DIY Investing or Seek Financial Advisory

I am off the age when peers are starting jobs, earning a decent salary, pursuing their dreams and basically holding a job. Last nite I had dinner with friends who were keen on investing.

Some had the view of doing it alone. Others believed that having a Financial Advisor helps because the advisor acts like a confidante and helps to hold in check speculative urges.

The awkward truths

Financial Planners in Singapore earn a Basic and a Commission based on a stream of future payments from the financial services that you purchase such as Insurance and Funds. That is true.

It is true that they make more money if they have more clients.

It is also true that they'll make more money if they sell more of a certain type of product.

So what?

Your job is to optimize your investment opportunities. In secure long term investment, your biggest enemy is yourself because:

1. You make all the final decisions. Therefore you determine the outcome. (You and the sum of your stupidity and irrational fears.)

2. You spend a lot more time thinking about investment opportunities rather than worrying about possible dangers.

3. You get emotional and irrational when you hear others are doing better than you in Fund/Stock/Investment Idea XYZ. You switch between funds and incur huge transaction costs when ideally you should park your money and let time do its thing.

Therefore Financial planners:

1. Offer you advise and counsel and can help you get up to speed on financial issues sooner.

2. They've got the tools to help you come up with an investment plan in a rational, logical manner which can act as a framework for future planning. (Its nothing more than an Excel spreadsheet based on Annuity calculations that you can download from the Net, but seriously, do you have the time and inclination to study the assumptions and work through the model and figure out why exactly Money has a Time Value and how that affects your returns?)

3. By going through a financial planner in an investment plan, you avoid OVERTRADING which increases the transaction cost of your investments.

Financial planners' advisory role dampens irrational desires to trade when you don't really have to.

After saying all that, if you still want to do it your own way you can start here: fundsupermart.com

Alternatively, you can drop me an email and I'll help you get in touch with a couple of friends who are dead keen on maximizing your wealth without sacrificing your sleep.

Donc.

Paybacks' a bitch: We haven't heard the last of the Subprime Mortgage Crisis.

"The semiannual meetings of the world’s top finance and banking officials are predictable in one sense: Europeans and Americans often use them to lecture leaders of poor countries about the need to modernize their capital markets, promote transparency and adhere to sound investment standards.

What a difference a subprime mortgage crisis can make. Now developing countries are lecturing the West."

Tables Turned: Poor Countries Wag Fingers at Rich Ones - New York Times (21 October 2007)

Remember the Asian Financial Crisis of '97 when Thailand, Korea and Indonesia were bailed out by IMF and got an earful from Developed Countries as to how to run their economies?

Well, now, its America's turn with no end in sight for the subprime mortgage crisis.

"Collateralized debt obligations — made up of bonds backed by thousands of subprime home loans — are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own, according to analysts and industry executives."

Mortgage Security Bondholders Facing a Cut-back in Interest Payments - New York Times, (22 October 2007)

Bondholders who hold CDO bonds may face the possibility of having their coupons not paid.

"With such a re-evaluation, owners of collateralized debt obligations — investment banks, hedge funds, insurance companies and public pension funds — may be forced to write down mortgage investments beyond the billions they have already written off."

Oooohh kkkkaaayyy... *gulp*

One would think that a re-rating would be sufficient to sort out the entire problem but CDOs are a tangled barrel of worms. Its like having a pie made up of good and bad apples. The bad ones taint the whole lot.

Here's an insight into how complex the whole thing can be:

"A re-evaluation of payments by trustees who oversee the debt obligations is part of a long, complex chain reaction that is caused by the surge in mortgage delinquencies and home foreclosures. As more homeowners fall behind on payments and lose their homes, the pressure builds on large pools of mortgages that issue bonds to investors. Many of the riskiest of those mortgage bonds have been bought by the C.D.O.’s, which issue bonds of their own.

On Friday, Standard & Poor’s lowered the ratings on $22 billion in bonds backed by mortgages made to people with weak credit in 2006, citing the continued deterioration in the housing market. Another credit rater, Moody’s Investors Service, lowered a similarly large group of bonds earlier in the month.It is unclear exactly how many bonds will be affected and how quickly. Investment banks issued some $486 billion in debt obligations linked to mortgages in 2006 and the first half of 2007.

A majority of the bonds have high credit ratings, and the trustees of the debt obligations typically shut off lower-rated bonds first to accelerate payments to investors holding higher-rated debt.When ratings on the bonds directly backed by mortgages are lowered, it forces the trustees to discount the value of their holdings in a calculation performed once a month. Some C.D.O.’s also hold bonds issued by other debt obligations, so it can take months for ratings downgrades to work their way through the system."

Okay, so when will we see a bottom?

"Most mortgage securities have not yet had significant losses, which are only recorded when homes are foreclosed and sold. Up to two years can pass between a borrower’s falling behind on payments and an auction. Each mortgage security has a reservoir of excess cash to draw upon to pay bondholders when borrowers do not make monthly payments.

“As far as the security is concerned, it’s only once the property is effectively sold that a loss is recorded,” said Nicholas Weill, chief credit officer at Moody’s. “The process of foreclosure is a long process. It doesn’t just happen overnight.”

So there'll be at least 2 years of unfavourable investment conditions in the US.

So what are the banks doing to contain the problem?

"Problems with these investments has led big banks including Citigroup, Bank of America and JPMorgan Chase to develop a $75 billion rescue fund that could be used to buy risky mortgage securities and other assets from them, a move intended to ease pressure on an important part of the credit markets."

A US$75 billion dollar fund to increase liquidity in the trade of CDOs by Citigroup, Bank of America, JPMorgan Chase. Would it be enough though?

What I did on the 20th anniversary of the Wall Street Crash of 1987

I stayed away from reading any market related news. I read popsugar.com , slashdot.org and boingboing.net instead. Later, I chatted with my girlfriend and had a cup of coffee. I napped for half an hour. Woke up and thought, this isn't too bad. I took the time to reconsider my investment behaviour and reconsider my options.

I stopped trading a few months ago because I blew up my trading account during the sub-prime crisis. The spillover from that event propagated through the financial system and made a couple of my warrants positions finish worthless.

I had bet big on the warrants of Singaporean banks and Capitaland, largest real estate group on the island. Given the fundamentals, I thought they were safe bets. I was wrong.

When the crisis hit, the stocks wouldn't climb to reflect stronger earnings results due to all the negativity in the US market and prices remained depressed. I had committed funds too early in an attempt to average out the losses but by the time the market had bottomed out, I had invested too much money into each bet to make them good candidates for the ride up again.

Looking back I think I began trading in warrants because I was bored. From my lecture notes, I figure I am what Larry Harris, author of 'Trading & Exchanges' describes as a Utilitarian/ Gambler/ Futile Trader.

I'll admit it. I regret placing those bets. I regret them because I compromised on my ideals. That I won't chase the stock. That I won't play the market's game. That I won't be fooled by my schooling.

The more you know, the more you think you have an edge over everybody else in the trading game. The truth is that I am a nobody with little new information and the cost of gathering every little scrap of information just to make a few trades is too expensive for my taste.

Fund managers can trade because they get paid to do it. Brokers trade because they get paid to do it. They need to be on top of the news, they need to be on the lookout for investment opportunities. Its their job.

I don't have to. I have a life. Its Mine. I have only one life and to waste it all scouring the Net for information, prowling the Forums for a sensing on market sentiments - its just too much.

So on the 20th anniversary of the Wall Street Crash of 1987, I'm relinquishing my dreams of becoming an Active Trader and surrendering myself to the way of the Informed Investor.

Energy demand 'til 2030 projections

Above: International Energy Agency energy demand projections from BBC News report, "World risks 'dirty' energy future" (link here) dated 7 November 2006.

They mention pursuing nuclear option. (Not a bad idea considering how much of it is left untapped and that it produces heck of a lot of energy. But the Greens won't like it though cos of the risk of radioactive contamination, not giving 'green' energy sources a chance, etc. But Australia and South Africa's got a lot to gain from an interest in yellow cake uranium mining.)

They mention growth in the use of biofuel as a transport fuel (Ethanol? Biodiesel?).

From the article:

The report also projected that biofuels were set to play an increasing role in road transport, providing up to 7% of the total consumption in 2030.

But here's the interesting bit:

But the WEO warned that the growing demand for food would limit the potential of the plant-derived fuel produced using current technologies.

So if there's expectations of increased demand for grains for food purposes and as an alternative energy source, where do you think the price of grains would go?

If grain prices are going up, which companies will benefit? I can think of one: Noble Group, listed on the Singapore Stock Exchange. How about agricultural themed stocks? Or countries with significant infrastructure in palm oil and grains?

The assumption here however, is that world economic growth continues. We hope that emerging markets continue their upward trend, with some occasional periods of volatility. Energy companies tend to be highly leveraged with a sizable fixed cost component which makes their net profits very sensitive to economic fundamentals. A downturn could have a material impact on their revenues considering their large capital outlay.

As of today, I'm bullish on energy themed stocks and funds.

Oil Prices: Huge Demand, Not Enough Supply; means Big Future Oil Prices!

This is so obvious its scary. In the next few years we can only expect higher oil prices because there's no new major oilfields left for easy extraction. Most of it is locked up in 'difficult' countries. The uncertainty in supply as well as the world's rapacious hunger for oil has created this huge jump in oil price expections.

Dr Michael Smith of energyfiles.com argues that not only are OPEC producers overstating their reserves, he also claims that the data is highly suspect. Link to page [here]; Link to PDF article [here]. In this 2 year old paper he claims that assumptions of future oil demand of 12omillion barrels a day is 'untenable'.

Quoting from article:

"Predictions that oil demand will increase to up to 120 million barrels per day by 2020 allied to automobile and airline traffic growing at extraordinary rates are futile and damaging to policy makers."

Even 95 million barrels are untenable, he writes.

The primary implication is that we're likely to see a switch to Gas (will require more infrastructure to be built) and alternative fuels as higher prices results in a substitution effect.

A couple of trading ideas:
I thought of buying Coal and other alternative energy companies in anticipation of an increase in demand for their services. The more immediate goal is figuring out which Oil & Gas co.s are likely takeover targets considering that its easier to buy a company and its proven petroleum reserves rather than look for the stuff itself.

Beware of China's overly optimistic economic growth projections!

Lester Thurow, MIT's professor of economics has written an article for the NYtimes warning analysts and investors to take the Chinese government's growth projections with a pinch of salt "A Chinese Century? Maybe it's the next one," - August 19, 2007 (link here)

Quote from article:

"Economic growth rates can be inferred from electricity consumption. In every country in the world, electricity use has generally grown faster than the G.D.P. Electricity is necessary for nearly all productive activities, and because of inefficiencies, consumption of electricity has generally outstripped economic growth. Rising energy costs have resulted in more efficient use of electricity, but especially in the developing world, economic growth has still generally lagged growth in electricity.

But if China’s official numbers are to be believed, there are provinces in China where the G.D.P. has been growing faster than energy use. That is unlikely, since the central government’s statistics also say that energy use per unit of G.D.P. is going up — not down, as claimed in provincial G.D.P. statistics.

Among the world’s 12 most rapidly growing economies over the last 10 years, the G.D.P. has grown only 45 percent as fast as electricity consumption. In the early 1970s, Japan was shutting down its electricity-guzzling aluminum industry. During this period, the G.D.P. grew 60 percent as fast as electricity consumption, the highest recorded level among industrialized nations.

Using those numbers as a guide, if we consider China’s actual electrical use, which is relatively easy to measure, and do a little math, we come up with this estimate: The G.D.P. in China has been growing somewhere between 4.5 percent (using the average for a rapidly growing country) to 6 percent a year (using the highest rate for Japan), not at the 10 percent rate claimed in official statistics."

Several lessons to be learnt here:
1. Whack 4.5% - 6% into calculating Terminal value growth projections of Chinese companies rather than 10% (or any higher Economic growth rate as a proxy for a company's growth!)

2. A method to figure out economic growth projections for a company in an emerging economy. Use Growth rates in Electric Consumption to estimate the economic growth rather than use the Government's stated economic growth rate.

An easy way of estimating single-stock beta

I submitted an earlier post about calculating Singapore Press Holding's beta using daily and monthly returns. I came up with some ridiculous beta figure.

I made a lot of mistakes in calculating the beta of a single stock against a larger market index and I'd like to post some corrections..

1. To calculate single stock beta use Microsoft Excel's '=slope('%change of stock returns', '% change of market returns')

2. The idea is that Excel's slope function measures the gradient of a curve. Here, the Y-axis is % change of stock returns and X-axis is the % change of market returns.

3. Beta is then defined as the 'change in Stock Returns' for a 1% change in Market Returns.

4. Note that you should compare like against like. Therefore, if you collect daily prices and then determine daily returns, plot it against the market indexes daily returns as well.