Considerations of ETF Selection

ETFs are great tools to start off passive index investing, whether you want to follow the Bedokian Portfolio or other investment strategies and approaches. Before you jump right in, here are some considerations that you should take note of.

Consideration #1 – The Index

The index determines the make-up of the underlying securities of the ETF. Take the Straits Times Index (STI) for instance, both the STI ETF and the Nikko AM STI ETF track it, but there could be some slight differences between them, such as their proportions of the STI components and how closely the ETF tracks the index.

Additionally, you may also want to see the sector/industry exposure of the index, as well as regional/country exposure if applicable. This is important due to diversification.

Consideration #2 – The Structure of the ETF

I had mentioned earlier about physical and synthetic ETFs. Although in my ebook I had stated that physical ETFs are preferred, due to the counterparty risk that synthetic ETFs have, the latter do track the index closer than the former. The verdict of going with physical or synthetic is up to you.

The other thing to take note of would be whether you want to have dividends from the ETF. An ETF could be capitalising (reinvest the dividends from the underlying securities back to the ETF) or distributing (distribute the dividends) on a periodic basis, so again it is your call which one is more suitable.

Consideration #3 – Total Expenses Ratio

Expenses are part and parcel of running an ETF, and ETF providers impose these expenses as a percentage (dubbed as total expenses ratio or TER) of the entire investment fund, so it is important to select an ETF with as low TER as possible.

As TER is imposed yearly, there is compounding effect at work. For example, take two similar ETFs called A and B, with an annual TER of 0.5% and 1% respectively. Assuming an initial $10,000 investment with a 10% annual return, after 20 years ETF A will return $61,416 while ETF B returns only $56,044. The 0.5% TER variation spelt a difference of $5K+ in returns.

To find out about an ETF’s TER, you can look it up at the ETF’s fact sheet or prospectus, or online on ETF screeners and Google/Yahoo Finance pages.

Consideration #4 – The Liquidity of the ETF

The liquidity of the ETF (or any other financial instrument) is the measurement of how quickly it can be transacted in the financial markets without affecting its price. For instance, if ETF A has a 10,000-unit buy queue at $1 and a 5,000-unit sell queue at $1.05, it is highly liquid, since the narrow price spread would make the buy/sell transactions easier. However, if ETF B has a 1,000-unit buy queue and a 500-unit sell queue at $1.00 and $1.50 respectively, then it is not so liquid or is illiquid.

Fortunately in a way, there are market makers (like the authorised participants that are responsible for the ETF creation and redemption processes with the ETF providers) who can facilitate some liquidity for the ETF. These market makers act as middlemen and will buy up the sell side and sell to the buy side, earning some profit along the way if feasible.

Consideration #5 – Tax 

Specifically tax from dividends. There are some ETFs whose dividends are subject to tax, like those based on foreign markets. Typically if you (as an individual) invest in a United States (U.S.) market ETF, and if you are not a U.S. person, a 30% withholding tax is imposed on the dividend. Meaning if an ETF is giving a 5% annual dividend yield, with the withholding tax, the effective yield is only 3.5%. 

Still, if you are still unsure about taxes and such, it is best to consult an accountant or tax expert (and I’m not one of them, apologies).

Putting Them All Together

The above five considerations are not exhaustive but I believe they are sufficient in your ETF selection for your investment portfolio. A holistic approach is needed; it is better to balance out the considerations and not to over-emphasize on one, like looking strictly at TER without regarding the index.

The SGX ETF Universe

There are almost 60 Exchange Traded Funds (ETFs) listed on the local Singapore Exchange (SGX). You can find them on the SGX webpage, under “ETFs”.

To make things easier, I have a screenshot of the webpage in Figure 1.

Fig. 1 – SGX Listed ETFs (as at 7 Sep 2018, 5:06PM)

From here, you can learn a few things on ETFs.

#1 – ETF Providers

The listed ETFs are typically prefixed with the name/abbreviation of the ETF providers, such as the IS Asia HYG, with IS being iShares; and SPDR being ETFs from State Street Global Advisors, etc. If there is no prefix (such as GLD ETF), a quick Google search will yield who the ETF provider is.

Some ETF providers will have a number of ETFs, while a few only have one so far (e.g. UOB’s UETF SSE50 China).

#2 – Asset Classes and Regions/Countries

The good thing about ETFs is that they allow you to invest in various asset classes, as well as different regions/countries. 

Interested in the United States (U.S.) equities market? There is the SPDR S&P 500 US$ and the XT MSUSA US$, to name a few. 

Want some bonds? We can choose the localised ABF SG Bond ETF or the more international IS Asia BND US$, among others.

REITs? PHIL AP DIV REIT, NikkoAM-STC Asia REIT or LION-PHILIP S-REIT may be your answer. 

If you wish to enter the ASEAN regional market, there is the CIMBASEAN 40 or the ONESTOXXASEAN. 

Commodities wise, we have the GLD ETF.

#3 – Physical and Synthetic ETFs

A physical ETF will hold all, if not most, securities that made up the index that it follows, while a synthetic ETF uses swaps (a form of derivative financial instrument) with a counterparty (usually an investment bank) to track the index.

SGX had labelled synthetic ETFs with a “X@” symbol  (e.g. Lyxor Asia US$, XT MSWorld US$, etc.) for ease of reference. Alternatively, you can visit the ETF provider page to read up the prospectuses for further information.

#4 – Inverse ETFs

There are also inverse ETFs, where if the indices go down, their prices go up, and vice versa. Inverse ETFs are used mainly for speculation and it is not meant for holding it long term. There is an inverse ETF on SGX called the XT S&P 500 – 1x US$ (see Figure 2), and can be found under Leveraged and Inverse Products (Specified Investments Products) in the SGX website.

Fig. 2 – SGX Listed Inverse ETF (as at 7 Sep 2018, 5:06 PM)

#5 – Trading Currency

You may have noticed by now that there are listed ETFs with the same name but different currencies, like the CIMB APAC Div S$D and CIMB APAC Div US$. The S$D and US$, representing Singapore dollars (or SGD) and U.S. dollars respectively, are called trading currencies.

Regardless of whether an ETF can be traded using SGD, USD, Euros or even Yen, all these are of no concern, for the most important part is not the trading currency, but the currency of the securities that make up the ETF. For example, if you have changed some SGD to buy a U.S. Dow Jones Index ETF in Sterling Pounds, the foreign exchange risk is between SGD and USD (which all constituents of the Dow Jones Index are based on), not the SGD – Sterling Pound and the Sterling Pound – USD pairs.

ETFs are great investment vehicles to start off a passive index investment portfolio. In my next blogpost, I will highlight some of the considerations when embarking on one.

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. https://www.cpf.gov.sg/Members/Schemes/schemes/retirement/cpf-life (accessed 19 Aug 2018)

2 – Ministry of Finance. Supplementary Retirement Scheme. 7 Dec 2017. https://www.mof.gov.sg/Portals/0/mof%20for/individuals/SRS_Booklet%20-%207%20Dec%202017.pdf?ver=2017-12-07-105458-317 (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.

References

SRS and The Bedokian Portfolio – Part 1

SRS and The Bedokian Portfolio – Part 2

SRS and The Bedokian Portfolio – Part 3

Using CPF for The Bedokian Portfolio? Part 1 

Using CPF for The Bedokian Portolio? Part 2

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!

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!

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:

https://www.nikkoam.com.sg/files/english_press_releases/2018/20180723_01_sg.pdf

https://www.nikkoam.com.sg/etf/sgd-investment-grade-corp-bond

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 Vanguard³ (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% guideline⁵ for 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