How's it like living in a 'Mickey Mouse' apartment?

Property developers in Singapore are marketing smaller flats these days as they are more "affordable". Apparently, Mah Bow Tan isn't the only one taking liberties with the word "affordable" these days.

[My very concise opinion on these flats is that they are not affordable at all and in fact, represent very poor value.]

I studied in Baltimore in the United States as an undergraduate. Back then, there was a limited supply of on-campus housing, so in my last two years as a student, I moved out of university housing and into a studio apartment. I lived alone for those 2 years, which really did a lot for improving my self-reliance and confidence.

[Having experienced living in such a rough town (Baltimore has an incredibly high crime and homicide rate, and there were at least 2 rape/homicide cases of undergraduates during my time there), I figure I probably have the wherewithal to live anywhere now ... but that's a story for another post.]

I'll spare readers the horror stories of looking for an apartment. Suffice it to say that the studio I lived in was quite small, about 400 square feet, so I think I am qualified to comment on what it's like living in a small apartment. I had friends who lived alone in even smaller apartments, about 250 square feet, which is approximately the size of the shoebox flats mentioned in the above news article.

I think I have to agree with property developers who steadfastly refuse to build apartments below 400 square feet in size. That is about the minimum for comfortable living. I viewed the 250 square feet apartments when I was apartment-hunting, but I quickly rejected them...and I'm not what you would call a fussy person.

Simply put, 250 square feet is not enough for one person. Living in such a small apartment will seriously 'cramp your style', so to speak.

You will not be able to:

1. Entertain, since there is no room for more than about 4 people to sit comfortably, assuming (and that's a big assumption) you have that many chairs and a coffee table in the first place. A sofa is out of the question of course. A (Western) futon is a compromise that lots of studio dwellers make.

2. Accumulate stuff. Every time you go out shopping, at the back of your mind, you will ask yourself not how much the item costs, but how much space it will take up in your apartment. At one point, all my worldly possessions in the US of A could fit comfortably into two suitcases and 4 boxes.

3. Cook, since the fumes of cooking (even with a hood) will permeate your apartment and saturate all the fabrics. Boiling and steaming are ok. Frying and saute'ing are not. Of course, this is assuming you even have the requisite paraphernalia for cooking. Remember, you will have no countertop space to prepare food, few cupboards and no room for appliances (except for a stove, maybe a rice cooker and the all-important microwave oven for reheating). It's right about this point that most people give up having any semblance of even having proper utensils and crockery. Then they decide to eat out or order in for all their meals.

4. Have all the comforts that most of us take forgranted. You can choose some, but not all of the following: a desktop computer, large refrigerator, dishwasher, television, stereo system, large desk, dining table, queen-size or larger bed, and other bulky items of furniture. A washer and a dryer are obviously no-go; you'll have to do all your laundry outside or in the basement of the apartment building (which is an alien notion for most Singaporeans). And needless to say, what large items of furniture a studio dweller selects is a reflection of his or her priorities. For many bachelors, having a queen-size bed is a necessity (no prizes for guessing why).

5. Stay at home much, if at all. This was a dealbreaker for me when I viewed the small 250 square feet apartments, as I am pretty much a homebody. I could not imagine coming home every day from school or work, opening the door and immediately facing a tiny closet-like living space, where a bed would immediately come into view and dwarf everything else around it (Believe me, you will choose miniature, collapsible or stackable versions of just about everything when you live in a studio. Tables, chairs, nightstands etc.). It is incredibly depressing, I can assure you.

So who would live in a shoebox apartment? People who fall into two categories: those who can't afford any better, and those happy (expat) singles who spend all their time out and about and return home only to sleep. The former we can discount, since they are clearly not the target demographic that Singapore private property developers are looking at. The latter are not likely to buy property in the first place, seeing as how they are so footloose.

That leaves investment buyers. For those buyers of Mickey Mouse flats who are thinking of buying these apartments and then renting them out to the aforementioned singles, good luck with that.

First of all, even swinging singles look at how much it costs to rent a place. Small and cheap will always find takers, the same cannot be said for small and expensive. Given the prices of these flats, a commensurate rent to yield a reasonable ROI would probably be in the ballpark of about $1k - $1.5k a month, not including utilities and condo expenses. Unless the location is very prime and the building amenities are excellent, no single is likely to pay that much. And by prime location, I mean proximity to town (Orchard Road), public transport (given how "unaffordable" a car is), laundry facilities, restaurants and eateries, malls etc.

The larger problem is that the kind of tenant that this kind of tiny apartment is meant to be rented out to, is supposed to live a lifestyle that our city is not geared towards supporting. Ergo, such a tenant is probably uncommon.

Cities that have high rental rates for small apartments include London (Zone 1), New York City (Manhattan), Tokyo and Hong Kong. All these cities have urban densities in their city cores that are in actuality, more concentrated than Singapore's, despite Singapore having a higher average population density. There are more shops, services, restaurants, nightclubs and crucially, subway stations, per square foot in the inner city core of these global cities than Singapore. And more of them operate at extended hours, or in some cases 24/7 (like the New York City subway, at least in Manhattan). In these cities, tiny apartments in the city core can and do get rented out at exhorbitant rates, simply because there is so much to do outside in the city. In addition, wages are considerably higher in these cities to pay for the astronomical cost of living.

In contrast, except for nightclubs, Singapore pretty much shuts down after 11pm. The lack of public transportation options after midnight is a major culprit for this. Singapore can bill itself as a family-friendly destination for expat families, but it cannot claim to be equally attractive to "zero-drag" singles. Especially since expats now tend to be employed on local packages instead of the cushy expat packages of yesteryear.

The inescapable conclusion is that these tiny-ass apartments will likely be rented out to less desirable, short-term tenants. Property analysts and experts interviewed by the article mentioned the likelihood of monthly, weekly or even hourly rentals (I have no idea what is the legality of such arrangements). This sure recalls another property case, though it may not stop determined landlords.

Possible tenants would be tourists (I once stayed in a New York City sublet in SoHo for a week; the original tenant was working abroad; speaks to how hard it is to land a good apartment in Manhattan) and short-term visitors such as business travellers. Less savory possibilities would be brothel clients, illegal immigrants, and the like.

Is the Mickey Mouse flat a sustainable trend? Hard to say, looking at how property prices have stayed gravity-defying through a recession. One thing's for sure, I know what it is like to live in small apartment, and I would never go below 400 square feet. For those who find out the hard way, well, lots of luck with owning a shoebox apartment. If there's one sign of a property bubble, this could well be it.

On CPF Life

[Warning: this is a fairly technical post, although the gist should be understandable by everyone.]

By now, everyone should have heard of the government's new mandatory retirement initiative, a life annuity scheme dubbed CPF Life. 

Ordinarily, I would not have an interest in something like CPF Life. After all, I am not anywhere near retirement age, which means current policy is likely to change by the time it affects me. Also, the Singapore government has the irritating habit of making things mandatory without public consultation or agreement. Bottomline, if it's policy that doesn't directly affect me in the near future and that I have no say in how it's implemented anyway, I'm not likely to pay any attention to it.

My mother, however, is near retirement age, and she asked me to explain to her how CPF Life works. Well, actually her question was more along the lines of "Should I sign up for CPF Life now so I can get the $4000 L-bonus?"

[Figures, dangle a financial incentive and awaken the kiasu instinct in the older generation of Singaporeans to get them to climb onboard the CPF Life bandwagon.] 

So after my mother asked, I decided to dig deeper into CPF Life and take a hard look at this retirement policy. It doesn't hurt that I also have a much better knowledge of actuarial science than the average person (better even than the typical finance professional I suspect). 

The main questions I wanted to ask were, what's the L-bonus, how much is it actually worth, and more broadly, is CPF Life a worthwhile investment, because make no mistake, a life annuity is a form of investment, and not just insurance against longevity risk.

In the remainder of my post, I will assume that the reader already understands how CPF Life works. If not, I refer the reader to Guide A and Guide B from the CPF Board. I will be referencing information in these 2 guides as well in my discussion below, so even if you're thoroughly familiar with Guides A and B, if you're interested in reading further, you should open these 2 guides now in your browser (in separate tabs of course).

First up, an annuity is properly defined as a series of payments, while CPF Life is more correctly called a life annuity. However, the link I have provided to Wikipedia's entry on "annuity" is still a useful read for those unfamiliar with the concept of the present value of money. 

Throughout this post, where I have written "annuity", I mean "life annuity". Also, this post will deal only with the Life Income Plan in CPF Life. The reason for this is that the presence of a bequest in the other CPF Life plans complicates calculations.

The first question we need to ask is, how does one value an annuity, because this will decide whether CPF Life is worth joining. The problem with valuing annuities is that payments are uncertain over time, since for most of us, we are blessed/cursed with not knowing the moment of our deaths. Hence, it is uncertain how many monthly payments each annuitant will receive over his/her lifetime.

Therefore, for the purpose of valuing annuities, actuaries speak of an expected present value, rather than just the present value that other finance professionals use. The EPV of an annuity is a function of monthly payments, interest rate and the probability distribution of human lifespan. The formula for calculating the EPV of a life annuity is:

This is a rather intimidating formula, so I will go through it slowly.

M is the monthly payment (hence there is a coefficient of 12 in front), the funny "a" symbol with the 2 dots, subscript x and superscript (12) is an annuity term used only in actuarial science, and x is the age of the annuitant at the time of the first payment. The superscript denotes the number of times payments are made in a year, hence the 12 in the parentheses.

On the right-hand side, breaking up the annuity term into its components, kpx denotes the probability that someone alive at age x will still be alive at age x+k, v^k is the discount term involving the prevailing interest rate, and the product of these terms is summed from k=0 to k=omega, where omega is usually the maximum age human beings live to. Typical values of omega range from 100-120. The subtraction of 11/24 is an adjustment made for monthly rather than annual payments. 

Values of M and v are available from page 6 of CPF Guide A . However, where does one get values for kpx for k=1 to k=omega to value the annuity? (by definition, 0px=1).

Answer: Actuaries whose professional job is to calculate these things rely on figures from life tables, which are data tables from which one derives these life probabilities.

Published life tables for Singapore's resident population may be found here.

From the life tables, for a given value of k,

kpx = (number of lives alive at age x+k)/(number of lives alive at age x)

From here, it's quick work on an Excel spreadsheet to calculate the EPV of an annuity. Note that I used the 2006 male life tables for my calculations. 

From page 6 of CPF Guide A, we have 4 examples of the Life Income Plan, 2 for an RA balance of $20,000, and another 2 for an RA balance of $40,000. Each pair is further divided up into one with an interest rate of 3.75% and one with an interest rate of 4.25%, for a total of 4 plans as mentioned above.

My calculations indicate that:

EPV $20,000 RA, 3.75% = $17,279

EPV $20,000 RA, 4.25% = $17,217

EPV $40,000 RA, 3.75% = $34,222

EPV $40,000 RA, 4.25% = $34,126

The first thing you would notice is that an RA balance always purchases less than the EPV of the corresponding annuity. This is perfectly normal. The reason for this is that administrative costs are incurred in setting up annuity policies, and annuity managers, out of prudence, typically provide for some kind of buffer or contingency in the funding of the annuity scheme (after all, there is a wide variation in when exactly people drop dead).

The EPV of an annuity, in actuarial parlance, is termed the risk premium. It is the expected cost of claims under an insurance policy (which in this case, is an annuity policy). Private insurers selling annuities will typically charge considerably more than the risk premium as they need to cover administrative costs, commissions as well as provide for a profit margin.

In contrast, the CPF board is a government entity, which obviates the need for profit, and since it already manages CPF accounts for all Singaporeans, additional administrative overhead would presumably be negligible. The small difference in risk premiums for the CPF Life Income Plans, as calculated above, relative to the cost of purchasing the annuities, is a reflection of these considerations.

So as far as annuities go, the CPF Life is actually a good deal [it is so rare that I have something good to say about a government policy!]. It is a much better deal than private annuity plans which are more expensive from a valuation standpoint. Also, CPF Life, unlike a private plan, is unlikely to go insolvent.

However, some caveats:

The main problem I have with CPF Life is the lack of transparency and guarantee. The footnotes on page 6 of Guide A states "The payout range ... does not represent the lower and upper limits of the payout ... monthly payout may be adjusted every year to take into account factors such as CPF interest rate and mortality experience."

Great, this basically defeats the purpose of buying an annuity. The whole point of buying insurance is to pass on the longevity risk to the insurance company at an expense which represents profit to the company. People buy insurance for certainty and peace of mind in an uncertain world. All the fine print here in Guide A provides an escape valve for the CPF Board to reduce payments to retirees who would otherwise expect to be on a fixed income. I do not use the word "reduce" here frivolously. Central bank response around the world to the ongoing financial crisis is to slash interest rates close to 0, which would tend to reduce monthly annuity payments. Improving mortality experience in the future (that is, people living longer) is almost certain due to advances in medicine over time. That is a second reason why annuity payments are likely to be reduced.

Next, the lack of transparency and guarantee brings me to the reason why I calculated risk premiums only for the Life Income Plans. With the pitiful amount of information available in Guides A and B on how bequests are calculated, there is no way I can accurately calculate the risk premia for all the other CPF Life plans which involve bequests. Based on the monthly payouts given on page 6, I can only guesstimate that the other CPF Life plans also represent fairly good deals from a valuation standpoint. But I cannot stand by this assertion as I have no hard figures to back me up.

Lastly, just because CPF Life seems like a wonderful annuity scheme doesn't mean that annuities are the right investment for everyone. Annuities may not be suitable for those in ill-health, or for those (including myself) who are concerned with that ever-present scourge called inflation. Bottomline, if you like annuities, you could do a lot worse than CPF Life, but that doesn't mean annuities are an ideal choice for you. Every person will need to consider their own financial and personal situation before purchasing an annuity. 

Personally, I think longevity risk is a real problem and the government is right to consider it at the policy level. However, I also suspect that CPF Life is not meant as a solution to longevity risk per se in our population, but is a manifestation of policy tokenism.

Simply put, the government must do something about our rapidly aging population, and CPF Life, just like Eldershield, is a token effort to show that the government is doing something. But the monthly payouts are pitifully low (particularly if we factor in the effects of inflation over time) and the very fact that all these schemes and policies are both mandatory and self-funded are indicative that the government has no desire to own the problems. Despite us paying our taxes and the government running huge budget surpluses (even after paying our ministers million-dollar salaries, and throwing money at "investments"), the government is still fearful of draining its abundantly filled coffers on something like healthcare and retirement care. Instead, it discriminatingly spends on education and economic development, which while worthy causes in their own right, more obviously provide a return on investment (which is why the government has no problem spending there).

PS: the L-bonus is a top-up of the RA that the government makes to eligible citizens for the purchase of an annuity plan. Simply substitute an amount of L-bonus in the EPV term on the LHS of the equation I have provided, and you will be able to calculate the M term instead. In practice, an L-bonus of $4,000 increases the monthly payout by approximately an additional $20 per month.  

"Wanted Trusted Advisors"

The Straits Times had an article today on the results of a survey on Singaporeans' attitudes towards financial planners. The article is here.

The survey results indicate that Singaporean consumers "ranked trust as the most important attribute when dealing with financial advisers".

BS.

Trust seems like the obvious thing to prioritise in light of the Minibonds fiasco; that's why so many Singaporeans gave it as their 'model' answer.

This survey is an object lesson in the old saw that what people say they do is different from what people actually do. 

What do Singaporeans really rank as the most important attribute when dealing with financial advisors?

That the advice is FREE.

Note that in the same article, it was stated that "Another crucial point raised in the study was that most participants preferred employers to provide access to financial advice as a company benefit."

Think about it. If financial advice was deemed really important to many people, would they simply go with the default choice of advisor provided by their employer, or would they hunker down and really put in the time and effort to seek out good advice on their own?

Employer-provided health insurance is a common benefit, but most people are prudent enough (i hope) to obtain private coverage on their own, usually for reasons of better coverage or portability.

The same goes for financial advice provided as a company benefit. People would deem the quality of such company-provided advice adequate and not seek out private advice on their own only if they perceived financial advice as a fungible commodity that should be low-cost or free.

And in a market where advice is often "free" (most financial planners get paid through commissions on products they sell), why pay for it?

[Do bear in mind that if companies provided financial advice as a benefit, it is possible that the lowest cost, and hence likeliest to win, bidders for such a contract to provide "advice" might waive their charges just to have the opportunity to sell commission-laden products to a "captive" audience. That is no improvement over the current situation.]

Accepting "free" advice is the chief reason why so many Singaporeans get conned, yes conned, into dubious investment schemes. Minibonds, structured products, oilpods...the list goes on. All this because "advice" was given to them by, who else, the agent shilling the product.

There are very few certified (which by the way, is no guarantee of ethical conduct) financial planners in Singapore that earn their money not through commissions, but fees for their time and advice instead. And this is likely due to the mentality of most Singaporeans that one should not need to pay for financial advice.

One last caveat. Investing is a risky business, so paying for advice is no guarantee of good advice. Just unbiased advice. All that it really does is to align your advisor's interests with your own (after all, if you get biased advice that leads to an investment loss, your advisor wouldn't be your advisor anymore, would she?).

That's why despite being a non-finance professional, I took the pains to study the intricacies of finance and investment on my own. That way, I can decide for myself whether or not to make an investment. 

"Hong Kong watchdog may sue banks over Lehman minibond sales"

The Channelnewsasia link to this story is here. I do not recall reading a similar report on this story in the Straits Times. If someone has, please notify me by making a comment of it in this post. If the Straits Times did omit this story from their line-up, then it's one more annoying thing I can chalk up to our national paper.

There is no indication that Hong Kong's Consumer Council, the watchdog cited in the headline, will actually proceed with the suit. FYI, the Consumer Council is the equivalent of Singapore's CASE.

Still, this story is significant. One thing the Straits Times had right is that the Hong Kong and Singapore authorities are both looking over each other's shoulders in trying to calibrate the right response to the Lehman Minibonds (and DBS High Notes) fiasco. And this is not merely altruism in trying to find the right resolution for investors who have lost massive amounts of money, although the Straits Times didn't specifically mention this point.

At first blush, it would seem that the actions of the HK Consumer Council and Singapore's CASE should have no bearing on how the governments of the two territories manage this public relations and financial regulation disaster. After all, they are both NGOs and consumer advocacy groups. However, as this is Singapore we are talking about, how NG an NGO actually is is far from clear. I have no idea how non-governmental the HK Consumer Council is (especially since Beijing has called the shots in Hong Kong since 1997), but I think it's a safe bet that CASE isn't a very pure NGO, as NGOs in Singapore go. For example, if you think that NTUC is run without government "input", I have a bridge I want to sell you (and BTW, NTUC is the parent organisation of CASE).

Without even meaning to, the differential treatment (HK vis-a-vis Singapore) of this Minibonds fiasco threatens public embarrassment for the government of one of the two territories. Because consumer advocacy groups are perceived (never mind the reality, whatever it may be) to be linked to their respective governments, how vigorously the consumer advocacy groups in HK and Singapore assert their stakeholders' rights in this financial debacle will have direct implications on how the citizens in their respective territories view their government's willingness to prioritize their citizens' interests over, say, the big banks.

In short, Singapore risks embarrassment if it is seen as doing less than the HK government. What aggravates the matter is that DBS is at the heart of this financial fiasco, since it is not only a distributor, but also the bank that structured some of these products (DBS High Notes). Now, the government is fond of saying that it does not take an active role in the day-to-day management of the companies that it holds in its investment portfolio (via Temasek Holdings and GIC), and even if this is indeed true (which, for the record, I largely, but not totally in all circumstances, believe), it does appear unseemly that a major government owned bank has now lost considerable face after losing the money of investors who also happen to be citizens, and as I have mentioned before, been unendingly portrayed in the media (also government controlled, how ironic), as poor, defenseless retirees.

This is just sooo perfect. Now bear in mind, the irony that a major government owned bank has been responsible for losing the life savings of citizen retirees through selling them risky, questionable and inappropriate financial dreck is a news angle that has NOT been explored in the local media. Don't hold your breath for that tasty little story.

Separately, I'm not a lawyer (and readers who are in law, I would appreciate your comments here), but it seems to me that this is just crying out for a lawsuit. If investors in Singapore and/or Hong Kong file a class action lawsuit against the relevant banks for mispresentation, mis-selling or just plain old fraud, then perhaps the consumer advocacy groups should also be filing amicus curiae briefs, at a minimum. If anything, at least this would help clear the air on what the banks should sell, how they should sell them, and how these products should be regulated in general. This would all help in making the retail investment scene that much safer.

Minibonds compensation

Now that DBS, among other banks, is starting to compensate investors, this opens up whole new issues to consider.

For starters, the definition of who's going to get compensated is bound to make some people very happy, and some very unhappy. Frankly, I think the whole episode of compensation stinks. It just seems so arbitrary who's going to be made whole and who's going to be left out in the rain. 

I like the Hong Kong plan better as it forces banks to make a market for these highly illiquid securities. Now do bear in mind that investors will have to swallow major losses by selling these securities at 'market' prices back to the banks (it remains to be seen how market prices will be arrived at when these securities were never meant to be traded on a secondary market).

The reason why I dislike the Singapore version of the Minibond resolution is that it conflates the two issues of investment risk and legal liability for product misrepresentation/mis-selling.

Everyone who bought the Minibonds should be on the hook for losses, regardless of educational level, retiree status, life savings on the line etc. But if investors feel hard done by misrepresentation or mis-selling of the Minibonds, then it should be the courts and the legal system that should decide if the banks should pay damages to the investors (which may be the total sum invested, or perhaps even more to take into account 'emotional distress' and the like). And in the public interest, perhaps it should be a regulatory authority like the MAS that undertakes legal action on behalf of all investors, and not just those that lost money in this Minibonds fiasco. In doing so, MAS could also seek to impose a punitive penalty on banks that actively hard-sell such risky products to retail investors, and hence discourage such behavior in the future.

Instead, we have some banks (and not every bank who sold the Minibonds) arbitrarily deciding who to make whole based on some in-house measure of whether the product should have been sold to so such and such investors or not. That is just so wrong. But then again, maybe this is what our vaunted monetary regulatory authority wants: to leave "doing the right thing" open to interpretation so it absolves itself of responsibility, doesn't have to take an unambiguious stand (in any direction),  and hence doesn't have to  offend anyone at all.

As for other peripheral issues:

DBS shareholders are probably none too pleased by this turn of events, but frankly, bad publicity is more costly than just $80-$90 million dollars. DBS had already committed itself to this fiasco when it decided to distribute this risky structured product. Oh, and my previous comment on how this will indirectly cost taxpayers still holds.

Thus far, it appears that DBS will compensate those investors it has decided to make whole out of its own funds. However, if I were one of those investors not compensated, I would be mighty suspicious about whether the compensation were to be at my expense, that is, if the compensation monies could possibly have come out, at least in part, from the dregs of what remains of the Minibonds. This is a very remote possibility, but if I were such an investor, this would be exactly what I would be asking DBS management.

Some quick thoughts on the Minibond fiasco

I have less time these days to blog in-depth about topics I am interested in, but nonetheless, I will pen down some quick thoughts. This post is on the Lehman Brothers Minibond fiasco.

I wrote a post on structured products about 3 months ago, and it is as relevant now as it was before.

Notwithstanding the plight of retirees losing their lifesavings (which is regrettable), I can't say I have much sympathy for the people who lost thousands of dollars in this most recent investment debacle. The golden rule is: don't know, don't touch. If people were more diligent with their investments, asked a few more questions, had a healthy dose of skepticism, and weren't swayed by the greed for an improved yield of a few percentage points over the fixed deposit rate, without questioning the disproportionately higher level of risk they were shouldering, they wouldn't find themselves in this situation today, gullible things that they are.

As it stands, my opinion is that their only case for getting their money back is to sue for misrepresentation of the product they were sold. And the chances of success for that are slim to none. After all, information on the product could be found in the prospectus, in black and white. The investor should take responsibility for their own actions. Even if he or she was unable or unwilling to read and understand the prospectus, he or she could have sought professional advice in doing so.

[To would-be flamers, please note that I am NOT indulging in an exercise in schadenfreude. I just think that investors should bear some responsibility as well for their losses. Ignorance is a poor defence for one's actions.]

Some other quick thoughts:

How much do I think investors will get upon dissolution of Minibonds? At best, pennies on the dollar, and more likely, nothing at all. Numbers like 50-70% are pure fantasy.

Separately, if the local banks (like DBS) do compensate investors out of their own balance sheets under overwhelming public pressure, you should realize that this comes indirectly out of taxpayers' money. Why do I say that? Because the government has recently tweaked the laws to allow it to spend more of our reserves, and the government owns large stakes in many banks (including DBS and Citibank) through its sovereign wealth fund holdings. I am not presuming a judgment call on whether bailing out the 10000 disgruntled Singaporeans (including impoverished retirees) is the right thing to do (or not). I am merely stating categorically that thanks to the government's byzantine layers of ownership of stakes in local banks, there are taxpayer dollars involved here should investors be compensated.

As for MAS's laughable comment on local banks to "do the right thing" and PM Lee's remarkable silence on the fiasco:

MAS is showing how toothless it really is. It can say anything it wants on this matter, but it either lacks the power or (perhaps more likely) the political will to enforce any of it.

As for the PM, I think it's a good move (for him) to say nothing. As the old adage goes, if you have nothing good to say, don't say anything at all. If the PM comes out with a speech that is anything less than in strong favor of making investors whole, investors who have been incessantly portrayed in the media as being impoverished retirees who have lost their life savings, he risks huge loss in credibility, empathy, political capital...you name it. On the other hand, if he does make such a speech, you can kiss goodbye to all the hedge funds, slush funds, private equity and other monies that have made their way here thanks to our friendly, welcoming, lightly regulated, and most importantly, discreet and circumspect environment.

CPF Tax Relief

Many working adult Singaporeans give a portion of their paychecks to their parents each month. And a number of parents actually don’t need the money at all. In some cases, the parents may still be working and may in fact be drawing larger paychecks than their offspring. In other cases, the parents may already be retired but have very substantial retirement savings or investments to draw upon. In such cases, the money given by adult Singaporeans to their parents is symbolic, a reflection of filial piety.

If you fall into the category of Singaporeans who give money to retired parents who do not have working income, but also do not require your contribution to get by, here’s one way to make your dollars work harder for you.

The CPF Board allows up to SGD7000 contributed each year into the retirement accounts of retired Singaporeans by their offspring to be eligible for tax relief. In other words, if you already give money to your retired parents, and they don’t need it, it’s far better to contribute it into their retirement accounts with the CPF than to give them cash. This way, you get to claim tax relief on the amount contributed. In the current low interest rate environment, your parents also get to enjoy the higher interest rates that the CPF provides (assuming they would have kept the cash in a lower-interest rate bearing bank account).

Full details are available at the IRAS, CPF and Singapore Budget websites.

Lorna Tan, July 20, 2008

Lorna Tan is a financial correspondent with the Straits Times, and the quality of her articles is generally good (a rare compliment from me for anything related to the rag).

She had two articles in the Sunday paper this past weekend.

Taking the right dose of health insurance was a good article on some general pointers when buying health insurance. I’m already aware of all of these pointers, but I think it’s still useful to summarize these for less knowledgeable readers of this blog:

1. Always buy private health insurance even if your employer provides excellent cover. The reason is that you will not work for the same employer your entire life, and the employer-provided cover will not persist when you change jobs or retire (the ‘portability issue’).

2. Always buy health insurance early on in your working life even if you are in perfect health. This is to avoid the problem of exclusionary clauses should you be diagnosed with a serious illness before cover has commenced (the pre-existing condition issue’). This is also linked to reason #1. I know of people who literally cannot quit their current jobs because they were diagnosed with a serious illness while not being covered with private insurance. Now, only their employment cover protects them; no private insurer will cover their pre-existing condition.

3. Always buy the insurance cover at or above the level that you think you will use. The simple reason is that downgrading coverage is a snap, while upgrading coverage later on may require underwriting.

4. Consider the optional add-on riders for your plain vanilla Health and Surgical (H&S) insurance. The most useful are the riders that remove the deductible and/or co-insurance portions of the claim amount (10% or 20% of a very big bill is still a very big bill). Also useful are the riders that remove category sub-limits on claims.

[As someone who trained as a biomedical engineer, I can assure you that many implants, particularly orthopedic implants, cost way more than the few thousand dollars that typically mark the limit on the ‘consumables’ category].

Somewhat less useful are the riders that cover outpatient treatment (such as physiotherapy and the like) and cash benefit riders/policies that pay a cash benefit for each day spent in the hospital.

5. Other health-related policies may also be considered. Critical illness coverage is one example, although some skeptics point out that the list of 30 (or some arbitrary number) of dread diseases is too short to cover the full spectrum of human suffering, far better to get comprehensive and heavy H&S coverage. Another important type of health insurance is long-term/continuing care insurance, best exemplified by Eldershield, although frankly, I think Eldershield the policy sucks. Not many insurers provide this kind of insurance, so far I have only seen Great Eastern provide this product, but then again, I haven’t shopped around all that much.

Lorna Tan’s other article was on inflation-linked investments, As prices rise, so can your returns.

As an explanatory article, the article was passable. As advice, well, you probably want to read up more on your own before committing to any investment.

I too have been hunting for investments that will offer a high likelihood of a positive real rate of return.

I haven’t found any that I’m really comfortable with yet. That should tell you something about the current market environment now.

My main beef with inflation-linked investments is that in general, most governments around the world are pre-disposed towards fudging the CPI numbers to make them look artificially low. “Core inflation” in the USA is a joke, and even the food and energy numbers have been fudged before stripping them out.

Why would governments want to deliberately fudge the CPI numbers to make inflation seem lower than it really it? Because it works directly on managing inflation expectations, and it also makes social security payments (normally indexed to inflation) and other payments (such as on oh, say, inflation indexed bonds) paid out by the government cheaper.

Needless to say, if the CPI systematically underestimates inflation, inflation-linked instruments will also fail to keep pace with the true rate of inflation.

The other reason why I am wary of inflation-linked investments is that countries with high inflation also tend to suffer from currency depreciation. Given the strong SGD now, the real return in SGD from such investments may still turn out to be negative. And even if the funds that manage these investments hedge their currency risks, you can bet that that will result in lower returns as well as higher management fees.

Other investments to consider using to beat inflation:

1. Real estate is normally a good inflation hedge, but is generally a bad idea now, given the deflationary climate in real estate.

2. Commodities. Uh, can you say bubble?

3. Precious metals. I am actually bullish on precious metals right now, but I suspect that precious metals are benefiting less from inflation fears than from the current credit crisis. You could make a case that precious metals are in a bubble right now, but unless and until the credit crisis is really over (it’ll take a year or two, at least), precious metals will probably remain at elevated levels, and will spike each time a major financial institution implodes.

4. Stocks of companies that have pricing power and hence can pass on price increases to their customers.

Investment #4 is probably the best inflation hedge over the longer term. But in the short term, the volatility will be extreme. Unless you can afford to hold onto the stocks for several years, and stomach largish paper losses at least part of the time, you might want to stay out of stocks until things settle down a little.

"As Price of Corn Rises, Catfish Farms Dry Up"

From the New York Times
As Price of Corn Rises, Catfish Farms Dry Up
By DAVID STREITFELD
Published: July 18, 2008

LELAND, Miss. — Catfish farmers across the South, unable to cope with the soaring cost of corn and soybean feed, are draining their ponds.

“It’s a dead business,” said John Dillard, who pioneered the commercial farming of catfish in the late 1960s. Last year Dillard & Company raised 11 million fish. Next year it will raise none. People can eat imported fish, Mr. Dillard said, just as they use imported oil.

As for his 55 employees? “Those jobs are gone.”

Corn and soybeans have nearly tripled in price in the last two years, for many reasons: harvest shortfalls, increasing demand by the Asian middle class, government mandates for corn to produce ethanol and, most recently, the flooding in the Midwest.

This is creating a bonanza for corn and soybean farmers but is wreaking havoc on consumers, who are seeing price spikes in the grocery store and in restaurants. Hog and chicken producers as well as cattle ranchers, all of whom depend on grain for feed, are being severely squeezed.

Perhaps nowhere has the rise in crop prices caused more convulsions than in the Mississippi Delta, the hub of the nation’s catfish industry. This is a hard-luck, poverty-plagued region, and raising catfish in artificial ponds was one of the few mainstays.

Then the economics went awry. Feed is now more than half the total cost of raising catfish, compared with a third of the cost of beef and pork production, according to a Mississippi State analysis. That makes catfish more vulnerable. But if the commodities continue to rocket up — and some analysts believe they will — other industries will fall victim as well.

Keith King, the president of Dillard & Company, calculates that for every dollar the company spends raising its fish, it gets back only 75 cents when they go to market.

“What’s happening to this industry is sad, but being sentimental won’t pay the light bill,” Mr. King said.

Dillard and other growers take their fish, still squirming, to Consolidated Catfish Producers in the hamlet of Isola, where workers run the machinery that slices them into filets. With fewer fish coming in, Consolidated Catfish is resorting to layoffs.

One hundred employees were let go in the last month, and an additional 200 will be cut soon. President Dick Stevens predicts that by the end of the year the company will have jobs for only 450, about half the number at its peak. That might not be enough to keep the plant open.

“The industry is going to implode,” Mr. Stevens said. He blamed the government’s ethanol mandates for making fuel compete with food for the harvest of the nation’s farmland. “Politicians were in a rush to do something, and it became a terrible snowball.”

Across the highway, one of the local feed mills, Producers Feed Company, has already shut down. The ripple effects have begun: between the grain mill and the fish plant was Peter Bo’s Restaurant, locally celebrated for, naturally, its catfish. Hanging on the door is a “for rent” sign.

Some catfish producers recently switched to a feed based on gluten, a cheaper derivative of corn, to reduce their costs. But corn gluten transportation and prices were particularly hard hit by the Midwest floods.

“As sick as we were over what happened to the Iowa farmers, we were also sick over what was going to happen to us,” Mr. Stevens said.

It is a feeling echoed by others who depend on corn and soybeans.

In the spring, hog farmers thought they were past the worst. Export sales to China were strong. Corn appeared to level off. Some farmers sought an edge by reformulating pigs’ diets and reducing the weight at which they sent the animals to the packer.

“And then corn goes up another buck, and you’re back where you were,” said Dave Uttecht, a producer in Alpena, S.D., who raises 70,000 pigs a year.

“I’m a farmer. I’m used to peaks and valleys.” Mr. Uttecht said. “But this is like falling into the Grand Canyon.”

Smaller herds will eventually put a floor under hog prices, and there is already some liquidation going on. But in the short term, sending more hogs to market will increase the supply of pork and push prices down further. Every farmer is hoping his colleagues will liquidate first.

“We’re all waiting for someone else to blink,” Mr. Uttecht said.

Hog farmers at least have the advantage that bacon and pork chops are solidly rooted in American cuisine, and if you want either there is no replacement.

In this and many other ways, catfish farmers are not so lucky.

Catfish started out as a local delicacy, widely celebrated in the lore of the Deep South. Mark Twain saluted it in “Life on the Mississippi.” A character in Eudora Welty’s story “The Wide Net” says after stuffing himself, “There ain’t a thing better.”

Mr. Dillard, whose operation at its peak was one of the country’s five biggest catfish companies, came to the delta 50 years ago to farm cotton. He put in some catfish ponds a decade later almost on a whim. “I liked the way they tasted,” he said. “Fried.”

Other farmers had the same idea. At first the ponds were put on soil too dry for cotton. When they proved a better crop, they took over cotton ground, too. For a long time, everyone made money.

In 2005, according to the Agriculture Department, catfish farming was a $462 million industry, far exceeding any other American farm-raised fish. The industry employed more than 10,000 people at its peak, almost all in Mississippi, Alabama, Louisiana and Arkansas.

Times were too good, perhaps. In retrospect, the name probably should have been changed. Chilean sea bass would not have eclipsed the catfish if it were still known as the Patagonian toothfish, nor would orange roughy have become so esteemed as the slimehead.

“We didn’t focus on the market or on the product,” said Mr. Stevens, the processing factory president. “We’re the first culprits here.”

The industry’s decline accelerated when producers from Vietnam and China flooded the domestic market, putting a ceiling on prices.

Efforts by American producers to portray the imports as unclean and potentially unsafe did not work. The campaign did, however, achieve a measure of vindication last summer when the Food and Drug Administration announced broader import controls on Chinese seafood, including catfish, saying tests had shown the fish were contaminated with antimicrobial agents.

Rising feed prices were the final straw for Dillard & Company, which decided to close last January. Eighty of its 10- to 20-acre pools are empty already. An additional 170 will follow as soon as their fish are big enough to sell.

“It’s easy. You just pull the plug,” Mr. King said, surveying a pool that was nearly dry. Nearby, half a dozen men were running their nets through a pond, then hoisting the last of its catfish onto a truck.

“I’ve been doing this for 23 years,” said one of the workers, Craig Morgan. “I don’t know what I’ll do now. And there are a bunch of me’s out there.”

It is unclear what can replace catfish as easily as catfish replaced cotton. Attempts to make a tourist industry out of the fact that the delta was the birthplace of the blues are still embryonic.

“If we don’t do something, there will be nothing but tumbleweed here,” Jimmy Donahoo, a former catfish farmer, said. He, like others in the industry, thinks the producers should be supported by government subsidies, just like other farmers.

At Dillard & Company, they are not waiting for help.

“You focus your resources where you can maximize your profits,” Mr. King said. All the empty ponds will be planted with soybeans and corn, those two commodities for which there seems boundless appetite.

______________________________________________

Note: This post bears the investment label for my own reference as it has implications on my investments.

Anchoring Bias

Anchoring bias is a common but fascinating cognitive bias, and it’s highly relevant to be aware of it now.

Anchoring bias in the narrowest sense refers to the phenomenon when the mind fixates on a number brought to its attention, and how when a person is asked to estimate a given, possibly unrelated figure, that person unconsciously uses the anchoring number as a point of reference for those estimates. The truly amazing thing about this cognitive bias is that the anchoring number need not bear any relevance to the figure that needs to be estimated.

Anchoring bias, like many cognitive biases, probably has its roots in evolutionary adaptations in what Gerd Gigerenzer terms “fast and frugal” thinking. It may be a heuristic designed to allow humans to process information quickly and accurately (in a prehistoric environment).

Why is anchoring bias highly relevant now? Because the global economy and stock markets around the world are now at or past an inflexion point.

Unless you’ve been living in a cave, it should be common knowledge that economic problems are in focus around the world now. Stock markets have been tumbling far below their peaks in the wake of the (continuing) credit crisis, inflation is ravaging countries around the world when it formerly was not a problem, oil and food commodity prices have blown past their historic highs, and growth is slowing everywhere. We are entering a period of stagflation, with anemic growth accompanied by high inflation, when we were in an economic boom only several quarters ago.

At inflexion points when the direction of the economy and stock markets change, econometric forecasts and models are notoriously unreliable, and this is arguably when their forecasting performance is most vital.

And how does anchoring bias figure in all this? Think of all the economic numbers that are important to you, and then consider how anchoring bias has affected how you perceive these numbers, or how they are generated.

If you invest in stocks, think of how the target price of your favorite stock has changed since the go-go times of yesteryear. Is applying a ‘discount’ to the anchor of last year sufficient now that the external environment has changed so drastically?

If you rely on financial analyst reports, be especially wary of target prices that have been ‘revised’ and backed up by ‘adjustments’ to various models. What goes for the target price also applies to the entry price. If I had a penny for every analyst that I’ve read or heard say “such and such a stock is now great value since it’s corrected by X% from such and such a price”…well, let’s just say that the historic peak price is one helluva anchor for those unaware of anchoring bias.

If you’re watching the prices of oil, gold and other commodities, historic highs (whether inflation adjusted or not) also constitute huge anchors.

If you run a business, you’d better be aware of what goes into your sales and profit projections, instead of just extrapolating from your experiences in previous years.

Economists who do inflation or economic forecasts might want to re-look their entire model or all the underlying assumptions instead of just tweaking their previous forecasts.

If you’re bothered by higher prices for everything, well, I have no solution for you. However, you may want to note that your misery stems directly from anchoring bias and reality not matching up with expectations. We are lightyears away from the low inflation [in necessities, but not in assets] environment of the past decade.

If you’re looking to buy or sell a property, you should already be aware that real estate prices are especially sticky. Sellers are unwilling to let go at too low a price or too low a cash-over-valuation because the booming (in contrast to this year) property market of last year was full of anchors to reference from. A cooling property market is not so much marked by lower prices as it is by low liquidity.

[Incidentally, if you’re watching the US subprime mortgage crisis as closely as I am, you might be interested in research from iTulip here and here. The research has been made available free for one week only due to wide ramifications on the US economy, so you might want to read it now.]

The dubious appeal of structured products

Structured investment products are frequently advertised in the newspapers.

I have serious misgivings about investing in structured products (SPs), and am glad not to have done so, going by the experiences of those I know who have dabbled in such products.

SPs are riddled with problems and pitfalls for the retail investor, and it's difficult to see how they are better than a plain vanilla mutual fund, or even direct investment into stocks and bonds.

The biggest problem with SPs is probably transparency. The transparency of product structure is poor. In addition, most retail investors are unsophisticated; they simply do not understand what the product is and how it makes or loses money.

SPs are really just derivatives, but with a jazzed up name that sounds better and not as risky. Derivatives do not in general exhibit linear behavior relative to their underlying assets. They are highly complex instruments whose workings are usually not immediately obvious to even finance professionals.

[For further (casual) reading on traders and derivatives, read Satyajit Das' Traders, guns and money.]

How SPs are structured and how they perform is highly opaque. While mutual funds are also somewhat opaque (usually only the top 10 holdings are disclosed, and even then, that's at the reporting date), SPs have a level of opaqueness that is impenetrable even for financial professionals.

Why do I say that even financial professionals would find these SPs impenetrable? Because in recent weeks, I have seen advertisements for SPs that are constructed out of synthetic CDOs and other exotic credit derivatives. Now of course you won't see this in the main tagline of the advertisement. More likely than not, it'll be buried in the fine print.

With the credit crisis still going strong, it's natural to ask how so many finance professionals and big banks failed to see the crisis coming, and how they got it so wrong, since in many cases, the provenance of these credit derivatives starts directly from their own securitization activities.

If even credit agencies can get their models of how credit derivatives perform wrong(or if they deliberately obfuscate), ordinary retail investors haven't got a prayer in understanding these things.

[As an aside, run far away from any SP that is composed of credit derivatives! The big banks aren't done with their writedowns by any chance and would only love to offload them to some unsuspecting patsy.]

Leaving aside SPs that are related to credit derivatives, I have a strong suspicion that SPs in general are structured to work better for the issuer than for the investor. For example, "early redemption", a feature trumpeted by many SPs, can just as easily mean "buying you out of your potential upside". What it really means is that the issuing house has an embedded call option on your investment and can redeem it when conditions are most favorable for the issuing house to do so (and frequently least favorable for the retail investor).

There is also the question of fees. The fee structure for SPs is again usually not transparent, but if there is any rule in fee-paying in finance, it's probably that fancier ice cream with toppings is always more expensive. That is, if hedge funds can charge more presumably because they have more complex strategies, then structured products, going by the same rule, are probably expensive from a fee standpoint. Warren Buffett is notably against investments that have high fees.

Two other sneaky tricks that managers of SPs use:

1. Capital guarantees, but only if the investment is held until maturity, in which case you would still lose out as the real value of your investment would have been eroded by inflation in the intervening period. And if you liquidate your investment before maturity, you might suffer a loss still.
2. Return of capital dressed up as dividend payouts. This is notorious among SPs that advertise their regular payout feature. The fine print states that any payout may erode the capital of the fund, which essentially means you are loaning them the money for free, minus the fund management fees.

However, after all that's said, that’s not to say that SPs, and more broadly, derivatives, do not have their place in a portfolio. As long as you have a view on how the markets will move, a derivative may be useful for gaining exposure in accordance with that view. That’s why options, discount certificates, futures, exchange traded funds and other derivatives may still be useful in an investment portfolio.

The lack of transparency with SPs does not allow the investor to make an informed investment decision though. That small glossy one-page rectangular brochure printed on both sides is NOT sufficient information on which to base a decision. And given the poor product knowledge of most bank shills, you’re not likely to get the full accurate picture of the product when it’s being hard sold to you. Your only hope is to read and understand the prospectus, but not everyone has the skills to to do that.

Ratchet Provisions by Temasek

This is an update on a previous post.

runmondeo commented on GIC and Temasek's so-called batting average and that they are savvy investors. There may be something in what he says, although I also note that the share prices of financial companies are heavily underwater since the capital raisings.

In any case, the following makes fascinating reading. See Eric Sprott's "Markets at a glance" June post here and a definition of ratchet here.

Temasek's investment into Merrill Lynch comes loaded with ratchet provisions as a form of downside protection. This was little publicised as it was released only after, probably in the footnotes of a 10-Q filing.

The price of being financially unsophisticated

This post is timely given the recent interest in OCBC preference shares. The Sunday Times had a good article explaining the difference between fixed deposits and preference shares, highlighting the fact that most people only focus on the superior yields of the shares.

I'm going to talk about a kind of investment that I almost never use. I'm talking about fixed income assets. It's quite a deviation for me, considering that I invest my money mostly in equities and related assets. But considering the poor financial literacy of many people I know, this post might make useful reading. A caveat though, I use financial jargon here so some terms may be confusing. The gist of this post should be clear enough though.

First, let's talk about why I don't invest in fixed income assets - bonds, money market funds and time deposits. While preference shares behave mostly like bonds, I will not include them in this discussion as they rank after debt in receiving the residuals following liquidation. Preference shares are equity, and as such have considerably higher credit risk in the event of default.

With oil trading at about $135 per barrel and food prices soaring, inflation is on the minds of everyone, from policymakers to CEOs to the proverbial man in the street. Under inflationary circumstances like now, fixed income assets are a poor performer in real terms. By definition, any asset that returns less than the rate of inflation is losing real value, and most fixed income assets today fall into this category due to low interest rates and high inflation rates (which may also be understated due to the vagaries in computing the CPI). In financial parlance, real interest rates today are mostly negative, so fixed income assets are almost definite loser investments.

Yet, most people find themselves uncomfortable with volatile investments like equities or equity funds. Indeed, due to poor market sentiment, equities in the near term are probably poised for even greater losses than have been seen so far. Hence, "no-risk" investments like time/fixed deposits are still where most people in Singapore put their money, even if they are loser investments in real terms. Even investors accustomed to risk-taking like myself find fixed income assets suitable places to park my money while waiting for new opportunities to surface, or for conditions to stabilize.

So if you must invest in fixed income, which fixed income assets to invest in? For myself, liquidity trumps return, so I leave most of my cash in my brokerage account, which earns a money market rate of return while being highly accessible for purchases of stocks.

But this post isn't about me. It's about the vast numbers of people in Singapore who place their very substantial savings in fixed deposits for fear of market volatility, and for lack of financial sophistication.

A quick check turns up fixed deposit rates here and here. The rates are truly dismal, obviously. And the marginally better rates require large amounts of cash to be placed on deposit.

Now let's look at Singapore Government Securities (SGS). For the uninitiated, and you know who you are, SGS are bonds and Treasury Bills (T-Bills) issued and backed by the Singapore Government, which, owing to decades of fiscal surpluses, is triple super duper whammy A rated.

The indicative "interest rates" or to be technically correct, yields to redemption, for the most recent tranches are here for 3-month T-bills, 1-year bonds and 5 or 10-year bonds. Look at the average yields. They are much higher than fixed deposit interest rates offered by the banks (though still lower than the rate of inflation).

SGS are open for investment to retail investors as well as institutional investors and the minimum denomination is SGD1000. Based on yield (clearly better), minimum investment (only SGD1000), security (backed by the Singapore Government for the full face value, and not just the first SGD20000 in deposits) and duration (as little as 91 days), they are clearly better than fixed deposits. On the measure of liquidity, SGS are slightly less liquid than fixed deposits and incur dealing costs (but not at subscription and not if held to maturity), but these are probably comparable to breaking the term of a fixed deposit before maturity.

In short, SGS are a closer equivalent to fixed deposits than preference shares can ever be, and they are superior to fixed deposits on almost all measures.

So why don't more people invest in SGS instead of fixed deposits? Simple, ignorance. Most Singaporeans have poor financial literacy, and also lack the skills to look for information independently. Furthermore, while the Monetary Authority of Singapore has appointed market makers for SGS, it is simply not in the interest of these dealers to cater to retail investors. Too administratively costly. So the primary dealers don't advertise this service.

Instead, they advertise their fixed deposits and the "attractive" interest rates. You can bet that some of this money that the banks get from depositors ends up in SGS. What is the price of being financially unsophisticated? One answer could be the spread between fixed deposit rates and SGS yields.