cost may well be enough to tip the balance against purchasing annuity. If I ever get to the point where I would consider an annuity, I will be asking some very pointed questions about the basis on which the quotes given to me are made.
Put simply, annuities just became even less attractive.
Since a lot of other goods and services effectively involve averaging risk across different groups of people (e.g. health insurance), I don't actually have an issue with the court decision itself - it's only the implications for myself as an investor that I am concerned with.
Tuesday, April 24, 2012
Hong Kong to issue more iBonds
While the Hong Kong government's plan to launch a second issue of iBonds in June is not exactly news, the upcoming issue has generated some recent debate in the media with views ranging from "it's the best free lunch on offer" to "they are a cynical political tool and a lousy investment".
While the iBonds are touted as bonds designed to protect investors from inflation, this is grossly misleading - they will do nothing of the sort. In the first place, there is no adjustment to the principal - you subscribe at face value and redeem at face value. Second, the coupon is linked to HK CPI - there is no premium over CPI to offer a "real" yield and, in fact, the yield is guaranteed to be less than CPI becuse (i) it is a trailing yield and (ii) bank charges on each coupon payment will have to be paid. Even this assumes that you believe that CPI is a realistic proxy for household inflation (not even close in my household). The floor of 1% is noted but I would be surprised if inflation dropped below 1%.
So why buy an investment that offers a guaranteed negative real return?
The investment rational is that I will be keeping a reasonable amount of money in the form of cash or near cash as I enter retirement (at least two year's worth of expenses). This asset allocation is all about reducing risk rather than maximising returns. While the returns on the iBonds are poor, they are better than anything else I can get in the short term debt or deposit market without taking on FX risk or material credit risk. This makes them more or less a no brainer.
Of course, like last time allocations are expected to be limited so it will be very much a case of taking what I can get (and, no, I wont pay a premium in the secondary market).
All this assumes that the terms of the new issue are the same as the first issue - which is yet to be announced.
While the iBonds are touted as bonds designed to protect investors from inflation, this is grossly misleading - they will do nothing of the sort. In the first place, there is no adjustment to the principal - you subscribe at face value and redeem at face value. Second, the coupon is linked to HK CPI - there is no premium over CPI to offer a "real" yield and, in fact, the yield is guaranteed to be less than CPI becuse (i) it is a trailing yield and (ii) bank charges on each coupon payment will have to be paid. Even this assumes that you believe that CPI is a realistic proxy for household inflation (not even close in my household). The floor of 1% is noted but I would be surprised if inflation dropped below 1%.
So why buy an investment that offers a guaranteed negative real return?
The investment rational is that I will be keeping a reasonable amount of money in the form of cash or near cash as I enter retirement (at least two year's worth of expenses). This asset allocation is all about reducing risk rather than maximising returns. While the returns on the iBonds are poor, they are better than anything else I can get in the short term debt or deposit market without taking on FX risk or material credit risk. This makes them more or less a no brainer.
Of course, like last time allocations are expected to be limited so it will be very much a case of taking what I can get (and, no, I wont pay a premium in the secondary market).
All this assumes that the terms of the new issue are the same as the first issue - which is yet to be announced.
Wednesday, July 06, 2011
An almost guaranteed loss - in real terms
The Hong Kong government has announced that it will press ahead with the issue of HK$10 billion of inflation linked bonds. In spite of going on a spending binge (unjustifiable increases in already bloated civil servant salaries, new government offices and, most likely, sticking the taxpayers with the cost of a third runway etc etc), the government does not need the money - it is sitting on financial reserves which are enormous however you measure them.
The bonds will pay interest at the higher of the rate of inflation (as measured by the CPI) or 1% pa every six months. Maturity is in 2014 (three year term). There will be no adjustment to the principal value of the bonds.
Unless inflation is below 1%, the bonds will guarantee a loss to investors in real terms because:
1. there will be a fee payable on application (expected to be 0.15%);
2. the interest payments will be at least six months in arrears;
3. the banks will charge a fee on each interest payment and on repayment of principal on maturity.
Depending on the amount invested and the CPI, the cumulative effect of items 1-3 above could be about 1% a year. Viewed in isolation, the bonds do not represent good value. IMHO, this remains true, even with the downside protection offered by the 1% floor in the event that we have very low inflation or even deflation.
However, I'll be applying for whatever I can get. With inflation currently above 4% and expected to exceed 5% this year, the yield is much better than I can get on either term deposits or other HKD/USD bonds with a similar maturity. I intend to keep about 24 months' worth of expenses in cash or near cash form once I retire. HKD bonds issued by the HKSAR government with a maturity of three years (less the interval between issuance and my retirement date) will be a much better option for the cash/near cash part of the private portfolio than bank deposits with their negligible yields.
The issue will be the fact that only HKD10 billion will be issued - getting a reasonable allocation may be difficult.
The bonds will pay interest at the higher of the rate of inflation (as measured by the CPI) or 1% pa every six months. Maturity is in 2014 (three year term). There will be no adjustment to the principal value of the bonds.
Unless inflation is below 1%, the bonds will guarantee a loss to investors in real terms because:
1. there will be a fee payable on application (expected to be 0.15%);
2. the interest payments will be at least six months in arrears;
3. the banks will charge a fee on each interest payment and on repayment of principal on maturity.
Depending on the amount invested and the CPI, the cumulative effect of items 1-3 above could be about 1% a year. Viewed in isolation, the bonds do not represent good value. IMHO, this remains true, even with the downside protection offered by the 1% floor in the event that we have very low inflation or even deflation.
However, I'll be applying for whatever I can get. With inflation currently above 4% and expected to exceed 5% this year, the yield is much better than I can get on either term deposits or other HKD/USD bonds with a similar maturity. I intend to keep about 24 months' worth of expenses in cash or near cash form once I retire. HKD bonds issued by the HKSAR government with a maturity of three years (less the interval between issuance and my retirement date) will be a much better option for the cash/near cash part of the private portfolio than bank deposits with their negligible yields.
The issue will be the fact that only HKD10 billion will be issued - getting a reasonable allocation may be difficult.
Friday, May 27, 2011
Corporate governance issues as a risk factor
In the space of 24 hours two reasonably prominent PRC companies listed in Hong Kong have been subject to allegations involving accounting irregularities:
1. Chaoda Modern Agriculture (HK:682) was subject to an allegation by a tabloid newspaper that it had overstated the size of its land bank (among other issues). The company's general denial carried no weight with investors and the share price dropped by about 25% during the course of yesterday's trading. This is from a company that was already deeply unpopular with investors due to various actual and proposed capital raisings which had diluted and damaged existing shareholders' interests;
2. Real Gold Mining (HK: 246) has been subject to claims reported in the SCMP that it filed different sets of accounts with the Hong Kong Stock Exchange and the regulatory authorities in the PRC. For 2009 (the most recent year for which both sets of reports are available) the revenue reported to the HKEX was in excess of 0ne billion RMB while the company's PRC operating companies collectively reported sales of only RMB3.45 million. The reports filed in the PRC have now gone "missing". These allegations have followed a number of top level management changes in 2009. As at the time of writing, the shares are suspended from trading.
In both cases, the companies have denied the allegations. In both cases, the denials are general rather than specific, there has been no confirmation that a more detailed explanation will be forthcoming and no proposals to verify the companies positions (unlike in the case of China Gas (HK:384) which dealt with its own much less serious issues in a robust and open manner).
While Real Gold was not a company that I ever considered investing in (I am not a believer in gold), I did take a long hard look at Chaoda Modern Agriculture but (fortunately) decided not to invest. If I did hold shares in either company, at this point I would be taking my losses and heading for the exits (where possible) - if the allegations are true then the problems are very serious.
The two cases illustrate some of the risks of investing in equities. These sorts of problems can occur in any market (and even the most heavily regulated markets have had their share), but are not going to deter me from maintaining my bias towards risk assets. Almost all companies are run honestly and there are few other investments which offer the potential returns of equities over the longer term. The "safe" alternatives simply represent a different types of risk. IMHO, being aware of and managing risk is a better strategy than avoiding it altogether.
1. Chaoda Modern Agriculture (HK:682) was subject to an allegation by a tabloid newspaper that it had overstated the size of its land bank (among other issues). The company's general denial carried no weight with investors and the share price dropped by about 25% during the course of yesterday's trading. This is from a company that was already deeply unpopular with investors due to various actual and proposed capital raisings which had diluted and damaged existing shareholders' interests;
2. Real Gold Mining (HK: 246) has been subject to claims reported in the SCMP that it filed different sets of accounts with the Hong Kong Stock Exchange and the regulatory authorities in the PRC. For 2009 (the most recent year for which both sets of reports are available) the revenue reported to the HKEX was in excess of 0ne billion RMB while the company's PRC operating companies collectively reported sales of only RMB3.45 million. The reports filed in the PRC have now gone "missing". These allegations have followed a number of top level management changes in 2009. As at the time of writing, the shares are suspended from trading.
In both cases, the companies have denied the allegations. In both cases, the denials are general rather than specific, there has been no confirmation that a more detailed explanation will be forthcoming and no proposals to verify the companies positions (unlike in the case of China Gas (HK:384) which dealt with its own much less serious issues in a robust and open manner).
While Real Gold was not a company that I ever considered investing in (I am not a believer in gold), I did take a long hard look at Chaoda Modern Agriculture but (fortunately) decided not to invest. If I did hold shares in either company, at this point I would be taking my losses and heading for the exits (where possible) - if the allegations are true then the problems are very serious.
The two cases illustrate some of the risks of investing in equities. These sorts of problems can occur in any market (and even the most heavily regulated markets have had their share), but are not going to deter me from maintaining my bias towards risk assets. Almost all companies are run honestly and there are few other investments which offer the potential returns of equities over the longer term. The "safe" alternatives simply represent a different types of risk. IMHO, being aware of and managing risk is a better strategy than avoiding it altogether.
Tuesday, April 05, 2011
Investor protection in Hong Kong - some changes needed
With the Lehman mini-bond saga showing signs of continued life in spite of the ridiculously overly generous latest settlement offer from the banks involved, I thought it would be time to set out my list of things which our government and our regulators could do to provide investors with better and more appropriate protection:
1. educate investors on taking responsibility for their own actions - if you don't read or don't understand the product, either don't buy it or don't complain when you lose money. For the most part, while I sympathise with anyone who loses money on their investments, there is no such thing as a risk free investment. If you want to invest you must accept the risk of loss - and this was clearly set out in the offering documents for the Lehman mini-bonds
2. ban derivative warrants - with the existence of the exchange traded options which offer better pricing for investors, there is absolutely no reason for the more expensive warrants to exist. Given the choice, no investor would choose to invest in warrants when options are available
3. require all investment products to have a clear statement of all fees and expenses which are paid in relation to the product - there are still far too many products where this information is not provided
4. abolish the MPF regime - the fees and expenses are simply too high for the current regime to be anything other than wealth destroying for investors. While a mandatory savings scheme is a good idea, it needs to offer more flexibility and lower costs than MPF. Something similar to the Australian or American regimes would be better for investors and, in the long run, taxpayers
5. ban insurance linked investment plans - there is no legitimate reason for such products to exist other than to hide the ridiculously high fees being charged. Why should a product which is demonstrably worse for investors than a combination of term life + a monthly contribution into a low cost fund be permitted to exist? At the end of the day only the ignorant, the stupid and those vulnerable to high pressure selling tactics would ever invest in such a product
6. ban placings by listed companies - placings are always done at a discount and always destroy value for existing shareholders. The inevitable fall in the share price after a placing is announced and the enthusiasm of institutional investors to participate in placings is conclusive evidence of the damage done to shareholders. Absent an insolvency situation, rights issues are the only acceptable way for listed companies to raise additional capital
7. confirm that rights issues by companies listed on overseas stock exchanges do not require registration under the Companies Ordinance - as a shareholder in a number of overseas listed companies I am fed up with some of those companies excluding Hong Kong shareholders from participating in those issues. Being excluded costs Hong Kong investors money
8. require persons selling overseas real estate to confirm that the prices being offered to Hong Kong investors are the same as those offered to local investors - the track record of properties being sold at higher prices in Hong Kong than in their local markets is pretty consistent and pretty awful
Any others?
1. educate investors on taking responsibility for their own actions - if you don't read or don't understand the product, either don't buy it or don't complain when you lose money. For the most part, while I sympathise with anyone who loses money on their investments, there is no such thing as a risk free investment. If you want to invest you must accept the risk of loss - and this was clearly set out in the offering documents for the Lehman mini-bonds
2. ban derivative warrants - with the existence of the exchange traded options which offer better pricing for investors, there is absolutely no reason for the more expensive warrants to exist. Given the choice, no investor would choose to invest in warrants when options are available
3. require all investment products to have a clear statement of all fees and expenses which are paid in relation to the product - there are still far too many products where this information is not provided
4. abolish the MPF regime - the fees and expenses are simply too high for the current regime to be anything other than wealth destroying for investors. While a mandatory savings scheme is a good idea, it needs to offer more flexibility and lower costs than MPF. Something similar to the Australian or American regimes would be better for investors and, in the long run, taxpayers
5. ban insurance linked investment plans - there is no legitimate reason for such products to exist other than to hide the ridiculously high fees being charged. Why should a product which is demonstrably worse for investors than a combination of term life + a monthly contribution into a low cost fund be permitted to exist? At the end of the day only the ignorant, the stupid and those vulnerable to high pressure selling tactics would ever invest in such a product
6. ban placings by listed companies - placings are always done at a discount and always destroy value for existing shareholders. The inevitable fall in the share price after a placing is announced and the enthusiasm of institutional investors to participate in placings is conclusive evidence of the damage done to shareholders. Absent an insolvency situation, rights issues are the only acceptable way for listed companies to raise additional capital
7. confirm that rights issues by companies listed on overseas stock exchanges do not require registration under the Companies Ordinance - as a shareholder in a number of overseas listed companies I am fed up with some of those companies excluding Hong Kong shareholders from participating in those issues. Being excluded costs Hong Kong investors money
8. require persons selling overseas real estate to confirm that the prices being offered to Hong Kong investors are the same as those offered to local investors - the track record of properties being sold at higher prices in Hong Kong than in their local markets is pretty consistent and pretty awful
Any others?
Friday, February 11, 2011
HK to issue TIPS
News reports have suggested that the Hong Kong government will issue inflation indexed bonds.
If the issue actually happens it would be both welcome and unnecessary.
The ability to buy some HKD denominated bonds at better yields than retail investors can get in the secondary market would be welcome. Assuming that they are offered at a real yield in the 2-3 percent range, they would be an attractive addition to the private portfolio as I transition into retirement. The attraction lies not in the expected return (which would still be less than what I would expect on equities), but the the ability to reduce risk.
The unnecessary part is that the Hong Kong government has massive reserves, being a by-product of excess taxation, and has zero need for additional funds. The purported reason for the proposed issue is to enable Hong Kong investors to protect their assets from inflation. Given the reason for the issue, it has been suggested that only retail investors would be eligible to apply. Terms being considered are 3 and 5 years.
If the issue actually happens it would be both welcome and unnecessary.
The ability to buy some HKD denominated bonds at better yields than retail investors can get in the secondary market would be welcome. Assuming that they are offered at a real yield in the 2-3 percent range, they would be an attractive addition to the private portfolio as I transition into retirement. The attraction lies not in the expected return (which would still be less than what I would expect on equities), but the the ability to reduce risk.
The unnecessary part is that the Hong Kong government has massive reserves, being a by-product of excess taxation, and has zero need for additional funds. The purported reason for the proposed issue is to enable Hong Kong investors to protect their assets from inflation. Given the reason for the issue, it has been suggested that only retail investors would be eligible to apply. Terms being considered are 3 and 5 years.
Thursday, November 11, 2010
Investment services to be avoided
Like may professionals, I get more cold calls from financial advisers than I would like (the preferred number of calls is zero). While standards have improved (very) marginally over the years, most are from "independent" financial advisers selling high cost and inflexible insurance products or off the plan overseas real estate.
This week I received a cold call from a large financial institution, one that I did not have a relationship with. Curiosity got the better of me and I agreed to meet with them to see what they had to offer. I should have known better. I really should have. Their product had the following features:
1. front end load of "only" 2-3% depending on the amount invested;
2. annual management fee of 1.5-2% depending on the amount invested; and
3. annual platform fee of 0.3%.
The very neatly dressed and earnest "senior vice president" assured me that they were completely transparent, that there were no hidden fees or charges etc etc etc
And what did they offer to earn these "completely transparent" fees? Access to thousands of mutual funds, ETFs and individual stocks. Big deal. I can also access thousands of funds, ETFs, individual stocks and other investments without paying those fees.
He also waxed eloquently about the portability of the plan - if I leave Hong Kong, I can keep the same account wherever I live (except the US). Hmmm .... and I can't do that with any of my existing accounts?
He seemed surprised when I told him it was a very unattractive proposal.
I really don't understand why anyone would sign up for something as ridiculous as this.
This week I received a cold call from a large financial institution, one that I did not have a relationship with. Curiosity got the better of me and I agreed to meet with them to see what they had to offer. I should have known better. I really should have. Their product had the following features:
1. front end load of "only" 2-3% depending on the amount invested;
2. annual management fee of 1.5-2% depending on the amount invested; and
3. annual platform fee of 0.3%.
The very neatly dressed and earnest "senior vice president" assured me that they were completely transparent, that there were no hidden fees or charges etc etc etc
And what did they offer to earn these "completely transparent" fees? Access to thousands of mutual funds, ETFs and individual stocks. Big deal. I can also access thousands of funds, ETFs, individual stocks and other investments without paying those fees.
He also waxed eloquently about the portability of the plan - if I leave Hong Kong, I can keep the same account wherever I live (except the US). Hmmm .... and I can't do that with any of my existing accounts?
He seemed surprised when I told him it was a very unattractive proposal.
I really don't understand why anyone would sign up for something as ridiculous as this.
Friday, September 10, 2010
RMB bonds - are they worth it?
Bond issues denominated in RMB have been very popular. In fact bond issues are popular generally. There are no shortage of stories about investors pulling out of stocks to invest in bonds. I put some relatively small sums into a few RMB issues over the last two years and a slightly larger sum into HSBC's 6.8% due 2038. The latter has been a good investment and the former haven't done me any harm.
The latest "hot" offering is by BOCHK which is offering two tranches by way of public offer - Tranche A due in 2012 paying 2.65% and Tranche B due in 2013 paying 2.9%.
Should I buy these bonds?
Looking at the Tranche B issue, the annual yield is less than a lot of stocks pay (including the dividend on BOC's own shares). The only real case for buying on yield is that the bonds are of sufficiently short duration to be viewed as an alternative for cash. If I had meaningful amounts of RMB, I would be happy exchanging bank deposits paying zero for bonds paying 2.9%.
Since I don't have meaningful amounts of RMB sitting around, the comparison between RMB bank deposits and the RMB bonds is not valid for me. I have to compare the HKD cash that I would convert to RMB with other things I could put those HKD into.
If one accepts the often voiced opinion that the RMB is undervalued against the HKD (which is pegged to the USD) and arbitrarily assume that the RMB will appreciate by 20% over the three year life of the bonds then the total return is 2.9+2.9+2.9+20 = 28.7% less the FX conversion spread and bank charges on the receipt of each semi annual interest payment. There is no compounding of the interest received given that deposit rates are near enough to zero. This is is roughly 8.4% compound p.a. (depending on fees and spread) which is a very decent rate of return - if the FX appreciation actually happens (a point on which I am agnostic). As alternatives, one can find no shortage of shares listed in Hong Kong with higher yields and the potential for capital gains which may or may not be larger than the potential for appreciation of the RMB. There is no certainty that the RMB will appreciate against the HKD by 20% - or at all.
Of course, there is less downside risk investing in bonds than in equities. Safety favours the bonds.
Lastly, buying some more bonds would make my portfolio more diversified which would not be a bad thing.
In the end, it is unlikely that I will buy these bonds (at least not in any great quantity). If I can buy equities with better yields (which have the potential to grow) and which have the potential for greater appreciation, then I will take that over the relative safety of bonds and the more limited potential for currency appreciation.
Note: once I retire I will allocate a part of my investments to cash and short term interest bearing products. At that time the case for short dated bonds like this becomes stronger.
The latest "hot" offering is by BOCHK which is offering two tranches by way of public offer - Tranche A due in 2012 paying 2.65% and Tranche B due in 2013 paying 2.9%.
Should I buy these bonds?
Looking at the Tranche B issue, the annual yield is less than a lot of stocks pay (including the dividend on BOC's own shares). The only real case for buying on yield is that the bonds are of sufficiently short duration to be viewed as an alternative for cash. If I had meaningful amounts of RMB, I would be happy exchanging bank deposits paying zero for bonds paying 2.9%.
Since I don't have meaningful amounts of RMB sitting around, the comparison between RMB bank deposits and the RMB bonds is not valid for me. I have to compare the HKD cash that I would convert to RMB with other things I could put those HKD into.
If one accepts the often voiced opinion that the RMB is undervalued against the HKD (which is pegged to the USD) and arbitrarily assume that the RMB will appreciate by 20% over the three year life of the bonds then the total return is 2.9+2.9+2.9+20 = 28.7% less the FX conversion spread and bank charges on the receipt of each semi annual interest payment. There is no compounding of the interest received given that deposit rates are near enough to zero. This is is roughly 8.4% compound p.a. (depending on fees and spread) which is a very decent rate of return - if the FX appreciation actually happens (a point on which I am agnostic). As alternatives, one can find no shortage of shares listed in Hong Kong with higher yields and the potential for capital gains which may or may not be larger than the potential for appreciation of the RMB. There is no certainty that the RMB will appreciate against the HKD by 20% - or at all.
Of course, there is less downside risk investing in bonds than in equities. Safety favours the bonds.
Lastly, buying some more bonds would make my portfolio more diversified which would not be a bad thing.
In the end, it is unlikely that I will buy these bonds (at least not in any great quantity). If I can buy equities with better yields (which have the potential to grow) and which have the potential for greater appreciation, then I will take that over the relative safety of bonds and the more limited potential for currency appreciation.
Note: once I retire I will allocate a part of my investments to cash and short term interest bearing products. At that time the case for short dated bonds like this becomes stronger.
Monday, September 06, 2010
Another small speculation
On Friday I purchased a few shares in Midland IC&I (489) at HK$0.05. I sold the shares this morning at HK$0.05, netting a profit after expenses of around 1.5%. Given the small amount of money involved, the gain will just about cover my lunches for this week. Fun, but hardly of any financial significance.
Wednesday, November 11, 2009
Defined contribution plans - a bad idea
There are a number of ways in which people can provide for their retirement. One method which is quite common is the defined benefit contribution plan. Under a defined benefit plan, participants will be entitled to a benefit on retirement which is calculated by reference to factors such as age, number of years in the plan and average salary in the final year(s) of employment. While at first glance defined benefit plans may look like an excellent way of providing for retirement, they are in fact a very bad idea for just about everyone - including the employee.
Here's why:
1. insufficient contributions: in theory, contributions will be made by either the employer or the employee or both over the period of employment. Actuarial calculations will be done to ensure that the total contributions over the life of the plan, together with the return on investing those contributions, will be sufficient to fund the future benefits. With depressing frequency, the contributions are not sufficient. The usual reasons are over estimation of the return on investing the contributions and longer life expectancies. Even a small shortfall in return will make a big difference over the life of the plan. Less frequently, the employer will simply fail to pay - either deliberately or under due to insolvency;
2. who pays for the shortfall: when the value of a plan's assets are insufficient to meet the claims by plan members, one of three things will happen (i) the employer will become insolvent in which case the employees will be left with reduced benefits (ii) the employer will attempt to negotiate lower benefits or (iii) the employer will fund the shortfall - which will usually come as a large and unpleasant surprise to shareholders if (as is just about always the case) the shortfall had not been provided for in the accounts. Another way of looking at it is employees are taking a very significant credit risk on their employer;
3. change of employment: defined benefit plans were designed in the days when people changed jobs less frequently than today. Since defined benefit plans are usually not fully portable, and plan administrators charge significant fees to people who withdraw from a plan), changing jobs or being laid off can have a significant adverse impact on future retirement benefits (remember that the size of the benefit is often linked to years of service). In some countries, regulations have been used to address this problem but with, at best, mixed success;
4. estate planning: if you use an alternative plan (defined contribution or self saving) all the assets in the plan are yours to keep forever (once vested). If you die, you can leave them to your spouse, children, favourite charity etc. With defined benefit plans, there may (or may not) be a benefit to a surviving spouse, but that is all. Once you cease to be eligible for benefits on death your estate has no further claims to either your contributions or your employers. This is fundamental to the way the plans operate (remember the actuarial calculations). If you die a day after retirement, a lot of money gets to benefit strangers. (What happens to your contributions if you die before retirement will vary from plan to plan but you can be assured that you will get less than full benefit);
5. value of benefits: studies have been done as to whether a defined benefit plan produces greater benefits than a defined contribution plan. The results tend to depend on what numbers are put into the calculations and whether a COLA is included. Unions and people who receive defined benefit plans tend to argue that defined benefit plans are better;
6. return risk: someone has to bear the risk of return on the investment of plan assets being lower than what is needed to provide the stated benefits. This should be the employee. Arguments that the employer should bear this risk are logically and morally flawed. As an investor I want to invest in companies that carry on a specific business - not a side business of investing in securities etc. Actually, the employee can avoid the risk by using defined contribution plan assets to purchase an annuity at retirement (and will have flexibility to select an annuity which suits their personal circumstances). From an employee's perspective, taking the investment risk off the table also takes away the possibility of benefiting from above average returns;
7. tax treatment: this is currently a non-issue for me. However, tax treatment in other countries varies;
8. inflation: some plans provide for COLA. Some do not. The value of a non-COLA plan will decline over time (even with low inflation). In contrast, a defined contribution plan can be invested in assets which have at least some prospects for preserving their real value (including annuities).
At the risk of stating the obvious, if one form of plan imposes greater costs on employers than the other, employers will either take the cheaper option or employee fewer people.
As a conclusion, defined benefit plans are generally bad for employers and will be bad for most employees. From the employees' perspective they are effectively obtaining the illusory comfort of a fixed benefit on retirement in exchange for taking on solvency risk, losing the potential for upside returns, losing flexibility with their jobs, increasing the cost of changing jobs or being laid off, losing flexibility on retirement and losing the opportunity to leave something behind for their heirs. If the plan does not include a COLA feature they also face greater exposure to inflation reducing their real post-retirement income. This is a very poor trade off.
The one group of people who may be better off with overly generous defined benefit plans are civil servants whose retirement is backstopped by the the taxpayers. As a tax payer, I find this offensive.
Here's why:
1. insufficient contributions: in theory, contributions will be made by either the employer or the employee or both over the period of employment. Actuarial calculations will be done to ensure that the total contributions over the life of the plan, together with the return on investing those contributions, will be sufficient to fund the future benefits. With depressing frequency, the contributions are not sufficient. The usual reasons are over estimation of the return on investing the contributions and longer life expectancies. Even a small shortfall in return will make a big difference over the life of the plan. Less frequently, the employer will simply fail to pay - either deliberately or under due to insolvency;
2. who pays for the shortfall: when the value of a plan's assets are insufficient to meet the claims by plan members, one of three things will happen (i) the employer will become insolvent in which case the employees will be left with reduced benefits (ii) the employer will attempt to negotiate lower benefits or (iii) the employer will fund the shortfall - which will usually come as a large and unpleasant surprise to shareholders if (as is just about always the case) the shortfall had not been provided for in the accounts. Another way of looking at it is employees are taking a very significant credit risk on their employer;
3. change of employment: defined benefit plans were designed in the days when people changed jobs less frequently than today. Since defined benefit plans are usually not fully portable, and plan administrators charge significant fees to people who withdraw from a plan), changing jobs or being laid off can have a significant adverse impact on future retirement benefits (remember that the size of the benefit is often linked to years of service). In some countries, regulations have been used to address this problem but with, at best, mixed success;
4. estate planning: if you use an alternative plan (defined contribution or self saving) all the assets in the plan are yours to keep forever (once vested). If you die, you can leave them to your spouse, children, favourite charity etc. With defined benefit plans, there may (or may not) be a benefit to a surviving spouse, but that is all. Once you cease to be eligible for benefits on death your estate has no further claims to either your contributions or your employers. This is fundamental to the way the plans operate (remember the actuarial calculations). If you die a day after retirement, a lot of money gets to benefit strangers. (What happens to your contributions if you die before retirement will vary from plan to plan but you can be assured that you will get less than full benefit);
5. value of benefits: studies have been done as to whether a defined benefit plan produces greater benefits than a defined contribution plan. The results tend to depend on what numbers are put into the calculations and whether a COLA is included. Unions and people who receive defined benefit plans tend to argue that defined benefit plans are better;
6. return risk: someone has to bear the risk of return on the investment of plan assets being lower than what is needed to provide the stated benefits. This should be the employee. Arguments that the employer should bear this risk are logically and morally flawed. As an investor I want to invest in companies that carry on a specific business - not a side business of investing in securities etc. Actually, the employee can avoid the risk by using defined contribution plan assets to purchase an annuity at retirement (and will have flexibility to select an annuity which suits their personal circumstances). From an employee's perspective, taking the investment risk off the table also takes away the possibility of benefiting from above average returns;
7. tax treatment: this is currently a non-issue for me. However, tax treatment in other countries varies;
8. inflation: some plans provide for COLA. Some do not. The value of a non-COLA plan will decline over time (even with low inflation). In contrast, a defined contribution plan can be invested in assets which have at least some prospects for preserving their real value (including annuities).
At the risk of stating the obvious, if one form of plan imposes greater costs on employers than the other, employers will either take the cheaper option or employee fewer people.
As a conclusion, defined benefit plans are generally bad for employers and will be bad for most employees. From the employees' perspective they are effectively obtaining the illusory comfort of a fixed benefit on retirement in exchange for taking on solvency risk, losing the potential for upside returns, losing flexibility with their jobs, increasing the cost of changing jobs or being laid off, losing flexibility on retirement and losing the opportunity to leave something behind for their heirs. If the plan does not include a COLA feature they also face greater exposure to inflation reducing their real post-retirement income. This is a very poor trade off.
The one group of people who may be better off with overly generous defined benefit plans are civil servants whose retirement is backstopped by the the taxpayers. As a tax payer, I find this offensive.
Wednesday, September 23, 2009
Life insurance - how much?
My post summarising in very simple terms the three main types of life insurance concluded that term life is useful if you have dependants but that whole of life and investment linked policies are wealth destroyers and should be avoided like the plague.
James pointed out that I had not addressed the important question of how much life insurance is needed.
So how much insurance is needed?
There is no universally correct number however the following may serve as a starting point:
If you have no dependants
If you have no dependants (or people you wish to benefit in the event of your death to an extent that exceeds the net assets of your estate): zero - you do not need any life insurance.
If you have a spouse/significant other but no children
If either (i) your spouse is financially independent through employment or other means or (ii) your estate (net of debt) will provide sufficient wealth to meet his/her financial needs, the theoretical answer is that you do not need life insurance. That said, a discussion with your spouse on the subject would be in order - you may conclude that a policy sufficiently large to pay off the home mortgage and any other debts is appropriate - especially if those debts could not otherwise be met out of the estate.
If your spouse is wholly or partly financially dependant on you, then things get a bit more complicated. The correct amount of life insurance is an amount which when aggregated with the net value of your estate (i.e. after paying off the mortgage and other debts) will be sufficient to sustain your surviving partner in the same life style as at present (or something acceptably close to it) for life. The ability and willingness of a non-working spouse to (re)enter the workforce, age and other factors will all affect the number that comes out of this exercise.
If you have children
If you have children, the bottom line is that you should provide through a combination of inheritance and life insurance, sufficient funding for them to become functional independent adults. Notwithstanding my father's opinion that this does not happen until the children reach at least 40, I would normally settle for ensuring that their cost of living, education costs etc are covered until they have completed an undergraduate degree. Anything beyond that is nice to have but not a necessity.
Once the children are grown and financially independent, life insurance to benefit them becomes optional.
Adding it up
The aggregate needs of a surviving spouse and children (net of estate assets) is the minimum amount of term life coverage I would consider necessary. Anything less may involve subjecting your surviving family members to undesirable financial constraints. Anything more, and you need to weigh the cost of the premium against the additional payments to your family.
What if the insurance premium is too great an expense?
Then you will need to accept that you cannot provide for both your spouse and your children in full and will need to make some compomises. If you have to make compromises, I would prioritise as follows:
first: discharge of any mortgage or other debts which cannot be met out of the estate
second: educational expenses for children (to be held on trust)
third: enough money to support your spouse for a year or two while he/she adjusts and/or finds a job
Annual review
An annual review is in order. As the children grow older, your spouse grows older and you accumulate assets, the amount of life insurance needed will usually decline (absent other factors). You may eventually reach the stage where it is no longer necessary and you can save yourself the expense of further premium payments.
My own situation
Until recently, our life insurance needs were relatively modest. My spouse was working and able to support herself and our children if the mortgage had been paid off. So I took out a term life policy which (i) would discharge the home mortgage and (ii) would leave small legacies to my siblings (based on love and affection rather than financial need). Under my estate my wife would take our current home and the previous home while the remainder of my estate would be held on trust for our children. Given my wife's earnings and the value of the estate, it was not necessary to provide life cover for our children.
That position has now changed. Mrs traineeinvestor has resigned from her job so that one parent can stay at home to deal with school work etc (she is still negotiating a finish date). Also, I drew down against the home mortgage to fund an investment in my employer which means that the life policy would not cover the home mortgage any more. Accordingly, I need to increase the amount of cover. My wife and I are working through the numbers but the likely outcome is that I will need to double the size of the cover when the policy comes up for renewal.
James pointed out that I had not addressed the important question of how much life insurance is needed.
So how much insurance is needed?
There is no universally correct number however the following may serve as a starting point:
If you have no dependants
If you have no dependants (or people you wish to benefit in the event of your death to an extent that exceeds the net assets of your estate): zero - you do not need any life insurance.
If you have a spouse/significant other but no children
If either (i) your spouse is financially independent through employment or other means or (ii) your estate (net of debt) will provide sufficient wealth to meet his/her financial needs, the theoretical answer is that you do not need life insurance. That said, a discussion with your spouse on the subject would be in order - you may conclude that a policy sufficiently large to pay off the home mortgage and any other debts is appropriate - especially if those debts could not otherwise be met out of the estate.
If your spouse is wholly or partly financially dependant on you, then things get a bit more complicated. The correct amount of life insurance is an amount which when aggregated with the net value of your estate (i.e. after paying off the mortgage and other debts) will be sufficient to sustain your surviving partner in the same life style as at present (or something acceptably close to it) for life. The ability and willingness of a non-working spouse to (re)enter the workforce, age and other factors will all affect the number that comes out of this exercise.
If you have children
If you have children, the bottom line is that you should provide through a combination of inheritance and life insurance, sufficient funding for them to become functional independent adults. Notwithstanding my father's opinion that this does not happen until the children reach at least 40, I would normally settle for ensuring that their cost of living, education costs etc are covered until they have completed an undergraduate degree. Anything beyond that is nice to have but not a necessity.
Once the children are grown and financially independent, life insurance to benefit them becomes optional.
Adding it up
The aggregate needs of a surviving spouse and children (net of estate assets) is the minimum amount of term life coverage I would consider necessary. Anything less may involve subjecting your surviving family members to undesirable financial constraints. Anything more, and you need to weigh the cost of the premium against the additional payments to your family.
What if the insurance premium is too great an expense?
Then you will need to accept that you cannot provide for both your spouse and your children in full and will need to make some compomises. If you have to make compromises, I would prioritise as follows:
first: discharge of any mortgage or other debts which cannot be met out of the estate
second: educational expenses for children (to be held on trust)
third: enough money to support your spouse for a year or two while he/she adjusts and/or finds a job
Annual review
An annual review is in order. As the children grow older, your spouse grows older and you accumulate assets, the amount of life insurance needed will usually decline (absent other factors). You may eventually reach the stage where it is no longer necessary and you can save yourself the expense of further premium payments.
My own situation
Until recently, our life insurance needs were relatively modest. My spouse was working and able to support herself and our children if the mortgage had been paid off. So I took out a term life policy which (i) would discharge the home mortgage and (ii) would leave small legacies to my siblings (based on love and affection rather than financial need). Under my estate my wife would take our current home and the previous home while the remainder of my estate would be held on trust for our children. Given my wife's earnings and the value of the estate, it was not necessary to provide life cover for our children.
That position has now changed. Mrs traineeinvestor has resigned from her job so that one parent can stay at home to deal with school work etc (she is still negotiating a finish date). Also, I drew down against the home mortgage to fund an investment in my employer which means that the life policy would not cover the home mortgage any more. Accordingly, I need to increase the amount of cover. My wife and I are working through the numbers but the likely outcome is that I will need to double the size of the cover when the policy comes up for renewal.
Thursday, September 17, 2009
Life insurance
At its most basic, life insurance is a very simple contract that represents a wager on when a person will die. From the perspective of the person taking out the contract, the purpose of the contract is usually to provide financial protection to dependent family members in the event of death of the insured. From the insurance company's perspective, it is a business that relies on a combination of life expectancies of a number of policy holders and investment returns on the premiums to generate a profit.
Where life insurance gets complicated is the variations (and the ridiculous and archaic legal documents which I will ignore).
Life insurance comes in three basic forms which can be summarised as follows:
1. term life: you pay a premium and if you die during the term of the contract (usually annually), the designated beneficiary will be paid the face amount of the contract;
2. whole life: you pay a recurring premium and are insured for life with the added benefit that if you are still alive when you reach a specified age, the policy will mature and you will be paid a guaranteed minimum cash value. There are several variations to these types of policies and the other forms of permanent life cover such as universal life cover and limited pay;
3. investment linked insurance plans: these are essentially a whole life insurance contract bundled with an investment savings scheme and sold as a single product.
As a general proposition, if you need to provide for dependants in the event of your death, a term life policy is a good idea. It's cheap and you are not locked in for more than the term of the contract. The downside is that your premiums are not fixed (they may go up each year) and the insurance company is not obliged to offer you a renewal each year (although some will commit to doing so).
Whole life is is generally a bad idea because the premiums are higher, the rates of return are awful and there is a lack of flexibility - you will lose a lot of your money if you cancel the policy before maturity. As a general proposition, you can achieve a much better result by taking out a term policy every year for as long as needed and investing the difference elsewhere.
An investment linked insurance scheme is almost always a bad idea. Term life renewed annually with the difference in premiums being reinvested should produce a much better result.
The key message is that insurance should never be viewed as a form of investment. Put differently, if whole life and investment linked polices where such great investments, why would insurance companies engage an army of people to sell them? The agents who sell policies earn massive commissions from the sale of whole life and investment linked polices - commissions which come out of the policy holder's pocket.
If you ever have the misfortune to be cornered by someone peddling whole life or investment linked policies, just asking two simple questions will demonstrate why these things are the modern equivalent to the medieval practice of buying indulgences:
1. how many years before I can surrender the policy and get back at least the total amount which I have paid in? You will either be given a number which will horrify you or be fobbed off with some nonsense about it being a long term plan;
2. how much commission will you get out of it? You will either be told a number which is close to a year's premiums (there is some variation here) - and remember that this is your money. Alternatively, they will shamelessly dodge the question.
The thing to remember about life insurance is that it is a tool to protect dependants in the event of your death - it is not a form of investment.
Where life insurance gets complicated is the variations (and the ridiculous and archaic legal documents which I will ignore).
Life insurance comes in three basic forms which can be summarised as follows:
1. term life: you pay a premium and if you die during the term of the contract (usually annually), the designated beneficiary will be paid the face amount of the contract;
2. whole life: you pay a recurring premium and are insured for life with the added benefit that if you are still alive when you reach a specified age, the policy will mature and you will be paid a guaranteed minimum cash value. There are several variations to these types of policies and the other forms of permanent life cover such as universal life cover and limited pay;
3. investment linked insurance plans: these are essentially a whole life insurance contract bundled with an investment savings scheme and sold as a single product.
As a general proposition, if you need to provide for dependants in the event of your death, a term life policy is a good idea. It's cheap and you are not locked in for more than the term of the contract. The downside is that your premiums are not fixed (they may go up each year) and the insurance company is not obliged to offer you a renewal each year (although some will commit to doing so).
Whole life is is generally a bad idea because the premiums are higher, the rates of return are awful and there is a lack of flexibility - you will lose a lot of your money if you cancel the policy before maturity. As a general proposition, you can achieve a much better result by taking out a term policy every year for as long as needed and investing the difference elsewhere.
An investment linked insurance scheme is almost always a bad idea. Term life renewed annually with the difference in premiums being reinvested should produce a much better result.
The key message is that insurance should never be viewed as a form of investment. Put differently, if whole life and investment linked polices where such great investments, why would insurance companies engage an army of people to sell them? The agents who sell policies earn massive commissions from the sale of whole life and investment linked polices - commissions which come out of the policy holder's pocket.
If you ever have the misfortune to be cornered by someone peddling whole life or investment linked policies, just asking two simple questions will demonstrate why these things are the modern equivalent to the medieval practice of buying indulgences:
1. how many years before I can surrender the policy and get back at least the total amount which I have paid in? You will either be given a number which will horrify you or be fobbed off with some nonsense about it being a long term plan;
2. how much commission will you get out of it? You will either be told a number which is close to a year's premiums (there is some variation here) - and remember that this is your money. Alternatively, they will shamelessly dodge the question.
The thing to remember about life insurance is that it is a tool to protect dependants in the event of your death - it is not a form of investment.
Monday, September 07, 2009
Options - What I use them for (2)
My previous post looked at writing put options as a means of enhancing yields on cash and forcibly buying the dips. The other use of options is as a speculative investment - either buying call options to benefit from an anticipated rise in the price of the underlying asset or buying put options to benefit from an anticipated fall in the price of the underlying asset.
Why use options instead of buying the underlying?
Options provide a degree of leverage. Put differently, you only have to invest a smaller amount of money to give the equivalent exposure to a much larger amount of money invested directly in the underlying. When you buy an option, you only have to pay the premium - you do not have to pay for the underlying unless and until the option is exercised (which may be never).
Another way of looking at investing in options is that you have limited downside (the premium) but greater and theoretically unlimited (or much less limited) upside. Investing $100 in options has the potential to produce a much bigger return than investing that same $100 in the underlying asset while only risking, at most, that $100.
What's the catch?
You can't get something for nothing. The sum of the premium on a call option and the strike price will always be greater than the market value of the underlying asset at the time the option is purchased. This means that even if the option ends up in the money (i.e. the underlying is worth more than the strike price), an investor can still lose money. Put differently, the price of the underlying not only has to move in the right direction, but it has to move by enough to make the investment profitable.
The other catch is time. Options have a finite life. As they get nearer to maturity, all other things being equal, the value of the option will decay. If you buy a call option and the price of the underlying remains unchanged, the value of the option will fall. Where the strike price remains above the underlying share price at expiry, the option will end up being worthless and an investor will sustain a total loss of the original investment.
An investment of $100 in options is much more likely to suffer a 100% loss than the same $100 invested in the underlying asset.
To use a recent example, the call warrants (options) I purchased over Hutchison Whampoa on 24 July are currently worth about 14% less than what I paid for them. The same investment in shares of Hutchison Whampoa would have shown a loss of about 6% over the same time period. Of course, these warrants do not expire until 19 July 2011 so I still have some time for the underlying to move sufficiently in my favour to make a profit. If this does not happen, then I risk losing the entire investment.
Needless to say, I only put very small sums of money into buying options.
Why use options instead of buying the underlying?
Options provide a degree of leverage. Put differently, you only have to invest a smaller amount of money to give the equivalent exposure to a much larger amount of money invested directly in the underlying. When you buy an option, you only have to pay the premium - you do not have to pay for the underlying unless and until the option is exercised (which may be never).
Another way of looking at investing in options is that you have limited downside (the premium) but greater and theoretically unlimited (or much less limited) upside. Investing $100 in options has the potential to produce a much bigger return than investing that same $100 in the underlying asset while only risking, at most, that $100.
What's the catch?
You can't get something for nothing. The sum of the premium on a call option and the strike price will always be greater than the market value of the underlying asset at the time the option is purchased. This means that even if the option ends up in the money (i.e. the underlying is worth more than the strike price), an investor can still lose money. Put differently, the price of the underlying not only has to move in the right direction, but it has to move by enough to make the investment profitable.
The other catch is time. Options have a finite life. As they get nearer to maturity, all other things being equal, the value of the option will decay. If you buy a call option and the price of the underlying remains unchanged, the value of the option will fall. Where the strike price remains above the underlying share price at expiry, the option will end up being worthless and an investor will sustain a total loss of the original investment.
An investment of $100 in options is much more likely to suffer a 100% loss than the same $100 invested in the underlying asset.
To use a recent example, the call warrants (options) I purchased over Hutchison Whampoa on 24 July are currently worth about 14% less than what I paid for them. The same investment in shares of Hutchison Whampoa would have shown a loss of about 6% over the same time period. Of course, these warrants do not expire until 19 July 2011 so I still have some time for the underlying to move sufficiently in my favour to make a profit. If this does not happen, then I risk losing the entire investment.
Needless to say, I only put very small sums of money into buying options.
Tuesday, September 01, 2009
Options - what I use them for (1)
I use options for two purposes:
1. yield enhancement: discussed below; and
2. speculative trading: discussed in the next post in this series.
What I do
I write put options against cash deposits. These are commonly called equity linked deposits (where the underlying is listed ETFs or shares) or currencies (where the underlying is a currency).
A recent example is here. I was paid a premium equivalent to HK$0.15 per unit. In return for receiving the premium I have agreed to buy the underlying units in the Hong Kong Tracker fund for HK$19.58 on the maturity date. If the price of units in the Hong Kong Tracker fund is below HK$19.58 on the determination date (two business days before the maturity date), I will have purchased the units at an effective price of HK$19.43 (HK$19.58 - HK$0.15). If the unit price is above HK$19.58 I will get back my deposit (as well as keeping the premium).
Why this is generally considered to be a bad idea
Fat tails is the technical term. I am receiving a very small amount of money in exchange for taking a big risk. If the market drops 20% I would end up losing (about) 15% of my investment. There have been months when indexes have dropped by that much or more. For individual stocks, the downside risk is even larger - the shares of a single company could go to zero. In contrast, the upside is limited to that small premium. In simple terms, I am taking a small certain gain in exchange for a potential large loss.
(You can also write calls - the risk/reward analysis depends on whether the calls are covered (you own the underlying) or naked (you do not own the underlying).)
Why I do it anyway
Asset allocation. Risk management. Buying the dips. Yield. Combating inflation.
Like most investors I have some of my assets allocated to cash rather than in equities or real estate (which are my main asset classes). In part this is by default (cash comes in each month from both my job and my investments). In part it is by choice - having some cash reserves is a good thing. Cash in the bank currently yields zero or as close to zero as makes no difference. By writing equity or currency linked options I and achieve annualised yields of anything from 2-3% up to more than 40% depending on how aggressive I want to be. I usually go somewhere in the middle.
So I am earning a lot more on my cash than I would just leaving it in the bank. But I am also taking risk. Given the volatility of the market it is inevitable that I will get hit (have an option exercised against me) at some stage. That is a risk which I (try to) manage as follows:
1. I only write options against assets I would be willing to hold as long term investments - index funds, blue chip stocks and currencies that have a role to play in my long term asset allocation. I am not going to end up owning something which I have no wish to own;
2. I only write at prices which (net of premium) represent a discount to the prevailing market price. If I get hit I am effectively committing to buying the dips;
3. I have cash coming in each month from my savings and investments and keep enough cash uncommitted to ensure that I will always be able to meet my obligations even if I get hit on all my open positions at once. Put differently, I am in a position to replenish the cash position if the need arises. Also, I am not going to end up in a position where I have to sell a loss making position in order to meet my obligations.
For me the incremental returns are worth the risks involved. I would rethink this strategy if (when) the market starts looking over materially valued - the higher the market the greater the risks.
1. yield enhancement: discussed below; and
2. speculative trading: discussed in the next post in this series.
What I do
I write put options against cash deposits. These are commonly called equity linked deposits (where the underlying is listed ETFs or shares) or currencies (where the underlying is a currency).
A recent example is here. I was paid a premium equivalent to HK$0.15 per unit. In return for receiving the premium I have agreed to buy the underlying units in the Hong Kong Tracker fund for HK$19.58 on the maturity date. If the price of units in the Hong Kong Tracker fund is below HK$19.58 on the determination date (two business days before the maturity date), I will have purchased the units at an effective price of HK$19.43 (HK$19.58 - HK$0.15). If the unit price is above HK$19.58 I will get back my deposit (as well as keeping the premium).
Why this is generally considered to be a bad idea
Fat tails is the technical term. I am receiving a very small amount of money in exchange for taking a big risk. If the market drops 20% I would end up losing (about) 15% of my investment. There have been months when indexes have dropped by that much or more. For individual stocks, the downside risk is even larger - the shares of a single company could go to zero. In contrast, the upside is limited to that small premium. In simple terms, I am taking a small certain gain in exchange for a potential large loss.
(You can also write calls - the risk/reward analysis depends on whether the calls are covered (you own the underlying) or naked (you do not own the underlying).)
Why I do it anyway
Asset allocation. Risk management. Buying the dips. Yield. Combating inflation.
Like most investors I have some of my assets allocated to cash rather than in equities or real estate (which are my main asset classes). In part this is by default (cash comes in each month from both my job and my investments). In part it is by choice - having some cash reserves is a good thing. Cash in the bank currently yields zero or as close to zero as makes no difference. By writing equity or currency linked options I and achieve annualised yields of anything from 2-3% up to more than 40% depending on how aggressive I want to be. I usually go somewhere in the middle.
So I am earning a lot more on my cash than I would just leaving it in the bank. But I am also taking risk. Given the volatility of the market it is inevitable that I will get hit (have an option exercised against me) at some stage. That is a risk which I (try to) manage as follows:
1. I only write options against assets I would be willing to hold as long term investments - index funds, blue chip stocks and currencies that have a role to play in my long term asset allocation. I am not going to end up owning something which I have no wish to own;
2. I only write at prices which (net of premium) represent a discount to the prevailing market price. If I get hit I am effectively committing to buying the dips;
3. I have cash coming in each month from my savings and investments and keep enough cash uncommitted to ensure that I will always be able to meet my obligations even if I get hit on all my open positions at once. Put differently, I am in a position to replenish the cash position if the need arises. Also, I am not going to end up in a position where I have to sell a loss making position in order to meet my obligations.
For me the incremental returns are worth the risks involved. I would rethink this strategy if (when) the market starts looking over materially valued - the higher the market the greater the risks.
Monday, August 31, 2009
Options - what are they used for?
Options can be used for a number of purposes:
1. hedging: buyers or sellers of an underlying asset or holders of an underlying asset can buy or sell options to hedge their exposure to future fluctuations in the price of the underlying asset;
2. speculating: an investor can buy or sell an option as a means of speculating on the future direction of the underlying asset;
3. arbitrage: an investor can use options as a means of exploiting perceived current or anticipated future price discrepancies between underlying assets;
4. yield enhancement: the writing of options can be used as a tool for enhancing the yield on underlying assets.
The rule that there is no such thing as a free lunch applies to options as much as it does to all other forms of investment:
(i) if you write an option you receive a premium but have to post security and undertake to buy or sell the underlying asset at the agreed price if the buyer exercises the option. In simplistic terms, the writer is being paid a small but certain sum against the possibility of incurring a much larger loss;
(ii) if you buy an option you receive the right to buy or sell the underlying at your election but have to pay the option premium to the seller. In simplistic terms, the buyer of an option is paying a small but certain cost against the possibility of earning a much greater profit.
As mentioned in my previous post on option basics , the value of an option will depend upon (among other factors), the difference between the market price and the strike price, the volatility of the underlying, interest rates and the time left until expiry.
It is crucial to remember that an option has a finite life. When the expiry date arrives it must either be exercised or expire worthless. This means that (other things being equal) the value of an option will decay as the expiry date approaches. I am told (repeatedly) that the majority of options expire worthless.
There are a wide variety of strategies available to investors which involve options. As a relatively unsophisticated retail investor, I use only two:
1. yield enhancement: I write options as a means of enhancing yield on cash balances;
2. long or short equity speculation: I buy call or put options in anticipation of making speculative profits.
I will discuss each of these in future posts.
1. hedging: buyers or sellers of an underlying asset or holders of an underlying asset can buy or sell options to hedge their exposure to future fluctuations in the price of the underlying asset;
2. speculating: an investor can buy or sell an option as a means of speculating on the future direction of the underlying asset;
3. arbitrage: an investor can use options as a means of exploiting perceived current or anticipated future price discrepancies between underlying assets;
4. yield enhancement: the writing of options can be used as a tool for enhancing the yield on underlying assets.
The rule that there is no such thing as a free lunch applies to options as much as it does to all other forms of investment:
(i) if you write an option you receive a premium but have to post security and undertake to buy or sell the underlying asset at the agreed price if the buyer exercises the option. In simplistic terms, the writer is being paid a small but certain sum against the possibility of incurring a much larger loss;
(ii) if you buy an option you receive the right to buy or sell the underlying at your election but have to pay the option premium to the seller. In simplistic terms, the buyer of an option is paying a small but certain cost against the possibility of earning a much greater profit.
As mentioned in my previous post on option basics , the value of an option will depend upon (among other factors), the difference between the market price and the strike price, the volatility of the underlying, interest rates and the time left until expiry.
It is crucial to remember that an option has a finite life. When the expiry date arrives it must either be exercised or expire worthless. This means that (other things being equal) the value of an option will decay as the expiry date approaches. I am told (repeatedly) that the majority of options expire worthless.
There are a wide variety of strategies available to investors which involve options. As a relatively unsophisticated retail investor, I use only two:
1. yield enhancement: I write options as a means of enhancing yield on cash balances;
2. long or short equity speculation: I buy call or put options in anticipation of making speculative profits.
I will discuss each of these in future posts.
Friday, August 28, 2009
One ETF to avoid (for now)
For many years Hong Kong has been plagued by a lack of low cost, no load index funds. Investors were faced with choosing between funds with outrageous front end loads and high expense ratios, searching for overseas products (which would often not be sold to Hong Kong residents) or doing it themselves. The typical equity fund charged around 5% front end load and cost about 3% pa to run - it is no wonder that Hong Kong had a relatively low penetration rate for such products.
Gradually this has changed, beginning with the the Hong Kong Tracker fund in November 1999. Deutsche Bank is the latest institution to list some ETF's on the Hong Kong stock exchange. As an investor, I view this as a very welcome addition to the range of products available to me.
There is one product in the range which I will avoid - the db x-trackers US Dollar Money Market ETF. The problem is simple - the current yield of 0.11% is so low that it cannot compensate for either the effect of the bid ask spread (HK$170.80 - $171.10 or 0.176%) or the typical transaction costs (brokerage, stamp duty etc) , let alone both of them combined, unless you invest for a very long period of time (years). In fact if you invest for long enough for the yield to exceed the spread and the transaction costs, you would probably do better with bank deposits and would definitely do better with short term bonds.
While I will consider adding some of the Deutsche Bank ETF products to my portfolio after I have completed the new property purchase, at current interest rates I will pass on the US Dollar Money Market ETF. If interest rates start rising I will revisit (but may well prefer to prepay mortgages in that scenario).
Gradually this has changed, beginning with the the Hong Kong Tracker fund in November 1999. Deutsche Bank is the latest institution to list some ETF's on the Hong Kong stock exchange. As an investor, I view this as a very welcome addition to the range of products available to me.
There is one product in the range which I will avoid - the db x-trackers US Dollar Money Market ETF. The problem is simple - the current yield of 0.11% is so low that it cannot compensate for either the effect of the bid ask spread (HK$170.80 - $171.10 or 0.176%) or the typical transaction costs (brokerage, stamp duty etc) , let alone both of them combined, unless you invest for a very long period of time (years). In fact if you invest for long enough for the yield to exceed the spread and the transaction costs, you would probably do better with bank deposits and would definitely do better with short term bonds.
While I will consider adding some of the Deutsche Bank ETF products to my portfolio after I have completed the new property purchase, at current interest rates I will pass on the US Dollar Money Market ETF. If interest rates start rising I will revisit (but may well prefer to prepay mortgages in that scenario).
Subscribe to:
Posts (Atom)