Jeremy Chia, Author at The Good Investors : Page 19 of 20

3 Essential Investing Lessons From a Top-Performing Fund Manager

John Huber’s fund has more than doubled the S&P500 index. Here’s a compilation of three investing lessons from his annual letters and blog posts.

John Huber is one of the top-performing fund managers of the decade. His Saber Investment fund has achieved a gross annualised return of 20.66% since 2014. That puts his fund well ahead of the S&P 500 which has annualised at 10.89%.

I spent my weekend studying some of Huber’s letters to shareholders and blog posts. Here are three investing lessons from his writings.

Time is a valuable edge

Fund managers often get asked the question, “what is your edge”? The two main responses that institutional investors look for are some sort of “information” or “analytical” edge.

However, Huber believes that in an era of easily-accessible information, both these edges do not exist anymore. Huber explains:

“I’ve observed over the years that whatever information an investor believes to be unique is almost always understood by many other market participants, and thus is not valuable.

The mispricing is not in the stock itself, but in the investor’s own perception of the value of information: it’s worth far less than they believe it is. Information is now a commodity, and like the unit price of computing power that provides it, the value has steadily fallen as the supply and access to it has skyrocketed.”

But the absence of an “informational” or “analytical” edge does not mean stock pickers cannot outperform the market. Huber believes that the “time horizon” edge is still alive and kicking.

The “time horizon” edge is formed because today’s market participants are more interested in short-term gains over the long-term. Huber notes that many investment firms today make investing decisions based entirely on short-term stock price movements. These decisions have nothing to do with long-term value.

This creates a huge pricing mismatch between a stock’s long-term value and the current stock price. In turn, it creates a massive opportunity for long-term investors to outperform the market.

But the “time horizon” edge does come with its price. Huber explains:

“The price of gaining this edge is the volatility that could occur in the near term. You have to be willing to accept the possibility that your stock will go down before it goes up. Very few investors are willing to pay that price, which is why even large-cap stocks can become disconnected from their long term fair values.”

Don’t be afraid to say, “I don’t know”

Huber wrote a great article on one of Warren Buffett’s underrated investment attributes: His ability to recognize when a situation is outside of his well-defined circle of competence.

Buffett has been able to do extremely well in the stock market simply by focusing on more-certain bets and resisting everything else.

The ability to say “no” has enabled Buffett to have very few major mistakes on his record.

More impressively, Buffett is also humble enough to admit when he is wrong. For example, his ability to realise his mistakes led him to make smart investment exits in IBM, Tesco, and Freddie Mac. Huber wrote:

“I think the vast majority of investment mistakes can be traced back to the inability to be honest about your own knowledge or level of understanding about a subject matter.

It’s hard for smart people who have spent their lives being right far more often than they are wrong to admit to themselves that something is too challenging.

It is even harder to admit that their original assessment was completely wrong. So I think intellectual honesty can be a source of a powerful edge for those who can harness it to their advantage.”

Individual thought is essential

Huber also explains that one of the biggest risks in investing is allowing others to indirectly make your investment decisions.

Too often investors rely on outside advisors to make an investment decision. But the advice may be based on different economic interests, investment horizons, or goals.

Investors also tend to copy high-profile investors. However, high-profile investors can also occasionally make mistakes.

Theranos, one of the most high profile fraud cases of the decade, managed to secure billions in funding before it was eventually found out. Its early investors were some of the most respected business people of our time. They included the likes of Carlos Slim, Robert Kraft, Larry Ellison, Rupert Murdoch, and the Walton family. Huber notes:

“My observation is that independent thought is extremely rare, which makes it very valuable.

On the other hand, outsourced thinking appears to be pervasive in the investment community, and because of how we’re wired, this dynamic is unlikely to change. Regardless of how convincing the facts are, we are just more comfortable if we can mold our opinion around the opinion of others.

Understanding this reality and being aware of our own human tendencies is probably a necessary condition to investment success in the long run.”

Why Frasers Logistics and Industrial Unitholders Should Be Pleased With The Proposed Merger With Frasers Commercial Trust?

Frasers Logistics and Industrial Trust has proposed a move to acquire Frasers Commercial Trust. Is it good for existing unitholders?

The proposed merger of Frasers Logistics and Industrial Trust and Frasers Commercial Trust is the latest in a flurry of mergers among Singapore REITs this year. But not all mergers are good for shareholders (technically, REIT investors are called unitholders but let’s not split hairs here).

To determine if the proposition is fair to Frasers Logistics and Industrial Trust shareholders, I did a quick analysis of the deal.

[Note: An article discussing what the merger means for Frasers Commercial Trust shareholders was published on 10 December 2019. You can find it here.]

Details of the deal

In essence, Frasers Logistics and Industrial Trust will be absorbing Frasers Commercial Trust. It will pay S$0.151 in cash plus 1.233 new units of Frasers Logistics and Industrial Trust for every Frasers Commercial Trust unit.

In addition, Frasers Logistics and Industrial Trust is proposing to purchase the remaining 50% freehold interest in Farnborough Business Park that is not already owned by Frasers Commercial Trust.

Is Frasers Logistics and Industrial Trust Overpaying?

A share-plus-cash deal can be complicated to process. That’s why I prefer to break it into two parts. First is the issuance of new shares, and second is the purchase of the REIT using existing cash and the capital raised from the fundraising exercise. I will address each of these separately.

Frasers Logistics and Industrial Trust is issuing new shares at a premium to its book value. The new shares (if you consider that they are issued at market prices of $1.23), is 29% higher than Frasers Logistics and Industrial Trust’s current book value per share of S$0.95. Additionally, the new shares are being issued at a trailing annualised dividend yield of 5.8%, which is quite low for a REIT. Because of the relatively high price of the new shares issued, I think the issuance of new shares is positive for existing shareholders of Frasers Logistics and Industrial Trust.
That brings us to the second part of the assessment- the price paid for Frasers Commercial Trust. Based on the current market price of $1.23 for each Frasers Logistics and Industrial Trust share, it is paying $1.66 (1.23 x 1.23+0.151) for each Frasers Commercial Trust share. The implied price is just a 3.1% premium to Frasers Commercial Trust’s book value per share of $1.61. It is also lower than Frasers Commercial Trust’s current market price of $1.68 per share. I think this is a fair purchase price, considering the potential long-term benefits of the deal (more on this below).

Based on the above considerations, I believe the deal will benefit existing unitholders of Frasers Logistics and Industrial Trust.

Immediate impact on distribution per unit and NAV per unit

The new units are being issued at relatively high prices, and the purchase price is just a slight premium to book value. So it is not surprising that the deal is expected to have an immediate positive impact for Frasers Logistics and Industrial Trust. Management expects the acquisition to be accretive to both distribution and book value per unit.

The two charts below illustrate the pro forma accretion to book value and distribution per unit (DPU).

Source: Investor presentation for Frasers Logistics and Industrial Trust merger with Frasers Commercial Trust

Other benefits of the deal

Besides the immediate positive impact on DPU and book value per unit, there are also other potential benefits to the merger:

The enlarged REIT will likely be able to negotiate lower interest rates on its debt in the future
There are potential economies of scale due to the enlarged size of the combined REIT
The bigger portfolio will increase diversification and decrease concentration risk
The new properties absorbed by Frasers Logistics and Industrial Trust have favourable characteristics that could drive growth. For instance, 51.8% of Frasers Commercial Trust’s properties have step-up annual rent escalations of between 3.0% and 4.0%. Also, Alexandra Technopark, one of Frasers Commercial Trust’s six properties, also recently completed an asset enhancement work.

The Good investors’ conclusion

There are many reasons for existing shareholders of Frasers Logistics and Industrial Trust to like the deal. First, the deal will be immediately accretive to both book value and DPU per unit. Second, the enlarged REIT will benefit over the longer-term through economies of scale and diversification. In turn, this should provide the REIT with a longer runway for DPU-growth in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

5 Ways to Invest For the Greater Good

By choosing to invest in companies that are doing good for the world, we not only stand to profit but can also improve the world in the process.

Ser Jing and I started The Good Investors as a platform to raise awareness on how investors can invest well for themselves while doing good for the world. These two objectives are by no means mutually exclusive.

Driving growth

In his book Sapiens: a Brief History of Humankind, Yuval Noah Harari devoted a whole chapter to how capitalism contributed to the modernisation and growth of the world’s economy. He wrote:

“Capitalism distinguishes ‘capital’ from mere ‘wealth’. Capital consists of money, goods, and resources that are invested in production. Wealth, on the other hand, is buried in the ground or wasted on unproductive activities.”

Capitalism is, hence, one of the driving forces of real economic growth over the last five centuries.

But free markets that are solely after profits can be detrimental to society. The slave trade, for example, was the product of free-market capitalism. Harrari wrote, “When growth becomes a supreme good, unrestricted by any other ethical considerations, it can easily lead to catastrophe.”

To prevent this, investors should focus on ethical investing, rather than simply chasing after profits. Investing responsibly can not only fuel economic growth but can also help drive innovation, promote good practices, and reverse climate change, among others.

Investors today are much more conscious of how they can do well while doing good. With that said, I have compiled a list of five ways investors can invest for the greater good.

1. Avoiding sin stocks

Tim Nash, the founder of Good Investing, describes negative screening as doing less evil. By avoiding sin stocks, capital allocators force companies to rethink their strategy and discourage entrepreneurs from moving into the controversial sector in the first place.

Each of us may have a different definition of sin stocks depending on our personal values. However, some commonly cited “sin stocks” include weapons, fossil fuels, and cigarette companies.

2. Investing in green technology

We can also actively invest in companies that are striving to make the world a better place.

Climate change is one of the biggest challenges of the world today. It is, therefore, no surprise that investors are now prioritising green technology more than ever. But the success of green technology can only be achieved if both investors and consumers are willing to back it.

Some examples of green technology include solar power, electric vehicles, water purification, and LED lights.

Thankfully, it seems that the world is moving in the right direction when it comes to green technology. In November 2019, the Singapore government announced that it will invest US$2 billion in funds that have a strong green focus.

3. Investing in necessities

In Singapore, we take clean water for granted. However, unsafe sanitation is still a massive problem in Africa. Unsanitary water contributes to more than 1,200 deaths of children under five years old per day.

The Bill & Melinda Gates Foundation has taken massive steps to alleviate the problem, through education and waste treatment technology.

Investors can contribute too. We can play our part by funneling our capital to companies that are helping to alleviate the sanitisation problem.

Besides water, investors can also consider supporting companies that champion basic human rights, promote education, enable sustainable farming, and others.

4. Innovative companies

Some companies are improving the lives of millions of people simply through innovative technologies.

Take Alphabet Inc, for example. The parent company of Google has increased its focus away from merely “organising information”. Today, the tech conglomerate has investments in healthcare and autonomous vehicles, and even provides the world with faster Internet access through fiber networks.

Many of us also probably also use some of Google’s other applications that make our lives much easier, like Google Maps, Gmail, Google Photos, and even Google Translate.

Alphabet is certainly not the only company making a difference to the world. Today, there are more tech companies than ever that are coming up with innovative solutions that are not only financially feasible but improving the lives of millions.

5. Healthcare

Another way we can invest for the greater good is by investing in healthcare companies. The pharmaceutical sector, for instance, is responsible for the innovation of numerous drugs that have saved the lives of millions.

However, pharmaceutical companies require bucketloads of cash to fund research and clinical trials.

While the biggest pharmaceutical companies are self-sustainable through the money earned from earlier blockbuster drugs, many are still in their infant stages. Such firms are desperately in need of capital.

Investors can help to fund research by investing in these companies. There is also the potential of profit should one of the pipeline drugs get commercialised.

Doing well while doing good

Contrary to popular belief, investing need not be solely for enriching yourself. By selectively investing in companies that are doing good for the world, we not only stand to profit but can also improve the world in the process.

My hope is that more investors use their capital not only as a means to enrich themselves but also for the greater good of the world.

REITs and The Power of Cheap Equity

REITs that have access to cheap equity are more likely to do well over the long term. Here’s why.

I’ve been studying real estate investment trusts (REITs) for some time. One thing that I noticed is that access to cheap equity is an often overlooked but powerful tool for REITs to grow.

“Cheap equity” is a REIT’s ability to raise money at a comparatively low cost.

The benefits of cheap equity

So how does cheap equity arise? First, the investing community needs to be bullish on a REIT. Usually, the REIT will exhibit some of the positive characteristics I tend to look for. The market realises the REIT’s potential and prices its units up. Such REITs end up being priced at a premium to its book value.

The high unit price of the REIT’s units creates an opportunity for it to raise money cheaply. Simply by issuing new units at this high price, the REIT is able to boost its book value per unit and its yield.

A prime example

Let’s consider a recent example. Mapletree Commercial Trust is a REIT that has been trading well above its book value for many years. In October 2019, the REIT decided to make use of its high unit price to raise cheap capital. It announced that it would raise around S$900 million to partially fund the acquisition of a property, Mapletree Business City (Phase2).

The new units were priced at S$2.24 each, well above Mapletree Commercial Trust’s book value per share of S$1.70 (as of October 2019). In addition, the REIT’s new units were issued at a low annualised yield of 4.1%.

There are two key advantages here. First, because the units were priced above book value, the equity fundraising will immediately increase the REIT’s book value per unit. Second, the funding exercise will be distribution per unit-accretive to shareholders as long as the new property purchased has an asset yield of more than 4.1% (or even less if you consider that part of the acquisition will be funded by debt).

A virtuous cycle

The ability to raise money cheapy creates a virtuous cycle for such highly regarded REITs.

Consider the case of Mapletree Commercial Trust:

Investors are bullish on Mapletree Commercial Trust’s prospects and attach a high valuation to it.
The REIT uses the opportunity afforded by its high unit price to issue new shares.
Backed by a strong sponsor, Mapletree Pte Ltd, and positive public sentiment, the REIT is able to raise new funds through an equity fundraising.
As the new units were issued at a high price, the fundraising is immediately-accretive to book value and distribution per unit.
Investors see the growth in DPU and book value per unit and become even more bullish on the REIT and the market pushes the price of the REIT higher. The REIT is now able to raise more capital cheaply.

This whole process creates a virtuous cycle that helps highly-regarded REITs keep on growing.

How investors can benefit

The lesson here is not to be put off by REITs that have relatively high unit prices. A REIT with a high unit price may not offer the best yield but it has the ability to grow much faster than its peers. Having said that, this is by no means a fool-proof scenario.

Investors will also need to pick the REITs that are best able (and willing) to make use of the opportunity afforded to the REIT through its high unit price. One of the key things to look out for is the REIT’s track record of raising equity and whether it has a sponsor with deep pockets.

The REITs that are sponsored by CapitaLand, Mapletree and Frasers have, historically, been some of the best REITs in Singapore’s stock market to own. These three sponsors have been willing to support their REITs through capital injections, even at high valuations.

Knowing this, shrewd investors who spot this trend can capitalise and ride the virtuous upcycle driving well-regarded REITs.

Why I Invested in Sasseur REIT

Sasseur REIT has been one of the top-performing REITs so far this year. Here is my thought process behind my decision to invest in it in March this year.

Sasseur REIT has been one of the top-performing Singapore-listed REITs this year, with a year-to-date return of more than 40%.

I invested in Sasseur REIT in March this year at a purchase price of 72 cents per share. Today, the stock trades at around 88 cents. In addition to the capital gain, I have also collected 4.9 Singapore cents in dividend (technically called a distribution but let’s not get nit-picky).

In this article, I will explain my investment thesis for Sasseur REIT and whether I think it is still worth a look at today.

Company description

Sasseur REIT owns four outlet malls in China. The REIT is sponsored by Sasseur Group, a privately-owned outlet mall operator that currently manages and operates nine outlet malls.

The China-based REIT was listed in Singapore on 28 March 2018. Since listing, Sasseur REIT has performed well above expectations. It beat its initial public offering forecast for seven consecutive quarters, both in terms of rental income and distribution to unitholders.

My 5-point framework

Over the years, I have built a five-point framework for investing in REITs. I try to invest in REITs that tick as many of the boxes as possible.

As a quick summary, the REITs I invest in should have (1) a good existing portfolio, (2) capable and honest management, (3) a safe capital structure, (4) a fair and responsible sponsor and (5) a decent valuation.

I will describe my investment thesis for Sasseur REIT using this REIT framework.

1. A good existing portfolio

In my view, Sasseur REIT has an excellent existing portfolio.

To understand the REIT’s portfolio better, we need to appreciate its unique mode of managing the four malls it owns. The REIT effectively outsources the management of the mall to a third party called the entrusted manager.

Favourable entrusted manager agreement

The entrusted manager is responsible for maximising the rental income of the assets. It collects the rent and pays Sasseur REIT an entrusted manager agreement rental income.

This comprises a fixed and a variable component.

There are a few things to like about this arrangement. First, the fixed component ensures a baseline level of rental income that is more or less guaranteed every year. The fixed component will also rise each year.

Second, the variable component gives Sasseur REIT the opportunity to participate in the upside, should tenant sales rise.

Increasing tenant sales

There are a few reasons to believe that tenant sales will increase in the long run. For one, total VIP members (a membership program to reward high-spending customers) have jumped a staggering 70% from the end of 2018 to 30 September 2019. Second, two of the REIT’s malls are still relatively new and should attract more shoppers as they mature.

There are also macro-economic tailwinds. China’s GDP is expected to grow by more than 6% in 2019 and 2020. The GDP growth, in turn, is expected to fuel a rise in the middle-income population in China, which will drive demand for discounted branded goods.

Sasseur REIT’s four malls demonstrated impressive growth in 2019. In total, the four malls generated a 20.9% growth in tenant sales in the first three quarters of 2019.

Positive portfolio characteristics

The occupancy rate at Sasseur REIT’s malls is also very high, averaging at 95.4%. This is a sign that the REIT is able to attract tenants to its malls.

The REIT has deliberately short tenant leases, which give the managers more flexibility to improve the tenant mix and to increase rent in the future.

Potential downsides

There are, however, two downsides to Sasseur REIT’s existing portfolio. First, its four malls are leasehold. The tenures range from 27 to 35 years. Second, the REIT owns only four malls so there is an element of concentration risk. Nevertheless, I think its current portfolio still possesses more pros than cons.

2. A capable and honest management

Sasseur REIT has a relatively short track record as a listed REIT. Despite its short history, I think the way the managers are incentivised gives me confidence that they have minority shareholders at heart.

First, the entrusted manager has shown a good track record of growing the portfolio’s tenant sales. In addition, resultant rent, and consequently distribution per unit, have beaten expectations each and every quarter since the REIT’s listing. I am more inclined to trust managers that underpromise and overdeliver.

Additionally, both the REIT manager and the entrusted manager have incentives that are aligned with shareholders’ interest.

The entrusted manager is paid a base fee that is calculated as the lower of (1) 30% of gross revenue or (2) gross revenue minus EMA Resultant rent (what is paid to Sasseur REIT).

In essence, the entrusted manager is entitled to the leftover of gross revenue after paying what it owes to Sasseur REIT. However, this amount is capped at 30% of gross revenue. If there is left-over after the base fee and EMA resultant rent is paid to Sasseur REIT, the entrusted manager is then entitled to 60% of the leftover amount as a performance bonus.

From the way the entrusted manager is incentivised, it is clear that it is in the entrusted manager’s interest to try to grow gross revenue for the REIT, which is ultimately also beneficial to the REIT unitholders.

The REIT managers also have a base fee and a performance fee. The REIT managers are only entitled to the performance fee if it achieves distribution per unit (DPU) growth over the previous financial year.

3. A safe capital structure that can be optimised

Sasseur REIT has a gearing ratio of 29.0%, well below the regulatory ceiling of 45%. This gives it the debt headroom to take more loans to invest in new properties.

The REIT’s cost of debt is also manageable at 4.43% (reasonable by China standards). The relatively low interest rates give it an interest coverage of 4.8 times.

I also take heart in the fact that the manager has emphasised that they are going to be using the REIT’s financial muscle prudently. The manager will only look at yield-accretive acquisitions that can benefit unitholders over the long-term.

4. A fair and responsible sponsor

As a first-time REIT sponsor, investors don’t have much information to judge Sasseur Limited.

However, the sponsor has not interfered much in the way that Sasseur REIT has been run. It has not shown that it will treat minority shareholders unfairly.

On top of that, the sponsor also has a lineup of right-of-first-refusal properties in its portfolio that Sasseur REIT can tap on for future acquisitions.

As one of the largest outlet mall operators in China, it also boasts the experience and know-how that Sasseur REIT can use as it seeks to expand its portfolio in the future.

Based on and despite the limited information I have, I am fairly satisfied with the sponsor.

5. A decent valuation

Valuation is the final aspect to consider. Sasseur REIT has seen its share price soar over the past 12 months. It currently sports an annualised distribution yield of 7.4%.

When I bought it earlier this year, the REIT had a yield of 9.8%. Based on the lower yield today, the REIT seems expensive now.

But investors should note that at the time of writing, REITs in Singapore have an average yield of around 6%. This makes Sasseur REIT’s current 7.4% yield look comparatively cheap. As such, it may be that Sasseur REIT was trading at an unfairly low valuation earlier this year, rather than an overly rich price today.

The Good Investors’ Conclusion

Despite the recent run-up in price, Sasseur REIT still looks like an attractive stock to hold. The REIT ticks many of the right boxes and seems primed to continue increasing its distribution per unit.

There are risks to note. The REIT has high concentration risk, currency risk and is highly dependent on economic tailwinds. But despite these risks, I think the REIT’s positive traits and growth potential still give me an excellent risk-reward profile.

Why It’s So Hard To Be a Contrarian Investor

Being greedy when others are fearful is easier said than done. Most investors may say they would do it but few actually practice it.

In the last downturn, how many of us actually had the courage to buy stocks when everyone else was selling? So why is it so hard to act against the grain?

Fundamentals change too

When we think of market downturns, we usually imagine a world where nothing changes except for stock valuations. The reality, however, is nothing like that. Morgan Housel from the Collaborative Fund explains:

“The reason you may embrace ideas and goals you once thought unthinkable during a downturn is because more changes during downturns than just asset prices.”

Take 2008 for example. Stock prices fell hard, but not without reason. The subprime mortgage crisis in the United States developed into a full-blown international banking crisis. Previously sound banks failed, companies went broke and consumer spending plunged.

These are fundamental changes that caused a decline in company earnings, huge layoffs and reduced consumer wealth.

In such times, it is easy to see why investor confidence was sapped.

People need positive reinforcement

Even when we do think differently from the crowd, most of us are not able to act on it. People require positive reinforcement to take action.

For instance, when we are bullish on a stock, we need encouragement from external sources. We seek out positive reinforcement in the mode of brokers’ opinions, analysts reports, or even friend’s approval.

However, in a time when everyone is fearful, positive reinforcement is hard to come by.

Fear is hard to ignore

Emotions also play a huge part in our investment decisions. When we start investing, we often tell ourselves to ignore emotions and to focus on facts. But, unfortunately, it is extremely difficult to tune out emotions completely.

In his book The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy, investor James Montier said, “It turns out there are numerous human traits that push us toward conformity and away from individual thinking.”

He explains that neuroscientists have found that when individuals take the road-less-travelled, they experience fear. Fear is there for a reason. It is a defense mechanism that is built to protect us. Acting against our fears, is thus, innately difficult.

As such, it is no wonder that fear plays a big part in our investing decisions. When the stock market is raging, investors have a fear of missing out (FOMO), while the fear of losing money makes people sell in a bear market.

Contrarian Thinking

“ …don’t be led astray by Wall Street’s fashions, illusions and its constant chase after the fast dollar. Let me emphasize that it does not take genius to be a successful value analyst, what it needs is, first, reasonably good intelligence; second, sound principles of operation; and third, and most important, firmness of character.”
Benjamin Graham

It is not difficult to see why contrarian investing is so challenging. If it were easy, it wouldn’t be called “contrarian” in the first place. But on the other end of the spectrum, simply being contrarian for the sake of it, is also extremely detrimental. We need to seek the right balance.

For us to be a successful contrarian investor, we need three key characteristics: The ability to digest and analyst facts; individual thinking; and the courage to overcome fear. If you master these three traits, you will likely reap the rewards in the future.

Should You Invest With Robo Advisors?

Robo advisors have grown in popularity in recent years. But before hopping on the bandwagon, here are some things to note about them.

With the improvement in artificial intelligence, it was only a matter of time before robots started managing money. Today, robo advisors are becoming commonplace among retail investors. Even traditional banks such as DBS are beginning to embrace the power of artificial intelligence as a wealth management platform.

But should you trust a “robot” to manage your hard-earned money? With that in mind, I map some of the advantages and downsides of using a robot-assisted wealth management tool.

What really are robo advisors?

Robo advisors are digital platforms that personalise the investor’s portfolio using an algorithmic-driven approach with little human supervision.

The process is really quite simple. Investors register for an account on the robo advisor’s platform. They then answer a few questions that help the robo advisor understand the individual’s financial goals and risk tolerance.

Using an algorithm, the robo advisor then advises the clients on a suitable portfolio for them.

Usually, robo advisors have a fixed list of Exchange Traded Funds (ETFs) or funds that it can choose from to build the client’s portfolio. These funds, in turn, invest in a variety of assets, such as stocks, bonds, or real estate. One thing to note, these funds are actually mostly managed by humans! So robo advisors simply help to allocate your wealth to the funds that it thinks suits your needs and goals.

What are the fees involved?

Robo advisors usually charge just a basic annual advisory fee that is a small percentage of the total assets under management.

For instance, Morgan Stanley’s Access Investing charges a fee of 0.35% per annum, while DBS digiPortfolio charges an annual fee of between 0.75% and 0.85%.

But to be clear, this does not include the fees related to owning shares of mutual funds and exchange-traded funds. I will explain more on this later.

The table below shows the fees charged by the prominent robo advisors in Singapore.

Why invest with robo advisors?

The beauty of robo advisors is that it removes emotional misjudgments and other possible conflicts of interest from the decision-making process.

The robo advisors use a methodological process that is immune to emotion and is not influenced by commission-related fees.

They are also really simple to use. The set up is usually a seamless process and the minimum outlay to invest can be fairly small.

They also offer regular statements that will give investors up-to-date information on how their investments are performing and keep track of all additional cash flows.

In addition, robo advisors can automate the rebalancing of the portfolio for the client. This removes the hassle of actively managing your portfolio and reallocating it manually every few quarters. Importantly, there is also no additional transaction cost for rebalancing, unlike a do-it-yourself portfolio.

Potential pain points

But as with any product, there are also things not to like about robo advisors.

Robo advisors only offer a few different fixed portfolios. It is not possible to deviate from these fixed portfolios. After answering a few questions, the robo advisor will recommend one of the fixed portfolios that they have built. Investors cannot deviate from these fixed portfolios and are not able to access funds that are not offered on the platform.

On top of that, the robo advisor’s advisory fee is an additional cost. As mentioned earlier, investors have to pay the advisory fee, on top of the total expense ratio of the funds that they invest in through the robo advisor.

Although the robo advisory fee is usually less than a percentage point, it quickly adds up over the years.

Is it right for you?

Ultimately, the fewer potential conflicts of interest and the fee-based structures make robo advisors a robust wealth management tool that has the client’s interest at the forefront.

However, they still have their limitations. If you want a more personalised portfolio, the limited number of portfolio constructions in a robo advisor platform may not be sufficient.

Many of the robo advisors also only offer ETFs on their platform. As a result, it may not be useful for investors who want exposure to more aggressively-managed active funds, which have the potential for higher returns.

All things considered, I believe investors who want a simple stress-free passive investment strategy can consider using robo advisors. More savvy investors who are willing to do some research on funds should have a more hands-on approach to save costs and gain access to better-performing funds in the market.

Why I Invest Only in Stocks

Most Financial advisors prescribe diversifying into multiple asset classes. However, I invest solely in stocks. Here’s why.

Professional financial advisors prescribe diversifying one’s investment portfolio across multiple asset classes. This means spreading your investments into each of the four major asset classes- stocks, bonds, real estate, and commodities. In theory, this helps to smoothen returns and reduces the “risk” in the portfolio.

So having a portfolio that is composed entirely of stocks is unconventional, to say the least. However, before you close this article and call me a nut job, let me explain the reasoning behind my asset-allocation strategy.

Stocks: the best-performing asset class

Stocks are unlike any asset class. Eddy Elfenbein, portfolio manager of the AdvisorShares Focused Equity ETF, explains in his blog:

“All other assets are things. They just sit there. If you buy some gold and leave it alone, in 50 years it will still be there, just sitting there. There are income-producing assets like bonds and real estate, which makes them a little better than commodities. But still, they’re just things. They can neither think nor create.

Equity, on the other hand, is wholly different. It’s a legal entity by which people can come together and employ said assets to make goods and services for people… The business works to make a profit, and it keeps investing those profits in the business to make still more profits.”

When you invest in stocks, you are really investing in the power of human ingenuity.

It is, therefore, not surprising to note that over the long term, stocks are by far the top-performing asset class. In fact, according to data from the University of Chicago, in the 100 years from 1915 to 2014, stocks had an average real return (after removing inflation) of 8.3% per year, while bonds returned just 1.1% per year. A $1000 investment in bonds in 1915 would have a “real worth” of $2,992 in 2014, while $1000 invested in stocks would have been worth $2,301,134.

Other studies also consistently show that over the long-term stocks always come up on top, followed by bonds, real estate, and commodities.

The power of time

But performance alone is not the only reason to invest solely in stocks. I also need to be able to ride out the inevitable market swings in the stock market. Thankfully, I have time on my side. As a young investor, I have the holding power to see out the downturns of the market. I do not foresee needing the money from my investments anytime soon, nor do I depend on cash flow from my investments.

On top of that, my investment objective is really to grow my retirement fund as fast as possible, rather than simply preserving wealth. This makes stocks the ideal investment asset for me.

I can also still be sufficiently-diversified even if I solely invest in stocks. Investing in a range of different companies that operate in different geographies and sectors help to diversify my risk. I can even gain exposure to real estate, by investing in real estate investment trusts (REITs), which are also traded on stock markets.

Building your portfolio

Legendary investor, Peter Lynch, once said, “Gentlemen who prefer bonds don’t know what they’re missing.”

If you are a young investor and have a long investment horizon like I do, having a more aggressive investment portfolio might be the right way to go. However, investing solely in stocks does come with caveats. Investors need to be able to stomach inevitable market swings and steep drawdowns. Having a disciplined long-term approach and sticking to your principles is key to success in the market.

Over the long-term, I take heart that despite the volatile nature of stocks, if history is anything to go by, my stock-heavy portfolio will likely provide better returns than if I diversify across multiple other asset classes.

Can Factor-Based Investing Outperform The Market?

Factor-based investing is an approach that involves investing in stocks that exhibit a few or just one particular characteristic.

These characteristics could be value, quality, or size “factors” to name a few. For example, an investment approach based on the value factor will involve investing in stocks that trade at a relative discount to their peers, be it on a low price-to-earnings (PE) or price-to-book (PB) ratio.

Does factor-investing work?

The idea behind factor-based investing is that the factors that shape the investing approach should be highly correlated with positive investment returns. For instance, back-testing has shown that stocks that exhibit a low PE ratio have over the long-run outperformed the broader market.

Therefore, exposing your portfolio to stocks that exhibit these characteristics will, in theory, reward you over time.

Sieving the wheat from the chaff

But not all factor-based investing works. Choosing the right factor to invest in plays a huge part in your success.

Andrew Ang, BlackRock’s head of Factor Investing Strategies, explained in a recent article that investors need to be able to distinguish between factors that are simply “passing fads” and those that are “fundamentally-based.” He explained two criteria he uses to make the distinction:

Economic rationale

The factor should have an economic rationale for its return premium. In the world of Big data, it is easy to find coincidental correlations between a factor and returns. However, many of these correlations are due to chance.

By focusing on factors that have economic rationale which drives their outperformance, we can be certain that there is a legitimate and very real reason behind the correlation between performance and the factor.

Decades of data

For the retail investor, it is difficult to gather enough information to backtest a particular factor over decades or even longer. However, funds with access to big data, are able to use the information to see if a factor has a long-term correlation with performance.

Using factor-based investing

If you are thinking of using a factor-based approach for your investment portfolio, there are a few things to take note of.

First, define your investment goal and identify factors that can help you achieve your goals.

Second, not all stocks that exhibit a particular factor will produce similar returns. The correlation between factors and returns is based on a large amount of data comprising thousands of companies. As such, your portfolio needs to be heavily diversified in many companies that exhibit that factor.

Combining factors into a solid investing framework

There is good evidence that factor-based investing has worked well in the past.

However, investors need to identify the factors that are the most correlated with positive returns. It may also be useful to combine certain “style” factors together into a more robust investment framework. An investment framework can help you focus your portfolio on stocks that are even more likely to do well over the long-term.

Timeless Investing Lessons From UK’s Best-Performing Fund

Established in 2010, Fundsmith is the largest mutual fund in the United Kingdom with £18bn assets under management.

Led by its founder, Terry Smith, the fund has more than doubled the market since its inception nine years ago. Investors who invested with Fundsmith from the get-go have earned a total return of 353.2%, or an annualised return of 18.3%, as of 31 October 2019. Comparatively, global equities in general “only” returned a cumulative total of 171.1% over the same time frame, or 11.7% annualised.

Its impressive performance makes FundSmith the number one performing fund in the UK. From its inception to the end of 2018, Fundsmith had a cumulative margin of 13% over the second-best fund and 188% over the average for the sector, which delivered a market-lagging 81.9% cumulative return.

Although I am not invested in the fund, I am extremely impressed by the way Fundsmith is managed. Terry Smith’s annual letter to shareholders is also filled with insightful comments and timeless lessons that we can apply in our own investing. With that, here are some of the key takeaways from Fund Smith’s latest annual report.

Stop trying to time the market!

We are all too familiar with market commentators warning of an impending bear market. Smith says:

“I can now trace back six years of market commentary that has warned that shares of the sort we invest in, our strategy and our Fund would underperform.

During that time the Fund has risen in value by over 185%. The fact that you would have forgone this gain if you had followed their advice will, of course, be forgotten by them if, or when, their predictions pay off for a period. I suggest you don’t forget it.”

Legendary investor Peter Lynch once said that “far more money has been lost by investors preparing for corrections than has been lost in corrections themselves.”

If you find yourself worried that the bull market has run its course, it will be wise to remember these words of advice.

Growth versus Value

Fundsmith’s investment strategy involves buying and holding fast-growing companies. This strategy has outperformed value investing over the last decade. However, with growth stocks reaching rich valuations, some market commentators believe that value investing may come back in favour.

In his annual shareholder letter, Smith outlines two main handicaps he sees in the value investing strategy:

“One is that whilst the value investor waits for the event(s) which will crystallise a rise in the share price to the intrinsic value that has been identified, the company is unlikely to be compounding in value in the same way as the stocks we seek. In fact, it is quite likely to be destroying value.

Moreover, it is a much more active strategy. Even when the value investor succeeds in reaping gains from a rise in the share price to reflect the intrinsic value he identified, he or she needs to find a replacement value stock, and as events of the past few years have demonstrated, this is far from easy. Moreover, this activity has a transaction cost.”

Let time work its magic

FundSmith has a simple three-step investment strategy: (1) Buy good companies, (2) Don’t overpay, and (3) Do nothing.

While some actively managed fund managers may scoff at the idea of the third point, it is actually one of the key reasons why Fundsmith has done so well since its inception. Smith explains:

“Minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 13.4% during the period. This is the highest level of annual turnover which we have undertaken to date, but it is still tiny in comparison with most funds.”

He adds:

“Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor.”

The low portfolio turnover ratio resulted in FundSmith having by far the lowest transaction costs among the 15 largest active equity funds in the UK.

In fact, Smith attached a table of the returns of the 15 funds over a 3-year and 5-year period and compared them to their transaction costs. There was, unsurprisingly, a strong correlation between funds with lower transaction costs and higher returns (With FundSmith sitting at the top of the pile).

Final Thoughts

Terry Smith has become one of the most successful fund managers of his generation. He has even been compared to the legendary Warren Buffett. From his investing principles above, it is easy to see why Smith has found so much success in an industry that has traditionally underperformed low-cost index funds. His guiding investment principals can also help retail investors invest better. If you want to read more of Terry Smith’s letters to shareholders, you can head here.