Property investors are killing it, sucks for everyone else


Our interactive guide to bricks and mortar across the world

Source: Daily chart: Global house prices | The Economist

People will claim it’s all about the fundamentals until it ends in tears.

Central banks and legislators need to assert control over retail banks. Start by preventing zero down-payment loans, and making all bank executives personally liable if their bank goes bust. Skin in the game, not fat bonuses until they cause a steep recession followed by a comfortable retirement.

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Passive investing doesn’t remove the need to make choices

I’ve been thinking about the passive vs active debate for a while. There has been a clear shift towards low cost passive investing. Many personal finance bloggers are massive advocates of index investing, some preaching  very high exposure to US equities.  Bloomberg just published “5 ways ‘Passive’ Investing is Actually Quite Active” by Eric Balchuna. The media commentary seems to be shifting from a simple active vs passive argument, to a more nuanced discussion on what passive investing actually is.

When reading about personal finance / DIY investing online, it appears some people think passive investment removes choice from investing. That is, you don’t need to think about, or know anything about investing if you choose to invest passively. This is obviously not true. You need to make important decisions such as:

  1. Asset allocation decisions (e.g. equities vs bonds vs real estate vs cash)
  2. Geographic exposure decisions (e.g. Home country vs global)
  3. Index selection decisions (e.g. S&P 500 vs  S&P total US stock market)

The above 3 choices can have a profound impact on your long-term investment performance. To see the wide variation in 1Y, 5Y and 10Y returns across the 334 ishares ETFs go here.

In summary, passive investing is preferable for most retail investors, but it doesn’t remove the need to make choices.

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Consequences or more pages?

Read William D Cohen’s piece on the mess which is Dodd-Frank. Surely severe consequences for criminal behaviour and true skin in the game (not outrageous options packages) would be more effective:

According to Davis Polk, the Wall Street law firm, the new regulations governing the banking system run to more than 22,000 pages of new rules, that’s on top of the 848 pages of the Dodd-Frank law—all of which is still in the process of being decoded, let alone understood, in the more than six years since the law was passed. Another 20 percent of the regulations mandated by Dodd-Frank still have not been written

Ignore the title of the article, it’s not a political piece.

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Book review: Black Edge

Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street. (Sheelah Kolhatkar)

Stevie Cohen’s SAC Capital Advisors had delivered c. 30% returns for two decades. He was The Man, when hedge funds were still the new kings of Wall Street. Sheehan Kolhatkar has successfully woven together the tale of how the government tried (and plot reveal – failed) to put Stevie in the can. You should read this book, but you will be disgusted by: (1) How crooked some hedge fund managers (and their enablers) are; and (2) The fact the big fish got away.

The book also gives a small peek into the lifestyles of the rich and famous. The anecdote involving casino mogul Steve Wynn accidentally putting an elbow through his Picasso after he had sold it to Stevie Cohen for US$139m is particularly amusing.

Buy a copy by clicking on the link below.

Note: I may receive a small commission from Amazon if you buy the book after clicking on the above link.

Head to the “Books” page to see a collection of other books you may enjoy.

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If investment managers aren’t focused on driving down costs now, they soon will be

Good chart and discussion on the flow to passive funds at Abnormal Returns. Investors are decisively moving towards lower fee funds:

No matter how you slice the data the shift into lower cost funds is firmly in place. The chart below shows the nearly monotonic relationship between fees and fund flows over the past year.

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Investing exponentially

The article “Soft Bank CEO Masayoshi Son Banks on Exponential Growth”  by Vitaliy Katsenelson (Contrarian Edge) really made me think about how I invest. Soft Bank has been in the news recently for its US$32bn investment in Arm Holdings (at 48x earnings!) and its US$100bn technology investment fund. The CEO has proven a master at placing bets on companies in rapidly accelerating industries.

A younger Masayoshi Son

Source: Wikipedia

Before discussing Masayoshi Son’s investment approach further, I’ll provide a bit of background about my own investment philosophy. I believe an investment philosophy is crucial for those interested in personal finance and financial independence. As a non-professional investor, I’m a huge fan of using index ETFs for cheap and low hassle exposure to equities. However, I also think I’m a smart guy, who occasionally comes up with a good investment idea, so I like to do some non-index investing. I know I will struggle to beat the index over-time, but don’t care. In summary, my philosophy is “mostly use low cost ETFs, but leave room in the portfolio for some small bets”.

My view of the market at the moment is:

  • P/E multiples (particularly in the US) are outrageous, particularly for many low growth businesses
  • However, money has no-where else to go if people are seeking real returns
  • The low interest rate environment could last for decades. Government and corporate debt levels make significant interest rate increases unlikely (but not impossible)
  • For those with a long-term horizon, investing in equities remains a no-brainer
  • But, you have to accept the risk of multiple contraction which will reduce your portfolio’s value

I’ve been doing a lot of thinking about what types of investments I should pursue with my non-index fund allocation. Here is where I am at:

  • Making investment in individual companies which are unlikely to perform substantially better than the market is more expensive and higher risk than index ETFs – it is pointless
  • Macro investing at times of significant volatility is attractive, but often difficult to execute for non-professional investors (e.g. profiting from the oil price crash has proved difficult, Oil ETFs tracking of the price recovery has been dismal)
  • The growth of PE/VC means getting early access to fast growing companies is increasingly difficult for retail investors

Now back to Masayoshi Son. Vitaliy Katsenelson’s article summarises Son’s investment approach, which is based on exponential (non-linear) thinking:

To understand this acquisition [purchase of Arm Holding for US$32bn], we need to come to terms with Son’s investment strategy and his mental models that have made him the richest person in Japan. Son is a master of exponential (nonlinear) thinking. Examine his past investments and you’ll find that he identifies industries about to go from high but linear growth into the exponential phase — where the rate of growth is accelerating.

Son has done this over and over again during the past 40 years. It started with PCs in the ’70s, when he built a software distribution business in Japan to capitalize on PC growth entering the accelerating phase. He saw the inflection point of Internet growth in the ’90s, bet on Yahoo and created Yahoo Japan (a joint venture with Yahoo).

In the early 2000s he saw e-commerce and the Internet taking off in China and purchased a stake in Alibaba, turning his $20 million investment into $60 billion today…

Identifying industries that are entering an exponential growth phase is hard enough, but acting on the insight is even more challenging. I remember looking at a report on Apple in 2009, analyzing smartphones’ potential market size, assigning a conservative market share to the iPhone and basically saying that over the next several years Apple’s sales could accelerate (or continue at the then-current rate of 30 percent or so) and reach $100 billion from less than $20 billion that year. I saw the logic in the analysis, but it was difficult for me (and, I think, for most people) to mentally process a high growth rate going exponential. By the way, iPhone annual sales reached $155 billion in 2015.

Investing at the pivot point when growth rates accelerate is especially tough for value investors (present company included). As revenue growth accelerates, costs usually don’t rise as quickly, and therefore earnings increase at an even faster rate than revenue — now earnings growth is truly exponential. This dynamic creates a lot of value, which our linear brains may or may not process…

Son believes we are at the inflection point when the Internet of Things (IoT) market is about to enter the exponential growth phase. There are 7 billion people in the world today. In 2015, ARM sold 15 billion processors — about 2 processors per person. By 2020, ARM expects to sell 75 billion processors a year — a fivefold increase.

Do read the whole article, available here.

This is a more operational and nuanced approach than typical big picture thematic investing. After all, Son is running companies. He is buying for the medium to long term. He’s not just chasing momentum or short-term returns.

This article has made me realise I need to refine my framework for making my “small bets”. I should be looking for both shorter-term macro bets, and bolder longer-term exponential growth bets. As discussed above, identifying, timing and executing exponential growth bets is very difficult. I won’t be placing many of these bets over the years, but will remain on the look-out.

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What’s the right way to rebalance a portfolio?

Nice brief article from Monevator on portfolio rebalancing:

What’s the right way to rebalance a portfolio is a question often asked and about as simple to answer as what’s the right way to end a relationship – the results vary according to circumstance and personal style.

A number of different portfolio rebalancing methods exist, but there’s no clear-cut evidence that there is one system to rule them all.

Research by the respected fund shop Dimensional Fund Advisors concludes:

There is no easy one-size-fits-all rebalancing solution. Rebalancing decisions should be driven by the need to maintain an allocation with a risk and return profile appropriate for each investor. The optimal rebalancing strategy will differ for each investor, depending on their unique sensitivities to deviations from the target allocation, transaction frequency, and tax costs.

When it comes to rebalancing, like so many things in life, it’s doing it that counts, not exactly how you do it.

Read the full article here.

I’m a fan of keeping it simple. Excessive rebalancing complicates your taxation situation and drives up investment costs. Rebalancing every year or so if the portfolio mix has materially changed seems sensible.

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On China, stay sceptical

I was in China a few months after Lehman Brothers collapsed. Guangdong, the manufacturing heartland bordering Hong Kong, was a mess. Factories were closing and previously buzzing night spots were shuttered. Yet the economy kept chugging along according to official statistics.  I assumed they were making them up.

The Chinese government response to the Global Financial Crisis, was to order a massive indiscriminate lending binge. They responded to a crisis caused by sub-prime lending, by accelerating their own sub-prime-lending. China undoubtedly cooks its GDP figures, but the lending binge did support the economy.

The below chart shows the Chinese miracle has involved an unprecedented acceleration in indebtedness.

Source: Blackrock

China’s private debt-to-gross domestic product (GDP) ratio has surged to more than 200%. Never has a big economy piled up so much debt so quickly…

…Thanks to its large domestic savings rate, it has little external debt—the original sin that has sparked many emerging market (EM) crises. Beijing is working on fixes for internal debt issues, such as turning short-term bank debt into long-term bonds and redirecting credit to the private sector and households. But ultimately, China needs to find more sustainable engines of growth beyond further debt accumulation by unproductive national and local SOEs, or accept slower growth.

High foreign debt prevents aggressive currency devaluations. By choosing not to borrow from foreigners, China has left open their ability to significantly devalue the currency to enable export fuelled growth. It will be interesting to see if China will risk a devaluation, with an US President more focused on protecting jobs than his predecessors. A currency devaluation won’t work if the response from the developed world is tariffs.

There are two other key unresolved questions when looking at China’s medium to long-term prospects. (1) How much longer can China keep piling on debt?; and (2) Will the political system be able to absorb lower growth?

On China, stay sceptical.

NB: If you want to see how your country I positioned on the above chart, go here.

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6 questions everyone should ask when investing

Passive investing is all the rage. Active managers have been enriching themselves for decades, taking too much of the upside and none of the downside. Recent research shows the more outrageous hedge funds were charging up to 5% to 6% per annum in management fees plus a performance fee. The consistent underperformance of active funds has seen a dramatic shift in money to index funds and ETFs. Large, often underfunded pension funds are looking more closely at fees as well, in the face of underperformance and political pressure.

For most people, the sensible (but less exhilarating) approach to investment is clearly index funds or ETFs. However, this increasingly common knowledge does not provide guidance on how to invest passively. That is, which types of assets should you invest in, and how should the portfolio be allocated. Take a look at the historical performance of different Blackrock ETFs:

  Performance NAV (%) as of 31 December 2016 
IVVCore S&P50011.914.596.894.59
AGGUS aggregate bond2.562.154.24.06
IJHCore S&P mid-cap20.6315.239.049.33
IJRCore S&P small-cap26.4916.588.9610.23
ITOTCore S&P total US stock market12.5914.67.027.66
EEMMSCI emerging markets10.510.641.1610.53
IOOGlobal 1000.768.923.232.69
EFAMSCI EAFE0.966.430.674.61
IYRUS real estate710.493.459.9
WPSInternational development property1.378.91N/A0.41
IFGLDeveloped real estate1.087.51N/A-0.77

Source: Blackrock website

There is a significant difference in returns over all time horizons. However, unless, you are Hindsight Capital, one cannot know which investments will deliver the greatest returns in the future.

Now, let’s look at the current situation:

  • American stock market is near all-time highs, with the S&P 500 trading at ~25x earnings
  • Interest rates are near zero, or below zero in most markets
  • China remains fragile, and no-one is really sure how fragile the financial system is
  • A loose cannon is in The Whitehouse
  • EU is still hobbling along
  • Technology continues to develop at a rapid pace
  • Service industry businesses are increasingly global and scalable
  • Despite all the noise, the global GDP keeps on growing

Some elements of the current environment are scary, others are comforting. For those seeking to invest, there are no easy answers. Investors need to choose a fund, or construct a portfolio which suits them. When doing so, I suggest asking yourself the below six questions.

Q1: Do I have enough cash set aside to deal with expenses to cover life’s ups and downs?

If you have insufficient cash set aside, you may be forced to liquidate assets to meet expenses when markets are down, which can destroy returns. You should be able to cover an extended period of unemployment or medical expenses without dipping into your investments.

Q2: Do I understand the fee structure?

Index funds and ETFs have the reputation of being low fee. However, more exotic ETFs can have fees over 1.5%. For low fees, stick to basic/core products offered by industry leaders such as Vanguard and Blackrock.

Q3: How liquid is the product?

ETFs are launched daily. More exotic and smaller ETFs can be less liquid than the core index products. This means they may trade at a significant variation to Net Asset Value, and be difficult to sell during volatile periods.

Q4: Do I understand what is in the index fund/ETF and implications for returns and risk?

Geographic and industry concentration are key considerations. Seemingly broad indexes can actually be highly concentrated. For instance the ASX 200 (200 largest Australian companies) ~40% financial services! Lessening concentration reduces risk (and potentially returns).

Q5: Am I the type of person who is likely to get nervous and pull money out of the market after a downturn?

Research has shown that many retail investor buy shares on the way up, and then liquidate after a crash, therefore missing the recovery. If you are prone to fiddle, a fund may be a better option than individually managing the portfolio.

Q6: Do I enjoy investing?

If you enjoy the process of investing, or the gambling aspect of it, you can set aside a small proportion of your assets for active management. Keep in mind, if you are investing in single stocks, or more exotic ETFs such inverse German bund products, there is the chance they go to zero or go up 100x. Make sure you are comfortable with the former, don’t bank on the latter.

So, what portfolio will give the greatest returns? No idea. Ensure you understand what you are investing in, and design a portfolio which allows you to sleep peacefully.


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Should I listen to financial independence gurus?

A cottage industry has developed around spruiking how to achieve financial independence (sometimes called “early retirement”). Financial independence Gurus have websites offering blow-by-blow accounts of how they achieved their goals (including personal financial information), and the awesome life they live outside the rat race. They are written in an engaging often amusing way, covering topics such as: lifestyle design, personal finance, investing, loyalty schemes and travel. High profile websites include Mr Money Moustache, Go Curry Cracker, The Mad Fientist, J Money, Millennial Revolution, Root of Good and The Escape Artist.

Despite the apparent transparency of many of the Gurus, significant scepticism is evident every time an article like “How this couple saved enough to retire early” goes viral. The Business Insider or Forbes article usually links to a well designed website with affiliate links. The blogging “hobby” is (or may soon be), a business generating tens, if not hundreds of thousands of dollars of income a year. The comments section at the bottom of the article get abusive quickly.

I don’t pretend to know the true nature of the individual Gurus personal financial circumstances. This article covers their common traits, what you can learn from them, and if you should stop working when you achieve financial independence.

Who are the Gurus

The Gurus I have come across typically have five common traits.

Above average intelligence

The intelligence of the Gurus is above (if not far above) the average person. Why do I think this? Before embracing their new lifestyles, they typically worked in jobs such as engineering, investment banking or law. They also write well.

Commercially savvy

The Gurus are undoubtedly commercially savvy. This is evident both by their history of high incomes, and ability to design, execute and monetise their websites.

Time and willingness to proactively manage spending

The proactive management of spending has several elements: (1) tracking how money is spent; (2) identifying and pursuing opportunities to save money (e.g. product switching such as Apple to Huawei smartphones, home downsizing); and (3) taking full advantage of credit card and other loyalty schemes. Ultimately, they focus on decreasing spending and maximising benefits from spending decisions.

Willingness to break from social circles and norms

You cannot lead the lifestyle that the Gurus lead without a willingness to break from social circles and norms. For example, moving to a lower cost destination will affect your interactions with your existing social circles. Similarly, dramatically decreasing entertainment expenses will change the nature of your social life.

Benefitted from investing in the stock market

The gurus typically invest a high proportion of their savings in US index funds or ETFs. The massive post-GFC bull market has accelerated the time frame taken to achieve financial independence.

What can I learn from the Gurus?

Scepticism to the individual success stories you read on the internet is warranted, but ignoring everything is foolish. There is undoubtedly lessons to be learned from the experiences and writing of the Gurus. In my view there are three key lessons that apply to people of all income and wealth levels:

  1. Financial independence is liberating. I define financial independence as the freedom to decide what work you undertake and how often you do so. Achieving financial independence alone will not make you happy, it’s just a number. But it does provide the opportunity to live your life as you wish.
  2. Managing spending is far more important than smart investing. No matter how good you are at investing, if you earn $100k and spend $98k per annum, financial independence is absolutely unachievable.
  3. Invest sensibly. The Gurus usually spruik the benefits of investing money in low cost index funds or ETFs. Index funds and ETFs minimise concentration risk and wealth management costs. This is backed by academic, regulator reports and financial services industry research.

Should I stop working when I achieve financial independence?

In a word – No. I believe people should continue to work, even if they have achieved financial independence. Work can provide purpose, fulfilment and social connections. Financial independence enables you to pursue work which makes you happy. Continuing to generate income also reduces the risk of you losing your hard-won financial independence.

Let’s say you achieve financial independence and quit your job. You live off your investment income, occasionally drawing down your capital. You travel the world for 10 years, and pursue your non-income generating hobbies of landscape painting and amateur theatre. There is a savage financial crises in 2027, with a 70% fall in the stock market, which then remains flat until 2037?  If this was to occur, you would no longer be financially independent, and be searching for work in an era of high unemployment with no recent employment history. Hello poverty line. An extreme hypothetical maybe, but not outside the realm of possibility.

Finally, I’d note that this is consistent with many of the Gurus, who have continued to generate income post “retirement”, whether it be blogging, writing books, carpentry or letting rooms through Airbnb.

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