Tuesday, September 19, 2017

The most important thing in Capitalism is Capital !

I wanted to do this article because of a spirited discussion with a highly respected VC in Singapore. In this discussion, I argued that capital is the most important thing in Capitalism. He reasoned that value creation is more important. It's not easy to carry out this debate because value and capital are not fully distinct from each other. There are ways to support and refute the statement depending on our definitions as to what value and capital is.

So instead, I propose an auxiliary argument which may have a more satisfying resolution : Which is better, engineering to create wealth or reallocation of capital to create wealth ? Another words, engineering or finance ?

If the argument were to simply ask the chicken or the egg question, then engineering wins hands down, product creation comes first or there will be no capital to allocate. If the argument focuses on who ultimately makes more money, then the fund managers and capitalists who allocate capital would generally win based on salary surveys.

I'm going to present a novel argument to make my case for finance and capital - a possible answer can be found via cryptocurrencies.

There's always been two ways to get more Bitcoins and Ethereum.

One way is through mining. You set up a rig involving graphics cards and you run some kind of daemon to mine for more coins. As the odds of solving the puzzle to get a coin reward is hard to come by, miners typically join a mining pool to guarantee an amount of coins mined per unit time. This is really similar to a development based engineering career. When you join a startup, you join a company to solve an important problem hoping for a reward that can be shared with fellow engineers.

The other way is through buying coins in an exchange. Various exchanges like Kraken exist for you to simply buy coins with money. When you do this, you are taking calculated bets on value of cryptocurrency. Analogically, you have chosen a career in finance and have chosen the role of a capital reallocator.

I've done a mixture of both strategies and noticed  that for some strange, inexplicable reason that it is, generally speaking, more profitable to buy cryptocurrency than to mine them due to electricity fees and dealing with obsolete hardware. So much so, that you can save on hardware and electricity and just buy the coin direct from the exchange. Successful miners might have been able to sustain themselves by selling mining contracts to other people who are trying to punt on contracts, or monetising their tremendous geographical advantage like having a data center in Iceland.

Does this analogy of the relative merits between mining and buying of cryptocurrency reflect an aspect of humanity that permanently plays down the value of engineering new solutions versus simply taking a bet once a new solution is created ?

I think it is.

With the exception of a few solid engineers who solve major problems and got a "coin reward" from society. The bulk of high income earners in Society are almost always capitalists who invest in companies and buy real estate. Even if you argue that Bill Gates did create some software when he was just starting out, I would think that Microsoft's success was largely due to the support Bill got from his dad who was a lawyer and was able to shape copyright law to give Microsoft the bulk of its profits.

What is the moral of the story ?

I spent 14 years in IT and there is certainly fun being in a fast changing industry. A lot of engineers are passionate about coding because they are introverts and like playing with toys as part of their working lives.

But these engineers need to remember one thing.

While work is rewarding, fun and puts you in the state of flow, you are not really being rewarded based on what you deserve per unit of intelligence and effort. You are just not getting the "coin rewards" you deserve based on the rigs and electricity you are installing in your home.

Why not accumulate some capital and play with that to even the odds against your peers ?

Saturday, September 16, 2017

Dealing with the hypocrisy surrounding academic achievement in Singapore.

The inspiration for the post came about because I am currently reading Private Education Singapore : Contemporary Issues and Challenges by Sam Choon-Yin, the Dean of PSB Academy. I picked this book up out of personal curiosity and, given my career plans, I really have no business sticking my nose into Private Education industry in Singapore but the information contained within the tome is too interesting for me to miss out on it.

More details will follow once I finish the book but I just want to share some ideas surrounding Singapore's inherent hypocrisy around academic achievements and how we can employ some economic concepts to understand why people sometimes act like hypocrites when it comes to academic performance in our neurotic society today.

I think the starting point is to understand what a positional good in economics is all about.

A positional good has this property whereby the benefits that you derive from this good is much greater when fewer people have such a good. Folks with this good essentially play a zero-sum-game against folks who do not have this good. In Singapore, a higher education like a degree is a positional good. The fewer people with access to a higher education, the more benefits accrue to folks with a degree.

Let us use this economic idea to deal with some situations we face in our daily lives.

a) People who want to de-emphasise the professions in daily conversation in favour of vocational training.

I observe that this is getting more common in a competitive society. There is always someone who speak of hawkers, plumbers and electricians as if they are noble savages and decry others who are academically competitive because in some Western societies, we are observing that salaries of folks who perform technical or personal services are climbing but the professions are currently being disrupted.

Normally, I would respect these folks if they are consistent with their proclamations with kids who take up a vocational career. But if you look at what they do for their own children, you will find that they often enrolled their own kids in the better local or foreign university programs.

The idea that education is a positional good completely explains such behaviour : If you can convince other people to play down their academic ambitions, it's ultimately better for yourself or your children.

My dad's friends have always teased me for academic performance for decades. You can hear a pin drop when I tell them that if they have a problem with my stellar performance, they need to get their own kids to drop out of school for their own good and let me mind my own business and personal ambitions.

Of course, not everything these folks say is untrue.

The Singapore government is raising the percentage of the cohort who can get into local universities to 40%. This will effectively reduce the benefit that any person can derive from having a degrees versus those who are not having a degree because the situation in the future is that more people have degrees.

The effect of this policy is predictable :  The arms race fought between parents will simply shift towards getting their kids into prestigious postgraduate qualifications.

The erosion of the benefits of having a degree is not about seeking vocational or lower qualifications but seeking more complicated and prestigious academic credentials.  Net result : People are going to spend a greater part of their lives in school reading more complicated academic texts.

Therefore, hypocrites really just want you to play the game the wrong way.

b) Legal industry's problems derives from legal training being a positional good.

This cuts deep into the bone for my classmates currently doing Part B.

A licensed advocate and solicitor 20 years ago makes a decent premium compared to an engineer even though we never had that situation where the law faculty attracted all the folks with straight As unlike our current situation today. The problem then was that the earnings of a legal professional is tied to the value of a law degree as a positional good. Fewer people with the degree that leads to a practise license would spark a war of talent among law firms. As an engineer who had my salary depressed by decades of additional engineering manpower supply from India and China, I found it hard to accept that I had to live on a lower standard of living because of the choice of my degree.

The music for legal professionals has stopped recently when parents started sending their kids to approved law schools by the dozens. These returnees from foreign countries created a lot of supply and  law firms can basically offer any salary package to a rookie associate because there are so many folks willing to do the work for less pay.

Of late, a lot of VIPs have spoken about the need to treat junior lawyers better and it was particularly entertaining that they are using a moral appeal in the hopes that things will get better.

I would suggest to my cohort that moral appeals seldom work where economic incentives are absent to improve someone's lot in life. Just look at how badly some of us engineers are doing in our 40s today.

Your legal qualification is a positional good, things can only get better when the industry has the ability to squeeze out more people and prevent others from joining the profession.

But this introduces a problem for us Part B students because wishing for that might mean that we, too, would be squeezed out in the process of tightening standards.

c) The solution ?

At the micro-level, there's hardly very much we can do when everyone is sacrificing other non-positional goods like building a family or getting more time for leisure. In Singapore, it's just nothing but the endless struggle for positional goods - better degrees, better grades and hopefully, better pay. The authorities love this because this makes us such hard-working and conscientious workers.

Perhaps the financial blogosphere has part of the answer - Struggle now and build up a portfolio of savings that can replace part of your income.

The trump card in Capitalism is more Capital.

No company will deny you your dividends over your educational qualifications.

But to earn enough to put some aside in an investment portfolio requires decent pay - which is a function of educational qualifications in the first place.

Thursday, September 14, 2017

Efficiently Inefficient #9 : The notion of Quality in Discretionary Equity Investing

As a follow to our previous article, we will delve deeper into discretionary equity investing. Remember that discretionary equity investing can be challenging task as the field is highly competitive and there are a lot of brains chasing the same few investments in the market.

It largely boils down to what investors perceive as the quality of a company:

a) Growth

It's easy to just reduce growth to one metric like compound annual growth rate of revenue, but I can hardly see it work when I back-test portfolios which use this criteria. Good sustainable growth can result in bigger free cash flows, imagine a store that found a way to increase sales without increasing their operational expenses. Growth can also be bad if it comes from manipulating accounting figures. imagine a company growing by acquiring rivals at high prices.

Somehow a growth investor needs to take all these considerations into account.

b) Profitability and Earnings Quality

The other factor to take into account is the profitability of the business. A profitable company of hihg quality has a great profit margin and has a history of high free cash flows.

But lower quality companies can game this by moving expenses into the future to inflate current figures.

c) Safety

A third element of quality if safety. Safe companies are predictable and this can come in the form of a lower beta. Some investors need to delve into the past variation of profitability by examining how the stock has performed in the Great Financial Crisis.

d) Payout and Management Quality

The final element, which is the element which I simply cannot handle is how friendly the company is to shareholders. The best discretionary investors have access to upper management and can tell whether they are managing the company for themselves or shareholders. As I do not have access to management, I have to use a proxy measurement- companies that return money to shareholders generally care about shareholders. With less cash in their hoard, the managers also would need to be more disciplined when they run the company.

At this stage, I'm trying link up the concept of quality to a discretionary investor to this other book I am reading written by Aswath Damodaran called Narrative and Numbers : The Value of Stories in Business. Perhaps in crafting a narrative for yourself if you are a growth investor, you would need to convince yourself that your investment is of high quality based on these four dimensions. After which you can proceed to assess the plausibility of your story by linking it up to accounting figures.

Whatever it is, this would be quite a difficult intellectual exercise if you are a retail investor. More likely, you will fall in love with a stock before can craft a compelling narrative based on it.

Wednesday, September 13, 2017

Slapping your face to look prosperous.

I am blogging from SMU where I am looking for textbooks to buy and read.

( By now, reading textbooks and academic papers have become more interesting than management books which are becoming just an endless stream of narratives with no unifying theme or point. Another point to select an ace engineer : Find out whether he reads IEEE papers. )

Two issues ago The Economist published a short article about folks belonging to the lower income group who have a propensity to overspend on branded goods. It was discovered that as we move towards the lowest quintile of income, extroverts tend to buy more branded goods but introverts do not exhibit this behavior.

What does this mean :

A) That ancient Cantonese saying makes some amount of sense.

The link to the saying is as follows. Our ancestors did not have the analytical tools to figure out that this only applied to extroverts.

B) If you want to marry someone who will suffer with you, choose an introvert.

This idea really takes on some traction if you claim that you want to marry someone who is willing to suffer with you. When you are poor, it is the introverted person who will stick around and cut their spending. Extroverts will double up and exhaust whatever resources you have.

Don't say I didn't warn you !

C) The folks queuing up for branded stuff might be rich or simply poor extroverts.

With this insight, we're no longer so sure that the folks queuing outside ION or the Apple Store are rich or simply extroverts who earn at the bottom quintile of the population. With the right kind of credit card, any acquisition is possible.

D) This might explain Sapeur culture

If you are frugal and follow financial blogs, you will find sapeurs or folks who adhere to La Sape culture fascinating. Sapeurs are African dandies who pawn their land to dress in French Designer wear.

This discovery has also caused me to have a double take of my personal life. I'm fairly extroverted if you benchmark me against the other guys who write financial blogs.

My life would have been very different if I were born under poorer circumstances.

Monday, September 11, 2017

Personal update : Mid-term break is upon us !

It's time for another personal update. I've been suffering from diarrhoea for the past two days but was only put on medication this morning.

a) Part B preparations

We've reached the mid-point for my Bar Preparation Course. I was still reviewing my course materials this morning and preparing for future tutorials until I found out that my mid-term break would last two weeks instead of one. This puts off a fair bit of pressure off me until next week. I just need to consolidate the tutorials I've been having so far.

b) Bleak future for the fresh legal graduates

Almost everyone I knew referred me to the article on the rough treatment of junior lawyers upon graduation. I did not read the article because there is no need to remind me about how bad the legal industry is. Compound that with a highly strung cohort that can somehow reduce their lives to a single GPA figure, it doesn't take a genius to figure out that the industry will face some kind of reckoning soon. Make no mistake - People have killed themselves in the legal industry. This is the price to pay for prestige, I guess.

But once again, we JDs are different. We can go back to our old industries with some of us being offered a decent income for our legal skills.  Even though I'm getting pretty eager to rejoin the workforce, there is no pressure for me to join any industry in the medium term.

You should save your tears for those parents who pay exorbitant fees to send their kids for a UK or Australian Law Degree.

c) Already took a break in KL

Me and my mum had to attend a funeral of a close relative recently, so I took an early break and brought my mum to KL for some shopping. This means that I have already travelled for this mid-term break. This was quite a bitter moment for my family, but at least my mum could just stop playing caregiver to my dad for a few days to go eating and shopping in Bukit Bintang and Mid-Valley.

d) Books I read recently

Of course if I visit KL, I will try to read some books about Malaysia. I read Economic Reform in Malaysia : The Contribution of Najibnomics by Bruce Gale and I was impressed with his analysis on Najib' Prime Ministership. As much as Singaporeans like to laugh at our neighbours over 1MDB, Najib's role was generally positive one for the Malaysian economy Najib being the first to seriously introduce KPIs to the civil service, reduce sugar and gas subsidies and diversify the Malaysian economy.

I will definitely use this book to debate more vigorously against my relatives on the folly of voting a party other than BN for the next Malaysian elections.

e) Our own Presidential elections.

I'm too stunned by the plot twist to blog about this event. This is a senseless sacrifice of political capital on the PAP's part.

f) Financial Markets

While the markets are going down during the 7th Month season, I've not been making any changes to my portfolio. The only I had been doing was using some back-testing. Things should look up after the Hungry Ghosts return back to where they came from.

g) Leisure and Gaming

I attended STGCC last weekend and bought myself the Tank War game by Gale Force Nine. Otherwise, it was quite disappointing for me as there was no second hand hobby shop where I can hunt for vintage game books unlike last year.

This week I look forward to playing more D&D on weekday evenings and at the close of the week, some members of the financial blogging community will be coming together for a karaoke session.

(The clean family karaoke where the mic is made of metal and not flesh !)

Saturday, September 09, 2017

Efficiently Inefficient #8 : The promised backtesting results.

As promised, I tried accessing a Bloomberg terminal to backtest some of the ideas from TUB investing. Here are my findings :

a) Dividends per unit P/B ratio was a strong screen.

Dividends generally do well in backtests. Putting up a screen incorporating the cheapness of a stock makes it even better. There is some research done this year in the Financial Analysts Journals which back-up my findings.

In fact, using Dividends divided by P/B ratio and setting it above a threshold value to target around 20 stocks yielded a return about 13.6% with a semi-variance of 13.51%. Returns were enhanced even further when I used 5 year average free cash flow yields.

TUB credited Teh Hooi Ling for this idea. This is definitely a workable investing idea.

b) ROA per unit P/B outperformed the STI ETF but the performance was unremarkable.

I did not fully adapt TUB's idea of using ROE divided by the PB ratio because ROE can be magnified by a company's gearing  and TUB used another screen to keep gearing low.  Using this screen to capture "management skill at a reasonable price" did not meet my personal expectations. Returns were at 8.86% with a semivariance of 14.19%.

c) Equity screening does not help growth investors.

This last section is something that readers should pay close attention to.

Perhaps I am still not good at equity screening, but a combination of growth screens did not yield anything concrete or useful for me. For this exercise, I searched for stocks with a combination of  high 5-year CAGR for Revenue, Zero debt, PEG ratio below 1. I gradually relaxed each criteria until I had a decent number of stocks and it returned only 3% annually over 10 years.

Because I probably fumbled with Bloomberg due to the lack of time, we should not conclude that growth investing does not work. I can only conclude that using equity screens to buy growth stocks is not a good idea.

More likely, the growth metrics were used as some sort of scorecard to funnel stocks into a bottom-up investing process that requires a more intimate investing process and an understanding of a business narrative that John happens to be quite an ace at.

Also please don't forget that Peter Lynch was a growth investor.

As of now, TUB Investing has been kind to grant me access to their database but I have not used this privilege yet because I wanted to do my own homework before using their bespoke database materials.

My simple screens, of course, do not do full justice as to the amount of work that they have done to create their database.

Thursday, September 07, 2017

Anonymous insurance agents declare war on financial blogosphere !!!

The financial blogosphere was a friendly place.

I'd like to point out that I did not start with a good general impression of some of my fellows financial bloggers such as Tim Ho from Dollars & Sense because, at that time,  I harboured some doubts about whether Dollars and Sense can be unbiased in light of their commercial interests. Over time, my respect for them grew and they seem earnest about giving the best possible advice to the readers. I should also mention that they often organise free events for bloggers to come together to give an unbiased look at some developments in the industry. It should also be noted that Dinesh's investment writings on investing in Singapore are amongst the sharpest you can find on the Internet.

Yesterday, it dawned upon me that a three anonymous insurance agents started a Facebook group that effectively declared war on us financial bloggers. In some of their articles, they attempted in their own clumsy way to challenge some of the ideas shared on blogs like Dollars & Sense and Budget Babe, subsequently going as far to declare that keyboard warriors should not be dishing out financial advice.

Like most financial bloggers, the victims in this saga felt that the Facebook group should be ignored. However, I think that we're are in a precarious position. Commissioned agents have a strong incentive to cause harm to business interests of financial education provides or information portals because the insurance industry simply attracts too much controversy from their sales tactics. For the most part, financial bloggers are unbiased and the Internet allows us to pool our wisdom together. For example, Budget Babe has an excellent expose on agent commissions here.

So this is what I did :

I challenged three of them to a public debate.

I suggested that the topic was about general ethical standards of the insurance industry.  I think folks would want to see a no-holds-barred debate between a team of unbiased financial bloggers and a team of commissioned sales agents and we might even be able to charge a decent amount for it.

As it stands, the majority of financial bloggers just want to ignore these agents. But we know that given the attractive incentives to sell ILPs and Whole Life policies, they will not stop discrediting bloggers who propose alternatives like Buy term invest the rest and the cheaper ETF strategies.

So I'm going to take the opposite tack:

They call themselves "The truth and nothing but the truth".

Subscribe to their group on Facebook.

You can lurk and just enjoy the popcorn.

But chances are that, they being merely commissioned agents, they will make mistakes when they talk about finance.

It is a good opportunity to point out their mistakes and show them up for the clowns that they are !!!

I for one, am itching for a spirited debate !