Thursday, August 9, 2018

Does Investing In Corporate Bonds Contravene Value Investing?

I was asked this question not too long ago by a fellow investor during a coffee session, and when I first heard it, I was like “Okay…is it going to be something complicated?”

After hearing out his explanation, I had gotten what he is trying to say. Basically and in gist; 

a.    Corporate bonds are considered long term liability, i.e. debt, and; 
b.    One of the rules of value investing is to find low debt or no debt companies. 

So his question was if I follow (b), then investing in (a) would contradict my rule in (b).

This is a very interesting question.

A Little Bit On Corporate Bonds

A corporate bond is issued by a company, and like its government bond counterpart, it has a maturity date and a coupon rate. Unlike government bonds, however, corporate bonds tend to be shorter in nature (within 10 years or so) and pay a slightly higher coupon rate to compensate for the possibility of default risk. The main reason why companies issue bonds is to get additional funding for their business operations or large projects.

Some corporate bonds are rated by credit ratings agencies (the big three: Standard & Poor’s, Moody’s and Fitch) while others do not. Rated bonds tend to be safer than unrated ones, although the “do your own due diligence” and caveat emptor (buyer beware) logic apply.

In accounting terms, bonds are placed under the “long term liabilities” in the company’s balance sheet, since the debt is to be repaid years later. If the bond maturity is due within the same financial year, then it will be termed as “current liabilities”.

Corporate bonds have different classifications as well, using these four words for categorization; secured, unsecured, senior and junior (or sometimes called subordinated), thus we have: 

a.    Senior secured debt
b.    Senior unsecured debt
c.     Junior secured debt
d.    Junior unsecured debt  

These are priority levels of payout should the company goes into bankruptcy or liquidation (after other priority creditors are paid off), with the holders of senior debts (bonds) getting paid first before the junior ones. For your information, share (equity) holders of a company are ranked below junior debts.

Debt And Value Investing

Value investing is simply the purchase of equities that are undervalued with relative to their current market price, using fundamental analysis in determining the value.

Most value investors dislike debts, especially long term ones, in a company’s balance sheet, for they could be a potential time bomb; when the debts are due, a substantial amount of cash is needed to cover this, and if not enough forecast is done or the maturity date meets up with a very bad business year, then it is bad news for the company. Some companies resort to raising additional capital (through equity rights issues, bank loans or more bonds) just to cover this debt hole, and this definitely does not sit well with shareholders and bondholders alike.

The Bedokian Answers The Question

There are a few ways to answer this question, depending on one’s investment mandate, philosophy and style. The simplest answer would be a “yes, so I shall not touch any corporate bond”, and we can close off this discussion. However, we could keep an open mind and further discuss on whether there would be a middle ground, so we could give ourselves an answer phrased as “it depends”.

Fundamental analysis is still key in looking out for good and value companies, even though they may take in long term debts. Taking into account the debt nature of bonds, we could view from the dimension of a company’s sustainability of these instruments and their proportion to its assets and equity. Some of the financial ratios you can consider using for your analysis would be:

Interest Coverage Ratio (Earnings Before Interest and Tax / Interest Expense) – A measurement of the company’s ability to pay down its expense of debt, i.e. interest. The larger the ratio, the better.

Debt Coverage Ratio (Net Operating Income / Total Debt Serviced) – This ratio calculates the company’s coverage of its debt, which includes interest and loan principal. Same as interest coverage ratio, the larger it is, the better.

Leverage Ratios (Debt / Equity; Debt / Assets; Debt / Debt + Equity) – These ratios look at the portion of debt over the various components that form up the Assets = Liabilities (Debt) + Equity equation. Looking at the equation, it is preferred to have the debt portion kept small, hence for these ratios the smaller they are, the better.

To complement the ratio analysis, you could also look at the company’s free cash flow, which is cash flow from operating activities minus capital expenditure. Then you could put the free cash flow against its debt obligations for analysis.

Another point to make would be: if you buy a company’s corporate bond, try not to buy its equities, and vice versa. This is to avoid overconcentration on the same company. Also, if the company is in bad shape, both its share and bond prices would go down together, thus there is no correlation to speak of even though they are different asset classes.

With so much points made above, back to the question, to me in some ways investing in corporate bonds does not contravene value investing, but ultimately the investor must know what he/she is doing and getting into.

Happy National Day!


Monday, July 30, 2018

The Bedokian Portfolio Has Turned Two! And Some Smart Tips For You!

Two years ago today, I had launched The Bedokian Portfolio ebook and blog. A lot of things happened between then and now in the financial markets, to name a few: the bull run of 2017, the trade war, the introduction of local REITs ETFs, disruptive technology, etc.

Despite these good and bad things happened around us, as investors we have to keep the course and stay invested, but we have to stay invested smartly against an unknown future. Here are some smart tips for you.

Smart Tip #1: Stay Diversified

Diversification is one of the key underlying principles of The Bedokian Portfolio. It is the simplest form of hedging against most types of investment risks and scenarios. From asset class types to different companies, diversification must be practiced along the entire spectrum.

While I understand there are some disagreements to diversification, with reasons such as potential missing out on huge returns and it is meant for the clueless, I find it is OK not to diversify, if you know what you are doing. If concentrating on some financial securities or only on one company, one must have the absolute conviction and foresight to do so, which unfortunately most of us do not have. The question is, even with confidence and almost complete information, what if one is wrong?

In the weeks leading to the 2016 United States presidential elections, a lot of analysts had predicted a Trump win would tank the markets; however the reverse happened and it started a bull run of 2017. Imagine what would happen if you had selected a bear market scenario and placed almost or all of your capital during that time?

With diversification, you may win some or lose some, but at least you don’t lose all.

Smart Tip #2: Stay Analysed

It would be foolhardy to go into any investment without first knowing what it is about. This is why I had included a chapter on fundamental analysis (FA), which is another key principle, in The Bedokian Portfolio.

If you have noticed by now, the Bedokian Portfolio caters to value, growth and a little bit of both. From my ebook and blog posts, I advocated getting company equities and REITs cheap (value), and I also provided some insights on looking out for the next big thing (growth; for more info read here).

You can use a myriad of FA techniques out there, or you could use the tiered Company-Environmental Factors-Economic Conditions model in the ebook. With FA, it is at least better to have a gauge and basis, which I called it “guesstimate”, rather than having nothing at all.

For passive Bedokian Portfolio investors who go the ETF way, it is advisable to do some basic analysis on the ETFs as to their structure and holdings, and see if any particular ETF is suited for your investment style and objectives.

Smart Tip #3: Stay Rational

We have rational investors and traders, but we also have irrational ones as well. Together, they form the participants of the financial markets. Irrationality stems from emotions taking over logic in the decision making process, and if there is enough irrationality it would move the markets in one direction or another.

Euphoria and panic are the two most common emotions displayed in the financial markets; the former would bring the markets up to a high, and the latter would bring it down to a low. Along the way, they bring collateral damage to your portfolio, at least on paper.

If you are a passive Bedokian Portfolio investor, that’s good. Just stick to your rebalancing plan and continue to enjoy life.

For the active ones, there are two ways to deal with market irrationality. First would be to ignore it, once you know the highs and lows are not results of real fundamental reasons. Second would be to capitalise on it; you could start doing a rebalance by selling the extreme winners and buying up the false losers in an up market (read up here) or treat it as a sale in a down market (read up here).

Emotional control is key to be a rational investor. Next time when the markets go awry, take a step back, calm down and think of the next logical step to do.

Well, that’s all I have to say in my second anniversary post. May all of us live long and prosper!

Saturday, July 28, 2018

Another Bond ETF is Coming

Nikko Asset Management (Nikko AM) had just announced it would list an ETF on the Singapore Exchange (SGX) on 27 Aug 2018. The new ETF, called the Nikko AM SGD Investment Grade Corporate Bond ETF (which I will shorten it to “the Fund”), tracks the iBoxx SGD Non-Sovereigns Large Cap Investment Grade Index.

About

This is a bond fund, similar to Nikko AM’s other offering, the ABF Singapore Bond Index Fund, which holds Singapore government and quasi-sovereign/supranational bonds. 

The Fund is Singapore dollar denominated, meaning all of the underlying assets are in SGD, although 74.8% of them are issued in Singapore. Being corporate bonds, the maturity date is shorter than that of government ones, averaging 4.7 years.

As the Fund’s name imply, it holds investment grade bonds ranging from AAA to BBB- under the Standard & Poor’s credit ratings. Also, the total expense ratio is about 0.2%, and the Fund intends to cap this ratio at a maximum of 0.3%.

The Bedokian’s Take

Given the fact that we only have a few locally listed bond ETFs, the introduction of this Fund is a refresher, especially for passive Bedokian Portfolio investors. Holding investment grade bonds, this would be a huge assurance as such bonds are deemed to be very less prone to default.

Though the Fund included the term “corporate bond”, it does contain some bonds from Singapore statutory boards such as the Housing Development Board and the Land Transport Authority, which I viewed them as quasi-government bonds.

Some may not like the fact that the distribution for this Fund is only once a year, unlike other securities that mostly pay out twice or four times annually. In my opinion, as long as it pays out regularly and timely, I am OK with it. 

If you are risk averse and want to take a step up to corporate bonds, this Fund would be a good consideration.


References:



Sunday, July 15, 2018

The Straits Times Index

By now a few people had pointed out something about the Straits Times Index (STI), viewed as the representative of the local equities market; there is not enough diversification and it is overweight on certain sectors.

Let us take a look, shall we?


Fig. 1 - Weightage of the STI1


The three main sectors of the STI are banks, industrial goods and services, and real estate, which constituted a total of 71.61%, quite a heavy concentration there. Banks, which consisted of the big three (DBS, UOB and OCBC), stood at 41.62% of the index, almost half!

Extrapolating this onto the balanced Bedokian Portfolio2, with the 35% equity portion invested only with the STI, 14.57% (35% x 41.62%) of your entire Bedokian Portfolio would be on banks. And if you remembered, this would contravene my 12% limit rule

Relooking at the link in footnote 1, there are other indices around, such as the FTSE ST Maritime and the FTSE ST Small Cap. If you have read investment portfolio books from the United States (U.S.), they encouraged diversifying into sub categories of equity based on market capitalization, such as large cap, mid cap and small cap, and/or by sector play, and they have related financial instruments for investors to go into. Just look at Vanguard(a U.S. ETF provider) alone and they have a slew of ETFs for the U.S. market indices.

While we do have these equity cap and sector indices locally, there is no ETF based on them, hence there is a limitation on what to invest for our local markets.

So how to go about it?

Alternative #1 – Core-Satellite Approach4

My oft-harped-about approach, this involves using ETFs and individual securities (in this case, individual company equities) to form the core and satellite, respectively. Using back the balanced Bedokian Portfolio, if the STI forms half of your 35% portion (meaning 17.5%), your bank weightage would be reduced to about 7.28% (17.5% x 41.62%), assuming that you have no local banks in your individual holdings.

But this alternative may not sit well for passive and index Bedokian Portfolio investors, so let us go to the next alternative.

Alternative #2 – Going Glocal

The second alternative is to go glocal (I had written about this here), where you could diversify into overseas equities ETFs. According to the Bedokian Portfolio, the order of diversification of region/country comes first before sector, so taking back the bank example, if your overseas ETF has a banking component, this would not count together with the ones in the STI.

It is up to you how you want to assign your equities between local and overseas, using the 10%-30% guidelinefor your Bedokian Portfolio.


1 – FTSE Russell. FTSE ST Index Series. 29 June 2018  http://www.ftse.com/Analytics/FactSheets/Home/DownloadSingleIssue?issueName=SGXSERIES (accessed 14 July 2018)

2 – 35% equities, 35% REITs, 20% bonds, 5% commodities and 5% cash

3 – Vanguard. Vanguard ETFs.  https://investor.vanguard.com/etf/list#/etf/asset-class/month-end-returns (accessed 14 July 2018)

4 – The Bedokian Portfolio, p122-123

5 – The Bedokian Portfolio, p109-110

Sunday, July 1, 2018

Going Local, Global or Glocal

A number of investors I know of started their investment journey from the local financial markets, like equities and bonds listed in the Singapore Exchange (SGX), Singapore Savings Bonds (SSB) and the local bank fixed deposits. Some had ventured on to overseas markets while others stayed put.

Coming from another angle, I know of a handful who began with foreign financial markets, in particular the United States (U.S.) markets. Again, some had “returned” with SSB and a mix of securities from SGX, while others just remained vested overseas.

There are many reasons why the above preferences happen. Some say it is due to familiarity, while others say one side provided more returns than the other. Whatever the rationale, it is up to the individual to decide, but for The Bedokian Portfolio investor, it is good to go glocal, i.e. local and global, due to the following reasons.

Diversification

I have constantly rambled on diversification, and besides doing it at the asset class level (the highest order), we could also do it at the regional/country level (the next lower order). Take for instance equities; at any given time, the stocks and shares of a region/country may perform better or worse than their counterparts in another region/country, even though they belong to the same asset class.

A good example would be the Asian Financial Crisis back in 1997-1998. The markets that were affected, like Thailand, Malaysia and Singapore, got hit at various degrees, while the U.S. and European markets remained business as usual.

Foreign Exchange

Foreign exchange (forex) is a double-edged sword; it could amplify your gains if your overseas investment appreciates in price and the forex rate goes up, but it could be a real bummer if both the price and forex go downwards. This is the main risk of investing overseas, but if you look the other way it could present higher potential returns.

Both the price and forex going up is a good textbook example of a gain, but it does not work in the real world all of the time. As long as this equation (share price gain > forex loss) holds true, then it is a worthwhile investment. For example, on 2 Jan 2009, the closing price of Berkshire Hathaway Class A (BRK-A) shares was USD 99,990and the USD/SGD exchange rate was USD 1 to SGD 1.45252. Fast forward to 29 June 2018, the USD/SGD exchange rate went down to USD 1 to SGD 1.36215but the price of BRK-A shot up to USD 282, 0404

Imported Inflation

This was brought up by an acquaintance and was not featured in my ebook. Imported inflation is defined as “inflation due to an increase in the price of imports”5. As most of our raw materials and consumer products are imported, an increase in the foreign price and/or the depreciation of our forex rate might cause imported inflation.

This is somewhat related to the forex section above. Imagine a factory here required a widget from the U.S. to make a gizmo, and assuming a fixed USD/SGD forex rate, an increase in the price of the widget in the U.S. would naturally increase the manufacturing cost of the gizmo. Similarly, if there is a change in forex rate and more SGD is required to change for USD, the cost of the widget and subsequently the gizmo go up, too. Viewing it on a macro scale, all these price increases may contribute to the overall inflation of the economy, ceteris paribus.

Local-Global Proportion

I had stated in The Bedokian Portfolio that the global portion would be between 10% and 30%, spread across the equities, REITs, bonds and cash asset classes6. If you decide to retire locally, it is good to have a portfolio that is based on local monetary terms, but investing overseas will bring about the advantages of diversification and forex, as well as to mitigate against the potential effects of imported inflation.

And do not forget, due diligence and analysis are still required when you venture overseas.


1 – Nasdaq. BRK-A Historical Stock Prices. https://www.nasdaq.com/symbol/brk-a/historical (accessed 1 July 2018)

2 – Monetary Authority of Singapore. MAS Exchange Rates https://secure.mas.gov.sg/msb/ExchangeRates.aspx (accessed 1 July 2018)

3 – Exchange-Rates.org. Singapore Dollars (SGD) per US Dollar (USD). https://www.exchange-rates.org/history/SGD/USD/T (accessed 1 July 2018)

4 – Yahoo Finance. BRK-A. https://sg.finance.yahoo.com/quote/BRK-A/?p=BRK-A (accessed 30 June 2018)

5 – Investor Words. Imported Inflation. http://www.investorwords.com/15442/imported_inflation.html (accessed 1 July 2018)

6 – The Bedokian Portfolio, p109-110

Thursday, June 21, 2018

It’s That Time of the Year Again

The first half of 2018 is coming to a close, and it is that time of the year again; yes, Bob will be rebalancing on 29 June 2018, the last trading day before the start of the second half, with an additional injection of $5,000.

I had mentioned that Bob may consider investing in some individual company securities, but had yet identified any to invest in, so he will be going along with his original ETF strategy. The $5,000, plus any dividends collected, will be split among the asset classes.

So watch out for Bob’s portfolio status here in July!

Saturday, June 9, 2018

Light Reads On Understanding Financial Statements

In my ebook The Bedokian Portfolio, I did not cover much on financial statements except for a brief description of the income statement, the balance sheet and the cash flow statement1. Short of reading up accounting and financial textbooks, it is not easy to explain the nooks and crannies of these statements in a simplistic form.

Fortunately, I have identified a couple of books that are light for reading (and light for your brain, too) in understanding some of, if not almost, the whole gist of things. Each of these books could be read over a lazy weekend and after reading them, I believe they will provide some form of enlightenment in understanding the financial statements.

Warren Buffett and The Interpretation of Financial Statements (ISBN 978-1-84983-319-6)

See book cover here.

Co-authored by Mary Buffett and David Clark, their aim is to provide “a straightforward and easy-to-understand book that would teach investors how to read a company’s financial statement”2. It also emphasizes on the search for companies with a durable competitive advantage, something that Warren Buffett, considered one of the greatest value investors of our time, would look for.

Buffett (Mary) and Clark introduced each line item in the financial statements in bite-sized chapters, and will disclose Warren Buffett’s strategies and viewpoints in some of them. 

Buy Low, Sell High, The Simplicity of Business Finance (ISBN 978-0-9969433-7-6)

See book cover here.

Written by Dr. Philip Young, a consultant and former MBA professor, this book is originally meant for people with non-financial background to understand business finance better. However, this book is suitable for investors as well, as he has stated, “understanding business finance is a critical part of being an educated investor”3, something which I agree wholeheartedly.

Young explained the financial statements in a simple manner, using examples and figures. He also touched on some financial ratios and the time value of money. To top it off, at the end of each chapter he gave diagnostic questions as a form of learning check.

I hope the above would give you a jump-start in knowing and understanding financial statements more. For the already trained, take them as a light refresher read.


1 – The Bedokian Portfolio, p86

2 – Buffett, Mary & Clark, David. Warren Buffett and The Interpretation of Financial Statements (2011). Simon and Schuster U.K. pxvii

3 – Young, Philip. Buy Low, Sell High, The Simplicity of Business Finance (2017). LID Publishing. p3