Tuesday, May 22, 2018

The Art of the Good Life #24 : The Spiral of Self-pity

Another short one,

There are three unproductive ways that we can deal with negative events.

a) Do nothing.
b) Complain
c) Engage in Self-Pity

The book misses out the fourth point :

d) Engage is self destruction

The trick is not to engage in any of these activites. The suggestion not to engage in self-pity comes about because there is no end to the injustice that your ancestors faced that led to your fate today.

I just want to say a few words about Millenials and personal finance.

In 2008 and 2009, our generation faced possibly one of the worst recessions ever. One effect of this is the rise of the Hipster. No, not the kind of hipster that sells rainbow-themed foods at the Geylang Bazaar ( Now that's really hopeless shit !) but the kind of ironic, frugal child of the Great Recession that is forced to work in the gig economy and avoid seriously engaging in the financial markets.

So this Millenial Generation was burned so badly by the markets, they eschewed Wall Street and missed out on the greatest bull market post-recession. But it gets worse - they invented a whole new asset class called the crypto-currency and dived into it without proper asset allocation and diversification.

Some became very rich but the majority are stuck with paper losses as they hold for dear life into financial oblivion.

For the folks suffering huge losses this quarter, try to avoid self-pity, just pick yourself up and start studying finance seriously.

At least, unlike me, you still have your youth.

Sunday, May 20, 2018

Feasibility of Bond Margin Financing

[ Feedback for this article is fast and furious !

Some concerns raised is whether investment grade bonds with a short duration can even be found in the markets ]

This has been a great week. The folks of Kim Eng held an open house and invited me to attend. The catered food was relatively good given that my exposure to free buffet is limited to what is available in SMU law school. They also gave me a pair of free movie tickets because I was such a special margin financing customer.

I'm just saying all this because I know they read this blog quite religiously.

Anyway, let's have a closer look at their bond margin financing facility.

Maybank Kim Eng has a fairly competitive rate to facilitate bond margin financing. I invite all readers to share with me what private bankers give them, but 2.28% is sweeter than my rates for REITs financing, but we have to live with the lower returns from bonds.

The framework I am using is the traditional use of the Kelly Criterion that blackjack players use to size their bets. The better the odds of winning, blackjack players will place bigger bets. I also employ a modification called the half-Kelly because gamblers generally half the output of the Kelly Criterion so as to err on the safe side when placing bets in a casino, this way they can survive longer.

Ok, so let's look at a typical deal the Maybank guys have suggested to me that night.

Suppose we have a bond with one year left to go. Let's assume that this is a bond issued by a local bank that returns 4% and is rated AA - it's a safe,conservative bet. As bonds are sold OTC, each bond position is a hefty $200,000. I also did some searching on Google and I found that in the worst case, a AA bond defaults with a percentage chance of 0.38% in a super bad year like 2008. This gives us a worst case scenario for a default. To simplify matters further, if a bond defaults, I assume  that you will lose everything even though the insolvency process might give you higher priority than shareholders.

So assuming that we have war-chest how much of it can we put into investing in this bond without leverage?

We apply the Kelly Criterion, or [b(p) - q] / b, where b is the odds on a success or 0.04, p is probability of success or 0.9962 and q=1-p or 0.0038. If this bond were a blackjack game, the Kelly Criterion will recommend that 90.12% of your war-chest can be placed on this bond. Sane gamblers use the half-Kelly and can invest 45.06% of their portfolio into a bet. At $200,000 for one position, you need to be almost half a millionaire to take this bet.

Now let's look at the Kim Eng deal that allows us to employ some leverage to buy these same bonds but at a cost of 2.28%. By leveraging 300%, you only need $66,667 to place a bet on one bond. There is, of course,  a 0.38% chance of utter ruin. Suppose we apply leverage, there is a 99.62% of winning (4%*3 - 2.28%*2) or 7.44%. This translate to odds of 0.0744. There is a corresponding chance of a disaster occurring with a probability of 0.0038 where we will lose 304.56% of our bet.

(Expect to lose everything when a bond defaults. Also you will owe the broker the money you borrowed from them as well. )

Put all the numbers into the Kelly Criterion,  the equation will allow us to bet [0.9962 x 0.0744 - 0.0038 x 3.0456] / 0.0744  or 84% of your war-chest. Using a half Kelly, this is a bet sized at about 42% of your war-chest.

What can we conclude from this exercise ?

a) A margin account for bonds allows a smaller retail investor to bet on bonds, something that is the province of the UHNW investor. The first case where there is no leverage, you will need about $400,000 to justify placing one bet on a bond. In the second case where you employ leverage, you only need ($66,667/0.42 ) or $160,000 to justify one position.

b) The equation covers credit defaults but most of the fear in our current market comes from interest rate risk. The smart money is betting that the Fed raise interest rates three times in 2018 and twice in 2019. If this prediction is wrong, there will be bigger shocks to bond prices. This is why leveraged bond bets should focus on bonds that will mature soon, like within 1 or 2 years of placing your bet.

c) Having bets with a size of $200,000 or $66,667 is still fairly large for a retail investor, so expect only quasi-affluent folks to be making use of this margin facility.

d) Unless you are a multi-millionaire, most of your positions will not allow you adequate diversification.

For now, I will be sticking with my REITs margin financing account which is doing ok. After it hits my ideal size and leverage ratio, I will not be ready for bond financing yet because I want to start working on a market neutral portfolio using CFDs which is something I hope to start doing in 2018.

Friday, May 18, 2018

People fail because they major in minor things.

The last article where I spoke about the complexity of Singapore life attracted some amount of constructive criticism from bloggers like La Papillon and Richard Ng, so I went back to the drawing board to see whether that idea can be reviewed or salvaged. 

In many cases, they are right, complex societies do not exist, only complicated people. And I think I tend to be more complicated than an ordinary Singaporean. In many matters, Singaporeans do have it easy compared to their international counterparts. Our tax code is simple and we do not spend too much effort trying to optimize our taxes unlike our friends in the US. 

One salvageable idea in that article is the advice that I give to readers not to major in minor things. I think this idea was invented by Jim Rohn and made famous by Anthony Robbins. 

According to Tony Robbins : People fail because they major in minor things.

Here's an example of what I did recently.

At this stage of my life, I don't want to be beholden to any employer. If I work for someone, I want the work to be interesting, rewarding or both. To do that, my finances must be able to sustain joblessness better than my 4 years of law school. Even better, I must be able to save more than most working folks even when I am jobless.

So I really wanted to optimize my expenses so I went through my broadband and mobile phone commitments. I went to a Starhub outlet and started to work with a salesperson to re-contract my phone and cable TV. The salesperson was actually quite nice and was willing to offer to me cheaper SIM only and no-frills cable TV plans. The total result of my effort was to shave off $50 from my telco expenses every month. Let's just say that in 2 years, this would have saved me $1,200.

Another hack I did was to buy a battery changing kit from a China vendor for my Oneplus 2 phone for about $20. With an extended battery life, I can now avoid buying a Google Pixel 2 and maybe even wait for the Google Pixel 3 to be launched. This can potentially save me another $1,300 over the next two years.

Net-net my micro-managing efforts yielded about $2,500 of savings over the next two years.

Now, suppose I move $200,000 of my portfolio from Tech stocks to my REITs margin account. I can push my dividend yields from 5% to 10%. This subtle change can net me an extra $10,000 in dividends every year. Of course, more effort would be required to do some research, but even if I miscalculate, an additional $5,000 with an improvement in the Sortino/Sharpe Ratio of my portfolio is quite a reasonable result.

As such, fooling around with Telco plans and optimizing some credit card benefits may be considered a minor thing compared to simple portfolio shift from Tech to Leveraged REITs.

But some decisions are even bigger than those involving your investment portfolios. Your decision to study for a degree will have a major impact on your total income you will make within your lifetime.

Choice of a degree affects your human capital. 

You can easily find a website and dig out statistics on starting salaries and employment rates of a degree program.

To stay politically correct, I have listed the worst NUS degrees you can apply for after your A level exams, omitting the truly abysmal numbers coming out from SIT. The third column from the right contains the median monthly income figures and the percentages are employment figures after 6 months of graduation.

In many cases, people do really major in minor things.

Enjoy !

Tuesday, May 15, 2018

The Art of the Good Life #23 : The "Good Death" Fallacy

Short post because I'm not feeling good ( sprained my back ) and it's been a long night.

The "Good Death" Fallacy is a mistake we make because we not give any weight to a duration of an event.

Consider Anna who was single, unmarried and had no children. She had good friends and enjoyed going on long holidays. At age 30, she suddenly died in a car accident.

Now consider Beth who was also single, unmarried and had no children. She had good friends and enjoyed going on long holidays. The last five years of her life was not as good as her first 30 years. At age 35, she suddenly died in a car accident.

When asked to determine who lived a better life, most surveyed participants said that Anna had a better life even though Beth lived 5 years longer.

Our mind is prone to over emphasize the peak in each event and how each event ended.

The duration does not matter so much.

Sunday, May 13, 2018

How hypergamy and rise of involuntary celibates affect our personal finances.

The recently Toronto attacks by a single man on women illustrates the danger of involuntary celibates to our modern society. If you have been following this blog, I write about about the rise of the useless caste - Video gamer males who do not participate in the labour and marriage markets. Involuntary celibates are a different archetype. Incels are angry men who are upset that they are being ignored by women or "Staceys" who prefer dating what incels label as jerks.

One of the root causes of involuntary celibacy among males is demographic policy. China is now ticking time-bomb because their rural areas are full of men who cannot find a spouse  thanks to the ago old practice of aborting female fetuses. A nation of millions of Incels is definitely not a safe place for our daughters.

But there is another reason for the rise of Incels.

Hypergamy is the act of marrying someone of a superior caste. The fact that women are generally hypergamous has been researched and generally supported by social science. The following paper rationalises this phenomenon - because women tend to invest much more heavily in offspring, women will tend towards marrying men with higher human capital and men want women with lower human capital because of men's desire to have legitimate children.

( My personal experiences being exposed to family law also seems to give me the impression that men with lower human capital marrying women with higher human capital will result in marriages of poorer quality. )

The effect of hypergamy on personal finances is largely ignored by investment gurus but it is far reaching and can impact your investments.

Face with a dearth of eligible women, men in China work punishing hours to own an apartment to attract a spouse pushing up real estate prices. Interestingly, many people still remains single. Chinese women who are highly-educated  and successful get dissed by society as sheng nu. At the other end of the spectrum, lowly educated rural men sometimes have to resort to kidnapping or sharing spouses.

Imagine our 4G leadership making a decision to re-introduce immigration to deal with our low fertility rate. The Chinese, being so used to high real estate prices, will definitely push up real estate prices in Singapore. This will occur without a corresponding increase in rentals creating price compression in local real estate markets. Wait... i think it's already happening today.

At a personal level, this means that I now see myself as a "corrupting influence" when I hang out with LLB interns.

To me, when a fresh male Law graduate starts a new career, the high starting salaries and career potential allows them some leeway to play a waiting game in the game of marriage. Their human capital is an appreciating asset and hypergamy guarantees that the harder they work on their cases, the more attractive they are as husband material. It's like playing blackjack and only committing the heavy bets when there are more 10s and Aces left in the shoe.

For the female Law graduate, the marriage game is much harder. The university is the last place where they will be surrounded by eligible men who are intellectually compatible with them. One bad move and they will miss out on the marriage markets.

I think this also answers my previous posts as to why we can't make RGS girls marry ITE guys.

Thursday, May 10, 2018

Why invoking Warren Buffett may be bad for the retail investor.

While Warren Buffett is over-represented in investment literature, the willingness of many gurus and trainers to channel him goes beyond belief. Invoking Warren Buffett in an investment lecture has almost become something akin to religious ritual. It creates instant credibility for the investment trainer even though in Singapore, he is not likely to be Warren Buffett.

( It's ridiculous right, it's like me quoting Xiaxue to get her readership figures.)

There are two instances in investment literature that show that such locally approximated "Warren Buffett" approaches might end up leading retail investors astray.

a) Quants have started figuring out the secret sauce of the Buffett technique

John Alberg and Michael Seckler in an article entitled Misunderstanding Buffett talks about how Berkshire Hathaway's returns can be replicated using factor models. A combination of value, quality, low beta and.... the liberal of leverage of up to 1.6x can allow a quantitative model to cover most of Buffett's returns.

Most of the time investment trainers tend to focus on the qualitative aspects of investment management like whether there is an investment moat or a sustainable competitive advantage or whether management is trustworthy. These are fluffy approaches towards investing which may cause the retail investors to lie to themselves and fall in love with a particular stock simply because too much time has already been spent analyzing it.

At this point I'd like to say that only Dr Wealth's Factor based approach seems to get the technique right with as little emotion as possible. ( While Alvin Chow is a friend, but he did not pay me to say this )

b) Berkshire actually runs three portfolios of which only two can be replicated by a retail investor.

 This second insight on Warren Buffett actually came from an autobiography by Ed Thorpe entitled A Man for all Markets whom I had a much closer affinity with because I'm primary a numbers guy, he is a mathematician and has beaten casinos in black jack and roulette before conquering the financial markets.

According to this book, the simplest way to look at Berkshire Hathaway is to see it as a collection  three portfolios. Only the first portfolio can be replicated well by a retail investor because it consists of publicly owned stocks. The second portfolio consists of GEICO/General Re - his various insurance businesses that allow him to create some kind of faux leverage through "insurance float", investing the premiums he earns that hasn't been paid out.  His third portfolio consists of stocks that simply are not publicly traded.like Wesco Financial and Clayton Homes.

Anyway, the next time you encounter a someone channeling Warren Buffett, you might want to read these two books and engage them in a spirited debate to see how their ideas hold up.

Tuesday, May 08, 2018

The Art of the Good Life #22 : Life Stories are Lies !

The world of RPGs is split between two broad player types. I belong to "Murderhobo" category. I create powerful PCs whose sole purpose is to kill monsters and spread mayhem in the gaming world. If the gamemaster gives me  a wish, I will often ask for a magic sword so that I can kill more monsters and spread more chaos in the campaign world. I like my RPGs to be chunky, mathematical and full of interesting loopholes. Characters possibly played by Murderhobo gamers include Saitama One Punch Man, Thanos, and Batman (Injustice).

The opposite of a "Murderhobo" is the "Storyteller". These assholes get into a game because they want to develop a narrative around their character. They wish to explore their inner world and how it interacts with the campaign.  These players value coherence of the campaign world and they hate murderhobos and the chaos we bring into the campaign. They like an RPG that is rich, descriptive and rule-lite Characters possibly played by Storyteller gamers include the Genos, Spider Man, and Batman (Dark Knight Returns).

As a dedicated "Murderhobo", of course I know that the "Storytellers" are wrong !

The narrative bias is my favorite cognitive bias because we are wired to love a great story. The ability to turn a set of disjointed facts is one of the key skills of a data scientist, litigator or a financial journalist.

Take for instance the recent rise of DBS stock which is currently the talk of the town. It's easy to spin a great story out of it. Perhaps bank stocks are rising because of rising interest rates and banks tend to become more profitable when interest rates are higher. But can this explain the recent fall in OCBC prices? You then go on to talk about DBS's fintech strategy which makes it part of the Fintech economy. As we discover more, we end up contradicting our story about DBS, you then go on to modify your story further to maintain its coherence. 

A good story has three elements that come in in the form of 3 Cs. It is "compact" or easily understood. It is "consistent" in that it does not contain an element that contradicts with itself. It is "causal" or formed by events that lead from one to another. Our human brain simply cannot accept facts as is and has evolved to turn any series of events into a story. This is the reason why we have superstition and religion - a story must be manufactured to explain a natural phenomenon.

Our inclination towards stories brings most of us to have some sort of life story for ourselves. It is some kind of lie we tell ourselves to make us seem more heroic than we appear to be.

This ultimately prevents ourselves from seeing ourselves realistically - multi-layered, paradoxical and incoherent.