Monday, August 27, 2018

Introducing The Portfolio Multiverse

The Portfolio Multiverse is a concept in which an individual would plan, manage and organise his/her investment and trading portfolios based on each portfolio’s objective(s) and characteristics, and the individual’s risk appetite, risk tolerance, knowledge and allowable time for the portfolios, asset classes and/or financial instruments used in it (that is a mouthful, I must admit). This concept stemmed from my mental accounting bias and personally I felt it is easy to view one’s overall investment/trading picture.

Is it difficult to start off this Portfolio Multiverse? Not really. In fact, if you are a salaried person and have started out investing using your disposable income, you already have a Portfolio Multiverse in place. For common folks like you and me, we can start off our Portfolio Multiverse with three basic portfolios. 

The Three Basic Portfolios

For most Singaporeans, the first basic portfolio to start with is their almost risk-free Central Provident Fund (CPF) accounts. Regardless of whether you tinker with it by investing, or just leave it as it is, the age to start withdrawing is known (from age 65, using the CPF Life model1), so there is a sort of rough gauge on how much you will be getting per month at a certain point of time. We can treat this as the basic retirement portfolio.

Then you can create an investment portfolio (e.g. The Bedokian Portfolio) using your disposable income to augment your CPF for retirement. Since the use of CPF is subjected to regulations, this portfolio is more flexible and liquid, and it can also be used to fulfill your financial objectives such as determining when to start collecting the yield as passive income or to fund foreseeable big ticket items like your child’s education.

If you still have spare cash, you may consider opening up a Supplementary Retirement Scheme (SRS) account2. You can save some taxes along the way while building up the SRS fund through investing. The uniqueness about SRS is that you are given up to 10 years to withdraw the amount3, and can start at or after the prevailing statutory retirement age when you first made the contribution (currently is age 62).

The Timeline Map

With these three basic portfolios, you can chart your financial plans and milestones using a timeline map. Each portfolio is assigned a timeline, and on each timeline you can indicate the objectives, milestones and payouts along the way; for example on the Bedokian Portfolio timeline, you can indicate that you want to have $100,000 by age 30 with a projected yield of 5%, by age 45 to withdraw $20,000 to fund your home re-renovation, and by age 55 you would want to commence drawdown at 3%, etc.

The timelines are not isolated from one another. They are supposed to work together to achieve your overall financial goals, especially at the retirement stage, at which you would have income streams from CPF, SRS and the Bedokian Portfolio. Furthermore, depending on what other timelines you might have and the prevailing regulations for CPF and SRS, the funds can be transferred among one another (e.g. allocate a portion of the dividends from your Bedokian Portfolio to top up your CPF or SRS).

Expanding The Portfolio Multiverse

As life goes on, and if more capital is available to you, you could either just add it into these three, or go for other portfolios, asset classes and financial instruments such as property or annuities (provided you have gained some knowledge on how to invest in them). There you can create additional timelines and further plan your financial path.

The Portfolio Multiverse concept is still a work-in-progress, but the main gist is described above.

In case you are interested, I have written some blog posts on how to implement The Bedokian Portfolio on your CPF and SRS portfolios (look them up at the references section below).

1 – Central Provident Fund Board. CPF Life. Last updated 23 July 2018. (accessed 19 Aug 2018)

2 – Ministry of Finance. Supplementary Retirement Scheme. 7 Dec 2017. (accessed 19 Aug 2018)

3 – You need not withdraw everything after 10 years, but 50% of the remaining amount after that period would be subject to income tax.


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!