The Bedokian Portfolio: May 2022

Sunday, May 22, 2022

Astrea 7 Or Singapore Savings Bond: Which One Shall I Choose?

With both inflation and interest rates rising, isn’t it an oxymoron to go for bonds, since they are not very suitable in such times which I had stated so myself here? The answer is simple: we still need bonds in a diversified investment portfolio. Also, we had seen some instances of investors moving towards bonds during the ongoing market sellout despite threats from the two “in-“ words, like the United States Treasury yields falling due to demand for bonds¹, thus proving their use as a safe haven.

With our Frasers Property Treasury 3.65% bonds maturing in a couple of days, we are looking for replacements to reinvest the redeemed funds. Besides the current bond ETFs that we are holding, I chanced upon the two Astrea 7 bonds and the Singapore Savings Bond (June 2022 issue).

Let us take a brief look at the three.

Astrea 7 Bonds

There are write-ups on the details of the Astrea 7 bonds (like here and here), so I shall not delve much into it. Basically, it is a corporate bond issued by Astrea 7 Pte Ltd, which ultimately is indirectly wholly owned by Temasek Holdings. The performance of the bonds is supported by cash flows from a portfolio of private equity (PE) funds, which are generated mainly through the monetization of or exit from investments by the PE funds. For retail investors there are the Class A-1 bonds denominated in Singapore dollars (SGD) with a minimum 5-year duration at 4.125% annual coupon rate, and the Class B bonds denominated in United States dollars (USD) with a minimum 6-year duration at 6% annual coupon rate.

Singapore Savings Bond

SSB for short, it is a bond backed by the Singapore government, and for the June 2022 issue, the average return rate is 2.53% annually if held over the full tenure of 10 years. The rates of the SSB are determined by a formula that takes reference from the yields of one, two, five and ten-year Singapore Government Securities (SGS).

Comparison

Besides the facts that both coupon rates and the nature of the bonds differ, we would still need to compare from an investor’s point of view in terms of other conditions. I had made a table for easy viewing and decision making:

Bond	Astrea 7 Class A-1	Astrea Class B	SSB (June 2022)
Denomination	SGD	USD	SGD
Minimum application amount (Principal)	SGD 2,000	USD 2,000	SGD 500
Tenure	10 years with mandatory call after 5 years	10 years with mandatory call after 6 years	10 years
Annual coupon rate	4.125% + 1% one-time step up after 5 years (if not redeemed)	6% + 1% one-time step up after 6 years (if not redeemed)	Averaged 2.53% if held for full 10 years
Payout frequency	Semi annual
Credit rating (Fitch)	Expected A + sf	Expected BBB + sf	AAA (rating for Singapore government)
Underlying assets	Private equity funds		NA
Bond seniority	Senior	Lower than Class A-1	NA

Fig. 1: Comparison of the bonds.

Risks

While all investments carry risks in many forms (which includes a total default), we need to manage in terms of the probability of them happening. I will highlight a couple of risks here that, in my opinion, have a higher probability of happening.

Interest rate risk – This risk is real with all the talk about interest rates rising. If the prevailing interest rate is higher than the bond’s coupon rate, then the bond’s value would go below par due to its sell-off by investors going after newer bonds with a higher coupon rate and/or bank deposits with higher interest rates. This is not applicable for SSB as the bond value can be redeemed at par value.

Forex risk – Astrea 7 Class B bonds are denominated in USD, which is subjected to foreign exchange risk. Though USD-SGD fluctuates between 1.2x and 1.4x for the past decade, we may not know its direction in the future. With a coupon rate of 6%, you may earn less or more if SGD strengthened or weakened against USD, respectively. On a related note, this also concerns the SGD value of your bond principal should you initially invest at a higher/lower USD-SGD and redeemed at a lower/higher USD-SGD, which could be viewed as an additional loss/gain.

Further Points

To have a glimpse on how the Astrea 7 bonds might fair, we could see from the past iterations that were listed the last few years: Astrea IV, Astrea V and Astrea VI (incidentally these three used Roman numerals). As of 20 May 2022, both Astrea IV and Astrea V were trading above par (SGD 1.04 and SGD 1.022 respectively) while Astrea VI was below par at SGD 0.99. Coupon rate wise among the four bonds, Astrea IV is the highest at 4.35% and Astrea VI is at 3%, which probably explain why the latter was trading below par. Based on Astrea 7’s higher rates at 4.125% for SGD or at 6% for USD, it might be trading at a premium (i.e., above par) upon listing, ceteris paribus.

Being a bond based on PE, the Astrea bonds are holding well so far. However, with an expected recession looming and the recent battering of growth stocks, this may pose a concern as usually PE are associated with growth, though I foresee this as a short-term kink.

Assuming all the compared bonds run the full tenure of 10 years, comparing June 2022 SSB’s averaged 2.53% per year, the risk premium is 1.595% (year 1 to year 5) / 2.595% (year 6 to maturity) for the SGD Class A-1 and 3.47% (year 1 to year 6) / 4.47% (year 7 to year 10) for the USD Class B. Class B’s rate is naturally higher to compensate for the risk taken since it is lower in debt seniority and exposed to forex risk.

The Bedokian’s Take

The Bedokian Portfolio’s bond selection entails the bond to be at least of investment grade and five years to maturity², to which all the bonds mentioned here had passed. Having reviewed and weighed the factors mentioned here and in other blog posts, we would be allocating between the June 2022 SSB and the Astrea 7 Class A-1.

The closing date for the application for the SSB and the Astrea 7 bonds are 26 May 2022 and 25 May 2022, respectively.

Disclaimer

Reference

Astrea 7 Bond Prospectus – https://www.azalea.com.sg/storage/app/media/reports/Prospectus/astrea-7-pte-ltd-prospectus-19-may-2022.pdf

1 – Min, Sarah & McKeever, Vicky. Treasury yields fall, prices climb as investors seek shelter from stock sell-off. CNBC. 19 May 2022. https://www.cnbc.com/2022/05/19/us-bonds-treasury-prices-climb-following-stock-market-sell-off.html (accessed 20 May 2022).

2 – The Bedokian Portfolio (2^nd Edition). p108.

Sunday, May 15, 2022

The Coming Crisis

With volatility and a host of bad news coming in on all fronts, the whole vibe of the markets kind of felt depressing. Day by day, your investment portfolio value is dwindling (unless you are vested in the Straits Times Index, which is showing a slight positive year-to-date), and you wonder would the markets recover soon or probably plunging into further depths.

While we cannot really tell the future, from guesstimating of the current macroeconomic and geo-political situations, it is painting a not-so-rosy picture. Rising interest rates, which are not good for a bullish market, are combating the effects of quick-rising inflation, which is also no good for the economy, and we are feeling the collateral of this. Accelerating the inflation drive is the global supply chain crunch and the rising prices of certain commodities such as wheat and oil due to the Russia-Ukraine conflict. These in turn could lead to higher inflation, which leads to more possible future spikes in interest rates to counter it, making the economy more sluggish. Such intricacies and the delicate relationships within the markets and economy are at work, and we cannot control them.

It is especially tricky that there is this ongoing inflation-interest rate conflict, to which there are investment strategies for both. High inflation? Get equities, commodities and REITs. High interest rates? Get cash. Problem is, who will prevail eventually, at least in the short term? Also, a typical investment playbook strategy states that if markets are going down, bonds would be the natural go-to. But again, interest rates and inflation are not friendly to them, so there goes it.

If you felt it is like stuck between a rock and a hard place, it is.

So how do we tackle this situation? Here are some general tips to ponder:

#1: Diversification

This is an obvious no-brainer advice coming from me, but diversification (in my humblest of opinion) is the only free lunch available in the world of investing. It allows you to have multiple exposures to the various asset classes, regions/countries, sectors/industries, and companies. All these are to reduce the market risks, so that even though your gains may be lesser than a concentrated portfolio, but the potential losses would be lesser.

#2: Looking For Strong “Swimmers”

A bear or correction market wave would bring a lot of securities down with it, even the strong “swimmers”. Eventually these swimmers, given their strong “physique” (a.k.a. fundamentals) would rise again to the surface and see the light of day. The easier part would be to pick the strong ones while they are still down, so that when it is time for them to rise, they will pick you up along.

#3: Keep Calm And Carry On

It pains to see one’s portfolio value dropping but fleeing the market by panic selling is not the correct way. Unlike trading, an investment time horizon is usually very long (in my opinion, at least 10 years), and such kinks are the norm rather than the exception. If you had invested for the past decade, you would have experienced the Eurozone crisis of 2012, the Chinese stock market crash of 2015 and the COVID-19 downturn of 2020. Though the markets and the economy would be down, the subsequent rebound would typically be stronger than ever.

I could sense that there might be some incoming remarks to say that this coming crisis would be different. To quote Sir John Templeton, a renowned investor and fund manager:

“The four most expensive words in the English language are ‘This time it’s different’.”

To further my stand, I would use this famous meme of James Franco from the movie The Interview:

Stay safe, stay calm, stay invested.

Wednesday, May 4, 2022

Covered Call ETFs: An Introduction

Previously, I had introduced the concept of options, explored their use in generating passive income and the possibility for passive investors to engage in options trading.

In this post, we are going to talk about the latter.

And understanding the passive investing methodology, we shall let exchange traded funds (ETFs) to do the job, namely covered call ETFs.

Sidetrack: What Is A Covered Call?

Covered call is an option strategy in which an investor writes (or sells) call options on the equivalent number of underlying securities that he/she owns.

The main aim of an investor doing a covered call is to generate passive income. As explained in my post on options here, the passive income comes in the form of premiums received. Ideally, an investor could earn passive income indefinitely by writing a new call option after the previous one expired, and repeat the process, hoping they were not exercised at all. However, when the options do get exercised, the investor would need to sell his/her securities at a lower-than-market price and may need to acquire new securities to carry on the cycle. Thus, the covered call strategy typically works well on securities that do not see much price movement, especially upwards.

The main disadvantage of a covered call is the limited “upside” or having less profit. By “locking” a selling price of the securities (the strike price), the opportunity cost would be the actual profit to be made from them, at the expense of getting the premium. For example, an investor initially bought 100 shares of X at $100 each and wrote a call option with a strike price of $120 at a premium of $5 per share (total $500). If X’s share price went up to $150, the call option buyer would exercise the option, and for the investor, instead of making ($150-$100) x 100 = $5000 by selling X on the open market, he/she only made [($120-$100) x 100] + $500 = $2500.

The Covered Call ETFs

There are ETFs listed in the United States (U.S.) doing covered calls, and they are a popular form of passive income instrument for U.S. based investors as some of them do monthly distributions for dividends. Here are some of the well-known ones:

Global X Nasdaq 100 Covered Call ETF (QYLD)
Global X S&P 500 Covered Call ETF (XYLD)
Global X Russell 2000 Covered Call ETF (RYLD)
Global X Nasdaq 100 Covered Call & Growth ETF (QYLG)
Global X S&P 500 Covered Call & Growth ETF (XYLG)
Amplify CWP Enhanced Dividend Income ETF (DIVO)
JP Morgan Equity Premium Income ETF (JEPI)
Nationwide Nasdaq-100 Risk Managed Income ETF (NUSI)

Counter	Date of Inception	Asset under management (AUM) (US$)	Expense Ratio	Dividend Yield	Distribution Frequency	Underlying Index	Options Strategy
QYLD	11-Dec-13	7.12B	0.60%	11.27%	Monthly	CBOE Nasdaq-100 BuyWrite V2 Index	Covered Call
XYLD	21-Jun-13	1.38B	0.60%	9.12%	Monthly	CBOE S&P 500 BuyWrite Index	Covered Call
RYLD	17-Apr-19	1.27B	0.70%/0.60%	11.34%	Monthly	CBOE Russell 2000 BuyWrite Index	Covered Call
QYLG	18-Sept-20	60.85M	0.60%	5.29%	Monthly	CBOE NASDAQ-100 Half BuyWrite V2 Index	Covered Call on 50% of portfolio
XYLG	18-Sept-20	44.56M	0.60%	4.26%	Monthly	CBOE S&P 500 Half BuyWrite Index	Covered Call on 50% of portfolio
DIVO	14-Dec-16	1.36B	0.55%	4.92%	Monthly	None. Actively managed in terms of stock selection from S&P 500 counters	Covered Call
JEPI	20-May-20	7.82B	0.35%	7.95%	Monthly	None. Actively managed in terms of stock selection from S&P 500 counters	Covered Call
NUSI	19-Dec-19	839.9M	0.68%	7.56%	Monthly	CBOE S&P 500 Zero-Cost Put Spread Collar Index	Protective Collar (Covered Call + Protective Put)

Fig.1: List of covered call ETFs. Information based on their respective factsheets as of 31 Mar 2022. Dividend yield data from ETFDB.com as of 2 May 2022. DIVO AUM data from ETFDB.com as of 2 May 2022.

From Figure 1, you could see the attractiveness of such ETFs based on their dividend yield and distribution frequency, especially RYLD, QYLD and XYLD (which ironically, they are from the same ETF provider, Global X). Given the high dividend yield, and the mentality of “there ain’t no such thing as a free lunch” in the financial markets, what gives?

Taking QYLD and XYLD as a basis since they were incorporated almost a decade ago, their share price since inception until 2 May 2022 were from around US$25 to US$19.60, and around US$40 to US$46.89, respectively. This meant that QYLD had lost about 21.6% and XYLD had gained only 17.23% of their respective share prices. Compare them to the actual Nasdaq 100 (using QQQ) and S&P 500 (using SPY) indices which for the same period, returned around 261% and 159% respectively. Factoring in reinvestment of dividends and using compound annual growth rate (CAGR), QYLD : QQQ is 7.2% : 17.5% and XYLD : SPY is 6.95% : 12.15%¹.

This brought us back to the characteristic of covered calls as explained in the section above: limited upside. These ETFs do not really cater for growth, but rather concentrate on the passive income part of it (i.e., premiums from writing of options).

There are some steps taken by the ETF providers in having a balance between growth and income for such ETFs, as seen from Figure 1. Two examples are QYLG and XYLG, in which 50% of the holdings are subjected to covered calls as opposed to the whole thing, at the compromise of much lower dividend yield. Others like JEPI and DIVO adopted an active management approach with respect to having growth and tactically employ covered calls.

Some Considerations

For Singaporean investors who are non-U.S. residents, the dividends are subjected to a 30% withholding tax, so the actual dividend yield would be 30% off the displayed number (e.g., RYLD’s 11.34% would be net down to 7.94%). This is a very big haircut, but that is the package that comes along with receiving dividends from the U.S. markets. Another factor to take note would be forex risk since the underlying assets are priced in US$.

While these ETFs do not really perform as well as their underlying indices, the main plus point is the higher dividend yield (e.g., QYLD’s 11.27% versus QQQ’s 0.45%, XYLD’s 9.12% versus SPY’s 1.22%)², and this enables a better cash flow from the securities without the need of liquidating them. This cash flow could be used to provide passive income and/or to fund other investments. It is still worth if the dividend part exceeds the loss of the capital overall.

The Final Question: Should I Go For A Covered Call ETF?

Having said much about covered call ETFs, it boils down to this basic question: should I be going for such ETFs? The answer is, as usual, it depends.

If you are not comfortable with having them, and/or trying to make your investment portfolio as simple as possible, then just leave them out. However, if you wish to include them, do make sure of the aims and considerations stated in the previous sections. As covered call ETFs are a form of derivatives, such securities would be outside of your normal investment portfolio and instead, be placed in a trading one (see here). Still, it is up to you on what to do with the dividends: you may continue to park them in the trading portfolio, or transfer some/all of them to feed your investment portfolio.

May The Fourth be with you.

Disclosure

The Bedokian is invested in RYLD.